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Jean Coutu: SCC Revises Test for Rectification under the Civil Code

On December 9, 2016, the Supreme Court of Canada rendered its judgment in Jean Coutu Group (PJC) Inc. v Attorney General of Canada (2016 SCC 55) along with its companion case Canada (Attorney General) v Fairmont Hotels Inc. (2016 SCC 56).

Our post on the Court’s decision in Fairmont Hotels is available here.

In Jean Coutu, a 7-2 decision, the Supreme Court specified and enhanced the civil law test applicable to rectification of a written instrument where the taxpayer has suffered an unintended and adverse tax result. The Court had previously addressed this test in Quebec (Agence du revenu) v Services Environnementaux AES Inc. (2013 SCC 65).

The Supreme Court confirmed that a general intention of tax neutrality does not permit the modification instruments in accordance with the Civil Code of Quebec.

In Jean-Coutu, the taxpayer brought a motion for rectification in the Superior Court of Quebec in order to modify certain documents for transactions that were undertaken to neutralize the effect of the fluctuations in foreign exchange rates. The transactions had achieved this goal, but such transactions had the unexpected and adverse effect of creating foreign accrual property income for one of the companies in the corporate group.

The taxpayer argued that the constant and clear intention of the parties to address the exchange rate fluctuation without generating adverse tax consequences was not reflected in the transaction documents.

The Quebec Superior Court allowed the taxpayer’s motion on the basis that the evidence showed there was discrepancy between the clear intention of the parties and the tax consequence of the transaction as executed.

The Quebec Court of Appeal allowed the Crown’s appeal and stated that the taxpayer’s general intent that its transactions be completed in a tax-neutral manner was insufficient to support a motion for rectification.

On appeal, the Supreme Court defined the issue as follows:

[14] This appeal raises the following key issue: Where parties agree to undertake one or several transactions with a general intention that tax consequences thereof be neutral, but where unintended and unforeseen tax consequences result, does art. 1425 C.C.Q. allow the written documents recording and implementing their agreement to be amended with retroactive effect to make them consistent with that intention of tax neutrality?

In its analysis, the Court applied and confirmed the guidelines it developed in Services Environnementaux AES Inc.

Pursuant to an exhaustive review of the provisions of the Civil Code of Quebec applicable to contracts, the Supreme Court reaffirmed that under the Quebec civil law the agrement or contract lies in the common intention of the parties. A contract is created by “an agreement of wills by which one or several persons obligate themselves to one or several other persons to perform a prestation” (see Article 1378 of the C.C.Q.), which prestation must be “possible and determinate or determinable” (see Article 1378 of the C.C.Q.), and must have a cause (see Article 1410 of the C.C.Q.) and an object (see Article 1412 of the C.C.Q.).

For the majority, Justice Wagner stated that, in light of these provisions of the Civil Code of Quebec, a court may not use the remedy offered by article 1425 C.C.Q. to modify a transactional scheme because it generated unforeseen adverse tax consequences. The Court stated:

[23] A taxpayer’s general intention of tax neutrality cannot form the object of a contract within the meaning of art. 1412 C.C.Q., because it is insufficiently precise. It entails no sufficiently precise agreed-on juridical operation. Nor can such a general intention in itself relate to prestations that are determinate or determinable within the meaning of art. 1373 C.C.Q. It says nothing about what one party is bound to do or not to do for the benefit of the other. Therefore, a general intention of tax neutrality, in the absence of a precise juridical operation and a determinate or determinable prestation or prestations, cannot give rise to a common intention that would form part of the original agreement (negotium) and serve as a basis for modifying the written documents expressing that agreement (instrumentum). As a result, art. 1425 C.C.Q. cannot be relied on to give effect to a general intention of tax neutrality where the writings recording the contracting parties’ common intention produce unintended and unforeseen tax consequences.

And specifying the applicable test developed in Services Environnementaux AES Inc., the Court stated:

[24] In my opinion, when unintended tax consequences result from a contract whose desired consequences, whether in whole or in part, are tax avoidance, deferral or minimization, amendments to the expression of the agreement in accordance with art. 1425 C.C.Q. can be available only under two conditions. First, if the unintended tax consequences were originally and specifically sought to be avoided, through sufficiently precise obligations which objects, the prestation to execute, are determinate or determinable; and second, when the obligations, if properly expressed and the corresponding prestations, if properly executed, would have succeeded in doing so. This is because contractual interpretation focuses on what the contracting parties actually agreed to do, not on what their motivations were in entering into an agreement or the consequences they intended it to have.

