Small Business Corporation Owner? Considering Filing a Personal Bankruptcy or a Personal Consumer Proposal?

At times, businesses and their owners can find themselves struggling with debts. Thankfully there are options available for the business and the individual owners/Directors to get out of debt and start fresh. However, when considering next steps, there can be confusion between what information is needed and the interrelationship between corporate and personal debts. When filing for a personal bankruptcy or a consumer proposal as a business owner, what information is needed before the process can begin?

Assets

If you own shares in a limited company, you must list the shares you own as a personal asset and determine their value.
It may be that the shares you own personally have little to no value if the company has debts that exceed the value of its asset (or if the company has simply stopped operating and there are no assets remaining)
However, the Licensed Insolvency Trustee (LIT) will still need to review the company activities i.e. its assets, debts, and any outstanding tax returns.
To help confirm the value of a company, as LIT’s we look to the previously filed corporate tax returns filed, the current fair market value of assets owned the company (trucks, bank accounts, equipment etc) and any corporate debts. Some corporate debts become personal debts of the Directors of the Company (“Directors”)

Liabilities

You need to write down all your personal debts including any potential CRA “Director Liability” debt. This includes debts you may owe IF you were a Director of a limited company. These types of corporate debts or “Director Liabilities” debts in BC include GST, PST, payroll withholdings including penalties and interest. It does not include COVID type grants.

Tax Returns

Consumer Proposal:

If you want to file a personal consumer proposal, and if you expect to have tax debts either personally or in your company, then all your personal and business tax returns will have to be prepared before we can file your consumer proposal.
This review may require reviewing any funds that that shareholders/directors may have taken from a limited corporation but not yet declared on your personal income tax return.

Personal Bankruptcy:

If you are filing for personal bankruptcy, you outstanding returns do not have to be filed before the bankruptcy process starts. However, at a minimum before the bankruptcy process ends the Trustee will need to file your personal tax returns for the year in which the bankruptcy is declared and the immediately preceding year.
This may require a review of the funds that you may have taken from a limited corporation in this period but failed to declare on your personal income tax return. If we are aware of income that should be on these tax returns (or prior years) we will need to update CRA with this information and file (refile) your personal taxes accordingly
The Trustee may opt to file for personal taxes for other years that are outstanding beyond the minimum requirements if there is benefit to the bankruptcy estate. (tax refunds are payable to the bankruptcy estate for all returns up to the date of bankruptcy)
If there are other years tax filings that are due, it is a significant benefit to file for these years. The main benefit is that CRA will not issue any future income tax refunds if there are tax returns outstanding. Additionally, upon retirement, CPP benefits are calculated based on earnings throughout ones working life. Failure to declare income in past years will reduce CPP benefits when retired.

NOTE: Personal bankruptcy of one of the Directors/Shareholders of a company does not mean that the company itself is bankrupt. If you have a personal bankruptcy trustee, that personal bankruptcy trustee may opt to review the financial information for the related company, but it is NOT the trustee for the company and so cannot deal with corporate assets or debts.

Corporate Dividends in an Insolvent Corporation

Declaring a Corporate Dividend is an option to account for funds moving from corporations to shareholders.
Small business owners (on the advice of their accountants) will often declare a dividend at the end of a corporate year to account for shareholder withdrawals.
However, declaring a dividend in a corporation is against Provincial incorporation statues IF the company is insolvent at the time the dividend was declared, or the dividend once paid renders the company insolvent.
If the company is insolvent, it has the option to simply stop operating. This means that that debts in the company remain unpaid.
However, even if the company shuts down or stops operating and is unable to pay its debts, the Directors continue to have personal obligations for Director Liability Debts, or any other corporate debts that they may have personally guaranteed.

Dividend Stripping

Routinely, shareholders of a corporation will take money or draw income from the company they operate. At the end of the corporate tax year, the shareholder withdrawals need to be reflected in the personal income of the shareholder. Accountants account with shareholder withdrawals issuing dividends to the shareholders. Issuing corporate dividends creates both personal tax obligations for the individual receiving the dividend and corporate tax obligations for the company declaring the dividend.
Essentially, (on a very simplified explanation) payments of Canadian Dividends to individual shareholders results in 50% of the applicable tax being payable by the individual personally and 50% of the tax being payable by the corporation. (corporate tax), whereas, if the shareholder were to be an employee, 100% of the tax obligation would fall to the individual (none in the company)
However, if the corporate tax remains unpaid when a company shuts down/stops operating, the individual has essentially benefited by income to which they have only paid 50% of the applicable tax (the corporate portion remains unpaid)
If someone who was a Director/shareholder of a company declared dividends in a company that they controlled/(or associated with for tax purposes), and the company has resulting corporate tax debt that remains unpaid, CRA considers this “dividend stripping”.
Dividend Stripping is something that CRA considers when the individual either declares personal bankruptcy or files a proposal.
In the past, CRA has taken the policy that it will not accept a personal proposal where there has been dividend stripping.
In some cases, CRA have reversed dividends when this occurred, and the Director subsequently declares personal bankruptcy (they do this to increase the personal debt obligations of bankrupt individuals)
Alternatively, CRA has the option under Section 160 of the Income Tax Act (Canada) to make both the company and the shareholders responsible for the unpaid corporate tax debt.

