4 November 1999 External T.I. 9900175 - BANKRUPTCY AND SPOUSAL DEDUCTION

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues: (1) Does section 118.95 affect the calculation of Ontario tax credits on Form T1C?

(2) What is the effect of bankruptcy on the calculation of the Ontario tax credits?

(3) How does the individual's bankruptcy affect the calculation of the spousal deduction at 118(1) when (a) their spouse is not bankrupt in the year; (b) when their spouse becomes bankrupt at the same time as the individual; (c) when the spouse becomes bankrupt at a different time than the individual?

Position: (1) . The Ontario tax credits are credits available under the Ontario Income Tax Act. Section 118.95 of the Federal Income Tax Act does not affect the calculation of Ontario tax credits. Section 118.95determines the personal tax credits available in years in which an individual became bankrupt and prevents an individual from claiming more tax credits under sections 118 to 118.9 than he would have been entitled to had he not become bankrupt

(2) Since January 1, 1998 the Income Tax Act of Ontario requires the Ontario tax credits be calculated as if neither the individual nor their spouse become bankrupt during the year. Prior to 1998, only the individual's post-bankruptcy income was used in the calculation, plus their spouse's income for the whole calendar year, whether or not the spouse became bankrupt in the year.

(3) In all three situations, the income of the individual's spouse for the calendar year is allocated to match the two taxation years of the individual. The limitation in section 118.95 will prevent the individual from claiming more personal tax credits than would have been allowed had bankruptcy not occurred.

XXXXXXXXXX 	5-990017
		David Shugar
November 4, 1999

Dear XXXXXXXXXX:

This is in reply to your correspondence of January 5, 1999 requesting our opinion regarding the effect of bankruptcy on the claim for Ontario Tax Credits on Form T1C (ONT.). We apologize for the delay in responding to your request.

In a phone conversation of February 2, 1999 (XXXXXXXXXX/Shugar), you stated that you often have situations where both spouses become bankrupt in the same calendar year and, therefore, would like to confirm how to compute the Ontario Tax Credits in such a situation. In that conversation, you clarified your question as "Is the income for purposes of Ontario Tax Credits based on the income of the bankrupt person for the period from the date of bankruptcy to the end of the year, plus the income of the spouse for the entire year, or from the date of bankruptcy, if they too declared bankruptcy." You also requested our comments regarding a letter you received from a Tax Centre concerning an adjustment made to the spousal deduction under paragraph 118(1)(a) of the Income Tax Act (the "Act") that was claimed by your client in a year in which the client became bankrupt. A copy of that letter was submitted with your request.

Our comments

Written confirmation of the tax implications inherent in particular proposed transactions are given by this Directorate only where the transactions are outlined in an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R3. Questions concerning actual fact situations must be directed to your local tax services office. Accordingly, since your situation appears to relate to a factual situation, we cannot provide any specific answers to your queries at this time. As an alternative, however, we can provide the following general comments which are not binding on the Department but may be of some assistance.

Ontario Tax Credits

We agree with your comment that section 118.95 of the Act applies to the calculation of non-refundable tax credits and not to the calculation of Ontario tax credits. An individual's Ontario tax credits are determined under the Income Tax Act (Ontario).

Prior to January 1, 1998, an individual's Ontario tax credits were calculated based on the total of the bankrupt individual's net income in the post-bankruptcy period and their spouse's net income for the entire year, whether or not the spouse also became bankrupt in the year. The Ontario Ministry of Finance, Tax Credits and Grants Branch, has informed us that, commencing January 1, 1998, an individual claiming Ontario tax credits in a calendar year in which they became bankrupt must now calculate their Ontario tax credits using their net income for the full calendar year. According to the Ontario Ministry of Finance, Tax Credits and Grants Branch, the January 1, 1998 amendments to the Income Tax Act (Ontario) now require that Ontario tax credits be calculated using the combined net incomes of the individual's pre- and post-bankruptcy periods, for both spouses, as if bankruptcy had not occurred.

