Retroactive tax credits not exempt from bankruptcy

Hill and McPhee (Re), 2026 NSSC 174
Are disability tax credits property of the bankrupt?

Summary: The Supreme Court of Nova Scotia held that disability tax credit-generated refunds for pre-bankruptcy years and the year of bankruptcy are both “property” and “property of the bankrupt” under the BIA, meaning they vest in the trustee for the benefit of creditors, even where the refunds are received only after the bankruptcy filing. The decision arose from two bankrupts who received retroactive DTC-related tax refunds after filing, with the Court concluding that the refunds were not merely speculative, compensatory, exempt or incapable of realization, but were tax refunds captured by the statutory bankruptcy regime. Although the Court recognized that this may produce harsh results where a bankrupt only receives the benefit retroactively, it noted that ss. 68 and 172 of the BIA give courts flexibility to address unfairness through surplus income adjustments or discharge conditions.

Morris Hill made his second bankruptcy filing in October 2020 and received his automatic discharge in October 2022. In October 2023, in respect of periods prior to his second bankruptcy, he received reassessments for the 2014-2020 tax years for a “disability tax credit” (“DTC”) claim, resulting in a total refund of $14,697.28. Taxes were not listed as an asset or a liability in his statement of affairs.

John Lawrence McPhee made his third bankruptcy filing in November 2021 and was not eligible for an automatic discharge. The Trustee filed a notice of opposition on May 3, 2022. Taxes were not listed as an asset or a liability in his statement of affairs. In response to SOA Question 12 (“Do you expect to receive any sums of money which are not related to your normal income, or any other property within the next 12 months?”), McPhee advised of a potential insurance receipt from a fire but was silent as to taxes. In May 2024, in respect of periods prior to or during the filing year of his third bankruptcy, he was re-assessed for the tax years 2017-2021, resulting in a refund of $10,245.38 (with interest) on account of DTCs.

Section 118.3 of the Income Tax Act provides for a non-refundable credit, which the recipient must have sufficient taxable income to “absorb”, thereby reducing the tax that would otherwise be payable. The ITA does not create a refund in and of itself. A qualified claimant can make a retroactive claim for up to ten years. For insolvency purposes, this can mean that if a claimant is successful, taxes paid in the past can be reassessed and this can result in a refund for those years, with interest. These DTCs create the cash that is in issue in this and other cases.

The eligibility for DTC is not automatic. The applicant must qualify, which involves medical evidence of a potentially highly sensitive nature. The BIA sets out a comprehensive regime for what is, and is not, distributable amongst creditors in a bankruptcy. It distinguishes between “property,” and “property of the bankrupt.” All “property” vests in the Trustee under s. 71. However, what is distributable amongst creditors is “property of the bankrupt.” What is “property,” but not “property of the bankrupt” is returned to the bankrupt as being “incapable of realization” under s. 40 of the BIA. In practice, such assets are generally left alone by the Trustee and not taken from the bankrupt only to be returned later, and characterized as “exempt” rather than “incapable of realization.” The practical end effect is generally the same.

The bankrupt also has obligations with respect to property acquired post-bankruptcy but prior to their discharge, and potentially with respect to payment of a portion of their income during a period after their date of bankruptcy, pursuant to ss. 67 and 68 of the BIA. Under s. 67, unless an exception applies, property “that may be acquired by or devolve on the bankrupt before their discharge” is captured by the operation of the section and is distributable among creditors. Accordingly, the issue was whether DTC-generated refunds attributable to the year of, or prior to, bankruptcy were income, property, or “something else,” and whether timing or other issues changed the answer to that question.

Pursuant to s. 67(1)(c), all DTCs for periods prior to, or in, the year of bankruptcy are vested in the trustee. The Office of the Superintendent of Bankruptcy distinguished between pre-bankruptcy (or year of bankruptcy) tax refunds overall, and post-bankruptcy tax refunds, characterizing the first as property of the bankrupt and the latter as income. It submitted that the parliamentary intent was to specify, not limit, the scope of income tax refunds captured by s. 67.

The Trustees for Mr. Hill and Mr. McPhee referenced the parliamentary intention for the BIA to “sweep up a variety of assets of the bankrupt not normally considered ‘property’ at common law”, including (at the time) a tax refund received after discharge but attributable to income earned during the bankruptcy period. This is “property” even if “future and contingent” in nature. The Trustees submitted that the 2008 amendments to s. 67 did not change the analysis on this point, insofar as it related to DTC-generated refunds for years prior to the bankruptcy.

The questions before the Court essentially raised a dispute about statutory interpretation. The Court agreed with the Trustees that “including any tax refund….in respect of the calendar year” in s. 67(1)(c) is clarificatory and not limiting. The amendments to s. 67(1)(c) were reflective of the pre-amendment treatment of tax refunds for the year of bankruptcy as deferred income, rather than property. The amendments, in this light, were Parliament’s response to make the bankruptcy year tax refund fully distributable amongst creditors. The amendments were intended by Parliament to move “year of bankruptcy” refunds into the property column, and not to restrict s. 67’s application to tax refunds for pre-bankruptcy years.

DTCs are not a compensatory regime insofar as they are a non-refundable credit. Their utility is dependent upon the disabled person having sufficient income to use them, or there being a qualified person to whom to transfer them, who has such income. The Court did not consider DTC to be a remote or speculative potential asset. Having found that DTCs are not distinct from other types of tax refunds, and Parliament did not intend to exclude tax refunds for years other than the year of bankruptcy in amending s. 67(1)(c ), it followed that DTC-generated refunds for years prior to, and the year of, bankruptcy were both “property” and “property of the bankrupt” within the meaning of the BIA, and thus vested in the Trustee pursuant to s. 71 of the BIA for the general benefit of creditors. They were not incapable of realization within the meaning of s. 40 of the BIA.

The Court recognized that it may appear unfair that a bankrupt who has been receiving DTC-generated refunds prior to bankruptcy gets to keep them and use them for their own account prior to their bankruptcy filing; but the bankrupt who retroactively receives DTC-generated refunds for years prior to bankruptcy has to turn them over to the Trustee. The person who qualified for the DTC and received a corresponding diminished tax bill pre-bankruptcy presumably was able to spend that money as they went along, either increasing their means or decreasing the debt that was captured in the eventual bankruptcy. Conversely, the bankrupt who is reassessed post-bankruptcy for prior years (or year of bankruptcy) did not have those means and either had to curtail their expenses or increase their debt, and the in-bankruptcy creditors should not be deprived of the funds which are generated by the reassessment.

Further, both s. 68 and s. 172 provide the Court with flexibility to address bespoke or unjust situations. Where a bankrupt has sacrificed their reasonable non-medical needs to address the financial demands of their disability that could have been defrayed by prior receipt of the DTC, the Court can adjust any s. 68 surplus income obligation and/or the conditions of their discharge to address any inequity.

Judge: Raffi A. Balmanoukian, Registrar in Bankruptcy

Professionals involved:

• Raul Rodriguez of McInnes Cooper for BDO Canada Limited, trustee of the estate of Morris Hill and for Rita Anderson & Associates Inc., trustee of the estate of John Lawrence McPhee

• Erin Kennedy of the Department of Justice for the Intervenor, the Superintendent of Bankruptcy

• Gavin MacDonald and Meaghan Kells of Cox & Palmer for the Intervenors Canadian Association of Insolvency & Restructuring Professionals and Nova Scotia Association of Insolvency and Restructuring Professionals

• Dr. Anna Lund, University of Alberta, amicus curiae