Tragedy of the Commons – Bankruptcy, Insolvency, and Tax Debt
As the world enters 2023, there are certainly worries of impending recessions. In the face of economic crisis, bankruptcies and insolvencies are to be expected, but Canadian taxpayers ought to be wary of certain tax obligations and actions which survive bankruptcies.
Under sections 222 and 223 of the Income Tax Act (the ITA), the Canada Revenue Agency (CRA) has broad powers to collect a taxable debt from a taxpayer. A general overview of these powers can be found in our blog post here.
These powers (often referred to as “legal actions”) can have profoundly detrimental impacts on taxpayers, from collecting portions of a taxpayer’s wages from their employer(s), to issuing liens and forcing sales of property. In an attempt to secure tax claims, these legal actions severely cripple the taxpayer’s ability to produce income and pay off their debt, which only worsens with the daily compounding interest.
For the purposes of this article, we’ll focus on the Tax Lien and Bankruptcy.
What is a Tax Lien?
A Lien is a way for creditors to secure the debt that is owed in the debtor’s property. Notably, this differs from a Writ or Memorial, which go beyond securing claims and can permit the seizure and forcible sale of property. A Tax Lien refers to the CRA registering a Lien (through a certificate at the Federal Court) on a taxpayer’s property for an amount of tax owing.
In a simple arrangement, once the debtor’s property is sold, the proceeds from the disposition automatically get distributed to the Lien holding creditor (in this case the CRA) up to the amount of the Lien. After the debtor’s obligations to that creditor is satisfied, any remaining proceeds will return to the debtor and the Lien and debt are discharged.
This certainly can become more complicated, such as when there are other creditors or debt obligations involved.
What happens if I declare a bankruptcy?
There are several rules to adhere to when declaring bankruptcy, which mainly flow from the Bankruptcy and Insolvency Act (the BIA). Although some debts, including certain tax obligations, may be removed upon declaring bankruptcy, other obligations persist.
Under the ITA, for example, section 128 ends the taxation year of a taxpayer at the date of bankruptcy, and immediately commences a new year. Moreover, a personal bankruptcy prevents interest from accruing on tax debts.
Unfortunately, if a Tax Lien that is properly registered before the date that the bankruptcy is declared, it will survive the bankruptcy under sections 86 and 87 of the BIA.
Moreover, even if your personal tax debt stops accruing interest, the interest on the Tax Lien itself may still accrue after the date of bankruptcy.
What else can I do?
A Consumer Proposal is a popular alternative to filing for bankruptcy and insolvency. Notably, consumer proposals can include tax debt to the CRA and may even prevent the CRA from taking certain legal actions.
We at R&A Tax Law are dedicated to providing effective legal services to meet your needs. If you have an issue with Tax Debt and are considering bankruptcy or consumer proposals, Contact Us today!
This article provides information of a general nature only. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in the articles. If you have specific legal questions, you should consult a lawyer.