9 May 2008 Internal Memo 2007-0260511A11 - Taxation & Insolvency

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: Who pays the tax on funds, remitted by court order, to the trustee?

Position: The trustee in bankruptcy should file an in-bankruptcy return and remit the tax arising from the funds received.

Reasons: Paragraph 128(2)(e).

May 9, 2008

Taxation of Funds Paid by Court Order to a Trustee

This is in reply to your query of November 16th, 2007, concerning the above-referenced. At issue is whether the trustee or the bankrupt should report the amount as income.

The Facts:

XXXXXXXXXX was adjudged bankrupt on XXXXXXXXXX . He became an undischarged bankrupt on XXXXXXXXXX . On XXXXXXXXXX , the trustee was reappointed, at which time he obtained a court order that all funds due from the XXXXXXXXXX be paid to the estate, as the trustee had an interest in them. On XXXXXXXXXX , the trustee received a cheque from the XXXXXXXXXX in the amount of $XXXXXXXXXX , which was deposited in an interest-bearing bank account. On XXXXXXXXXX , the court ordered the trustee to distribute the sum of $XXXXXXXXXX to the creditors, and $XXXXXXXXXX to the bankrupt's counsel. On XXXXXXXXXX , the bankrupt was discharged absolutely from his bankruptcy. The CRA attributed the income, obtained by the trustee, to the bankrupt.

As explained below, the income is attributable to the trustee, who should report the amount, plus the interest earned on that amount, on an in-bankruptcy return, pursuant to paragraph 128(2)(e) of the Income Tax Act.

Explanation:

At bankruptcy, in accordance with subsection 71(2) of the Bankruptcy and Insolvency Act, a bankrupt ceases to have any capacity to dispose of, or otherwise deal with, his property, as such property vests in the trustee. Pursuant to paragraph 128(2)(a) of the Act, the trustee is the bankrupt's agent for all purposes of the Act. Among the trustee's duties is the duty to file a return, under paragraph 128(2)(e) of the Act, on the bankrupt's behalf, to disclose income arising from dealings in the bankrupt's estate. Further, the trustee is liable to pay any tax so determined for that taxation year.

When the trustee received the cheque on XXXXXXXXXX , he received it on account of his being the bankrupt's agent from his dealings in the estate. Therefore, that income was attributable to the trustee, and he should have filed an in-bankruptcy return in XXXXXXXXXX to report the income and pay any tax associated with that return.

An analogous situation occurred in Meltzer v. R., [1996] 1 C.T.C. 2493 (T.C.C.), that is, whether proceeds, paid by an insurance company pursuant to a court order, were correctly attributed to the bankrupt taxpayer. Prior to assigning themselves into bankruptcy, and in an attempt to protect their assets from their creditors, the taxpayers collapsed RRSPs they had held at a financial institution. They then transferred the proceeds into guaranteed income annuities at an insurance company. When RRSPs and similar assets are held at a banking institution, they are not considered to be exempt property. However, when such are held at an insurance company, they are considered to be exempt property.

The taxpayers' creditors brought an action against the bankrupt regarding the transfer of the funds. The court considered the transaction to be a settlement under the then Bankruptcy Act, and declared it void. Further, it held that the annuities were not exempt property. As a condition for their discharge, the court ordered that the funds, net of taxes, be made available to the bankrupts' creditors. The Department (as it then was) included the proceeds from the annuities as income in the hands of the taxpayers. The taxpayers appealed.

The taxpayers based their appeal on section 56 of the Income Tax Act ("the Act"). They argued that by virtue of paragraph 56(1)(d) and subsection 56(2), they did not receive any payment, directly or indirectly; by virtue of subsection 56(4), they did not direct, or concur in, the payment being made to their creditors, nor did they derive any benefit from such. The court allowed the appeal, finding that the annuity payment would have to be income to be reported by the trustee, and the trustee would have to file a tax return and pay the tax thereon, pursuant to paragraph 128(2)(e) of the Act.

In your case, the bankrupt, as in Meltzer, did not receive the funds; rather, his estate did. In Meltzer, the Department had to reassess the taxpayers to properly attribute the income to the trustee. The same will have to be done with this taxpayer.

Trusting this is satisfactory,

Bob Skulski
Manager
Insolvency & Administrative Law Section
Business & Partnerships Division
Income Tax Rulings Directorate