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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

Baytex: ABQB Grants Rectification

In Baytex Energy Ltd. et  al. v. The Queen (2015 ABQB 278), the Alberta Court of Queen’s Bench considered whether rectification and/or rescission were available to address mistakes that could result in the taxpayer being taxed on additional resource income of $135 million for 2003-2006 and $528 million for 2007-2010.

The Court determined that the requirements for rectification had been satisfied and thus granted the rectification of certain documents to accord with the parties’ original intention.

Facts

Baytex Energy Trust (the “Trust”) was a publicly-traded mutual fund trust (the Trust later converted to Baytex Energy Corp. (“BEC”), a publicly-traded dividend-paying corporation). The Trust wholly-owned Baytex Energy Ltd. (“BEL”), which owned and operated oil and gas properties prior to transferring the properties to Baytex Energy Partnership on January 1, 2010.

The Baytex companies were subject to the pre-2007 oil and gas royalty regime in the Income Tax Act, which required certain additional resource income for an oil and gas producer (referred to in the judgment as “Phantom Income”) and denied certain deductions for provincial Crown royalties and taxes. A 25% resource allowance was available to the producer. The Phantom Income could be transferred by the producer to another party, and a non-deductible and off-setting reimbursement would be made back to the producer. In this case, BEL and the Trust agreed that BEL would transfer 99% of its income and cash flow to the Trust.

In the Budget of February 18, 2003, the federal government announced the phase-out of the oil and gas royalty regime and the elimination of the regime as of January 1, 2007.

Parties’ Agreements

BEL and the Trust executed a Net Profits Interest Agreement (the “Original Agreement”) in September 2003 for the transfer of income and the off-setting reimbursement. However, the written terms of the Original Agreement failed to address the transfer of Phantom Income. A subsequent agreement (the “Collateral Agreement”) – not all of the terms of which were reduced to writing – addressed the transfer of Phantom Income.

The parties intended that the transfer and reimbursement would cease effective January 1, 2007 because of the elimination of the oil and gas royalty regime in the Income Tax Act.

However, from January 1, 2007 to December 31, 2010, the parties continued the practice of transferring and reimbursing the Phantom Income. When this error was initially discovered in 2008, the Baytex companies’ tax professionals advised that the Original Agreement should be amended to provide for the reimbursement beyond 2006 to be consistent with the practice of the parties. The Baytex companies were told this amendment would have no adverse tax consequences. Based on this advice, the parties entered into an Amended Agreement.

The CRA reviewed the Baytex companies’ arrangements and concluded that an additional $135 million was taxable income to BEL for 2003-2006, and that the Trust earned an additional $528 million of taxable income for 2007-2010.

Rectification/Rescission

The Baytex companies sought rectification of the agreements. The CRA did not oppose the rectification of the agreements for the pre-2007 period, but did oppose the rectification for the post-2006 period on the basis that the Baytex companies had intentionally amended the Original Agreement, based on professional advice, to reflect the practice of transfer and reimbursement, and thus the parties mistaken assumption about the tax consequences would not meet the test for rectification. The taxpayers argued that the evidence (which consisted of two affidavits of BEC’s Chief Financial Officer) established that the parties always intended to transfer and reimburse the Phantom Income and that no transfers would occur after January 1, 2007.

The Court considered the authorities on rectification and concluded that the test for granting rectification had been met. The uncontroverted evidence was that the parties’ common intention was to transfer BEL’s income to the Trust, and that this practice would cease as of January 1, 2007. The Original Agreement and the Amended Agreement were inconsistent with this common intention. The precise form of the corrected agreement was not in dispute. And there were no other considerations that would limit/prevent the availability of rectification. Accordingly, the Court granted the rectification.

While this determination was sufficient to dispose of the application, the Court did go on to consider whether, if the Court was wrong on rectification, rescission was available to the parties. The Court held that the Amended Agreement triggered an unintended tax consequence that constituted a fundamental mistake that went to the root of the contract. The Court concluded that rescission was available to rescind the Amended Agreement, which would restore the parties to their Original Agreement, which the Crown had agreed should be rectified.

