How Taxes Work in a Consumer Proposal And Bankruptcy

How Taxes Work in a Consumer Proposal & Bankruptcy

Table of Contents

A pain at the best of times, filing your tax returns can get incredibly stressful if you anticipate owing money to the Canada Revenue Agency (CRA). Maybe you can’t afford to pay your taxes and are contemplating filing a consumer proposal to obtain much-needed debt relief.

But what exactly happens to your tax debts in a consumer proposal? What are your current and future tax obligations once you file? Are you still entitled to your refunds, or is it all up for grabs by the CRA?

In this article, we’ll explain how taxes work under a consumer proposal, including how to work effectively with the CRA to deal with your liabilities. We’ll also break down the treatment of tax debt and tax responsibilities under bankruptcy so that you can weigh the pros and cons of both insolvency options.

What happens to your tax debt under a consumer proposal?

Can you include tax debts in a consumer proposal? The answer is “yes.” CRA tax debt is an unsecured debt, which means you can add to your proposal along with debts like credit cards, lines of credit, and payday loans.

All unpaid taxes you owe to the CRA up to the date of your proposal’s filing date qualify, including:

  • Income tax debt
  • GST/HST credit
  • Business GST/HST debt
  • Canada Child Benefit overpayments
  • Interest and penalties on the above debt

The only exception is if the CRA has issued a lien against one or more of your assets to secure the debt; in that case, a consumer proposal will not help with this debt.

Filing a consumer proposal is the only way to legally negotiate a settlement with the CRA to pay less than you owe. Under your proposal, a portion of your tax debt is forgiven, with the remainder payable over five years interest-free.

For a crash course on how a consumer proposal works in practice and how to file one, visit our consumer proposal in Ontario page.

What are your tax obligations after filing a consumer proposal?

Let’s say you contacted a Licensed Insolvency Trustee (LIT), and they’ve successfully filed a consumer proposal on your behalf. Below, we’ll explain what that means for your tax obligations going forward.

Tax returns

By law, you must continue to file your tax returns while enrolled in your proposal—it’s something the CRA will demand during the negotiation process. Failing to do so could void the terms you’ve agreed upon with the CRA and your other unsecured creditors.

Remember: a consumer proposal is a legally binding agreement, not an informal promise. So always stay up to date with your tax filings.

Taxes owed and refunds

Suppose you incur tax debt in the year of filing your proposal. In that case, you’ll be responsible for paying the pro-rated portion of the taxes owing for the part of the year after filing.  So if you filed your consumer proposal on April 1, 2024, you would not have to pay the pro-rated portion of the taxes owing for the period January 1, 2024-March 31, 2024 or ¼ of the year (3 months divided by 12 months) but you would have to pay the pro-rated portion for April 1, 2024 – December 31, 2024 or ¾ of the taxes owing.  As mentioned, the only tax liabilities you can include in your proposal are those that existed before your filing date. 

On the other hand, if you are to receive a refund for the year of filing, and you owe CRA for any tax years prior to the filing year, you only get to keep the pro-rated portion of the year after the filing date.  Otherwise, you get to keep all of it.  The Canada Carbon Rebate, which is part of your tax refund, but paid separately and quarterly, starting in April of the year after the tax year to which it relates can be seized against taxes owing up to the date of the filing of your proposal, and thereafter will be paid to you.

A consumer proposal doesn’t require you to give up your assets, which includes your tax refund. This is one of the most notable advantages this debt relief program has over bankruptcy.

How to ensure the CRA accepts your consumer proposal

In a consumer proposal, you work with your LIT to craft a debt payment plan and offer it to your unsecured creditors, including the CRA, for review. If the majority of them (based on the dollar value of the debt they’re owed) vote in favour of your proposal, it becomes legally binding on all of them.

Compared to other creditors, the CRA’s conditions tend to be more demanding – and they’ll have considerable leverage if they’re the majority creditor in your proposal. You’ll have to include specific CRA debt forgiveness clauses in your proposal for the tax agency to consider your offer seriously. These include:

  • Filing all outstanding tax returns up to the date of your proposal’s filing date
  • Filing all tax returns that are due by the deadline while enrolled in your proposal
  • Paying all taxes owing during your proposal period by the deadline

The CRA may also request that you include additional guarantees, especially if they have reservations about your ability to make timely payments. The more you can do to demonstrate to that you can resolve your debts, the more they’ll be willing to accept your consumer proposal.

Also, the chances of the CRA accepting your proposal are higher if you offer it a better deal than if you filed for bankruptcy. In other words, it must stand to recover more money by voting “yes” to your proposal. The tax agency may scrutinize your income, assets, expenses, and other financial details to determine whether your offer is fair and reasonable.

Your Licensed Insolvency Trustee will help you draft the necessary terms to ensure you have the best chance of your proposal getting approved.

Does the CRA have priority over other creditors included in your consumer proposal?

In terms of voting power, the CRA is equal to all other unsecured creditors included in your consumer proposal. Despite their status as a federal government agency, they don’t receive any preferential treatment, which means your tax debt doesn’t take priority over other types of debt.

