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Guindon: SCC Hears Arguments in Penalty Case

The Supreme Court of Canada heard oral arguments today in the case of Guindon v. The Queen (Docket No. 35519). At issue in the case is the nature of the third-party penalty in section 163.2 of the Income Tax Act.

See our previous post on the case here.

The taxpayer’s factum is available here, and the Crown’s factum is here. In written submissions, the taxpayer argued:

    1. Section 163.2 is an offence provision that attracts the protections of section 11 of the Charter, and
    2. No notice of constitutional question was required.

In response, the Crown argued:

    1. The taxpayer’s failure to file a notice of constitutional question is fatal to the appeal, and
    2. Section 163.2 is not an offence provision.

The seven-member panel was chaired by Justice Rosalie Abella. (Absent were Chief Justice Beverley McLachlin and recently appointed Justice Suzanne Côté.)

Taxpayer’s Arguments

The Appellant first addressed the question of whether notice of a constitutional question was required under section 19.2 of the Tax Court of Canada Act. The Appellant argued that it was not advancing the position that section 163.2 was invalid or inapplicable or inoperable, and thus no notice was required. Further, if notice was required, it had been provided in respect of the Supreme Court proceeding.

This brought a series of pointed questions from Justices Abella and Moldaver, who asked whether the effect of the Appellant’s interpretation would be to “throw out” the third-party penalty regime in section 163.2 because it would become subject to criminal procedural requirements. Further, the Court was unconvinced that providing the notice in respect of the Supreme Court hearing cured the failure to provide the notice in the Tax Court.

In respect of the Wigglesworth test, the Appellant argued that section 163.2 is directed at any person, and therefore it is intended to promote public order rather than to regulate a private sphere of conduct. Further, section 163.2 has a true penal consequence in that the penalty imposed under this section is identical to the penalty that could be imposed under section 239 for criminal tax evasion.

Justice Rothstein asked several questions about how section 163.2 differs from the other penalty provisions in the Act and whether a finding that section 163.2 was an offense would require Parliament to redraft the provision to include language similar to that found in section 239. On this point, Justice Abella returned to the issue of whether the Appellant was in fact seeking to have section 163.2 declared inoperable.

Crown’s Arguments

The Crown’s submissions were generally received with less judicial intervention from the Court.  The Crown began its submissions with a discussion of the issue of notice of constitutional question.  When asked whether the failure to give notice can be cured in subsequent proceedings, counsel for the Crown conceded that it could in certain cases, but that by the time the dispute comes before the Supreme Court, the matter should be fully argued and the evidentiary record should be complete.

The Crown argued that, in this case, the Federal Court of Appeal could have done one of three things, each of which would have been acceptable: (1) it could have said that notice of constitutional question is required, adjourned the proceedings to remedy the failure, and heard arguments on the substantive issue; (2) it could have returned the matter back to the Tax Court to have the notice served and arguments re-heard so that the evidentiary record could be completed at trial; or (3) it could have done what it did in this case, and held that failure to give notice prevented the court from considering whether section 163.2 implicates the Charter. On this point, Crown counsel argued that the Supreme Court should not sanction a practice that makes it better to ask for forgiveness on appeal rather than asking for permission in the Tax Court.

Regarding the substantive issue, Crown counsel argued that since the penalty is computed mathematically, and with specific reference to the amount of tax credits that the individual taxpayers claimed under the Income Tax Act, then the penalty in section 163.2 is a non-discretionary penalty that bears none of the principles of sentencing (e.g., blameworthiness, retribution, denunciation, reparation, etc.).

Crown counsel discussed the facts of the case to show the link between the penalty amount and the underlying income tax at issue.  Interestingly, Crown counsel distinguished this penalty (i.e., the “tax preparer” penalty) from the “tax advisor” penalty in section 163.2, on the basis that the tax advisor penalty takes into account “gross entitlements”, which this particular penalty does not (therefore, it remains to be seen in a future case whether the “tax advisor” penalty in section 163.2 could be treated differently).  In response to questions from Justices Abella and Rothstein, Crown counsel stated that this penalty is not an “outlier”, as counsel for the Appellant suggested, and that the type of stigma attached to this penalty is a different kind of stigma than the one attached to criminal sanctions.

Finally, regarding the issue of quantum, Crown counsel argued that the amount of the penalty was irrelevant to the analysis.  Justices Abella and Rothstein asked whether the analysis would change if the amount was sufficiently enormous.  Crown counsel argued that the analysis turns on whether the penalty is penal in nature, and if the answer is no, then only in extreme cases would the actual amount cause a penalty to be penal.

