Is Bankruptcy the answer to your tax debt?

Few things strike fear in a person’s heart like tax debt. There’s a long-held belief that you can’t fight the government, so most people resign to not even bother. Instead they suffer under the weight of high interest rates and penalties — often in silence and often for years — hoping maybe they’ll pay it off one day.  

Fortunately, the outlook is rarely as bleak as most people imagine. It is possible to overcome tax debt. In fact, debtors can include most tax debts in a Bankruptcy and often be free of those debts when they receive their discharge. 

With that said, every situation is different. So, to help you understand how this process might work for your unique situation, below are a few factors to consider.

A creditor like any other

Like many things, the common knowledge that you can’t escape your tax debt is rooted in a historic truth. The Canada Revenue Agency (CRA) was a preferred creditor under the Bankruptcy and Insolvency Act (BIA) until 1992And it was common for it to use that status against debtors.

In situations where a bankrupt individual owed substantial personal income tax arrears, the CRA would often oppose their discharge and request the courts make it conditional on payment of all or part of the tax debt. 

However, the CRA has ranked as an ordinary unsecured creditor under the BIA since 1992. That means it can no longer petition the courts for preferential debt repayment. And, in most cases, once a bankrupt individual receives their discharge, they will be free of any tax debts they owed when they began the process.

Some exceptions

Unfortunately, not every person who includes income tax debt in a bankruptcy will receive an automatic discharge once they have fulfilled their statutory duties. There is one notable exception to be aware of.

High-tax debtors — whose tax arrears exceed $200,000 (including principal, penalties and interest) and represent 75 percent or more of their proven debts — face a slightly more complicated process. These individuals will not qualify for an automatic discharge from their Bankruptcy and must attend a special hearing.

At this hearing, the courts have a wide range of powers, including the ability to:

  1. Grant an absolute order of discharge
  2. Impose a conditional order of discharge (e.g. repay a portion of the outstanding taxes, attend additional financial counselling sessions, etc.)
  3. Suspend the discharge for specified timeframe
  4. Suspend the discharge and attach concurrent or consecutive conditions
  5. Adjourn the hearing to a future date
  6. Refuse the discharge altogether

Deciding on conditions

If the Court decides to issue a conditional order of discharge, it will often be contingent on the bankrupt individual paying a fair and reasonable amount toward their outstanding debts. The courts will consider several factors in deciding how much of the bankrupt’s income meets that criteria, including:

  1. Causes of the bankruptcy
  2. The bankrupt’s personal and family situation — both at the time of the bankruptcy and the court hearing
  3. Nature of the bankrupt’s creditors (i.e. unsecured, secured, preferred)
  4. Amount owing to each creditor
  5. Total amount owing to all creditors
  6. Whether a Consumer Proposal could have been a viable alternative to Bankruptcy
  7. Prior history of Bankruptcy or Consumer Proposals
  8. The bankrupt’s tax compliance history, both pre- and post- bankruptcy.

Determining tax compliance

There are two key factors the courts will use to evaluate a bankrupt individual’s tax compliance before and since they filed for bankruptcy:

  1. Did they file all personal income tax returns as required under the Income Tax Act?
  2. Have they paid (or made an effort to pay) the assessed income tax debt?

Additionally — even though these fall outside of the scope of income tax debt — the Court may also look at any outstanding GST / HST liability and whether the bankrupt has made similar efforts to file and pay these returns as required.

How this works in practice

Courts take an extremely contextual approach to high-tax debtors. The case law contains numerous examples highlighting the different circumstances and potential outcomes. To see how these can vary from person to person, consider the following two examples:

Leaning toward leniency — In one case, the courts determined repaying 10 percent of the income tax principal would strike the fairest possible balance between the bankrupt’s need for a fresh start and his responsibility to contribute to society.

Protecting the integrity of the Bankruptcy process — In another case, the courts considered an individual’s two previous bankruptcies as an affront to the spirit of the law. It ordered him to pay the entirety of their outstanding tax debt, less penalties and interest.

Finding the right option for you

Income tax debt can feel overwhelming. But it doesn’t have to be. An MNP Licensed Insolvency Trustee (LIT) can help you find effective solutions to help you overcome it for good.

A Life-Changing Debt Solution such as a Bankruptcy or a Consumer Proposal not only addresses your debt head on, it also puts a halt to creditor action such as court judgements and wage garnishments so you can focus on rebuilding your finances.

An LIT will be there every step of the way, from the first meeting to the day you receive your discharge. They can help you understand the process, benefits and drawbacks of each — and help you make an informed decision to minimize your costs, reduce potential complications and deliver the most fair and positive resolution possible. And they

It’s time to defeat your debt and start a new chapter. Reach out for a no obligation Free Confidential Consultation today and find out what options might work best for you.

Based out of Toronto and Markham, Mary Plahouras is a Senior Estate Manager at MNP LTD. To learn more about how MNP Debt can help, contact our local office at 416.515.3921 or toll-free at 310.DEBT (310.3328).