Furthermore, the Court distinguished Jean Coutu from Services Environnementaux AES Inc.:

[31] In contrast, in the appeal here, the parties to the contract did not originally and specifically agree upon a juridical operation for the purpose of turning their general intention to neutralize tax consequences into a series of specific obligations and prestations. This general intention of the parties was not sufficiently precise to establish the details of a contemplated operation […] The determinate scenario agreed on by PJC Canada and PJC USA was drawn up properly, but because it was drawn up properly, it produced unintended and unforeseen tax consequences.

The Court dismissed the taxpayer’s appeal and affirmed the decision of the Quebec Court of Appeal.

In dissent, Justice Côté stated that the convergence of principles between the common law and the civil law as expressed by the majority in Jean Coutu was inconsistent with the contract law applicable in Quebec:

[91] […] I agree with my colleague that convergence between Quebec civil law and the common law of the other provinces is desirable from a tax policy perspective (para. 52). Indeed, in this Court, the parties agreed that the common law and the civil law are functionally similar with respect to the availability of rectification. But retreating from the interpretation of art. 1425 C.C.Q. adopted in AES in order to achieve harmony with this Court’s contraction of equitable discretion in Fairmont is inconsistent with the law of contract in Quebec.. […] Given that contracts can be expressed orally without recourse to written instruments, AES left open the possibility of rectifying errors in oral expression (paras. 28 and 32). This is consistent with the civil law principle, inherent in arts. 1378 and 1425 C.C.Q., that a contract is based on the common intention of the parties, not on the expression of that intention.

[92] The majority’s reasons in Fairmont are irreconcilable with these articles of the Code. Rectification in Canadian common law jurisdictions in now “limited to cases where the agreement between the parties was not correctly recorded in the instrument that became the final expression of their agreement” (Fairmont, at para. 3). There appears to be no scope for rectifying oral agreements. With respect, to the extent that my colleague in this case would import this limitation into the civil law, the “convergence” between the two legal systems is, in my opinion, far from “natural” (majority reasons, at para. 52).

The decision rendered by the Supreme Court in Jean Coutu is of significant importance as it restricts the circumstances in which taxpayers may rely on Article 1425 of the Civil Code to rectify transaction documents in tax cases.

Quebec tax professionals should carefully consider the additional guidelines provided in Jean Coutu in assessing whether or not a motion for rectification is available to correct mistakes resulting in unintended and unforeseen adverse tax consequences.

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Jean Coutu: SCC Revises Test for Rectification under the Civil Code

Mac’s: Quebec CA Affirms Denial of Rectification

In Mac’s Convenience Stores Inc. v. Canada (2015 QCCA 837), the Quebec Court of Appeal affirmed a lower court decision (2012 QCCS 2745) denying rectification of corporate resolutions that had declared a dividend that unintentionally put the company offside the “thin-cap” rules in subsections 18(4)-(8) of the Income Tax Act.

Facts

Mac’s, an Ontario corporation, was a wholly-owned subsidiary of Couche-Tard Inc. (“CTI”). In April 2005, Mac’s borrowed $185 million from Sidel Corporation, a related Delaware corporation.

In April 2006, Mac’s participated in several transactions with various related entities, including the declaration of a $136 million dividend on the common shares held by CTI. A similar series of transactions had been undertaken in 2001. However, in 2006, Mac’s professional advisors failed or forgot to take proper account of the $185 million owed by Mac’s to Sidel.

While the $136 million dividend itself was generally without tax consequences, the dividend had the effect of putting Mac’s offside the (then) 2:1 ratio in the “thin-cap” rules in the Income Tax Act. This resulted in the reduction of deductible interest paid by Mac’s to Sidel in the years following the dividend payment (i.e., 2006, 2007 and 2008).

Rectification

After Mac’s was reassessed by the CRA to disallow the interest deduction, Mac’s sought rectification of the corporate resolution declaring the dividend, and additionally sought to substitute a reduction of its stated capital and the distribution of cash to CTI. This would have had the same effect of paying an amount to CTI while maintaining the proper ratio for interest deductibility.

The Quebec Superior Court dismissed the application on the basis that the Mac’s directors never had any specific discussions regarding the deductibility of interest on the Sidel loan after the payment of the dividend. The various steps in the 2006 transactions reflected the intentions of the parties, and thus there was no divergence between the parties agreement and the documents carrying out the transactions.