Section 160 of the Income Tax Act, Canada

The Canadian Income Tax Act empowers the Canada Revenue Agency (CRA) to pursue various avenues for recovering debts from businesses. Among these, Section 160 targets individuals who have received money or property from a tax debtor without proper consideration, regardless of whether the tax debt existed before or after the transaction. This provision aims to prevent tax evasion through the transfer of assets to non-arm’s length parties.

Under Section 160, the CRA can act against a wide array of transactions involving related parties to the tax debtor, including:

Direct transfers to related parties, such as gifts to spouses or children, or dividends from a corporation to its shareholders.
Indirect transfers, where property is initially transferred to an arm's-length party before being passed on to a non-arm's length party.
Transfers to trusts with non-arm's length beneficiaries.
Any other means of transferring property to a related party, ensuring comprehensive coverage.
If Section 160 applies, both the transferor and the recipient become jointly and severally liable for the tax debtor's original income tax debt. This means that the CRA can pursue both parties for the same tax debt. These claims against recipients are termed derivative assessments.
However, the recipient's liability under Section 160 cannot exceed the fair market value of the transferred property. Any consideration given in return for the property reduces the recipient's liability.
Furthermore, payments made by either the transferor or the recipient toward the tax debt diminish their respective liabilities. Complete discharge of the recipient's liability necessitates payment equal to or greater than the fair market value of the received property.
In essence, Section 160 of the Canadian Income Tax Act casts a wide net, encompassing various transactions involving related parties to the tax debtor, ensuring that attempts to transfer assets to avoid tax obligations are effectively addressed by the CRA.

Corporate Bankruptcy

For a basic corporate bankruptcy, the costs associated with the LIT's services typically start at a minimum of $25,000. This fee is typically derived from the sale of unsecured assets, or a deposit paid by a guarantor, such as the shareholders of the corporation.

In situations where there is no benefit to unsecured creditors from undergoing the formal corporate bankruptcy process, it may be more practical to allow secured creditors to seize their collateral, notify the remaining creditors that there will be no additional payments coming, and then the company to simply shut down its operations - without the need to undergo a formal bankruptcy process.
However, even if a company has shut down and no longer has assets, Directors of a company are responsible for some corporate debts including those identified as "Directors Liabilities" and any other debts they may have personally guaranteed.
In many instances, the costs associated with filing for corporate bankruptcy may outweigh the potential benefits. When faced with significant unpaid corporate debts, Directors may find themselves personally insolvent and compelled to explore their personal options, such as personal bankruptcy or proposing arrangements with creditors.
Opting for bankruptcy or a consumer proposal can provide Directors relief from corporate debts, effectively halting creditors' collection actions against them. While creditors may still pursue the company for outstanding debts, if the company has ceased operations and no assets remain, creditors may find themselves with limited means to satisfy the debts.

Corporate “Wind-Up”

A formal “winding up” under provincial/federal incorporating statues of a limited corporation generally requires that all debts are paid, and all assets have been formally accounted for/liquidated/sold and the final financial statements and required tax filings have been filed.
Alternatively, the company can simply stop operating and stop filing its annual returns with the Provincial Registry Office - after two years, the company will be struck off the registry and cease to exist as a company.

CRA vs BCA (Registry of Companies)

Canada Revenue Agency filing obligations and the provincial Registry of Companies obligations are not the same thing and have different effects and results.
For provincially incorporated companies, they are required to file annual returns listing names of Directors etc. with the provincial registry. If this is not done, then the company “ceases to exist” legally.
Even if the company has been struck from the provincial registry (after failing to file its annual return for 2 years), CRA will be looking to receive the final accounting/payments for the company up to the period it stopped operating. (tax return, GST etc)
CRA issues each new company a Business Identification Number (BIN) and this can be requested to be cancelled when the company stops to operate – however, all outstanding CRA returns must be filed and paid before CRA will consent to cancel this number.

CRA Filing Obligations for Directors after a Personal Bankruptcy or Consumer Proposal

Directors of limited companies have an obligation to FILE outstanding CRA returns and may have a personal obligation to PAY some CRA corporate debt (Director Liability).
However, sometimes, Directors do not have the information to file the outstanding corporate returns or the personal ability to pay corporate debts.
If a person has acted as a Director of a limited corporation that has outstanding returns and CRA debt, they may simply opt to file a personal bankruptcy or proposal. This does not absolve them of the Director obligation to FILE the outstanding returns (legal technicality) but the personal bankruptcy/proposal will include/discharge any potential Director Liability Debts that are payable personally.
The Director does not have to file all outstanding corporate tax returns before they declare personal bankruptcy. However, CRA has taken the policy that if there is outstanding corporate filing obligations, CRA will not accept a proposal filed by individual Directors personally.
If a Director wishes to file a Consumer Proposal personally, then all filing obligations (both corporately and personally) must be met before filing the Proposal (otherwise CRA will automatically vote “no” on accepting the Proposal. )
If a company simply stops operating, the corporate assets/debts also remain. Corporate creditors can seize any corporate assets to satisfy corporate debts.

Final Thoughts

In BC, a person who is bankrupt cannot act as director of a Limited Corporation and as such must resign. IN BC there must be at least one person registered as a Director of any company.

There are many options for both individuals and businesses who are struggling with debt. Our Debt Solution staff at C.E. Craig & Associates Inc with offices in Victoria, Nanaimo, Langford and Surrey are here to answer your questions and we will outline all options.