Income Taxes and Bankruptcy – Beware the Sleeping Bear

Posted in Personal Bankruptcy
Posted by Ian Martin, CPA, CA, CIRP - LIT

income-tax-bankruptcyThe mandate of the Canada Revenue Agency (CRA) is to assess and collect the correct amount of tax for individuals and businesses in Canada.  My colleague Bill Kilner blogged last week about how it’s easy to ignore your taxes after you start to fall behind.  I want to expand a little bit on why it’s important to deal with your tax debts.

I like to think of the CRA as a big sleepy bear.  When he’s hibernating for a long time, it’s easy to forget that he is there.  When he wakes up and flashes those razor sharp claws, you start to appreciate just how dangerous he can be.  Furthermore, he’s not going to give up chasing you once he gets your scent.

Compared to an average creditor, the tax man has super powers to help collect money owing to him.  The CRA can freeze your bank account or garnishee your wages with just the signature from the director of your local tax office.  A bank or credit card company has to go through a lengthy court process to able to do the same thing.  I’m not here to argue whether it’s fair or right.  It is what it is.

What else can the tax man do?  If you have a business and the CRA knows who your major customers are, they can send a notice to those customers directing them to pay to them (to CRA, not you) the money your customers were to pay to you for the work you have done.  Again, no court order required.

There’s more.  If you have a house, the CRA can register a lien against the property.  No consent required by you.  No court order required.  Think of it as a second mortgage where the tax man is dictating the repayment terms.

Obviously, the best way to avoid these nasty consequences is to pay the debt.  Just like any creditor, the CRA has collectors with whom you can negotiate a payment plan.  However, the CRA is typically unwilling to accept less than the full amount owing.

So, what do you do if a repayment plan just isn’t realistic?  There’s a common misconception that tax debts are not included in personal bankruptcy.   There are some special considerations that I will discuss in a moment, but the general rule is that the tax man gets treated the same as any other creditor if you file for personal bankruptcy.

I want to make something absolutely clear.  In no way do I advocate bankruptcy as a way of “getting out of paying” your tax debts, or any other debt.  Bankruptcy is a legal process available to Canadians to get a fresh start from their debts (tax and non-tax) when there is no reasonable expectation of being able to pay those debts in full.

The goal in bankruptcy is not to file for bankruptcy, the goal is to be discharged from bankruptcy.  It is not until you are discharged, that the debts are legally released.  In most situations, as long as you fulfill various financial and non-financial duties, you are eligible to receive your discharge without a requirement to go to court.  This is called an automatic order of discharge and is granted by the trustee.

One of the “special considerations” is that you are not eligible for an automatic discharge if your personal tax debts are greater than $200,000 and represents more than 75% of your total unsecured debts.  This is one of the many changes to bankruptcy law in September 2009.  That means going to court and having a judge (called a registrar in bankruptcy court) deciding what conditions you have to meet to be discharged.  It could involve paying back a portion of the debt.  It could mean a time delay before you can be discharged.  It could mean that the refuses to grant a discharge altogether, but that would be in extraordinary circumstances.

Another “special consideration” is if the CRA has registered a lien against your house.  Bankruptcy deals with the unsecured debts.  Registering a lien makes the taxes a secured debt.  If this has happened and you want to keep your house, you should be talking to the CRA about payment arrangements.  Filing for personal bankruptcy will not remove the lien.

If you have a business, your debts with the CRA might not be limited to income taxes.  You might also have debts for unremitted GST/HST or payroll deductions.  These are debts that are included in bankruptcy, but there are considerations that go behind the scope of an article like this.  My advice is to contact us so that we can go over your circumstances in detail.