Bankruptcy and paragraph 118(1)(a) of the Act

Subsection 118(1) of the Act states:

"For the purpose of computing the tax payable under this Part by an individual for a taxation year, there may be deducted an amount determined by the formula ..."

The personal tax credit for a married individual is at paragraph 118(1)(a) and states:

"in the case of an individual who at any time in the year is a married person who supports the individual's spouse and is not living separate and apart from the spouse by reason of a breakdown of their marriage, an amount equal to the total of

(i) $6,000, and

(ii) an amount determined by the formula
$5,000 - (C - $500)

where

C is the greater of $500 and the income of the individual's spouse for the year or, where the individual and the individual's spouse are living separate and apart at the end of the year by reason of a breakdown of their marriage, the spouse's income for the year while married and not so separated, ..."

Where an individual becomes bankrupt during a calendar year, paragraph 128(2)(d) of the Act provides that the taxation year of the individual ends on the day that is immediately prior to the day of bankruptcy and deems a new taxation year to have commenced on the day of bankruptcy. Accordingly, the individual has two taxation years that end within that calendar year with the first being from January 1 until the day before the individual became a bankrupt (the "pre-bankruptcy period"), and the second taxation year from the date of bankruptcy to December 31 (the "post-bankruptcy period").

In the calendar year in which the individual becomes bankrupt, a number of income tax returns must be filed by, or on behalf of, the individual:

ù a return to be filed for the taxation year that ends on the day before the bankruptcy;
ù a return to be filed under paragraph 128(2)(e) of the Act by the trustee in bankruptcy with respect to certain income of the estate and business of the individual for each taxation year in that calendar year; and
ù a separate return to be filed by the individual for the taxation year that begins on the day of bankruptcy.

Paragraph 128(2)(f) of the Act permits the bankrupt individual to claim the personal credits available in sections 118 to 118.9 of the Act. Prior to the introduction of section 118.95 of the Act, an individual could have claimed full credits in respect of each of the taxation years, even though this meant that the individual could have used the benefit of these credits twice in respect of the same calendar year. Section 118.95 of the Act, which applies to bankruptcies that occur after April 26, 1995, ensures that where an individual becomes bankrupt in a calendar year, the total of these non-refundable tax credits deductible in respect of each of these two periods in the calendar year cannot be greater than the amount that could have been claimed had the individual not become bankrupt in the year. Subsection 118.95 requires that the non-refundable tax credits be calculated on a pro-rata basis (except for those credits that are based on expenditures or the receipt of certain types of income during the period). The personal tax credits, the age tax credit, the disability tax credit, and the transfer of unused credits are subject to pro-ration based on the number of days in the period for which the return is filed.

When calculating the personal credit of a bankrupt individual under paragraph 118(1)(a) of the Act, it is not apparent what amount is required to be used at item C as the "income of the individual's spouse for the year", in each of the taxation years of the individual. In our view, the correct approach in determining these pro-rata amounts would be to use the income of the spouse for the periods that correspond to the pre- and post-bankruptcy periods of the individual. Where the individual became bankrupt in the year and the individual's spouse did not become bankrupt, the tax credits for the individual's pre-bankruptcy period would be determined by using the income of the spouse from January 1 until the day before the individual's date of bankruptcy. Tax credits for the post-bankruptcy period would be determined using the income of the individual's spouse from the date of bankruptcy until December 31. The same method would be used if the individual's spouse became bankrupt on the same day as the individual.

In the situation where the individual's spouse became bankrupt at a different time than the individual, say, one month before the individual, for the purpose of applying paragraph 118(1)(a) of the Act to the individual's pre-bankruptcy period, the "income of the spouse for the year" would be the spouse's income until the date of the spouse's own bankruptcy, plus the income for the additional month up to the time of the individual's bankruptcy. The spouse's income for the remainder of the year would be used in applying paragraph 118(1)(a) of the Act to the individual's post-bankruptcy period. A similar calculation would be done if the individual's spouse became bankrupt sometime after the individual.

We trust our comments will be of assistance to you.

Yours truly,

Roberta Albert, CA
for Director
Business and Publications Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch

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