Introduction
Most payroll compliance discussions focus on penalties for late remittances — a straightforward financial consequence. What is less commonly understood by incorporated contractors is the legal mechanism that underlies those penalties: the deemed trust.
Understanding the deemed trust is not academic. It explains why unremitted source deductions are one of the most serious CRA compliance risks a construction company can face — more serious, in certain respects, than unpaid income tax.
What Is a Deemed Trust?
Under subsection 227(4) of the Income Tax Act, when an employer withholds source deductions from an employee's pay — income tax, CPP, and EI — those withheld amounts are deemed to be held in trust for the Crown. They are the property of the federal government from the moment of withholding, not the property of the employer.
This deemed trust applies regardless of whether the amounts are actually segregated in a separate account or commingled with general operating cash. The legal characterisation arises automatically by statute — not by any action of the employer.
The employer's portion of CPP and EI contributions is similarly subject to deemed trust treatment once the pay date has passed.
Priority Over Other Creditors
The most significant practical consequence of the deemed trust is its priority in insolvency. Under the Income Tax Act and the Bankruptcy and Insolvency Act, the deemed trust for unremitted source deductions has super-priority — it ranks ahead of secured creditors, including banks with registered security interests in the company's assets.
This means that if a construction company becomes insolvent with unremitted source deductions outstanding, those amounts are the first call on the company's assets — before the bank's mortgage or equipment financing, before trade creditors, before everything else.
For lenders who understand this, it is a significant risk factor in construction lending. For business owners, it means that using withheld employee money to fund operations — even temporarily, with the intention of catching up — is not a manageable cash flow manoeuvre. It is borrowing from the Crown at effectively infinite priority.
Directors' Personal Liability
As discussed in Article 7, directors of a corporation are personally liable for unremitted source deductions if the corporation fails to pay them. The deemed trust status of these amounts means the CRA has a strong legal foundation for pursuing director liability — the argument is not merely that the director failed to ensure a debt was paid, but that the corporation misused property that was never legally the corporation's to begin with.
In construction companies where the owner is the sole director, this translates directly to personal liability for unremitted payroll amounts — potentially affecting personal assets, including the owner's home, in extreme cases.
The Due Diligence Defence
A director can avoid personal liability for unremitted source deductions if they exercised due diligence to prevent the failure to remit. The due diligence defence requires that the director took concrete, positive steps to ensure remittances were made — not merely that they were unaware of the problem.
In practice, this means actively monitoring the corporation's payroll remittance status, ensuring the accounting or bookkeeping function is tracking remittance dates, and taking action when remittances are at risk. A director who simply delegated payroll responsibility without any oversight and claims ignorance of the missed remittances typically does not meet the due diligence standard.
What to Do If Remittances Are Already Behind
If a construction company is behind on payroll remittances, the appropriate steps are:
Contact a CPA and potentially a tax lawyer immediately. Do not delay.
Contact the CRA proactively. The CRA has payment arrangement options for taxpayers who engage constructively before enforcement action begins.
Do not use the withheld amounts for other purposes in the interim. This compounds the liability and undermines any due diligence defence.
When to Speak With a CPA
For contractors who have experienced cash flow pressure that has affected payroll remittance timing, a CPA review of the remittance position — and a proactive conversation with the CRA if amounts are outstanding — is the right first step. Early intervention is significantly less costly than waiting for enforcement action.