*     *     *

Following brief submissions made by the intervener, the Court reserved its decision.

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Guindon: SCC Hears Arguments in Penalty Case

Guindon: SCC Hearing Scheduled for December 5, 2014

The highly-anticipated appeal to the Supreme Court of Canada in Guindon v The Queen has been scheduled for hearing on December 5, 2014, and the parties have now filed their factums in the appeal.

For our prior posts on this decision, refer to our summary of the Tax Court decision (2012 TCC 287), our guest blogger’s summary of the Federal Court of Appeal decision (2013 FCA 153), and our summary of the Supreme Court leave application (Docket No. 35519).

The Appellant’s (Ms. Guindon’s) Factum is available here, and the Respondent’s (Crown’s) Factum is here.

The appeal concerns the “third party” penalties under section 163.2 of the Income Tax Act.  In short, the Tax Court found that the penalty imposed under section 163.2 is a criminal penalty, not a civil one, and therefore subject to the protection of (inter alia) section 11 of the Charter of Rights and Freedoms.

The Federal Court of Appeal reversed on the basis that Ms. Guindon did not provide notice of a constitutional question, and thus the Tax Court lacked jurisdiction to make an order on the nature of section 163.2.  In any event, the Federal Court of Appeal also stated that the penalty under section 163.2 was not criminal in nature, and hence, was not subject to Charter protections.

Taxpayer’s Arguments

On appeal to the Supreme Court, Ms. Guindon has framed her appeal as follows: based on the Supreme Court’s decisions in Wigglesworth and Martineau, section 163.2 is an offence provision that attracts the protection of (inter alia) section 11 of the Charter on the basis that section 163.2 is (1) an offence provision “by nature” and (2) an offence provision by virtue of its true “penal consequences”.

In addition, if section 163.2 is an offence provision, then Ms. Guindon argues that her section 11 Charter rights were breached in a manner that cannot be justified under section 1 of the Charter (applying the Oakes test).

Finally, Ms. Guindon asserts that a notice of constitutional question did not need to be filed in this case, since she was not seeking a declaration that section 163.2 was unconstitutional, but was rather merely asserting her Charter rights (and in the alternative, if notice of constitutional question was needed, Ms. Guindon argues that no prejudice resulted to the Crown and the Supreme Court can simply replace the lower court’s decision with its own).

Crown’s Arguments

The Crown, not surprisingly, has focused its primary argument on the fact that no notice of constitutional question was made by the taxpayer.  Accordingly, the Crown argues that the Supreme Court should dismiss the appeal on that basis alone and need not consider the substantive issues.

Alternatively, the Crown argues that section 163.2 is not an offence provision “by nature”, as its objects are purely administrative, the purpose of the penalty is to deter non-compliance under the Income Tax Act, and the process by which to challenge the penalty (i.e., the objection and appeal process under the Act) is not criminal in nature.

Moreover, the Crown asserts that section 163.2 does not impose true “penal consequences”, since (i) prosecution could have resulted in harsher sanctions (including prison time), and (ii) the magnitude of the penalty must be assessed in the context of the malady it intends to remedy (notwithstanding the lack of a penalty “ceiling”).  If the Supreme Court finds that section 163.2 infringes section 11 of the Charter, then the Minister will not seek to uphold it under section 1 of the Charter.

Potential Implications

Regardless of the Supreme Court’s finding on the issue regarding the notice of constitutional question, it would be surprising if the Supreme Court did not consider the substantive issue – it would be puzzling for the Court to grant leave and consider only the preliminary question. Accordingly, even if Ms. Guindon’s appeal fails on technical grounds, we expect the Court to offer much-needed guidance on the nature of section 163.2.

If the Court determines that section 163.2 infringes section 11 of the Charter (regardless of its finding on the “notice” issue), we can expect the Department of Finance may consider amendments to 163.2 (and the parallel provision under the Excise Tax Act) in a manner that takes into account the Supreme Court’s reasons.

The Court’s decision will also have implications for the Excise Tax Act (the “ETA”).  Section 285.1 of the ETA imposes a similar planner/preparer penalty for GST/HST purposes. At the CPA Commodity Tax Symposium in Ottawa (held on September 29 and 30, 2014), the CRA announced that it had recently issued the first penalty under section 285.1 of the ETA.

