Does Filing For Bankruptcy Eliminate All Debt?

Many Canadians are struggling with debt as high interest rates and rising inflation increase the cost of day-to-day necessities. You may be searching for a way to relieve your financial stress and asking yourself if bankruptcy is the right solution for your situation. However, bankruptcy does not eliminate all debts — and it is important to understand what types of debt a bankruptcy eliminates before you make a decision. 

Let’s review insolvency in Canada and which debts can and cannot be eliminated through bankruptcy. We will also discuss whether bankruptcy can eliminate income tax debt and the importance of reaching out to a professional like a certified non-profit Credit Counsellor or Licensed Insolvency Trustee (LIT) to help you navigate all the available options for debt relief.

Understanding Insolvency in Canada

Canada has strong and fair insolvency rules, with insolvency laws designed to allow an honest debtor to obtain a financial fresh start. A person who is struggling with an overwhelming amount of debt has several options to deal with their debt. One of them is bankruptcy.

Filing for bankruptcy will allow an individual to obtain relief from their creditors (collection calls, garnishments, etc.) and keep their essential assets. Once the bankruptcy is completed, they can restart their financial life debt-free. A bankruptcy must be filed with an LIT, who will assist the individual to complete the bankruptcy administration. 

An individual who files for bankruptcy has several duties they must comply with, including submitting income reports and attending financial counselling sessions. These duties also include providing the information necessary to prepare income tax returns for the year of bankruptcy. Reporting on any property obtained after filing for bankruptcy and paying any agreed-upon amounts is also required.  

A consumer proposal is another form of insolvency to deal with an overwhelming amount of debt and allows an individual to settle their debt for less than the full amount they owe. The amount they will need to pay depends on each person’s unique situation, such as assets and household income. An LIT will assist the debtor to put forward a consumer proposal that they can afford, usually structured as monthly payments over five years. An individual filing a consumer proposal must also attend two financial counselling sessions. 

While debt consolidation is not a formal insolvency proceeding, it also allows an individual to obtain relief from their creditors by consolidating their debt into one fixed affordable monthly payment. 

Additionally, creditors have a specific window of time to collect outstanding debt that varies from province to province. If your debt has passed this limitation period, it becomes statute-barred and not legally collectible in some circumstances. An LIT can advise you of your options for dealing with those types of debts as well.

What Debts Are Eliminated Through Bankruptcy? 

A bankruptcy or consumer proposal eliminates most unsecured debts, such as credit cards, credit lines, personal loans, and even taxes. An unsecured debt means that when you buy something, the creditor cannot take back the purchased goods if you do not pay. 

A purchase made using a credit card is an example of an unsecured debt, where you then owe the credit card company the money and they don’t have the right to ask for the purchase back. Income taxes, rent, public services (electricity, cable TV), and personal loans are also usually considered unsecured debts. 

The creditor can still come after you in other ways if you are unable to repay your unsecured debts — such as by making threatening phone calls or garnishing your wages with a judgment. Filing for bankruptcy or creating a consumer proposal can protect you from further action by the creditor and allow you to resolve your debt challenges.

What debts can’t be eliminated through Bankruptcy? 

There are some debts that can’t be discharged through a bankruptcy or consumer proposal, as it would be unfair to creditors and not in the public interest. These include:

• Secured debts
• Alimony or child support payments
• Court-imposed fines and parking tickets
• Student loans under seven years old     
• Some debts arising from fraud or gambling.

Secured debt

A secured debt is any type of debt that is backed by an asset or property, which is used as a guarantee that the debt will be repaid. Mortgages and car loans are examples of a secured debt. This type of debt cannot be eliminated through a bankruptcy or consumer proposal if the individual wishes to keep the asset. Scheduled payments must continue to be made to retain possession of the property. 

Surrendering the asset is an option at the time of filing — and any shortfall will be included in the bankruptcy or consumer proposal. A good example of this is a vehicle loan. If the vehicle is worth $10,000, but the balance of the loan against the vehicle is $15,000, an individual may choose to surrender the vehicle back to the secured creditor. The $5,000 shortfall will be a claim provable in the bankruptcy or consumer proposal.

