Tax refunds and taxes during a consumer proposal

You are considering a consumer proposal, and you are thinking about the tax refund you count on every spring. Or you have already filed one, and you are wondering whether next year’s refund still belongs to you. Or you owe the Canada Revenue Agency, Canada’s federal tax authority, for a past year, and you are not sure a proposal touches that debt at all. This page answers one question, what happens to your tax refund, together with the tax questions that travel with it, in the order they tend to arrive.

Here is the short answer first. In a consumer proposal you generally keep your tax refunds, and that is one of the real differences between a proposal and bankruptcy. There are a few qualifications, and the main one depends on whether you owe the Canada Revenue Agency for a period before the day you filed. This page walks through each in turn.

A consumer proposal is the formal, legally binding debt settlement set out in Division II of Part III of the Bankruptcy and Insolvency Act, R.S.C. 1985, c. B-3 (“BIA”), sections 66.11 to 66.4. For what it is and how it works from the first meeting to the final certificate, see the what-is pillar. This page stays on one subject: tax.

The year you file, and how the refund is split

The refund question matters most in the year you file, because that year is split by the filing date. Part of it falls before you filed and part of it falls after.

Here is how it works. Suppose you file partway through the year, and you owe the Canada Revenue Agency for an earlier year. When your return for the filing year is later assessed, the refund is divided at the date you filed the proposal. The industry has a name for that division: pro-ration. It is the word you will hear from any Licensed Insolvency Trustee who works on your file, and this page uses it the way the profession does. Since almost nobody files a consumer proposal on December 31 or January 1, nearly every filing lands partway through a year, so assume pro-ration can apply to yours. The portion of the refund that relates to the period before you filed can be applied against the tax you already owed. The portion that relates to the period after you filed is paid to you. If you owe the Canada Revenue Agency nothing from before you filed, there is nothing for it to apply a refund against, and the whole refund is generally yours.

You keep the rest for a structural reason. When you file a consumer proposal, your property does not pass to a trustee. Division II of the Act, the part that governs consumer proposals, contains no rule that takes your property from you when you file: filing lodges your documents and starts the legal pause on collection, but title to what you own does not move. That is the core point: a proposal settles what you owe without taking what you have. The full legal basis for that point is set out on the what-is pillar.

Why the pre-filing portion can be applied and the post-filing portion cannot comes down to a set-off right the Canada Revenue Agency has, and the limits the law places on it. The plain version is the one above: the agency can reach back to a debt that was already yours before you filed, and no further. Your own Licensed Insolvency Trustee, the federally licensed professional who administers the proposal, will confirm exactly how a refund you are expecting would be treated in your particular file.

When you owe taxes for the year you file

A refund is only one way the year you file can end. The more important issue, in my experience, is whether you will owe taxes when your return for this year is assessed next spring. The answer up front: the share of that bill that belongs to the part of the year before your filing date goes into the proposal, with every other debt you owed that day, and the share after your filing date is yours to pay in the ordinary way. My debtors get a bit confused on this topic, so I spell it out for them, the same way every time.

Think about it logically. All the debts you owe your creditors as of the day you file are included in the proposal, and the income tax you have built up for the year so far is one of them. But on filing day there is no fast and easy way to determine exactly how much tax you owe. So the year runs its course. Early in the new year you file your tax return as you always do. If the Notice of Assessment, the Canada Revenue Agency’s statement of what you owe or are owed, shows taxes owing, call your Licensed Insolvency Trustee and ask for assistance. They can contact the agency and make sure your taxes owing get pro-rated: divided by the share of the year that ran from January 1 to your filing date, counted in days. The pre-filing share falls into the proposal with your other debts. This division is the agency’s own long-standing practice, applied at its discretion, not a rule written into the tax law, which is exactly why it helps to have your trustee ask for it rather than assume it happens on its own. And please be patient. The adjustment cannot even begin until your return for the year is assessed, which is the year after you file, and the credit can take longer to show on your account than you expect.

