Companies facing financial difficulties often have to make tough decisions about what actions to take to save their business. These decisions can have a significant impact not only on the business itself but also on the taxes involved. If you are a Canadian business facing company insolvency or restructuring and want to learn more about the tax considerations involved, contact Jeremy Scott Law today at (902) 403-7201 to get the answers you need.

What Is Insolvency?

In Canada, insolvency is a federal matter that involves two separate processes: bankruptcy and restructuring. Bankruptcy involves selling off the debtor’s assets bit by bit, while restructuring can be done through an agreement between the debtor and their creditors or by selling the debtor’s assets or business on an ongoing basis.

The federal statutes that are primarily responsible for governing insolvency proceedings include the following:

The Companies’ Creditors Arrangement Act (CCAA): According to the Government of Canada, the CCAA outlines the restructuring process for insolvent companies with debts over $5 million. This law allows for the creation of plans of arrangement that enable debtors to reach agreements with their creditors or for the business to be sold under the court’s oversight.
The Bankruptcy and Insolvency Act (BIA): The BIA is a Canadian law that governs the bankruptcy process. The law’s provisions include a streamlined proposal regime for debtors to reorganize and negotiate with creditors.
The Winding-up and Restructuring Act: The Winding-up and Restructuring Act is typically used to wind up regulated institutions such as insurance companies, banks, and trust corporations.

Tax Considerations Involved With Insolvency

Using the CCAA or BIA may result in tax implications for debtor corporations that directors and owner-operators should consider. Some of these implications are discussed below.

Restructuring Issues

Creditors may agree to a partial settlement of their claim or a conversion of their claim into shares of the debtor company when it is restructured. If the debtor company is not bankrupt under the Bankruptcy and Insolvency Act, settling a debt for less than its principal amount will have tax consequences for the company. This means that certain tax attributes of the debtor company, such as loss carryforwards, undepreciated capital cost (UCC) of depreciable property, or adjusted cost base of capital assets, will be reduced by the amount of the receivable reduction.

Depending on the specifics of the case, if the corporation’s tax attributes are insufficient to absorb the amount of debt forgiven, the forgiven amount may be included in the calculation of the company’s taxable income under the Income Tax Act, which can lead to tax liability.

Strategies To Limit The Tax Consequences

Restructuring under the Companies’ Creditors Arrangement Act can be managed through various strategies to limit negative tax outcomes. For instance, in some cases it may be feasible to transform the debt into shares of the debtor company without any adverse effects, provided that the fair market value of the shares issued at the time of conversion of the debt is equivalent to the principal of the debt.

In addition, it may also be possible for a shareholder of a debtor company to have their debt written off without any consideration or the need to issue shares. Reserve mechanisms or tax deductions can be used to avoid the debtor corporation’s income inclusion in certain situations. However, because company insolvency is such a delicate and complicated matter for companies, proper tax planning is critical to maximize the efficiency of the corporate restructuring process. For more information about this planning or restructuring as a Canadian business, contact Jeremy Scott Law to speak with our legal team today.

How Business Structures Impact Tax Implications

In Canada, the tax implications of filing for bankruptcy vary based on whether the business is a sole proprietorship, partnership, or corporation.

Sole Proprietorship: When it comes to bankruptcy, sole proprietorship is treated the same way as personal bankruptcy. This is because the Canada Revenue Agency (CRA) views the business and the owner as a single entity. Even if the sole proprietor declares bankruptcy, the business can continue its operations.
Partnership: If you are in a business partnership with another person and declare personal bankruptcy, the partnership will cease. However, if you are in a partnership with more than one person and declare personal bankruptcy, the partnership may continue to operate. In either case, you will face the same consequences as filing for personal bankruptcy.
Corporation: A corporation is a legal entity that requires a board of directors to pass a resolution authorizing a bankruptcy filing.

To better understand how bankruptcy can impact your company’s taxes, consider reviewing your situation with a legal professional experienced in tax advisory services. A skilled Canadian tax lawyer may be able to provide you with the tailored advice you need to assist with your unique situation.

Discharge of Tax Debt

When an organization files for bankruptcy in Canada, the Canada Revenue Agency is informed. Any outstanding tax debts owed to the agency or provincial tax authorities at the time of filing are usually included in this process. This means that those debts are typically forgiven or discharged. However, if the organization owes income tax after being discharged from bankruptcy, the restructured company will still be required to pay the tax as owed. In some cases, if the tax attributes of a business filing for bankruptcy are not enough to cover the debt forgiven, this amount may be included in the business’s taxable income calculation, which could create a tax liability.

Learn More About Tax Considerations in Restructuring and Company Insolvency

The corporate restructuring process can be difficult, and even knowing where to begin may present challenges for many Canadian business owners. If you own or operate a Candian business considering company insolvency, or simply want further information about the tax implications involved with the corporate insolvency process, contact Jeremy Scott Law by calling (902) 403-7201 to review your questions and concerns with a experienced Canadian tax lawyer and learn how our legal team may be able to help you.