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Baytex: ABQB Grants Rectification

Lau: BC SC Corrects Articles of Incorporation After $17.3 Million Reassessment

Many tax rectification cases address situations in which certain transaction documents contain errors that do not accord with the parties’ intent to minimize or avoid taxes. However, there are several cases in which the courts are asked to correct errors in a company’s constating documents – errors that lead to unintended and adverse tax results for the company or its shareholders.

In Lau v. A.G. (Canada) (2014 BCSC 2384), the British Columbia Supreme Court considered whether a mistake in the drafting of a company’s Articles of Incorporation could be corrected under BC corporate law and/or the doctrine of rectification.

0777020 B.C. Ltd. was incorporated in 2006. The Articles of the company stated, among other things, that the Class E preferred shares could be issued (i) as a stock dividend, or (ii) in exchange for property. The directors of the company could establish the redemption amount of the Class E shares, but the Articles stated that this power of the directors existed only in respect of the issuance of the shares for property (i.e., no redemption amount could be determined where such Class E shares were issued as a stock dividend).

In 2008, the company issued 100 Class E shares as a stock dividend. The directors determined the redemption value to be $17,635,000. There were several subsequent transfers of these Class E shares among the individual shareholders and companies in the corporate group, and certain pre-existing liabilities were cancelled as a result of the Class E share transfers.

Subsequently, the CRA alleged the Class E shares had never been validly issued because no power to determine a redemption value existed in the company’s Articles. The CRA reassessed an individual shareholder to include $17.3 million in his income for 2008.

The individual shareholder objected and eventually appealed to the Tax Court. In the meantime, the company brought proceedings in the British Columbia provincial court to correct certain errors in the corporate documents, including the provision in the Articles addressing the directors’ power to determine the redemption value of the Class E shares. There were several proceedings that addressed the various errors:

  • May 21, 2013 – Taxpayers initiate first proceeding to correct various corporate documents
  • September 17, 2013 – Court grants requested relief in first proceeding
  • December 4, 2013 – Taxpayers initiate second proceeding to correct various corporate documents and Articles
  • April 10, 2014 – Taxpayer amends second proceeding to remove requested relief in respect of Articles
  • April 30, 2014 – Court grants requested relief in second proceeding
  • May 2, 2014 – Taxpayers initiate third proceeding to correct provision in Articles addressing Class E share redemption value

In the third proceeding, the taxpayers had revived the relief originally requested in the second proceeding in respect of the Articles. However, they adduced and relied on more extensive evidence concerning the drafting error. In response, the CRA argued that (i) the issue was barred by cause of action estoppel, (ii) the BC Court should decline jurisdiction, and (iii) rectification should not be granted.

On the first two issues, the BC Court held that (i) cause of action estoppel did not apply to prevent the taxpayers from seeking rectification of the Articles, and (ii) the BC provincial courts have exclusive jurisdiction to consider the requested relief (i.e., under the British Columbia Business Corporation Act or the doctrine of rectification) and it was not appropriate to decline jurisdiction in favour of the Tax Court of Canada.

On the third issue, the BC Court noted that the taxpayers had sought relief based on ss. 229 and 230 of the BC BCA and the court’s equitable jurisdiction. The BC Court held that the evidence of the individual shareholders and their counsel clearly established that the parties intended for the company’s directors to have the power to determine the redemption price of the Class E shares when issued as a stock dividend and in exchange for property. The absence of language in the Articles in respect of this power was a result of an error by the company’s solicitor.

The BC Court stated that ss. 229 and 230 of the BC BCA provide a court with the ability to correct any corporate mistake. Further, the BC Court was satisfied that the taxpayers had proven they had a common intention to empower the directors to determine the redemption amount and that the company’s Articles did not reflect this true intention.

The BC Court ordered that the Articles were corrected nunc pro tunc from 2006 to include language that established the proper powers of the directors.