Day-count arithmetic is the usual way the year is divided, but it is not the only way. If you incurred a tax liability that you know for certain arose entirely before the day you filed, you can ask for a break-out that reflects that, rather than a division by simple ratio. The way to get it is to have your trustee give the agency a statement setting out the actual split; without such a statement, the calendar-day ratio is what applies. The example I see in practice: a person who was self-employed for the earlier part of the year, owing instalments of income tax, HST (the federal Harmonized Sales Tax) and payroll remittances that were never sent in, who by the day of filing has become an employee of a third party, with no more of those payments to make. In a case like that the tax liability is clearly allocatable to the proposal, all of it, because every dollar of it belongs to the period before the filing.

Cases like that are also when your accountant may be asked to prepare a provisional income tax return. That is a return prepared but not filed, a pro-forma calculation the Canada Revenue Agency does not assess. Its job is to state the tax you owe up to the day of filing, so the tax debt going into the proposal is stated properly in your sign-up paperwork; your real return for the year is still filed in the ordinary way the following spring. Most straightforward employees never need one. It comes up mainly where the year’s income has not had enough tax taken off at source, the self-employment case above being the clearest example, and your Licensed Insolvency Trustee will tell you whether your file needs one.

That estimate has to be made with an accountant’s care, not padded with a safe-sounding number, and the care matters in both directions. If the figure turns out too high, the extra does not follow you: tax you never actually owed cannot survive the proposal, because the Canada Revenue Agency is only ever entitled to prove what your real assessment supports. The cost of guessing high is quieter than it looks. Your proposal was priced against a debt that did not exist, and once it is accepted your payments do not shrink just because the agency’s claim came down. If the figure turns out too low, the shortfall can land back on you after the proposal, as a debt the proposal never settled. That asymmetry is the whole reason this number deserves care rather than a guess in either direction.

Refunds in the later years of your proposal

For tax years that end after you file, the refund is generally yours. A consumer proposal fixes your payment at the start, and an ordinary annual refund does not raise it. That is different from bankruptcy, and different from surplus-income calculations: in the ordinary case, the payment you agreed to is the payment you make, whatever the refund turns out to be.

You still have to file your taxes

A consumer proposal does not pause your ordinary tax obligations. You must still file a return for each year it is due, under the Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.) (“ITA”), section 150. Filing on time during the proposal matters for a practical reason as well as a legal one: the Canada Revenue Agency generally expects outstanding returns to be filed before it will settle a tax account, and a stack of unfiled back-returns is its own problem at the start of a file.

If you are coming to a proposal with several years of unfiled returns behind you, the practical answer is that they get filed, early: the agency generally holds back any refund while a required return is outstanding, and it expects the back-returns in before it will deal with the account. The CRA garnishment guide walks through starting a file with unfiled years.

If you already owe the Canada Revenue Agency

The Canada Revenue Agency as a creditor worries people more than it should. Income tax you owe for years before you file is generally an ordinary unsecured debt in a consumer proposal: it is included and settled along with your other unsecured debts, unless the agency has already taken a step to secure it. Certain business amounts the agency holds in trust, such as payroll source deductions and debts owing which were initially fully unsecured but have since become the subject of a tax lien, are treated differently again, and your Licensed Insolvency Trustee checks how the agency has treated your particular balance. The agency does accept consumer proposals, it expects your outstanding returns filed before it will deal, and until a filing is made its collection powers reach further than a private lender’s. The CRA garnishment guide walks through that ground step by step, from how the agency votes on proposals to how its collection powers work and when they stop.

How bankruptcy is different

Bankruptcy treats the refund the opposite way. On a bankruptcy the debtor’s property vests in the trustee (BIA sections 71 and 67). The tax refund for the year of bankruptcy is expressly caught for the creditors under section 67(1)(c). Refunds for prior years vest under the same opening words of that provision. Both are part of what the trustee collects. A proposal has no equivalent step, which is why the refund stays with you. The full side-by-side comparison, refunds and everything else, is worked through in the versus-bankruptcy article.

Common questions

One last thing, because it is the mistake that brings most people to this page. Do not assume your refund disappears because that is what happens in bankruptcy. The two systems work differently, and they are built differently on purpose. Understanding the difference often changes the conversation about which option fits.