Proposals made easy

By Bryan Tannenbaum
Illustration: Susanna Denti

Thanks to a CAIRP initiative, debt problems can now be solved and finances rehabilitated with greater ease

Individuals with debt problems will be able to make arrangements with their creditors and then rebuild their financial lives more easily, thanks to an initiative by the Canadian Association of Insolvency and Restructuring Professionals (CAIRP). Much of the past uncertainty surrounded the treatment of income tax liability for individuals who file proposals under the Bankruptcy and Insolvency Act. Previously, there was uncertainty whether liabilities incurred within the calendar year up to the time of the proposal would become a liability post-proposal. Part of the uncertainty came from the fact that Canada Revenue Agency (CRA) representatives had no firm rules to follow, so they would use their discretion regarding splitting of the tax year when considering proposals. This meant there was little or no consistency in CRA decisions, as practice was different among individual CRA offices. In some cases, proposals would be directed to one CRA office or another, depending on that office’s reputation for ruling on income tax liability.

This meant that debtors would not know whether they would be hit with a sudden demand for a tax payment, which might come at precisely the time when they could least afford to pay. So, proposal proponents and their advisers looked for ways to minimize the amount of uncertainty around income tax liability. For many, the solution was to delay filing their proposal until the end of the calendar year, or the start of the next.

While it removed the income-tax uncertainty, this solution often caused other problems. Trustees in bankruptcy saw such situations played out in many cases and observed three major difficulties caused by delayed proposal filings:

• the debtor has no chance to start rebuilding his or her financial affairs until a proposal is filed, perhaps months from the time financial disaster was first noted;
• debtors’ situations often get worse as time goes on, so delays in dealing with the situation through filing a proposal often leave the individual financially weaker. This means when eventually filed, the proposal is much less attractive to creditors than it might have been if filed earlier, and more likely to be rejected by some or all creditors because it means lower realizations for them;
• creditors are under pressure to resolve outstanding debt situations promptly. They want to realize as much of their debt as they can, and move on. If they are forced to wait months for the situation to be resolved because the debtor is delaying filing until December or January, they may just go ahead and petition the debtor into bankruptcy, to achieve closure. This can be devastating for the debtor, as climbing out from under bankruptcy is much harder than doing so from a proposal. We can see this in the R rating of the North American Standard Account Rating System, in which an R1 rating indicates a reliable payer, with numbers ranging up to R9, indicating someone with a truly terrible credit history. Filing a proposal means the debtor endures R9 status only for the proposal period and upon completion of the terms it becomes R7 for the following three years. However, bankruptcy means R9 status for the debtor for six years subsequent to discharge and if the individual becomes bankrupt again, it means R9 status for 14 years.

Having seen the negative effects of delayed proposals, CAIRP proposed a solution. In December 2002, it submitted a brief to Finance requesting an amendment to the Income Tax Act that would permit a deemed year-end in proposals. With a year-end that suits the debtor rather than the calendar, it was hoped, debtors would be freer to file sooner.

However, amendments to a major act do not happen overnight. So, for the interim, CAIRP has developed a Standard of Professional Practice regarding the income tax debt of proposal debtors. Effective February 1, 2004 CRA has agreed to institute application of CAIRP’s standard to proposals.

Under this standard, CRA files a provisional proof of claim, based on an accurate-as-possible estimate of the pre-proposal income.

This means it is important for the debtor to calculate, as carefully as possible, the estimated pre-proposal income tax debt for the calendar year. If this estimate turns out to be too low, CRA will add the missing amount to the post-proposal income tax liability. Consistent with the decision in Gollner v. CCRA (2003) D.T.C. 5608, 4J C.B.R. (4th) 76, I C.T.C. 254, CRA will no longer pro-rate income and deductions.

The standard has several aspects that should improve the quality of information going to CRA, so its officials will have less difficulty deciding how to vote on the proposal.

• One way the standard supports accuracy is through the guidelines it provides for determining the pre-proposal liability.
• The trustees will be required to consider the accuracy of the income tax debt as set out in the debtor’s statement of affairs. Further, the proposal must include specific terms that attest to the accuracy of the information about the debtor’s finances.
• The debtor must undertake to make sure that the post-proposal debt is not affected by the proposal and will be paid as normally required.

We can hope the change in practice regarding proposals will result in greater availability of proposals as a means of helping individuals’ financial rehabilitation. Accountants advising anyone with debt problems can be more confident that the proposal route is a viable option when it comes to settling with creditors and assisting clients in getting their financial lives back on track and eliminating the misery of this overwhelming burden.

A major success factor in working with CRA is communication. This has assumed even greater importance due to another recent change in the way CRA works with taxpayers in financial difficulties.

It used to be that a trustee in bankruptcy could take to CRA a “no-names” scenario on behalf of a debtor, and without disclosing the individual’s identity, obtain CRA’s preliminary view as to whether CRA would be inclined to accept the terms of the proposal, if it were filed. CRA will no longer permit this approach and will not discuss its views on the potential terms of a proposal unless a proposal is filed, or the individual files a Notice of Intention to make a Proposal. Therefore, it is essential to put one’s best foot forward at the start.

To see why, it’s important to understand the process from CRA’s view. CRA wants to resolve the situation as soon as possible, so its representatives’ time is not misused and it can receive at least part of the tax owed in a timely manner.

CRA also wants to be convinced that these financial difficulties will not be a recurring event and its willingness to make a deal will not be abused by the individual in question in the future.

Accordingly, CRA requires detailed in-formation on the debtor’s financial situation, how he or she wound up in difficulty and the steps taken by this person to get back on firmer financial footing. CRA needs to be convinced the proposal is the best deal possible and will result in a greater realization than it would achieve by pushing someone into bankruptcy.

To develop an effective communications program that meets CRA’s needs regarding a given proposal, it is important to consider its information needs and then act accordingly. CRA often knows little about the individual and the circumstances that led to the financial difficulties. Providing financial information clearly to CRA will result in the decision being focused on the proposal, rather than having the discussion concentrate on clarifying the individual circumstances. It may also mean further meetings and/or discussions with CRA to provide updates. This includes updates of bad news as well as good.

It is important to be appropriate in the communication method chosen. CRA prefers to get its information through completed forms and documents that meet its requirements. In some cases, CRA’s representatives will be content to receive updates informally.

A good indication of success is when the proposal report provided to CRA results in few, or no, questions for clarification or requests for further information. The best indication of success is when CRA accepts the proposal put forward.

Bryan A. Tannenbaum, FCA, CA·CIRP, trustee in bankruptcy, is president of Mintz & Partners Ltd. (bryan_tannenbaum@mintzca.com)

Technical editor: Peter Farkas, CBV, CIRP, CA, is a vice-president Richter & Partners Inc. in Toronto