IRD deduction notices and priority issues

The IRD appears to be issuing "deduction notices" more frequently to recover overdue tax under the under the Income Tax Act and the Goods and Services Tax Act. When these notices are issued, priority issues may arise between the IRD and secured parties of the debtor.

The IRD may serve a deduction notice on the clients of a taxpayer who fails to pay GST or PAYE. Under the deduction notice, the client, usually a company, is required to pay any amounts which were otherwise due to the taxpayer direct to the IRD.

Deduction notices have the potential to place third parties in a difficult position as they may have conflicting demands for payment. The debtor taxpayer may have granted a security interest over accounts receivables and secured creditors could also be demanding payment of the amounts due to the taxpayer from third parties.

Unless the taxpayer is in liquidation, or the secured creditor has appointed a receiver to recover accounts receivables, the secured creditor will most likely have priority over the IRD on amounts due to be paid to the taxpayer. If that is the case, a deduction notice would be of no effect because the funds in question are due to the secured creditor, they are not "payable" to the debtor taxpayer.

The difficulty secured creditors may face in these circumstances is that deduction notices carry with them the threat of prosecution if the IRD's demands are not complied with. Faced with this threat, clients of the taxpayer could well decide to pay the IRD, even though the secured creditor may have priority to the payment.

Where a company has been placed into liquidation, or where the secured creditor has appointed a receiver, it is likely that the IRD has priority to the amounts owed by clients to a debtor taxpayer. The concern for the IRD is that, despite the fact that it may have issued a deduction notice, the significance of the company having been placed into liquidation or receivership may not be appreciated by the taxpayer's client. If the client pays the secured creditor as a result, the IRD may be forced to issue proceedings to recover the payment.

Given the potentially difficult priority issues which arise, we recommend legal advice be obtained whenever a deduction notice is issued.