Does Bankruptcy Clear Tax Debt in Canada?

The Canada Revenue Agency (CRA) is a formidable creditor, and they are difficult to negotiate with. They collect government debts for personal income tax, HST, employment deductions, student loans and benefit overpayments.

If you have a large unpaid tax debt, the CRA charges penalties and interest is compounded daily.

They can also apply tough collection measures, including garnishing wages and bank accounts, seizing assets, offsetting benefits, withholding credits, diverting tax refunds and placing a lien on your home.

But the good news is if the CRA hasn’t registered a lien on your property, you can use bankruptcy to clear your tax debts and stop CRA collection actions.

Does bankruptcy clear tax debt in Canada?

You can use bankruptcy to legally clear your tax debt alongside other unsecured debts. The CRA is treated the same as other unsecured creditors, such as loan providers or credit card companies.

However, the CRA can oppose your bankruptcy. If your tax debt is substantial or makes up a large chunk of your total debt, you may need to meet certain conditions before being discharged.

The CRA will only accept a formal debt arrangement to resolve outstanding debts, either bankruptcy or a consumer proposal.

What happens when you file for bankruptcy?

Bankruptcy is a legally binding debt program where you give up some of your assets in exchange for debt forgiveness. Those who declare bankruptcy may pay significantly less than the total debt.

During your bankruptcy, a stay of proceedings provides legal protection under the Bankruptcy and Insolvency Act. Creditors (including the CRA) cannot contact you, penalties and interest are frozen, and court orders and wage garnishments stop.

To be discharged, you must complete some duties, including attending financial counselling and supplying proof of your income and expenses. A Licensed Insolvency Trustee will guide you through the process.

Your CRA debts are eliminated when you complete your bankruptcy.

Can you file bankruptcy on back taxes?

Bankruptcy affects your income taxes. If you have unfiled income tax returns, your Licensed Insolvency Trustee must file any outstanding tax returns up to the date of your bankruptcy.

Your trustee might file an in-bankruptcy return to report income from any liquidated assets, such as RRSPs, or assets from businesses that your trustee is winding up.

You also need to file a pre-bankruptcy return (January 1st to the day before your bankruptcy) and a post-bankruptcy tax return (date of bankruptcy to December 31st).

Any tax owed from the date of bankruptcy to December 31st will be your responsibility, but any tax debt owed for previous years will be eliminated.

Will filing for bankruptcy affect my tax refund?

If you are due a tax refund for returns before the year of bankruptcy, this money is sent to your trustee to form part of your bankruptcy estate, which is distributed amongst your creditors.

This also applies to refunds for your pre-bankruptcy and post-bankruptcy returns. After the year of your bankruptcy, future tax refunds will be yours to keep.

Talk to your trustee about a consumer proposal which lets you keep all tax refunds.

Wrapping up

If you have income tax debt, don’t wait until the CRA garnishes your wages, seizes your assets or registers a lien on your property.

While bankruptcy eliminates tax debt in Canada, it’s not always the best approach. Bankruptcy can be expensive if you have to pay surplus income and can often be avoided by filing a consumer proposal instead.

If you have a high income and assets to protect, a Licensed Insolvency Trustee may recommend a consumer proposal to deal with your tax obligations. Schedule a consultation to figure out the best way to resolve your outstanding debts.

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