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Does bankruptcy stop tax debt in Canada?

Posted on 11 December 2021

Written by Chris Galea

In Canada, tax debt is a very common occurrence. It is easy for any of us to create, particularly if you have worked an extra job, or taken out RRSP funds early for an emergency or to make a large purchase. The same applies to small businesses – anyone can lose track of their business receipts or HST input tax credits. All too often, tax debt can spiral and drive many Canadians into insolvency. Tax debts can creep up, and are often large and land unexpectedly. On top of this, the powers of the Canada Revenue Agency (CRA) make tax debt a particularly urgent topic to tackle. After all, you do not want to find yourself facing a wage garnishment or collection calls on top of everything else. For this reason, it is important to act quickly. Regardless of why you have tax debt, it is important to find a method of tax debt relief quickly. Ignoring the issue will only make it worse. If you have already considered some more minor forms of debt relief, perhaps bankruptcy is the most appropriate pathway to take. So, does bankruptcy stop tax debt in Canada? In this article, we share all you need to know.

What happens when you file for bankruptcy in Canada?

Bankruptcy is not an easy decision – typically, it is the form of debt relief you take when all other options have been explored. For many, however, it is the most appropriate action for clearing any unsecured debts and allowing for a fresh financial future. In Canada, bankruptcy is a legal form of debt relief, backed by the government’s Bankruptcy and Insolvency Act. Debts are eliminated by assigning any non-exempt assets you may have to a Licensed Insolvency Trustee in exchange for debt clearance. When filing bankruptcy, a stay of proceedings is automatically triggered, which offers you full protection from your creditors. This means they can no longer chase you with collection calls, and any wage garnishments will be stopped. Ultimately, it helps you to move forward with your life. Although it can seem like an intimidating process, a reputable Licensed Insolvency Trustee will be there to walk you through the process. At Spergel, unlike other bankruptcy firms, you will receive your own dedicated trustee to walk you through the process instead of passing you from person to person. Filing bankruptcy is a proactive step towards a better future without the stress of tax debts.

Does bankruptcy stop tax debt in Canada?

The good news is that in most instances, tax debt is treated in the same way as any other unsecured debt when it comes to bankruptcy. This means that once you complete your bankruptcy, any tax debt you filed will be cleared along with any other debts. Tax debt can, however, feature some complex rules that your Licensed Insolvency Trustee is best placed to unpick and handle on your behalf. For instance, Child Tax Benefit and HST cannot be cleared by bankruptcy, although we can advise you as to other methods of handling these debts. They will review your unique circumstances and recommend the best pathway for you to take. Your trustee will review your books, records, and receipts to ensure accuracy when it comes to your tax debt and ensuring it matches what the CRA has noted. After all, before you file bankruptcy you will need to know exactly how much you owe in tax debt to the CRA, so any discrepancies in filings will need to be fixed and all tax returns up to date. Your trustee will run through your records and help you to resubmit your tax return and try to reduce what you owe. They will also handle the CRA on your behalf, communicating with them regarding any action you will be taking. Once your tax debt has been filed, the CRA will no longer be able to pursue a wage garnishment against you, and all collection calls will stop. This will help to bring peace of mind while your tax debts are cleared. So, does bankruptcy stop tax debt in Canada? The answer is yes!

Alternative methods of clearing tax debt

Once you and your Licensed Insolvency Trustee have ensured there are no further discrepancies in your tax debt and all filings are up to date, you will know exactly how much you owe to the CRA. This is crucial in determining the debt relief solution you choose. In some cases, filing a bankruptcy may not be the best option. It is not always the easiest solution for those with a lot of tax debt, as it could limit your options further down the line. There are, however, a number of bankruptcy alternatives to choose from, each of which should be carefully reviewed with your Licensed Insolvency Trustee. Here are some other methods of clearing or reducing your tax debt:

Filing a consumer proposal

A consumer proposal is an increasingly popular bankruptcy alternative in Canada. Many Canadians are less familiar with this option than bankruptcy, but it has a A consumer proposal is an increasingly popular bankruptcy alternative in Canada. Many Canadians are less familiar with this option than bankruptcy, but it has a huge number of advantages. A consumer proposal is a legal form of debt settlement, regulated by the Canadian government. In essence, it is a deal that is put in place with creditors to eliminate overwhelming debts. It is possible to treat the CRA as one of your creditors in order to reduce your tax debt by up to 80%. Consumer proposals must be filed by a Licensed Insolvency Trustee. They will work with you to establish a manageable and affordable monthly repayment. Your trustee will then negotiate with your creditors to find a deal that works for both parties. If accepted, you can reduce your overall debt while enjoying protection from creditors and being able to keep your assets. At Spergel, unlike other bankruptcy firms, you will receive your own Licensed Insolvency Trustee to walk you through each step of filing a consumer proposal instead of being passed from person to person.

Getting a debt consolidation loan

In some scenarios, a debt consolidation loan may be appropriate for helping with tax debt. If you are struggling with multiple separate debts, it can be a great way to condense your debt in order to reduce and simplify your monthly payments. A debt consolidation loan is a new loan that you take out to condense multiple existing debts into one monthly payment. It is essentially refinancing in order to simplify paying off various outstanding debts. In many instances, you can gain a lower interest rate on your debt, or have the interest wiped completely. This can often give you additional funds to put towards your tax debt repayments. It is also possible to spread your loan across a longer time period, potentially making your monthly payments more manageable. Debt consolidation loans can still come with risks, however. If you only qualify for a high-interest rate loan, you could end up simply trading one debt for another without any resolution of your tax debt. It is always a good idea to speak to an experienced Licensed Insolvency Trustee who can walk you through your debt consolidation options.

Arranging a repayment plan with the CRA

The CRA will only agree to negotiate repayment terms with those owing tax debt if they will result in full repayment of the debt owed. Unlike a consumer proposal or bankruptcy, this method of debt relief will not reduce or clear your tax debt in any sense. It can, however, provide some relief by offering lengthier repayment terms. This can allow you to spread out your payments over more months to make them more manageable and affordable. A downside is that you will still be required to pay any associated tax penalties and interest, which are typically cleared through legal forms of debt relief.

Making a CRA fairness application

A CRA fairness application is a government program used to grant relief from tax debt interest and penalties. It does not offer any reduction on the principal of your tax debt, but can assist by waiving these additional fees. In order to have an application approved, you have to prove extraordinary circumstances and financial difficulties that provide evidence for your lack of ability to make your tax debt repayments. You will most likely need a Licensed Insolvency Trustee or a tax lawyer to assist with your CRA fairness application.

How to avoid tax debt in the future

Here are a few key ways to avoid tax debt moving forward, to keep your finances in check and ease any stresses associated with tax debt:

  • Ensure all prior tax years are filed – this is to help you understand exactly how much tax debt you owe in total, and will assist in how the CRA responds to your Licensed Insolvency Trustee regarding tax debt relief
  • Understand how you have previously got into tax debt – perhaps this is because you cashed out RRSPs to pay off debts, or you are self-employed or took on another role. Understanding how the situation escalated is key to avoiding the same tax debt in the future
  • Estimate the amount of tax debt you will owe – at the start of each year, estimate how much income tax you may owe based on the previous year, and keep this amount aside throughout the year so that you are prepared for your tax return
  • Have realistic expectations of your expenses – tax debt only really comes about when you have miscalculated or when you cannot afford to pay it. By budgeting appropriately, you can remove the deficit at the end of the year that can lead to substantial tax debt

So, does bankruptcy stop tax debt? For the most part, yes it does! If you are struggling to repay your tax debt, you have plenty of options as well as bankruptcy. For a tax debt solution, book a free consultation with Spergel. We will review your tax debt circumstances and offer advice to allow you to begin a fresh financial future. Reach out – you owe it to yourself.

Chris Galea

Chris Galea is a Chartered Accountant and Insolvency and Restructuring Professional with over 20 years’ experience as an LIT (Licensed Insolvency Trustee). He is also our resident expert on tax debt, COVID debt, and the region of Saskatchewan, Canada. When he’s not at the office educating people about bankruptcies and consumer proposals, Chris is playing pick-up hockey with his friends, spending time with his family, and learning Spanish!

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