On a sub-issue, the BC Court considered whether the CRA should have been named as a party in the third proceeding (the taxpayers had named the CRA as a party in the first two proceedings, but had refused to name the CRA as a party in the third).

The BC Court noted that there did not appear to be any consensus or consistent approach on this issue. The BC Court stated that the CRA need not be named as a party in every BC BCA or rectification proceeding. In the appropriate circumstances, the CRA may apply to be named as a party, and a court may exercise its discretion to join the CRA as a party. In this case, it was appropriate that the CRA be named as a party.

In light of the mixed success on the application, the BC Court did not award costs to either party.

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Lau: BC SC Corrects Articles of Incorporation After $17.3 Million Reassessment

Fairmont: Ont SCJ Unwinds Share Redemption and Substitutes Loan Arrangement

The common law doctrine of rectification operates to correct mistakes in transactions that produce (or may produce) unintended and adverse tax results. This was established in the landmark case of Juliar et. al. v A.G. (Canada) (50 O.R. 3d 728) (Ont. C.A.) (Dentons was counsel to the successful taxpayers).

In Fairmont Hotels Inc. et al. v A.G. (Canada) (2014 ONSC 7302) the Ontario Superior Court of Justice has provided another example of the manner in which rectification can be used to unwind certain impugned steps in a transaction and substitute the proper steps that accord with the parties’ intention to avoid tax.

Legacy Hotels REIT owned a collection of hotels, which were purchased from Fairmont in or around 1997. Fairmont continued to manage these hotels. In 2002 and 2003, Fairmont was involved in the financing of Legacy’s purchase of two hotels in Washington and Seattle. Through the use of several reciprocal loans between Legacy, Fairmont and several subsidiary companies, Legacy purchased the Washington hotel for $67 million USD and the Seattle hotel for $19 million USD. Fairmont hedged its loans to eliminate or reduce its foreign exchange tax exposure in Canada.

In 2006, Fairmont was acquired by two companies and its shares ceased to be publicly traded. This acquisition of control could have frustrated the parties’ intention that no entity would realize a foreign exchange gain or loss in connection with the reciprocal loan arrangements. A tax and accounting plan was created that would have allowed the companies to complete the acquisition and continue the full hedge of the foreign exchange exposure. However, this plan was modified before implementation with the result that certain foreign exchange exposure was not hedged.

In 2007, Legacy asked Fairmont to terminate the reciprocal loan arrangements on an urgent basis so that the Washington and Seattle hotels could be sold. A Fairmont officer mistakenly believed that the original 2006 plan had been implemented (i.e., the plan that continued the full hedge of the foreign exchange exposure) and agreed to the unwinding of the loans (which involved the redemption of certain preferred shares of the subsidiaries involved in the loan arrangements). Subsequently, the CRA reviewed the transactions and reassessed Fairmont on the basis that the 2007 share redemptions triggered a foreign exchange gain.

Fairmont brought an application to rectify the 2007 share redemptions and to substitute a loan arrangement. Fairmont argued that its intent from 2002 was to have the original reciprocal loan arrangements unwound on a tax-neutral basis. In response, the Crown argued that Fairmont had never intended the proposed substituted loan arrangement and thus was engaged in retroactive tax planning.

Fairmont relied on the Ontario Court of Appeal decision in Juliar for the principle that the exact method to achieve a common intention to avoid tax is not required at the time of the transaction. In response, the Crown argued that the Alberta Court of Queens’ Bench in Graymar Equipment (2008) Inc. v A.G. (Canada) (2014 ABQB 154) had been critical of Juliar and had stated that rectification is granted to restore a transaction to its original purpose and not to avoid an unintended effect.

However, in the present case, the Ontario Superior Court of Justice stated that, unlike the Alberta court, Ontario courts “do not have the luxury of ignoring” the Ontario Court of Appeal’s decision in Juliar. Further, the Ontario court stated that the Alberta court had not accurately described what happened in Juliar, and that another recent Alberta decision had in fact followed the reasoning in Juliar.

