1. Skip to navigation
  2. Skip to content
  3. Skip to sidebar

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.

 

,

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.

,

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.

*  *  *

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

, , , ,

Supreme Court of Canada Considers Two Quebec Rectification Cases

Two Rectification Cases from Quebec to be Heard by the Supreme Court of Canada on November 8, 2012

Two appeals will be heard tomorrow morning by the Supreme Court of Canada in rectification decisions from the Quebec courts. The first appeal is Agence du Revenu du Québec (formerly the Deputy Minister of Revenue of Quebec) v. Services Environnementaux AES Inc., et al. while the second appeal is Agence du Revenu du Québec v. Jean Riopel, et al.  In each case, the Quebec Court of Appeal agreed with the taxpayers that rectification was in order.

The Supreme Court’s summary of the first appeal may be found here.  Each factum in the first appeal may be read here.

The Supreme Court’s summary of the second appeal may be found here.  Each factum in the second appeal may be read here.

The decision of the Quebec Court of Appeal in the first appeal is here.  The decision of the Quebec Court of Appeal in the second appeal is here.

At 9:30 a.m. tomorrow, the live webcast of the hearings may be viewed here or here.  The archived webcast will be available for viewing a day or two later.

The newest member of the Supreme Court of Canada, Justice Richard Wagner, was a member of the panel of the Quebec Court of Appeal that decided the second appeal.  He will, therefore, not hear tomorrow’s appeals.  Accordingly, a maximum of seven judges will be on the panel tomorrow morning.

Postscript: At the conclusion of the hearing, the panel reserved judgment.  During the course of the hearing, highlights of argument were tweeted live @CanTaxLit

,

Two Rectification Cases from Quebec to be Heard by the Supreme Court of Canada on November 8, 2012

More on Rectification in Quebec

Rectification continues to be a topic of heated debate in Quebec. After a series of decisions by the Court of Appeal last year on the subject, the Quebec Superior Court rendered an important judgment on June 19, 2012 (Mac’s Convenience Stores Inc. v. Couche-Tard Inc., 2012 QCCS 2745) on a motion for declaratory judgment involving a well-known Canadian business.

This case is a reminder that rectification is not always available to correct errors made in the planning of a transaction, even if the unintended tax consequences result in a loss of several million dollars for a taxpayer.

The Facts

On April 14, 2005, Mac’s Convenience Store Inc. (“Mac’s”) borrowed $185 million from a U.S. corporation, Sildel Corporation (“Sildel”), which was a “specified non-resident” for purposes of the thin capitalization rules in subsection 18(4) of the Income Tax Act (the “Act”). Under this loan, Mac’s paid interest to Sildel ($911,854 in 2006, $11,069,590 in 2007, and $10,674,247 in 2008). These interest payments were deducted in computing the income of Mac’s for income tax purposes in the relevant years. This loan was fully repaid by Mac’s in 2008.

On April 25, 2006, Mac’s declared and paid a dividend of $136 million to Couche-Tard Inc. (“CTI”) out of its retained earnings. The decision to declare this dividend was taken after consultation with professional advisers.

More than 18 months later, it was discovered that the dividend of $136 million paid to CTI had the effect of raising the “debt” portion of Mac’s debt-to-equity ratio vis-a-vis Sildel for thin capitalization purposes beyond the then statutory limit of 2:1 under subsection 18(4) of the Act. In early 2008, Mac’s notified the CRA of the situation. After conducting an audit, the CRA issued notices of reassessment to Mac’s denying the deduction of all the interest it paid to Sildel during taxation years 2006, 2007, and 2008.

Mac’s filed a motion for declaratory judgment with the Quebec Superior Court requesting that the dividend of $136 million declared on April 25, 2006 and paid to the respondent CTI be cancelled retroactively and replaced by a reduction of Mac’s paid-up capital in the same amount. This rectification would have required no transfer of funds between the parties, but it would have allowed Mac’s to deduct the interest paid to Sildel in computing Mac’s income under the thin capitalization rules.

To read the full article, click here.

, , , ,

More on Rectification in Quebec

Trust Me, This Isn’t What It Looks Like

Tax law geeks call it “form over substance” – how Canadians are taxed on their actual relationships and transactions rather than what they intended those to be.

However, mistakes can be made – and sometimes the tax assessed is not reflective of the true nature of the situation at hand.

In the March 16, 2012 issue of The Lawyers Weekly, I discuss the ways in which mistakes may be fixed so as to avoid unintended and adverse tax consequences.

, ,

Trust Me, This Isn’t What It Looks Like