Will Bankruptcy Take My Tax Refund?

Bankruptcy is a legal way to eliminate debt if you can’t afford to repay what you owe. It’s a relief for many Canadians facing serious financial stress. But if you’re expecting a tax refund, you might be worried you’ll lose it. Let’s walk through how filing bankruptcy affects your tax refund – and whether there’s a way to keep it.

Will You Lose Your Tax Refund if You File Bankruptcy?

Yes, if you file for bankruptcy in Canada, the Canada Revenue Agency (CRA) will forward any tax refunds for the year you file and any previous years to your Licensed Insolvency Trustee (LIT) for the benefit of your creditors. This happens because tax refunds are legally considered assets that form part of your bankruptcy estate.

If you owe taxes for years before or up to your bankruptcy filing date, this debt will be discharged through the bankruptcy process.

Understanding Bankruptcy and Tax Returns

When you declare personal bankruptcy, special rules in Canada’s Income Tax Act and Bankruptcy and Insolvency Act (BIA) determine how you file your tax returns and what happens to refunds and credits. Below is a simple overview of these rules.

Pre-Bankruptcy and Post-Bankruptcy Periods

Tax law splits the year in which you go bankrupt into two parts:

1. Pre-Bankruptcy Period: From January 1 up to (and including) the day before your bankruptcy filing date.
2. Post-Bankruptcy Period: From the date of bankruptcy until December 31st of the same year.

A separate tax return must be filed for each of these periods.

Filing Responsibilities

Under the Bankruptcy and Insolvency Act, your Licensed Insolvency Trustee must:

• Ensure an income tax return for the year before your bankruptcy is filed.
• File the pre-bankruptcy tax return.

While not legally required to do so, the Trustee often also prepares and files the post-bankruptcy return.

Tax Refunds and Tax Debt

When you file for bankruptcy:

• If there is no tax debt, the Canada Revenue Agency will forward any tax refunds owing for the year of bankruptcy and any prior years to the Licensed Insolvency Trustee.
• You do not have to pay any personal income tax debt for the pre-bankruptcy period or for any previous years. These tax debts are discharges at the completion of your bankruptcy. However, the Canada Revenue Agency will use any refund generated from these periods (pre-bankruptcy or earlier years) to reduce any outstanding tax debt you owe.
• You keep any tax refunds for the years after your bankruptcy started. You are also liable to pay any taxes owing on the post-bankruptcy return and subsequent years.

Other Government Benefits & Credits

In addition to your income tax refunds, here is a summary of other benefits or tax credits CRA will send to the trustee as part of your bankruptcy:

Canada Carbon Rebate (CCR) – you will lose unpaid rebate benefits related to prior years and the year of bankruptcy. Payments received in the year after your bankruptcy started must be included in your income for surplus income purposes.

Advanced Canada Worker Benefits – only credits related to years before bankruptcy are sent to your trustee. You keep all other benefits but just include them in your bankruptcy income calculation.

Benefits you keep:

• Ontario Trillium Benefit
• GST / HST credits are not an asset for the benefit of your creditors although some trustees can apply your GST credit towards administration costs. Some (like Hoyes Michalos) do not.
• Canada Child Benefit

Tax Refunds: Bankruptcy vs Consumer Proposal

When you file a proposal, you are making a deal with your creditors and one of the benefits to doing this is that you keep all your assets, including any income tax refunds. As long as you do not have past owing taxes, you do not lose any tax refunds when you file a consumer proposal. If you want to keep your refund or other assets, a consumer proposal can be a good alternative to bankruptcy.

It’s natural to feel nervous about losing your refund if you need to file for debt relief, but you don’t have to decide alone. Our team is here to help you explore whether bankruptcy or a consumer proposal is right for you and how the loss of your tax refund weighs against the benefits of eliminating your debt.

Schedule your free consultation today and get clear answers tailored to your situation.

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3. The Pros and Cons of Canadian Bankruptcy
4. What Does it Cost to File for Bankruptcy in Ontario?
5. Income Taxes and Bankruptcy – What You Need to Know