In the present case, the Ontario Court held that Fairmont’s intention from 2002 was to carry out the reciprocal loan arrangements on a tax- and accounting-neutral basis so that any foreign exchange gain would be offset by a corresponding foreign exchange loss. This intention remained unchanged when Fairmont was sold in 2006 and when the reciprocal loans were unwound in 2007. A mistake had caused the unintended tax assessments.

The Court also stated that this was not a situation in which the taxpayer was engaging in retroactive tax planning after a CRA audit. The parties intended to unwind the loans on a tax-free basis.

The Court allowed the application and rectified the corporate resolutions as requested. The Court awarded $30,000 of costs to the Applicants.

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Fairmont: Ont SCJ Unwinds Share Redemption and Substitutes Loan Arrangement

Brent Kern Family Trust: FCA Dismisses Appeal

In Brent Kern Family Trust v. The Queen (2014 FCA 230), the Federal Court of Appeal dismissed the taxpayer’s appeal with reasons delivered from the bench. The taxpayer had argued that the decision of Canada v. Sommerer (2012 FCA 207) should not apply in this case and, in the alternative, that Sommerer was wrongly decided and ought not to be followed.

Brent Kern Family Trust was a case in which the taxpayer undertook a series of transactions whereby a taxpayer (Mr. K) completed an estate freeze for two corporations (the underlying facts are described in detail in the Tax Court decision (2013 TCC 327)).

Following the estate freeze, two family trusts were set up each with Mr. K and his family as beneficiaries as well as each trust having a separate corporate beneficiary. Next, each of the trusts subscribed for common shares in the corporate beneficiary of the other trust.

Once the structure was in place, a dividend was flowed through the structure and, as a final step, one of the trusts paid funds to Mr. K but relied on the application of subsection 75(2) of the Act to deem the dividend income received by the trust to be income in the hands of one of the corporate beneficiaries. Accordingly, if subsection 75(2) of the Act applied, the income would not be subject to tax as a result of section 112 of the Act and Mr. K could keep the gross amount of the funds.

In the decision rendered at trial, the Tax Court held that Sommerer case applied and subsection 75(2) of the Act did not apply on the basis that the trust purchased the property in question for valuable consideration and no “reversionary transfer” occurred.

In Brent Kern Family Trust, the Court of Appeal found that there was no reviewable error in the trial judge’s finding that Sommerer applied, that the Court of Appeal in Sommerer “spent considerable time analyzing the text, content and purpose of subsection 75(2)”, and no reviewable error had been brought to the Court’s attention in the present case.

The Court of Appeal dismissed the taxpayer’s appeal and upheld the Tax Court’s decision.

We note also that at least one taxpayer has brought an application in a provincial court to correct a transaction where the taxpayer never intended for Sommerer to apply. In Re Pallen Trust (2014 BCSC 405), the B.C. Supreme Court rescinded two dividends, the effect of which was to eliminate the tax liability in the trust. Re Pallen Trust is under appeal to the B.C. Court of Appeal.

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Brent Kern Family Trust: FCA Dismisses Appeal

Brogan Family Trust: CRA Not Entitled to Notice of Rectification Application

Is the CRA entitled to notice of a rectification application?

In Brogan Family Trust (2014 ONSC 6354), the Ontario Superior Court of Justice said “no”, and dismissed the Crown’s motion to set aside an earlier rectification order on the basis that the CRA had not been notified of the proceeding.

In Brogan, the taxpayer had restructured his business and settled a trust for family tax planning purposes in 2004. Subsequently, in 2010, the trustees became aware of an error in the trust agreement that prevented the distribution of trust property to intended minor beneficiaries. The trust made an application for rectification of the trust agreement so that the trust property could be distributed as intended. The trust’s tax litigation counsel advised that no notice to the CRA was required.

The rectification application proceeded in November 2010. Shortly before the rectification order was granted, the trust sold a business. In its 2010 tax return, the trust allocated the proceeds to the beneficiaries, who in turn reported the income in their returns.