How personal bankruptcy impacts your tax debt

A consumer proposal may not give your budget the breathing room you need to deal with your tax liabilities. In that case, you might consider filing for personal bankruptcy instead. The most significant advantage of the bankruptcy route is that it completely eliminates unsecured debts, including those owed to the CRA. However, bankruptcy has drawbacks you should get to know as well.

If your personal tax debts total $200,000 or more and comprise more than 75% of your unsecured debts, you will not qualify for an automatic discharge from your bankruptcy and must attend a court hearing to determine the terms of your discharge from bankruptcy. In this scenario, you’ll have to present your case in court, as the CRA will typically object to forgiving your debts in full.  If you’re successful, the court will grant you a Conditional Order of Discharge, usually requiring you to pay more into your bankruptcy.

Check out our Ontario bankruptcy page to learn more about how bankruptcy works and its effects on your finances.

What are your tax obligations during bankruptcy?

Tax obligations under bankruptcy differ from those under a consumer proposal. Here’s the impact on your tax return filing duties, payment obligations, and refunds.

Before filing for bankruptcy

You can declare bankruptcy in Canada even if you have tax returns you haven’t yet filed. However, before proceeding any further with your bankruptcy, you must bring them all up to date. If you have outstanding tax returns, the CRA will send you a letter insisting that you file them before your bankruptcy can be completed.

The good news is that it’s never too late to get caught on your tax filings. Plus, the CRA has copies of all your T4, T4A, T5, and other tax slips. If you’re missing critical documents required to complete your past-due returns, all you have to do is submit a request, and it’ll send them to you.

During bankruptcy

During the tax year that you declare bankruptcy, you must split your income tax return into two filings: pre-bankruptcy and post-bankruptcy returns. Your LIT must file both.

Pre-bankruptcy tax return. This tax return covers the period from January 1st to your bankruptcy filing date. Any tax you owe to the CRA gets added to your bankruptcy and forgiven, plus any balance due from previous years’ returns. However, you must also give up any refunds you receive to your LIT, who’ll include it in your bankruptcy estate for distribution to your creditors.

Post-bankruptcy tax return. This tax return extends from the day you file for bankruptcy until December 31st. If there’s a balance owing from this return, it’s a debt you must pay to the CRA, as you incurred it after you declared bankruptcy. If you get a refund, it will be remitted directly to your bankruptcy estate for the benefit of your creditors.

Canada Carbon Rebate

The Canada Carbon Rebate, which is part of your tax refund, but paid separately and quarterly, starting in April of the year after the tax year to which it relates can be seized by CRA against taxes owing up to the date of the filing of your bankruptcy.  Any amounts that remain to be paid, for any tax years prior to and including the year of filing your bankruptcy, will become part of the assets of the bankruptcy, for the general benefit of all of your unsecured creditors.  This means that you will lose the Canada Carbon Rebates that are payable up to and including the year of filing of your bankruptcy and will start receiving a Canada Carbon Rebate, if you qualify, in April of the second year after filing of your bankruptcy.

It’s worth considering your future tax returns when deciding between filing a consumer proposal and bankruptcy. One of the reasons we encourage our clients to consider a consumer proposal over bankruptcy is that it allows you to keep your tax refunds (except any amount that relates to tax debt you owe before your proposal’s start date).

The average tax refund in Canada is over $2,200, a considerable sum that can help you climb your way out of debt. But you’ll have to surrender this money to your creditors in bankruptcy.[MM1] 

Of course, once you’re discharged from bankruptcy, you can keep 100% of any future tax refunds you receive.

The bottom line on tax treatment in a consumer proposal and bankruptcy

Dealing with tax debt can be frustrating and nerve-wracking, especially when the CRA engages in aggressive collection tactics. But if you file a consumer proposal, you can devise an agreement with the tax agency to reduce the balance you owe. It’s Canada’s only debt relief program that allows you to do so.

Remember to include in your proposal a guarantee stating that you’ll file all tax returns by the deadline on time and pay any balance owed when due. As part of your proposal, you must follow your tax reporting and payment obligations. Any breach in the contract means your proposal risks getting annulled.

Bankruptcy can help you even more if you’re struggling financially, as it will eliminate your total unsecured debts, including unpaid taxes. But that comes at a price, namely, having to surrender some of your assets to creditors, including any tax refunds that come your way.

Determining the optimal way to get a handle on your tax debt can be challenging, depending on your financial situation. At David Sklar & Associates, we are happy to help you weigh your options for tax debt relief. Our compassionate trustees will walk you through the process of both consumer proposals and bankruptcies in Canada and explain in detail the nuances and legalities involved in both debt management programs.

Take Your First Step Towards A Debt Free Life

If you are overwhelmed by debt, call us at 1-844-962-9200 to book a FREE, confidential appointment. We will review your financial situation in detail and discuss all of your options with you. Alternatively, you can fill out the form below and our team will reach out to you. 

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