And for both the ITA and ETA, we expect there may be other potential penalty reassessments issued – or not – depending on the result of the Guindon case.

For these reasons, we eagerly await the hearing on December 5, 2014 and the Court’s subsequent decision.

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Guindon: SCC Hearing Scheduled for December 5, 2014

SCC Grants Leave to Appeal in Guindon v. The Queen

The Supreme Court of Canada has granted leave to appeal in Guindon v. The Queen (Docket # 35519).  In this case, the Supreme Court of Canada will consider whether penalties imposed under section 163.2 of the Income Tax Act (Canada) constitute an “offence” within the meaning of s. 11 of the Charter.

The Tax Court found that the penalty imposed under section 163.2 of the Act is a
criminal penalty, not a civil one, and therefore subject to the same constitutional protections as other penal statutes enacted by the federal government.

The Federal Court of Appeal reversed the Tax Court’s ruling, first on the basis that Ms. Guindon had not followed the proper process in challenging section 163.2 by failing to provide notice of a constitutional question, and so the Tax Court lacked the jurisdiction to make the order it did. However, the Federal Court of Appeal considered the merits of the issue in any event, and held that advisor penalty proceedings are not criminal in nature and do not impose “true penal consequences.”

Our previous comments on the decisions are here and here.

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SCC Grants Leave to Appeal in Guindon v. The Queen

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

Waiving rights of objection and appeal: SCC declines to hear the taxpayer’s appeal in Taylor v. The Queen

On August 15, 2013, the Supreme Court of Canada dismissed the application for leave to appeal in Terry E.Taylor v. Her Majesty the Queen (2012 FCA 148).

In Taylor, the issue was whether a signed settlement agreement under which the taxpayer waived his right to appeal was binding. In that case, the taxpayer was assessed for income tax and GST, as well as gross negligence penalties and interest. He signed a settlement agreement under which the Minister of National Revenue would vacate the gross negligence penalties and, in exchange, he would waive his right to object or appeal in accordance with subsections 165(1.2) and 169(2.2) of the Income Tax Act and subsections 301(1.6) and 206.1(2) of the Excise Tax Act. The taxpayer, who did not have counsel advising him at the time, later claimed that he was under duress when he signed the agreement. Having already disposed of the penalties, he went to Tax Court to challenge the amount of tax assessed.

Justice Judith Woods held that the taxpayer’s testimony that he was “scared” and pressured into signing the agreement lacked credibility given his qualifications as a Certified Management Accountant and his extensive business and financial experience. He had ample time to consult with counsel prior to meeting with the CRA. The Tax Court held that the settlement agreement was “freely made” and signed without “undue pressure.”  The Tax Court dismissed the taxpayer’s appeal (2010 TCC 246) and the Federal Court of Appeal affirmed at 2012 FCA 148. As noted above, the Supreme Court of Canada has declined to hear Mr. Taylor’s appeal.

Taylor adds to an existing body of case law on the question of whether, and under what circumstances, settlement agreements between taxpayers and the CRA can be set aside. The Tax Court has held that in certain limited circumstances a settlement agreement may not be binding. For example, in 1390758 Ontario Corporation v. The Queen (2010 TCC 572) and Huppe v. the Queen (2010 TCC 644), agreements were held to be binding so long as they were made on a “principled” basis (see, for example, Daniel Sandler and Colin Campbell, “Catch-22: A Principled Basis for the Settlement of Tax Appeals“, Canadian Tax Journal (2009), Vol. 57, No. 4, 762-86).

Given that a significant portion of tax disputes are settled and never reach the courtroom, professional advisors should ensure that taxpayers understand the implications of signing settlement agreements under which they relinquish rights of objection or appeal.

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Waiving rights of objection and appeal: SCC declines to hear the taxpayer’s appeal in Taylor v. The Queen

The Latest Word from the Supreme Court of Canada on Conflicts of Interest: Canadian National Railway Co. v. McKercher LLP

The Supreme Court of Canada shed a bit more light on the “bright line rule” for determining when a conflict exists when a law firm represents clients whose interests are adverse in the recent decision of Canadian National Railway Co. v. McKercher LLP, 2013 SCC 39. The Court also provided further clarification regarding a law firm’s duty of loyalty to its clients and guidance for determining the appropriate remedy where this duty is breached.