The CRA commenced an audit of the sale of the business and the trust in June 2012, at which time it became aware of the 2010 rectification order that had corrected the trust agreement. In August 2012, the CRA was provided a copy of the rectification order. And then in May 2013, the CRA brought its motion for an order setting aside the 2010 rectification order.

The Court considered three issues:

  1. Did the CRA bring the motion “forthwith” after learning of the rectification order?
  2. Did the CRA have standing to bring the motion?
  3. Should the CRA have been notified of the rectification application?

The Crown argued that (i) the delay was not inordinate because there had been internal confusion at the CRA in respect of the rectification order, (ii) the CRA was a creditor and thus was affected by the rectification order, and (iii) the CRA’s own view and the custom among tax litigators is that the CRA should be given notice (see, for example, Income Tax Technical News No. 22, at pg. 6).

The taxpayer argued that (i) the CRA’s 10-month delay was unreasonable and not “forthwith”, (ii) the CRA was not affected by the rectification application, and (iii) in any event, there was no requirement the CRA be notified of the rectification application.

The Court agreed with the taxpayer and dismissed the Crown’s motion.

The Court stated that the CRA was not a creditor and thus was not affected by the rectification order. The Court contrasted the current case with Snow White Productions Inc. v. PMP Entertainment Inc. (2004 BCSC 604), in which the rectification proceeding had been launched in response to an adverse ruling by the CRA and it was thus appropriate for the CRA to receive notice and participate (see also Aim Funds Management Inc. v. Aim Trimark Corporate Class Inc. (2009 CanLII 29491 (ON SC)).

On the issue of delay, the Court stated that the CRA had not brought the motion forthwith. The 10-month delay was the fault of the CRA, and even after the rectification order was referred to counsel, it still took two months for the motion to be launched.

And finally, on the issue of whether notice should be provided to the CRA, the Court stated that it had been directed to no authority on the point that the CRA should be given notice, nor on the point that notice is required if the CRA is not a creditor. The Court was not persuaded that providing notice to the CRA was the practice of tax litigators, and nor was it the law.

Rather, in the Court’s view, the delivery of a Notice of Assessment creates rights for the CRA to participate in a rectification proceeding as a creditor (see, for example, Canada (A.G.) v. Juliar ((2000) 50 O.R. (3d) 728 (C.A.) (a case on which Dentons was counsel for the successful taxpayer)).

The Court concluded as follows:

[22] … the CCRA is only required to be given notice of a proposed rectification proceeding when the CCRA’s legal interests might be directly affected by the outcome of the rectification proceeding, such as where the CCRA is a creditor and the rectification would affect its rights. Otherwise, the CCRA might be made a party when so advised by counsel that notice should be given to the CCRA.

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Brogan Family Trust: CRA Not Entitled to Notice of Rectification Application

Whose Mistake? Ontario Sup. Ct. Rectifies Trust Deed

Most tax rectification cases address situations in which a professional advisor has made a mistake in the planning and execution of a transaction with the result that an unintended tax consequence follows (i.e., payment of a capital dividend at a time when the company did not have a sufficient balance in its capital dividend account).

These are the relatively simple cases. However, in certain situations, the taxpayer and the CRA may take a different view on the interpretation and effect of a document, which could lead to an unintended tax result. Does the doctrine of rectification operate in these situations?

This was the situation considered by the Ontario Superior Court of Justice in Kaleidescape Canada Inc. et al. v. Computershare Trust Company of Canada et al. (2014 ONSC 4983), in which the Court was asked to determine whether the parties intended that a company remain a Canadian-controlled private company (“CCPC”) for the purposes of obtaining certain scientific research and development tax credits under the Income Tax Act (Canada) (the “Act”).

The Court granted the rectification, and Kaleidescape is a helpful case for those situations in which the “mistake” in a transaction arises as a result of competing interpretations of a parties’ document(s).

