At times, small business owners may find themselves struggling with debt. Fortunately, there are options available for both the business and its owners to obtain financial relief and start fresh. However, determining what information is required and understanding the relationship between corporate and personal debts can be complex. If you are a business owner considering filing for personal bankruptcy or a personal proposal, here’s what you need to know before beginning the process.
Assessing Your Assets
- If you own shares in a limited company, they must be listed as a personal asset, and their value must be determined.
- Your shares may have little to no value if the company has debts that exceed its assets or if it has ceased operations with no remaining assets.
- A Licensed Insolvency Trustee (LIT) will need to review the company’s books and records, including a list of its assets (Fair Market Value), debts (especially CRA debts), the last filed corporate tax return, financial statements, and outstanding corporate tax filings.
- To confirm the value of a company, as your LIT we will examine previously filed corporate tax returns, the fair market value of corporate assets (such as trucks, equipment, and bank accounts), and corporate debts. Some corporate debts may become personal debts for company Directors (“Directors’ Liabilities”) – see below.
Understanding Your Liabilities
- You must document all personal debts, including any potential CRA “Director Liability” debts.
- Directors Liabilities Include: In BC, Directors can be personally liable for certain unpaid corporate debts, including:
- Goods and Services Tax (GST)
- Provincial Sales Tax (PST)
- Payroll withholdings (including penalties and interest)
- Other corporate debts to which a personal guarantee was granted.
NOTE: COVID-related grants (i.e. CERB loans) do not attract Directors’ Liabilities.
Tax Return Requirements
Personal Consumer Proposal
- If you have outstanding tax debts personally or through your company, all tax returns must be prepared before filing a personal proposal.
- Business records must be reviewed to determine whether all advances or funds taken by the shareholder/director have been reported on personal income tax returns.
- If CRA is expected to compromise tax debts under the proposal, full disclosure of all personal tax obligations is required. Failure to fully value tax debts may lead to the proposal being deemed null and void against undisclosed ‘CRA debts, even after full compliance with the settlement terms.
Personal Bankruptcy
- If you are a Director/Shareholder and have opted to file a personal bankruptcy, the outstanding tax returns do not need to be filed before starting a bankruptcy process.
- However, before the bankruptcy process ends, the Trustee must file personal tax returns for the year of bankruptcy and the immediately preceding year.
- If there is undeclared income from a limited corporation during this period, the Trustee must update CRA and file (or refile) personal tax returns accordingly.
- The Trustee may file additional outstanding tax returns if it benefits the bankruptcy estate (as tax refunds for previous years become assets of the bankruptcy estate).
- Currently CRA has a policy where they will not issue future tax refunds if there are outstanding tax returns.
- Additionally, failure to declare income in past years can reduce Canada Pension Plan (CPP) benefits in retirement in future. (as CPP benefits are calculated based on reported employment earnings – if you don’t report, then your future benefits will be reduced.
Corporate Dividends and Insolvency
- Declaring a corporate dividend is a common method of accounting for funds paid to shareholders.
- Declaring a dividend creates income tax obligation for both the shareholder who received the dividend and the company declaring the dividend (corporate income tax payable.)
- If a company is insolvent, declaring a dividend may violate provincial incorporation statutes if:
- The company was already insolvent when the dividend was declared.
- Declaring the dividend rendered the company insolvent.
- Declaring a dividend shifts part of the tax burden (roughly half) to the company that would otherwise be payable by the shareholder if the funds were treated as wages.
- If the company is unable to pay its debts, it may cease operations, but unpaid debts remain.
- Directors remain personally liable for any Director Liability Debts and any other personally guaranteed corporate debts, even if the company ceases to operate.
Dividend Stripping
- Shareholders often withdraw funds from their corporations as dividends rather than wages.
- When a company shuts down without paying corporate taxes, shareholders have effectively benefited from the income they received but taxed at a lower rate if the corporate income tax remains unpaid in the company.
- CRA considers this practice dividend stripping and may reject personal proposals filed by individuals involved in such practices.
- CRA may also invoke Section 160 of the Income Tax Act to hold both the company and shareholders responsible for unpaid corporate income taxes.
Section 160 of the Income Tax Act, Canada
- CRA can pursue individuals who receive money or property from a tax debtor without proper consideration.
- This applies to:
- Direct transfers to related parties (e.g., gifts to spouses or dividends to shareholders).
- Indirect transfers involving arm’s-length parties before reaching a related party.
- Transfers to trusts with non-arm’s length beneficiaries.
- If Section 160 applies, both the transferor and recipient are jointly and severally liable for the original tax debt.
- The recipient’s liability cannot exceed the fair market value of the transferred property.
Corporate Bankruptcy vs. Informal Wind-Up
- A corporate bankruptcy filed under the Bankruptcy and Insolvency Act costs at least $25,000 and is often funded by asset liquidation or shareholder contributions.
- If a company ceases operations and has no assets, creditors may have limited means to recover debts.
- Instead of a formal bankruptcy, any secured creditors may just opt to seize their collateral, and the company can then just notify remaining creditors of its closure without undergoing a formal bankruptcy.
- However, Directors remain personally responsible for any Director Liabilities and personally guaranteed corporate debts.
Corporate “Wind-Up” under Formal Winding up Statues
- formal winding-up of a limited corporation requires:
- Payment of all debts.
- Liquidation of all assets.
- Final corporate tax filings.
- Alternatively, a company can cease operations and stop filing annual provincial registry returns. If no filings occur for two years, the company will be struck from the BC Corporate Registry and legally cease to exist.
CRA vS. BC-Registry of Companies
- CRA and the BC Registry of Companies have different filing obligations.
- BC-incorporated companies must file annual returns listing Directors with the Provincial Registry.
- Even if a company is struck from the BC Registry, (which happens after two years of not filing annual corporate returns with the Registry) CRA still requires final tax returns (T2 corporate tax, payroll, GST) for its last operating year and all other operating periods..
- CRA assigns every business a Business Number (BN), which can only be cancelled when the company has met all filing and payment obligations.
Director Obligations After a Personal Bankruptcy or Proposal
- Directors remain responsible for filing outstanding CRA returns even after a personal bankruptcy or proposal has been filed. Once they go through a formal insolvency process, they no longer have an obligation to pay the corporate debts, but the statutory obligation to FILE any outstanding returns, remains. .
- Personal bankruptcy/proposals may discharge Director Liability debts but do not remove the requirement to file outstanding corporate returns.
- If corporate tax returns remain outstanding, CRA often will automatically vote “No” on a personal proposal filed by a Shareholder/Director of the company.
- In BC, a bankrupt individual cannot serve as a Director of a Limited Corporation and must resign.
Navigating corporate and personal insolvency can be complex. If you’re struggling with personal or business debts, speaking to a Licensed Insolvency Trustee (LIT) can help you understand your options.
At C.E. Craig & Associates Inc., we assist business owners across Victoria, Nanaimo, Langford, & Surrey in making informed financial decisions.