Appeal

The taxpayer appealed to the Quebec Court of Appeal. The Court described the taxpayer’s position as not invoking any error in the lower court judgment but simply alleging that, if the taxpayer’s advisors had made a mistake, then the lower court decision must be reversed on the basis of the Supreme Court of Canada’s decision in Quebec v. Services Environnementaux AES Inc. (2013 SCC 65) (“AES“) (see our previous post on AES here).

The Court of Appeal stated that it understood the Supreme Court’s decision in AES to stand for the proposition that parties who undertake legitimate corporate transactions for the purpose of avoiding, deferring or minimizing tax and who commit an error in carrying out such transactions may correct the error(s) in order to achieve the tax results as intended and agreed upon. The Court of Appeal cautioned that AES does not sanction retroactive tax planning.

In the present case, the Court of Appeal held there was no common intention regarding the “thin-cap” implications of the dividend payment, and thus there was no agreement that should be given effect by the courts.

The Court of Appeal held there was no error by the lower court and dismissed the taxpayer’s appeal.

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Mac’s: Quebec CA Affirms Denial of Rectification

Supreme Court of Canada: Rectification is Alive and Well in Quebec

Earlier today, the Supreme Court of Canada delivered its decision in two Quebec rectification cases, Agence du Revenu du Quebec v. Services Environnementaux AES Inc. and Agence du Revenu du Quebec v. Jean Riopel. In a unanimous decision rendered by Mr. Justice LeBel (the only civil law judge on the panel) the Court upheld the decisions of the Quebec Court of Appeal in these two cases, permitting the parties to correct mistakes which resulted in unintended tax consequences. However, the reasons set out in Mr. Justice LeBel’s decision differ in part from the decisions of the Quebec Court of Appeal.

By way of background, Canada has a bijuridical legal system. The French civil law is the law in Quebec relating to civil matters while the law in the rest of Canada is based on the English common law. In these two cases, the issue related to whether rectification (which is a concept under the common law) can also be applied under Quebec civil law. It should be noted that the term “rectification” is not used in the reasons for judgment in either of the two appeals.

After going through the facts of each case and the decisions of the lower courts (see our previous posts on these cases here and here) Mr. Justice LeBel stated that the dispute between the taxpayers and the Quebec tax authority raises both procedural and substantive issues. He then went on to state that the substantive issue of whether proceedings to amend documents are permitted under Quebec’s civil law is the main issue and that the procedural issues are of only minor importance.

Mr. Justice LeBel noted that there was uncontested evidence establishing the nature of the taxpayers’ intention in each case and that under the civil law, in most cases a contract is based on the common intention of the parties and not on the written document. In this case, it was clear that the taxpayers’ intention was not properly documented because of the errors made by the taxpayers’ advisors. Accordingly, the taxpayers could rescind the contract or amend the documents to implement their intentions. In this case, the taxpayers had agreed to correct the documents so that the documents were consistent with their intentions.

The issue that then arises is to how such correction affects the tax authorities. Mr. Justice LeBel notes that in this case, there is an interplay of civil law and tax law and he makes the important point that the tax authorities generally do not acquire rights to have an erroneous written document continue to apply for their benefit where an error has been established and the documents are inconsistent with the taxpayer’s true intention.

Mr. Justice LeBel held that the parties in these two cases could amend the written documents because there was no dispute as to the intention of the parties and that it is open to the court to intervene to declare that the amendments to the documents made by the taxpayers were legitimate and necessary to reflect their intentions. He goes on to state that if a document includes an error, particularly one that can be attributed to an error by the taxpayer’s professional advisor, the court must, once the error is proved in accordance with the rules of evidence, note the error and ensure that it is remedied. In addition, the tax authorities do not have any acquired rights to benefit from an error made by the taxpayers in their documents after the taxpayers have corrected the error by mutual consent to reflect their intentions.

However, Mr. Justice LeBel warns taxpayers not to view this recognition of the parties’ common intention as an invitation to engage in bold tax planning on the assumption that it will always be possible for taxpayers to redo their contracts retroactively should the planning fail.

In the cases under appeal, the taxpayers amended the written documents to give effect to their common intention. This intention had clearly been established and related to obligations whose objects were determinative or determinable. Accordingly, the taxpayers’ amendments to the written documents were permitted.