Facts

Kaleidescape Canada Inc. (“K-Can”) was a research and development company in Waterloo, Ontario. Under the Act, a CCPC is a Canadian corporation that is not controlled by a public company or a non-resident (or a combination of such persons). K-Can was structured as a “deadlock” corporation so that it would not be controlled by a non-resident and therefore would qualify as a CCPC.

From 2006 to 2008, K-Can’s shareholdings were restructured. In 2008, K-Can shares were owned by Kaleidescape Inc. (“K-US”), a Delaware company with head offices in California, and Kaleidescape Canada Employment Trust (the “Trust”). Computershare Trust Company of Canada (“Computershare”) became the sole corporate trustee. A Restated and Amended Trust Deed was entered into with K-Can as the settlor and Computershare as the sole trustee.

K-US and Computershare held equal voting rights. Additionally, a unanimous shareholders agreement relieved K-Can’s directors of their powers and conferred those powers on the shareholders. There was no provision to resolve a deadlock, and neither the shareholders nor directors had the right to make unilateral decisions.

K-Can received notices from the CRA advising that, in its view, K-Can was not a CCPC for the tax years ending December 31, 2008 and December 31, 2009. As a result, K-Can’s federal SR&ED and Ontario ITCs were denied. The CRA’s position was that the combined effect of the provisions of the Restated and Amended Trust Deed was to give a non-resident authority to direct Computershare how to vote its shares of K-Can, such that a non-resident controlled K-Can and the definition of CCPC was not met.

In response to the CRA’s reassessments, K-Can and Computershare entered into a “Deed of Rectification”, which revised the wording of Restated and Amended Trust Deed to protect K-Can’s CCPC status.

At the rectification application hearing, the Applicants argued that their common and continuing intention at all times was to structure and operate the company in a manner that would establish and preserve its CCPC status. The Respondent argued that the Applicants could not prove common intention, did not admit that a mistake had been made, and could not show the precise form of a corrected document that would express their prior intention.

Decision

In its analysis, the Court cited only two non-tax cases dealing with rectification (Performance Industries Ltd. v. Sylvan Lake Golf and Tennis Club Ltd. (2002 SCC 19) and Shafron v. KRG Insurance Brokers (Western) Inc. (2009 SCC 6)). (For tax rectification cases see Juliar v. Canada (A.G.) ([2000] O.J. No 3706), 771225 Ontario Inc. et al. v. Bramco Holdings Co. Ltd. et al. ([1995] O.J. No 157), McPeake v. Canada (A.G.) (2012 BCSC 132)Graymar Equipment (2008) Inc. v. Canada (A.G.) (2014 ABQB 15), and Re: Pallen Trust (2014 BSCS 305)).

Turning the facts of the current case, in several short paragraphs the Court stated that, on the entire record and history of the Applicants, the intention throughout was to ensure that K-Can – as an R&D body, with no other functions than research and development – qualified for CCPC status and the relevant research tax credits.

The Court held that wording chosen in the Restated and Amended Trust Deed was chosen by mistake and did not give K-US de jure control over K-Can. In respect of the proposed correction, the Deed of Rectification corrected the mistake in the original wording. The Court stated that Deed made it clear that the decision-making body was the board of directors and that the trustee was only to accept a direction in written form.

The Court granted the rectification sought by the Applicants.

 

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Whose Mistake? Ontario Sup. Ct. Rectifies Trust Deed

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 to Release Two Decisions on Tax and Rectification

On Thursday November 28, the Supreme Court of Canada will release its decisions in the companion cases of Agence du Revenu du Québec v. Services Environnementaux AES Inc., et al. (Docket #34235) and Agence du Revenu du Québec v. Jean Riopel, et al. (Docket #34393).

The narrow question on appeal is under what circumstances the Superior Court of Quebec may correct a written instrument that does not reflect the parties’ intentions. More broadly, the issue is how and to what extent the equitable principles of rectification operate in the context of the Quebec Civil Code. These will be the first substantive decisions of the Supreme Court on tax and the doctrine of rectification.

See our previous posts on the cases here and here.

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Supreme Court of Canada to Release Two Decisions on Tax and Rectification

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.

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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