Alimony and child support arrears

Alimony and child support arrears and ongoing payments must continue even after declaring bankruptcy. If an individual’s wages are being garnished, these cannot be lifted by filing a bankruptcy or consumer proposal. Regulations for collecting these arrears depend on the province you live in, and an LIT can provide insights into how they should be handled.

Court-imposed fines, penalties, and parking tickets

A bankruptcy cannot discharge court-imposed fines, penalties, and parking tickets. However, it's essential to differentiate between these court-related obligations and judgment debts from lawsuits, as the latter can often be eliminated in a bankruptcy or consumer proposal. An LIT will help determine which debts are covered.

Student loans

Student loans cannot be discharged through a bankruptcy or consumer proposal if the individual has been out of school for less than seven years. However, determining the age of a student loan can be complex — depending on factors such as your graduation year or last date attended. The timing of the filing matters, and an LIT can clarify whether your student loan is eligible for discharge through bankruptcy or a consumer proposal.

Debts from fraud or gambling

You should seek professional advice from an LIT if you’re dealing with fraud and gambling debts. Discuss the specifics of your situation with them as their role is to guide you towards the best path while being fair to your creditors and adhering to bankruptcy and insolvency regulations in Canada.

Fines, penalties, and restitution orders

Fines, penalties, and restitution orders given by a court for damages in civil cases related to intentionally inflicted bodily harm, sexual assault, or resulting wrongful death are not eliminated through a bankruptcy or consumer proposal. An LIT will need to review the specifics of the debt, including copies of the orders and underlying claims, to make a determination of these types of debts.

Can a bankruptcy eliminate income tax debt?

Most people assume that income tax debt cannot be eliminated through a bankruptcy or consumer proposal. However, income tax debt is a provable claim in a bankruptcy or consumer proposal and will be eliminated once the bankruptcy or consumer proposal is completed. 

The Canada Revenue Agency (CRA) does have some rights of set-off — which means they can use some of your money from refunds or credits to pay off the tax debt you owe. For example, they may take your income tax refund from before you filed for bankruptcy to pay off income tax debts from that same time period. 

If a bankruptcy is filed, any tax refunds an individual is eligible to receive for the year of bankruptcy and prior is considered an asset in the bankruptcy proceeding. These will be sent directly to the LIT by the CRA. Tax refunds will go back to normal in the year after bankruptcy and the individual will begin receiving them again. 

Many individuals are also concerned that their government payments will be affected by filing a bankruptcy or consumer proposal. However, the government cannot stop payments such as Canada Pension Plan (CPP), Old Age Security (OAS), or Guaranteed Income Supplement (GIS) payments, child tax benefit payments, Ontario trillium benefit payments, etc. 

In some circumstances in a bankruptcy, the LIT may receive GST credits. Since the Canada Climate Rebate is included in the tax refund, this will also be sent to the LIT for amounts related to the year of bankruptcy and the prior year. However, the LIT will not receive any tax refunds or credits if a consumer proposal is filed. 

What are the alternatives to a bankruptcy or consumer proposal?

It's important to seek relief and explore debt solutions tailored to your circumstances if you find yourself overwhelmed by financial stress. A certified non-profit Credit Counsellor or an LIT will review your unique financial situation to determine the best options to deal with your debt. A debt professional can review and help you understand all the available options — even if that does not include filing a bankruptcy or consumer proposal.

As Canada’s largest consumer insolvency firm, MNP Debt has over 60 years of experience helping Canadians break the cycle of debt. With more than 80 local Licensed Insolvency Trustees serving more than 240 resident and satellite offices strategically located across the country, they’re here for you. Your first step toward a debt-free future is sitting down with one of their Licensed Insolvency Trustees for a free confidential consultation. Visit www.mnpdebt.ca to learn more or speak to a certified Credit Counsellor today.