Interestingly, the Attorney General of Canada, who intervened in the appeals, asked the court to consider and reject a line of authority that has developed since the Ontario Court of Appeal‘s decision in Attorney General of Canada v. Juliar, 2000 DTC 6589 (Ont. C.A.). Juliar is recognized as the leading case in rectification matters and has been the basis of numerous successful rectification applications in respect of tax matters in the common law provinces of Canada. Mr. Justice LeBel stated that the two cases under appeal are governed by Quebec civil law and it is not appropriate for the court to reconsider the common law remedy of rectification in connection with these appeals. Accordingly, Mr. Justice LeBel refrains from criticising, approving or commenting on the application of Juliar and rectification under the common law.

It is also interesting to note that in Juliar the CRA sought leave to appeal the decision of the Ontario Court of Appeal to the Supreme Court of Canada and that leave was denied. We will have to wait to see if the CRA attempts to take another case to the Supreme Court of Canada to determine the applicability of Juliar and rectification under the common law. However, it is now clear that Quebec taxpayers can now “fix” most tax mistakes if they can prove that their intention was to undertake a transaction which does not result in tax and the transaction does not involve “bold tax planning”.

Supreme Court of Canada: Rectification is Alive and Well in Quebec

Supreme Court of Canada Considers Two Quebec Rectification Cases

In what circumstances may the Superior Court of Quebec correct a written instrument that does not reflect the parties’ intent?  That is the question that was considered by the Supreme Court of Canada on November 8, 2012 on appeals from decisions of the Quebec Court of Appeal in Agence du Revenu du Québec (formerly the Deputy Minister of Revenue of Quebec) v. Services Environnementaux AES Inc., et al. and Agence du Revenu du Québec v. Jean Riopel, et al.

The panel consisted of McLachlin C.J. and LeBel, Fish, Abella, Rothstein, Cromwell and Karakatsanis JJ. The Court reserved judgment in both cases.

Services environnementaux AES Inc.

Centre technologique AES Inc. (“Centre”) was a wholly-owned subsidiary of Services environnementaux AES Inc. (“AES”). In the context of a corporate reorganization, AES decided to sell 25% of its shares in Centre to a new investor. AES and Centre instructed their advisors that there was to be an exchange of shares under section 86 of the Income Tax Act (“ITA”) and the corresponding provisions of the provincial legislation.

AES believed – mistakenly – that the adjusted cost base of its shares in Centre was $1,217,029. Based on that error, a promissory note of $ 1,217,028 was received by AES as part of the consideration for its shares.

Subsequently, AES received a Notice of Reassessment that added a taxable capital gain of $840,770 to its taxable income. The parties discovered that the adjusted cost base of the shares had been miscalculated and that it was, in fact, only $96,001.

AES filed an application in the Superior Court of Quebec for an order rectifying the written instruments for the transactions. The Superior Court granted the application, noting that its judgment was effective as of the date of the transactions and that it was enforceable against third parties (including tax authorities). The Court of Appeal dismissed the appeal of the Quebec Revenue Agency (QRA).

Riopel

The Riopel case is another case about a corporate reorganization gone wrong.

Mr. Riopel was the sole shareholder of a corporation and held a 60% stake in a second corporation. Ms. Archambeault, Mr. Riopel’s wife, held the remaining 40% of the shares in the second corporation. The parties intended to amalgamate the corporations, with Mr. Riopel as the sole remaining shareholder of the amalgamated corporation. Both shareholders met with a tax advisor and agreed on plan for the reorganization. The parties were clear that the reorganization was to be completed with no immediate tax impact.

However, the Articles of Amalgamation included an error (i.e., the Articles did not reflect the correct share ownership). The shareholders’ professional advisors realized the error, and they tried to correct the situation without notifying the taxpayers.

Subsequently, Ms. Archambeault received a Notice of Reassessment adding a deemed dividend of $335,000 to her taxable income. The shareholders and the corporation brought an application in the Superior Court of Quebec to rectify the written instruments to accord with their true intention (i.e., implementing a reorganization without immediate tax effect).

The Superior Court denied the rectification on the basis that the agreement between the parties was distinct from the mandate given to their advisors. The Court suggested that the error could have vitiated the agreement, but it was not the remedy sought by the parties. The Court added that the error affected both the form and substance of the transactions. Accordingly, rectification was not an appropriate remedy.

That decision was reversed by the Court of Appeal of Quebec. The Court of Appeal applied the reasoning in AES and ordered the rectification so as to give effect to the parties’ common intention.

