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Diewold (Re), 2018 SKQB 149

How does the Court determine if a bankrupt is an honest but unfortunate debtor?

The Debtor—a 64 year old pensioner with no available surplus income—owes the Government of Canada a debt of $263,817.16 for personal income tax. The income tax debt makes up over 99% of the unsecured proven claims in the bankruptcy. The Canada Revenue Agency (“CRA”) opposed the Debtor’s bankruptcy discharge. The Trustee reported that the Debtor has assets worth $425,249, but only $5,124 of those assets are realizable for the estate.

When a personal income tax debt equals or exceeds $200,000 and the same debt makes up 75% or more of the proven unsecured liabilities in a bankruptcy, a hearing is required to determine the appropriate terms of discharge by operation of s. 172.1 of the Bankruptcy and Insolvency Act (the “BIA”). A court must consider the bankrupt’s conduct to determine whether the bankrupt is an honest but unfortunate debtor who ought to be given a fresh financial start. Specifically, a s. 172.1 analysis involves the following considerations:
  1. the circumstances of the bankrupt at the time the personal income tax debt was incurred;
  2. any efforts made by the bankrupt to pay personal income tax debt;
  3. whether the bankrupt made payments in respect of other debts while failing to pay the personal income tax debt; and
  4. the bankrupt’s financial prospects for the future.
 There is a distinction between income tax debt and other debts insofar as income tax debt is incurred and payable from the moment income is earned. If there is no taxable income, there is no income tax. Income tax is not a liability presently incurred to be paid from future income. As such, in most high income tax cases, general deterrence ought to be given more weight than the policy objective of a bankrupt’s financial rehabilitation.

The Debtor’s personal income tax debt was incurred because, from 2003 to 2012, she participated in a fictitious donation scheme that was designed to create inflated refunds and help its participants avoid paying income tax. The Debtor argued that she had no reason to believe that the tax shelter and her related tax deductions were unlawful. She pointed to the fact that the CRA had issued a registration number and allowed her tax filings in regard to the shelter for years. She believed that the discrepancy between what she paid for each donation and the amount on the receipts that she claimed with the CRA was a lawful benefit.
The Debtor stopped contributing to the tax shelter in 2005. However, she continued to claim $56,000 worth of donation carry forwards even after she became aware that the CRA was reassessing the donation claims. The Debtor admitted that she was aware of the CRA’s determination that the investment arrangement was not legitimate in 2009, but she continued to claim carry forwards since the question the arrangement’s legitimacy was still making its way through the courts. The CRA argued that the Debtor knew or ought to have known that this donation scheme was fictitious and that she was participating in it for the purpose of avoiding her taxes.

The Debtor had had the benefit of $160,687 that ought to have been provided to the government for the public benefit. The Court inferred that the Debtor used these funds to pay her expenses during the years leading up to her bankruptcy. She did not make any voluntary payments to deal with her income tax debt.
It was not reasonable for the Debtor to believe that it was acceptable for her to avoid having to pay taxes that other Canadians were required to pay, even if the Court were to concede that the CRA ostensibly sanctioned the arrangement by allowing the tax filings. A reasonable person ought to question the legitimacy of a scheme that provides receipts for tax deductions that are significantly more than the amount paid for a donation. The Debtor was not an honest but unfortunate debtor, and she ought to have realized that there were concerns of legitimacy regarding the investment arrangement.
The Court concluded that an emphasis on general deterrence was warranted and ordered the Debtor to pay $35,000 to the Trustee and be subject to a suspension of seven years before being eligible for discharge. In making the order, the Court considered that the Debtor did not have the support of family and would likely have to work longer than she may have planned to. It would benefit no one to put her in a position where she became dependent on assistance payments. Still, the Court maintained that it could not disregard the fact that the Debtor had the benefit of $160,687 that was not available to other taxpaying Canadians.

CounselBryan Frape for the Attorney General of Canada 

 Full case: http://canlii.ca/t/hs0kj