A taxpayer can still be held liable for a tax debt thought to have been erased by bankruptcy. This was the decision of the Federal Court of Appeal in Canada v. Heavyside, 1996 CanLII 3932 (FCA) and more recently affirmed in Légaré v. The Queen, 2019 TCC 106 (CanLII).
Central to the issue of bankruptcy and persisting tax debts are the derivative liability provisions of the Federal Income Tax Act such as section 160. It's counterpart under the Federal Excise Tax Act, section 325, operates similarly. Pursuant to sections 160 and 325, a person can be held liable for the tax debt of another, including a corporation. Per section 227.1 of the Income Tax Act, a director is jointly and severally liable for certain tax arrears of a corporation (director liability). Similar director liability provisions can be found in Canadian legislation such as the Excise Tax Act, Canada Pension Plan and Employment Insurance Act.
Section 160 operates by assigning liability for tax arrears to a person who received a transfer of property from a tax debtor, for less than fair-market value consideration. A simple and common example is an individual taxpayer who transfers title of a home to their spouse for nil consideration, with the intention of skirting CRA's attempts to lien the property. In such a case, if the tax debtor transfers the property for less than fair-market value, including to a minor or non-arm's length person, the transferee can be held liable for the transferor's tax arrears.
But what if the corporation enters and is discharged from bankruptcy? Or the husband in the above example goes bankrupt? Can CRA then assess another person for the same tax debt?
In Heavyside, the husband transferred 50% of his property interest to his wife, for less than fair-market value consideration, while he had an outstanding tax debt to CRA. In a later year, the husband began the bankruptcy process and was subsequently discharged. At that point he was no longer liable for the tax debt. However, pursuant to section 160 of the Income Tax Act, the CRA assessed the wife for the same debt.
The Tax Court of Canada ruled that the wife's potential liability for the tax arrears was extinguished upon the husband's bankruptcy. The Federal Court of Appeal disagreed, ruling that the liability of the husband (the original tax debtor) was erased, but not the debt. Accordingly, the wife's joint liability endured. According to the Federal Court of Appeal:
[t]here is no doubt that the husband's discharge from bankruptcy relieves him from paying the Minister the amount due by him under section 160 of the Income Tax Act; this is made clear by subsection 178(2) of the Bankruptcy Act...[But to] allow the [wife] to escape her tax liability in the present case because of her husband's discharge from bankruptcy would be to allow what Parliament precisely sought to prevent by the adoption of section 160.
Similar reasoning applies to other joint liability provisions such as garnishment pursuant to section 224 of the Income Tax Act. Per this section, CRA collections can demand that a person liable to make a payment to a tax debtor instead make that payment to CRA. As with the other third-party liability legislative provisions, the bankruptcy of the original tax debtor does not prevent CRA from third-party garnishment.
In, Heavyside, the Federal Court of Appeal relied upon section 179 and subsection 178(2) of Canada's Bankruptcy and Insolvency Act. The latter provides that a discharge order releases a bankrupt from liability for proven debt. Section 179 states that a jointly liable person is not released.
Before a taxpayer considers the bankruptcy process to avoid a tax debt, they should ensure they are properly advised on the risk of a third-party or derivative assessment of the same debt, along with methods to prevent or lessen the possibility of same.
Originally published 4 October, 2021
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