Exploring Bankruptcy as a Solution to Tax Debt
Are you bogged down by an overwhelming tax debt? Ever wondered if bankruptcy could be your way out? Let’s delve into the realm of bankruptcy and see if it could be the right solution to your tax debt issue.
The Dread of Tax Debt
Tax debt often instills a sense of dread and despair in individuals. The common notion is that fighting the government is a futile exercise, leading many to bear the burden of hefty interest rates and penalties in silence. They continually hope for a future where they can pay off their tax debts, often enduring this hardship for an extended period.
However, the situation isn’t as grim as it appears. It’s absolutely possible to overcome tax debt. In many cases, bankruptcy can be a viable solution to this predicament, completely absolving individuals of their tax debts upon discharge.
But remember, every case is unique. Let’s explore how bankruptcy could potentially work in your favor, given your specific circumstances.
Redefining Tax Debt: A Creditor Like Any Other
The widely held belief that tax debt is inescapable is grounded in historical truth. Until 1992, the Canada Revenue Agency (CRA) enjoyed a preferred creditor status under the Bankruptcy and Insolvency Act (BIA). This status was often used against debtors, especially those with considerable personal income tax dues.
In cases where an individual declared bankruptcy owing a significant amount in income tax arrears, the CRA would frequently contest their discharge, calling upon the courts to make it contingent on the payment of all or part of the tax debt.
However, post-1992, the CRA was reclassified as an ordinary unsecured creditor under the BIA. This meant they could no longer solicit the courts for preferential debt repayment. In most instances, once a bankrupt individual is discharged, they are absolved of any tax debts that existed at the time they filed for bankruptcy.
Exceptions to the Rule
While bankruptcy can alleviate the burden of income tax debt, it doesn’t automatically guarantee a discharge once all statutory duties are fulfilled. There’s a critical exception you should be aware of.
High-tax debtors, i.e., individuals with tax arrears exceeding $200,000 (including principal, penalties, and interest) that constitute 75% or more of their proven debts, face a more complex process. These individuals do not qualify for an automatic discharge from bankruptcy and must attend a special court hearing.
During this hearing, the court wields a range of powers. These include:
- Granting an absolute order of discharge;
- Issuing a conditional order of discharge (e.g., requiring repayment of a portion of the outstanding taxes, mandating extra financial counselling sessions, etc.);
- Suspending the discharge for a specified timeframe;
- Attaching conditions to the suspended discharge, either concurrently or consecutively;
- Postponing the hearing to a future date;
- Denying the discharge.
Conditions of Discharge
If the court decides to issue a conditional order of discharge, it typically depends on the bankrupt individual’s ability to pay a fair and reasonable amount towards their outstanding debts. The court takes several factors into account when determining what constitutes a ‘fair and reasonable’ amount, including:
- Causes of the bankruptcy;
- The bankrupt’s personal and family situation, both at the time of the bankruptcy and during the court hearing;
- Type of creditors (i.e., unsecured, secured, preferred);
- Amount owing to each creditor;
- Total amount owing to all creditors;
- Whether a Consumer Proposal could have been a feasible alternative to bankruptcy;
- Prior history of bankruptcy or Consumer Proposals;
- The bankrupt’s tax compliance history, both pre- and post-bankruptcy.
Tax Compliance Evaluation
The court evaluates a bankrupt individual’s tax compliance, both before and after filing for bankruptcy, based on two key factors:
- Whether they filed all personal income tax returns as required under the Income Tax Act
- Whether they have paid (or attempted to pay) the assessed income tax debt
Additionally, even though GST / HST liabilities fall outside the scope of income tax debt, the court might also consider any outstanding GST / HST debts and whether the bankrupt individual has made efforts to file and pay these returns as required.
The Practical Implications
Courts adopt a highly contextual approach when dealing with high-tax debtors. Case law contains numerous instances highlighting the different outcomes that can arise due to varying circumstances.
Consider these two examples for instance:
Towards Leniency – In one case, the courts ruled that repaying 10% of the income tax principal was the fairest balance between the bankrupt individual’s need for a fresh start and their societal obligations.
Upholding the Spirit of Bankruptcy Law – In another case, the individual’s two previous bankruptcies were deemed a violation of the law’s spirit. The court ordered them to pay their entire tax debt, excluding penalties and interest.
Choosing the Best Option for You
Tax debt can indeed be overwhelming. However, solutions exist to help you conquer it permanently. A Licensed Insolvency Trustee (LIT) can guide you towards effective strategies to overcome your tax debt.
A Life-Changing Debt Solution like Bankruptcy or a Consumer Proposal not only tackles your debt directly but also halts creditor actions such as court judgements and wage garnishments, allowing you to refocus on rebuilding your finances.
Your LIT will support you throughout the process, from the initial meeting to the day you receive your discharge. They can help you understand the process, the pros and cons of each option, and assist you in making an informed decision that minimizes costs, reduces potential complications, and ensures a fair and positive resolution.
It’s time to conquer your debt and embark on a new chapter. Take the first step towards a debt-free future by scheduling a no-obligation Free Confidential Consultation today.
