The process of declaring bankruptcy is an emotional journey, especially for small business owners. In light of the discontinuation of pandemic aid for businesses from the Canadian government, many businesses are battling to regain their footing, and bankruptcy cases are on the rise. If you’re considering bankruptcy as a Canadian small business owner, it’s crucial to understand the tax implications, as they can significantly affect your financial status and future tax responsibilities.
Business Structures and Bankruptcy
The type of business structure you operate under in Canada determines the tax implications when filing for bankruptcy. The business structures include sole proprietorship, partnership, and corporation.
- Sole Proprietorship: The bankruptcy process for a sole proprietorship mirrors that of personal bankruptcy, as the Canada Revenue Agency (CRA) views you and your business as a single entity. Despite the bankruptcy, the business operations may continue.
- Partnerships: In a partnership, if one partner declares personal bankruptcy, the partnership ceases to exist. However, if there are multiple partners and one declares bankruptcy, the partnership may continue, but the bankrupt partner will face the same implications as personal bankruptcy.
- Corporations: Since a corporation is a separate legal entity, its board of directors needs to authorize bankruptcy filing. Typically, if a corporation cannot settle all its debts, it ultimately dissolves.
In Canada, a Licensed Insolvency Trustee (LIT) is a regulated professional who can guide you through the bankruptcy process, providing advice tailored to your unique situation.
Discharge of Tax Debt
When either an individual or a business declares bankruptcy in Canada, the CRA is promptly informed. The tax debts owed to the CRA or provincial tax authorities at the time of filing are generally included in the bankruptcy process, which means the tax debts are usually discharged or forgiven. However, should the business incur taxable income after your discharge from bankruptcy, you are still liable for it.
In some instances, if the tax attributes of a bankrupt corporation are insufficient to absorb the forgiven debt, this amount may be factored into the corporation’s taxable income, potentially resulting in a tax liability.
Filing Tax Returns
Despite bankruptcy, a business is required to file all necessary tax returns, including for the period leading up to the bankruptcy date and any overdue returns. A LIT will alert your creditors and make any tax refunds available. If you hold shares in a bankrupt corporation, you can declare the value of your shares as a loss in your upcoming tax return.
Reporting Obligations
A LIT can assist you in filling out all the necessary forms for bankruptcy filing in Canada. This includes the “Assignment,” where you declare that your bankruptcy trustee is assuming control of your property for your creditors’ benefit, and a “Statement of Affairs,” which details your assets, liabilities, income, and expenses.
Supporting documents may include tax returns, proof of your family’s income and expenses, and evidence of any assets you own. For more information on the process and reporting requirements, visit the CRA website.
GST/HST Implications
Filing for business bankruptcy doesn’t necessarily impact you personally; however, it does have implications regarding the harmonized tax (HST) and payroll taxes. If the CRA cannot collect these taxes from the business, they can personally assess a director of the business and hold them liable for the full amount of unpaid taxes. Consequently, if your business is registered for GST or HST, the bankruptcy trustee must cancel this business tax account and file any outstanding returns.
Tax Losses
In the case of a corporation, any tax losses that the business incurred prior to bankruptcy can usually be carried forward and applied against future taxable income if the business continues to operate post-bankruptcy.