Position of the Tax Authorities in the Supreme Court of Canada (Oral Argument)

In the Supreme Court, counsel for QRA argued that the rectifications obtained by the taxpayers were not an exercise of interpretation of contracts as permitted by the Civil Code of Quebec (“CCQ”). The contracts in question were clear and should not have been modified, even though the transactions had unintended tax consequences for the parties.

Indeed, tax considerations may be the motivation behind a transaction, but they do not reflect the intent of the parties and are therefore not part of the “scope of the contract”. Thus, according to counsel for QRA, the Court of Appeal erred in rectifying the written instruments in order to make them consistent with the parties’ tax motivations. The parties could have sought cancellation of the contracts, but they failed to do so.

Justice LeBel asked if there was a legal principle that would operate to prevent parties from varying or rescinding a contract. Counsel for QRA responded that there was none, but that such a variation or rescission cannot have retroactive effect with respect to third parties. The situation would be different if the contract was cancelled by the Court since the contract is then deemed to never have existed. In such a case, the QRA would respect the decision of the Court and would assess the taxpayer accordingly.

Justice LeBel also asked if the tax authorities are third parties for the purposes of civil law. QRA’s position is that they are third parties and they have an obligation to apply the law based on the contracts concluded by the taxpayers.

Justice Fish noted that there was no dispute that the parties intended to comply with the provisions of the ITA and that, in this case, they had failed to do so because of human error. Counsel for QRA replied that the only relevant intent was in respect of the actual terms of the contract and not the tax motivation. The CCQ does not operate to vary clear contractual provisions so as to conform to the parties’ tax motivation. A possible remedy would have been the cancellation of the contracts, but that was not what the parties sought.

Counsel for the Attorney General of Canada essentially took the same position. Counsel explained that a party (or parties) cannot rewrite the history of a transaction because of unexpected tax consequences. Counsel emphasized that a distinction must be drawn between the motivation of the parties and the object of the contract. He added that the courts have long recognized that a “mistake in assumption” does not warrant the rectification of a contract. This applies in both common law and civil law.

Position of AES in the Supreme Court of Canada (Oral Argument)

Counsel argued that AES did not ask the Superior Court to modify a contract, but rather to rectify a written instrument to accord with the parties’ common intention in order to reflect the true legal relationship. In this case, the parties intended to complete the transaction in accordance with section 86 of the ITA but the written instrument did not reflect this intention. Accordingly, it was legitimate and necessary for the Superior Court to order rectification.

Justice LeBel asked about the impact of the law of evidence in the context of an application for rectification (i.e., the parol evidence rule). Counsel responded that the restrictions on presenting evidence of a party’s intent did not apply in this case since it has been admitted that the parties’ intention was not correctly reflected in the written document.

Justice LeBel also asked if it was AES’s position that a tax authority is a third party to a contract. Counsel stated that a government has an obligation to enforce tax law based on bona fide legal relationships between the parties. A tax authority would not be a third party because it would have no rights to claim with respect to the rectification of a written instrument. However, on a practical level, it may be appropriate to give the tax authorities an opportunity to be heard.

In closing, counsel stated that an application for rectification in Quebec is based solely on the principles of civil law and that it is not an attempt to “import” a common law concept.

Position of Riopel in the Supreme Court of Canada (Oral Argument)

Counsel stated that this was not a tax case but rather a civil law case. The question that must be asked was the following: Where can the contract be found? It is a mistake to confuse the contract with the written document evidencing it.

The Court of Appeal relied on Article 1425 of the CCQ to grant the application for rectification. Indeed, the application met the three criteria developed by the Court of Appeal in AES (i.e., necessity, legitimacy and no harm to third parties). Moreover, even if the tax authorities should be regarded as third parties, they would not be prejudiced because the rectification had no impact on the tax base.

Justice LeBel noted that numerous errors had been committed. Counsel responded that the errors all had a common origin, namely the Articles of Amalgamation. The number of written instruments to be rectified was not relevant, as long as the purpose was to give effect to the parties’ true intention.

Justice LeBel also wondered if this was an exercise of contractual interpretation. Counsel responded that granting rectification is an operation of correction following the interpretation of the parties’ true intention. Just because the provisions of a contract are clear does not mean that they reflect the parties’ intentions.

*  *  *

As noted above, judgment was reserved in both appeals. We will report on the decisions as soon as they are released.

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Supreme Court of Canada Considers Two Quebec Rectification Cases