9 August 2011 Internal T.I. 2011-0410301I7 - Offset of Post-Bankruptcy Refunds

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: Whether a refund for the calendar year of a bankruptcy can be offset?

Position: Yes.

Reasons: A refund in respect of the calendar year of bankruptcy forms part of a bankrupt estate, pursuant to paragraph 67(1)(c) BIA. However, exceptions permit offset under subsection 164(2) to limit its operation. The exceptions include:
(1) liability of a proprietorship or partnership for source deductions or GST/HST that arose before the proprietor's or partner's bankruptcy;
(2) a derivative assessment under subsection 159(3), 160(1), 224(4), or 227.1(1) ITA where the liability arose from an act or failure that occurred after the date of bankruptcy;
(3) a derivative assessment under subsection 270(4), 317(7), 323(1), or 325(1) ETA where the liability arose from an act or failure that occurred after the date of bankruptcy;
(4) an income tax liability for a year subsequent to the year of bankruptcy where the liability arose before the return claiming the refund was filed;
(5) a derivative assessment for a director's liability under subsection 227.1(1) ITA or 323(1) ETA where the corporation's failure to remit occurred before the individual's bankruptcy, but the precondition in paragraphs 227.1(2)(a), (b), or (c ) ITA or 323(2)(a), (b), or (c) ETA was not met until after the date of the individual's bankruptcy.
Legal advice should be sought:
(1) to determine whether a deemed trust claim under subsection 227(4) or (4.1) ITA in respect of a source deductions liability of a proprietorship or partnership which arose before the bankruptcy of the proprietor or partner would have priority over paragraph 67(1)(c) BIA; and
(2) to ascertain if other situations exist where subsection 164(2) ITA might have priority over paragraph 67(1)(c) BIA.

		August 9, 2011

	Individual Returns Directorate			HEADQUARTERS
	Processing Division					Income Tax Rulings
		  							Directorate
	Attention: Pamela McCarthy, Manager			Lindsay Frank
	           T1/T3 Accounting Enquiries Section	(613) 948-2227

									2011-041030

Offset of Post-Bankruptcy Refunds

This is in reply to an inquiry from Valorie Bunce regarding the interplay of paragraph 67(1)(c) of the Bankruptcy and Insolvency Act ("BIA") with subsection 164(2) of the Income Tax Act ("ITA"). The issue relates to the exigibility of refunds pertaining to the taxation year that is deemed, pursuant to subparagraph 128(2)(d)(i), to begin on the day an individual becomes bankrupt. Specifically, she would like to know whether such a refund could be offset against other tax liabilities.

Subsection 152(1) ITA requires a return to be processed with all due dispatch. Any resulting refund does not necessarily have to be issued to the taxpayer. Pursuant to subsection 164(2), the refund may be applied to an actual or impending tax liability. However, where the refund relates to the taxation year that is deemed to begin by operation of subparagraph 128(2)(d)(i), it is subject to the provisions of paragraph 67(1)(c) BIA, which provide that it forms part of the bankrupt estate. There are exceptions, and these will be discussed later.

It should be noted that subsection 97(3) BIA allows for set-off; moreover, a bankrupt's estate includes only the net amount of a debt owing to the bankrupt after allowance for set-off, see Husky Oil Operations Ltd. v. M.N.R. (1993), 22 C.B.R. (3d) 153 (Sask.C.A.), aff'd in 35 C.B.R. (3d) 1 (S.C.C.). Where an income tax claim is concerned, the law of set-off does not apply; rather, it is the offset provisions of subsection 164(2) ITA that apply, see Re White Motor Corporation of Canada (1981), 38 C.B.R. (N.S.) 173 (Ont. S.C.).

As indicated earlier, there are a number of exceptions, including ones under the Excise Tax Act ("ETA") where offset pursuant to subsection 164(2) may limit the operation paragraph 67(1)(c) BIA. The following, while not exhaustive, is a list of the exceptions:

(1) the liability of a proprietorship or partnership on account of source deductions or GST/HST that arose after the date of bankruptcy of the proprietor or partner;

(2) a derivative assessment under any of subsections 159(3), 160(1), 224(4) or 227.1(1) ITA, where the liability arose as the result of an act or failure that occurred after the date of bankruptcy;

(3) a derivative assessment under any of subsections 270(4), 317(7), 323(1) or 325(1) of the ETA, where the liability arose as the result of an act or failure that occurred after the date of bankruptcy;

(4) an income tax liability in respect of a year subsequent to the year of bankruptcy, where the liability arose before the return claiming the refund was filed;

(5) a derivative assessment on account of a director's liability under either subsection 227.1(1) ITA or 323(1) ETA, where the corporation's failure to remit occurred before the individual's bankruptcy, but the precondition in paragraphs 227.1(2)(a), (b), or (c) ITA or 323(2)(a), (b), or (c) ETA was not met until after the date of the individual's bankruptcy.

You might wish to check with Legal Services to determine whether a deemed trust claim under subsection 227(4) and (4.1) ITA in respect of a source deductions liability of a proprietorship or a partnership, which arose before the bankruptcy of the proprietor or partner, would enjoy priority over paragraph 67(1)(c) BIA. Needless to say, the deemed trust would have been extinguished had the individual been discharged from bankruptcy. You should also inquire from Legal Services if there are other situations where subsection 164(2) ITA might have priority over paragraph 67(1)(c) BIA.

Should you have any questions or require additional information, please do not hesitate to contact Lindsay Frank at the number provided at the outset of this memorandum.

B.J. Skulski
Manager
Insolvency and Administrative Law Section
International and Trusts Division
Income Tax Rulings Directorate

c.c. Valorie Bunce
T1/T3 Accounting Enquiries Section
Processing Division

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