In Canada, monthly spousal support is usually taxed in the hands of the recipient, but unlike employment income, there are no mandatory “source deductions” to ensure that enough money is set aside to pay the tax bill at the end of the year. As a result, spousal support recipients who do not set aside enough money for taxes can be faced with an income tax bill and no means to pay it, and bankruptcy is not always available to address this debt.
In Re Knowles, 2023 NSSC 94, a spousal support recipient declared bankruptcy to alleviate the CRA debt caused primarily when she did not pay taxes on her spousal support. Although she was granted relief initially, she continued in the same course of action, and was denied relief when she re-applied a second time.
Ms. Knowles went bankrupt in 2017, owing substantial funds (almost $100,000) to CRA. After a divorce, she received taxable spousal support of $10,000 per month, but did not pay taxes on the support. She also made RRSP withdrawals under the Lifelong Learning Plan, resulting in deferred taxes, but the vast majority of her bankruptcy was related to unpaid taxes on the spousal support.
During her bankruptcy, Ms. Knowles was given a budget, including an amount to pay toward taxes for her spousal support that would avoid further arrears. Ms. Knowles paid significantly less. but did not do so after she stopped receiving spousal support and went back to work. As a result, she fell into arrears again.
At her bankruptcy discharge hearing in 2020, Ms. Knowles was required as a condition of her discharge to file and pay her taxes for 2018 and 2019 (the years after she filed for bankruptcy), but her taxes owing through the end of 2017 were cleared.
Ms. Knowles came before the court in January 2023 claiming that she could not pay the new arrears, and asked to make another assignment in bankruptcy to address the post-bankruptcy tax arrears. This request is permitted under s. 172(3) of the Bankruptcy and Insolvency Act (“BIA”).
The court noted that an application under s. 172(3) is neither a back-door appeal from the original order, nor is it a mechanism for a new hearing. The court noted that variations had been granted in cases of significant health deterioration, loss of employment, and substantially reduced income after the original order. The court noted that variations were typically denied where “the bankrupt has created circumstances that render it impossible for him to meet the discharge conditions”, and “Obviously only changes that are beyond the control of the bankrupt should be considered.”
In refusing Ms. Knowles application, the court recognized that all of Ms. Knowles circumstances, including the termination of her spousal support (which was a fixed term of her separation agreement) were known at the time of the original discharge.
The Registrar also refused to permit the bankrupt from applying again for at least one year, stating:
“It is clear that Ms. Knowles’ application, paraphrased, consisted of “you ordered me to comply with two years’ post-bankruptcy tax payment obligations; taxes were also one of the causes of my bankruptcy; I didn’t appeal and didn’t comply; and now I want you to change the order because as a result of not doing it I have a problem; I can’t get out of it until I get a discharge; and my way of dealing with it will be to make a proposal or if that fails perhaps file another bankruptcy.” That’s not in keeping any of the objectives of debtor rehabilitation, creditor protection, or system integrity. I accordingly order that no further application for variation can be made for a period of one year from the date of release of this decision, without prior leave of the Court.”
If you receive spousal support, it is imperative that you get advice as soon as possible from an accountant or other financial advisor, to make sure you are paying enough taxes on this income in order to avoid surprises when your income tax bill comes along.
This blog is not a comprehensive treatment of this topic or legal advice. If you or a family member require more information, we recommend booking a consultations with MDW Law today so our lawyers can assist you.