Tax Debt in Canada: Bankruptcy, Consumer Proposals, Uncollected Taxes, and the CRA’s Approach

Uncollected Taxes in Canada

Uncollected taxes, encompassing unpaid personal income taxes, GST/HST, payroll source deductions, or corporate taxes, create significant challenges for taxpayers and the CRA. When these obligations remain unpaid, they accrue interest and penalties, escalating the financial burden. Estimates suggest Canada’s federal tax gap, including uncollected taxes, ranged from $30 billion to $51 billion annually in recent years, though precise figures vary due to underreporting and enforcement challenges.

The CRA wields extensive powers to recover these debts, including garnishing wages, seizing assets, placing liens on property, or redirecting tax refunds. However, when taxpayers face severe financial hardship, options like bankruptcy, consumer proposals, or CRA write-offs come into play, each with its own implications.

Bankruptcy as a Means to Discharge Tax Debt

Bankruptcy, governed by the Bankruptcy and Insolvency Act, offers a legal path to discharge most unsecured debts, including tax debts, such as income taxes, GST/HST, penalties, and director’s liability for unremitted corporate source deductions, provided no fraud is involved.

Upon filing, a Licensed Insolvency Trustee (LIT) assumes control of non-exempt assets (i.e. assets that a LIT can seize and sell to pay creditors), files pre-bankruptcy and in-bankruptcy tax returns, and redirects any tax refunds to creditors unless offset by prior tax debts.

Post-bankruptcy tax obligations remain the debtor’s responsibility and are not discharged. If tax debt exceeds $200,000 and comprises 75% or more of unsecured debt, a court hearing may impose partial repayment. Secured tax debts, such as those with CRA liens, complicate discharge, and while bankruptcy halts collection actions, a first-time bankruptcy typically remains on your credit report for 6 to 7 years after discharge, depending on the credit bureau and your province. If it’s your second bankruptcy, it stays on for 14 years.

Consumer Proposal as a Means to Discharge Tax Debt

Alternatively, a consumer proposal allows taxpayers to negotiate with creditors, including the CRA, to settle unsecured tax debts for less than the full amount over a period of up to five years.

Administered by a LIT, this option requires all tax returns to be filed and stops CRA actions such as garnishments and interest accrual. The CRA, treated as an unsecured creditor, may accept a proposal if it yields more than bankruptcy would.

If the majority of your creditors (based on the dollar value of their debts) vote in favour of the proposal, it becomes binding on all creditors. Debtors retain assets, keep tax refunds (except those offsetting pre-proposal debts), and face a less severe credit impact lasting three years post-completion.

The CRA Writes Off Bad Debt

When collection efforts fail, the CRA may classify tax debts as uncollectible, writing them off for accounting purposes without forgiving them. This occurs in cases of prolonged hardship, deceased taxpayers with no estate, or businesses with no recoverable assets, but the CRA can resume collection if circumstances improve.

Historical data indicates write-offs of $2.7 billion in 2018–2019, rising to $3–4 billion annually during the COVID-19 pandemic, reflecting economic disruptions. These amounts, a fraction of the CRA’s $400+ billion yearly revenue, highlight the scale of uncollectible debts, often tied to insolvency.

Taxpayers can also seek relief from penalties and interest (not principal) through the CRA’s discretionary taxpayer relief provisions, though approval requires supporting documentation and is challenging without professional help from a top Canadian tax lawyer.

Before insolvency, taxpayers can explore payment plans, requiring full repayment with ongoing interest, or debt consolidation loans, which risk asset loss if secured. Informal settlements with the CRA for less than the full amount do not exist outside formal processes.

Acting early is critical, as delays increase penalties and enforcement risks. Filing tax returns on time, even without payment, avoids arbitrary assessments and late filing penalties and supports insolvency options. Consulting an experienced Canadian tax lawyer helps navigate complex rules, especially for large or secured debts.

Pro Tax Tip: Choosing Between a Consumer Proposal and Bankruptcy

When it comes to a consumer proposal or bankruptcy, each option has distinct advantages and trade-offs. A consumer proposal lets you retain assets such as your home and vehicle, settle unsecured tax for less than owed over a period of up to five years, and halt CRA actions such as garnishments on unsecured debt, with a less severe credit rating lasting three years post-completion.

However, it risks CRA rejection if you hold significant debt, locks you into payments with LIT fees, and may not fully resolve secured or fraud-related tax debts.

Conversely, bankruptcy discharges most tax debts,  stops CRA debt collection, and requires no repayment if assets are minimal, but it demands surrendering non-exempt assets, forfeits tax refunds to creditors, imposes an R9 credit rating for six years post-discharge, and leaves post-bankruptcy tax obligations unpaid, alongside potential career restrictions.

Choosing depends on your assets, repayment ability, and tolerance for credit impacts, with both requiring filed tax returns and LIT guidance to navigate CRA complexities like liens or large debts exceeding $200,000. If you have a tax debt that you are struggling to repay, contact an expert Canadian tax lawyer to discuss your options and the best path forward.

FAQ

What happens if I can’t pay my taxes to the CRA?

If you can’t pay your taxes, the CRA can garnish wages, freeze bank accounts, seize assets, place liens on property, or redirect tax refunds to recover the debt. Interest and penalties accrue as long as the debt is unpaid, increasing the amount owed.

If payment remains impossible, you can explore options like payment plans, a consumer proposal, or bankruptcy to manage or discharge the debt, depending on your financial situation.

As interest will continue to accrue as long as there is an outstanding balance, it is advisable to consult with a Canadian tax lawyer sooner rather than later to ensure the interest does not balloon more than it needs to.

Can the CRA reject my consumer proposal?

Yes, the CRA, as an unsecured creditor, votes on your consumer proposal. If it holds over 50% of your debt, its vote determines approval. The CRA may reject the proposal if it believes bankruptcy would yield more for creditors, so your offer must be compelling, often requiring LIT expertise to structure effectively.

What happens to my assets in bankruptcy vs. a consumer proposal?

In bankruptcy, you surrender non-exempt assets (e.g., home equity, non-registered investments) to the LIT for creditor distribution, based on provincial exemptions. In a consumer proposal, you keep all assets, as no liquidation occurs, making it ideal if you own a home or vehicle that you want to protect, provided you can afford the negotiated payment and the amount is acceptable to your creditors.

What are non-exempt assets under the Bankruptcy and Insolvency Act?

In bankruptcy, non-exempt assets are those that a Licensed Insolvency Trustee (LIT) can seize and sell to pay creditors under Canada’s Bankruptcy and Insolvency Act. These typically include real estate equity beyond provincial exemption limits, such as $10,783 in Ontario, and vehicles like cars or motorcycles exceeding values, such as $7,117 in Ontario.

Investments, including stocks, bonds, or non-registered savings like TFSAs, as well as valuable personal property such as jewelry or art above certain thresholds, are also non-exempt. Business assets, such as equipment or inventory, may be included if not protected by exemptions.

However, exempt assets, which cannot be seized, cover necessities like basic clothing, tools of trade up to a certain value, and certain pensions, like RRSPs, excluding contributions made within 12 months of bankruptcy. Exemption rules vary by province.

Disclaimer: This article just provides broad information. It is only up to date as of the posting date. It has not been updated and may be out of date. It does not give legal advice and should not be relied on. Every tax scenario is unique to its circumstances and will differ from the instances described in the article. If you have specific legal questions, you should seek the advice of a Canadian tax lawyer.