27 October 1993 External T.I. 9308245 F - Trustee's Liability for In-bankruptcy Taxes

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.

XXXXXXXXXX

Attention:  XXXXXXXXXX

Dear Sirs:

RE:  Bankruptcy & Asset Realization by the Trustee

We are replying to your letter of March 16, 1993 concerning the liability of trustees under the Income Tax Act (the Act) in various situations dealing with individual bankrupts. We apologize for the delay in our response.

You ask us to confirm that the following amounts are to be reported on the return required to be filed by the trustee under paragraph 128(2)(e) of the Act (the "in-bankruptcy return"):

-     amounts received by the trustee out of or under the bankrupt's Registered Retirement Savings Plans and

-     the gain or loss on the disposition of the bankrupt's assets (such as the disposal of business assets which have been fully depreciated).

We agree with your understanding that any income realized by the trustee in the dealings in the estate of the bankrupt are required to be included on the in-bankruptcy return. Such a return would also include any related source deductions withheld on such amounts and, subject to the comments below, the trustee would be liable for any outstanding tax to be paid in respect of that return or would be entitled to any resulting refund arising therefrom.

You describe the situation where the tax payable in respect of the in- bankruptcy return is greater than the cash realized from the disposition of the assets which gave rise to the tax payable. For example, the disposition of a partnership interest which has a large negative adjusted cost base may generate a larger amount of tax than the cash realized from the disposition thereof. You ask for our views on the extent of the trustee's liability in such a case.

While the trustee is liable for the tax payable on the return filed under paragraph 128(2)(e) of the Act, that liability is limited to the amount of the bankrupt's assets to which the Department would otherwise be entitled under the Bankruptcy and Insolvency Act.

You also describe the situation where a bankrupt's assets have been used as security for a debt and the trustee, being satisfied that the bankrupt had no equity in the asset, disclaims any interest in that asset in favour of the secured creditor. The secured creditor then acquires the asset in satisfaction of the debt and is free to deal with that asset in any manner. While you point out that the creditor is supposed to amend the secured claim in the event of the disposition of the security, it is your experience that the trustee does not always know the extent to which the debt has been reduced by the release of the asset. In your view, the trustee has not dealt with an asset so released and as such, any income arising from the disposition of that asset should not be the responsibility of the trustee. You then ask who is responsible for the income tax payable in respect of such property.

The Bankruptcy and Insolvency Act gives the trustee authority over the bankrupt's property to the extent that the property is not exempt from execution or seizure under the laws of the province within which the assets are situated and within which the bankrupt resides. To the extent that the beneficial ownership of the bankrupt's assets is transferred to a creditor in consequence of the bankrupt's failure to pay all or part of the debt owing to the creditor, section 79 of the Act will deem the bankrupt to have received proceeds of disposition for that asset equal to the amount by which the debt has been extinguished. It is not the eventual disposition of the asset by the creditor which gives rise to the gain or loss to be reported on behalf of the bankrupt but the transfer of the beneficial ownership of that asset to the creditor. The release of property to a secured creditor can be distinguished from the situation where income is earned on property which had been assigned to the creditor prior to the date of the bankruptcy as in the case of McLeod Estate v MNR (92 DTC 1033).

Accordingly, the trustee will be required to include in income any gain or loss arising from the deemed disposition arising from the transfer of beneficial ownership to the secured creditor, notwithstanding that the creditor may still have a provable claim after the realization of that security. Any subsequent gain or loss realized by the creditor would be reported by the creditor in the normal manner, taking into account any adjustments to the creditor's cost base as required by section 79 of the Act.

We trust our comments will be of assistance to you.

Yours truly,

P.D. Fuoco for DirectorBusiness and General DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch

c.c.      Assessment of Returns Directorate