In McKercher, Gordon Wallace hired McKercher LLP to act for him as the representative plaintiff in a proposed $1.75 billion class action against Canadian National Railway (CN) and others for allegedly overcharging western farmers to transport grain. At the time McKercher was retained by Mr. Wallace, the firm was acting for CN on several unrelated matters. McKercher did not tell CN in advance that it was entering into a retainer with Mr. Wallace, and after entering into this new retainer, the firm withdrew as counsel on some of CN’s matters. CN learned that McKercher was acting for Mr. Wallace in the proposed class action when it received a copy of the Statement of Claim, at which point CN terminated its relationship with McKercher and applied to disqualify the firm from representing Mr. Wallace. The Court of Queen’s Bench of Saskatchewan ruled in CN’s favour and disqualified McKercher from acting in the class action. However, the Court of Appeal overturned the disqualification and allowed McKercher to continue acting for Mr. Wallace, and CN appealed to the Supreme Court of Canada.

The Supreme Court allowed CN’s appeal, finding that McKercher breached its duty of loyalty owed to CN by breaching its duties (1) to avoid conflicts of interest, (2) of candour, and (3) of commitment to its client’s cause, which the Court described as the three salient aspects of the duty of loyalty.

In considering whether a conflict of interest existed, the Supreme Court applied the bright-line rule and found that McKercher clearly crossed the bright line by accepting the retainer with Mr. Wallace without CN’s consent. The Court upheld a strict interpretation of the rule, which stipulates that a law firm cannot concurrently represent clients whose interests are adverse without first obtaining their consent, even if the matters are unrelated.

Despite expressly rejecting arguments for a less strict interpretation of the rule, the Supreme Court pointed out that the scope of the rule is not unlimited. The Court clarified that the bright-line rule:

  1. only applies where the clients’ immediate interests are directly adverse in the legal matters the firm is representing them on;
  2. only applies to legal interests, not to commercial or strategic interests;
  3. cannot be used tactically; and
  4. does not apply where it would be unreasonable for a client to expect that the firm would not act against it in an unrelated matter (for example, with professional litigants, whose consent can be inferred when the conflicting matters are unrelated and there is no risk of improper use of confidential information).

When the bright-line rule does not apply, the Court endorsed a more contextual approach and stated that the test for determining whether a conflict of interest exists is whether there is a substantial risk that the lawyer’s representation of the client would be materially or adversely affected.

The Supreme Court observed that disqualification is normally the appropriate remedy for a breach of the bright-line rule in order to:

  1. avoid misuse of confidential information;
  2. avoid impaired representation; and
  3. maintain confidence in the administration of justice.

However, the Supreme Court noted that disqualification may not always be warranted where there is no risk of misuse of confidential information or prejudice to the complaining party. In cases where disqualification is sought only to maintain confidence in the justice system, courts must consider factors that may weigh against disqualification, including:

  • conduct that could disentitle the complaining party from seeking disqualification (such as delay in applying for disqualification);
  • significant prejudice to the non-complaining client in retaining its choice of, or any, counsel;
  • a law firm’s having accepted the conflicting matter in good faith and with the belief that the concurrent representation would not breach the bright-line rule.

The Court found that McKercher did not have confidential information that could prejudice CN in the class action. Therefore, the only relevant ground for disqualification in this case is to maintain public confidence in the administration of justice, which requires consideration of the above factors. As a result, the McKercher case has been returned to the Court of Queen’s Bench to determine the appropriate remedy for CN in light of the Supreme Court’s reasons.

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The Latest Word from the Supreme Court of Canada on Conflicts of Interest: Canadian National Railway Co. v. McKercher LLP

Daishowa-Marubeni: A Tree Fell in the Forest and the SCC Caught it!

In Daishowa-Marubeni International Ltd. v. The Queen, 2013 SCC 29, Justice Rothstein marries tax philosophy and tax practice by asking and answering the question:

If a tree falls in the forest and you are not around to replant it, how does it affect your taxes?

The Court analyzes the difference for tax purposes between liabilities and embedded obligations, considers the law of contingent liabilities, the role of tax symmetry in the Income Tax Act (Canada) (the “Act”), the role of the agreement between the parties and the role of accounting treatment in reaching the conclusion that embedded obligations are not liabilities that form part of proceeds of disposition.

For a full analysis of the decision, click here.

Daishowa-Marubeni: A Tree Fell in the Forest and the SCC Caught it!

Supreme Court dismisses leave application in Johnson v. The Queen

On March 21, 2013, the Supreme Court of Canada dismissed (with costs) the application for leave to appeal in the case of Donna M. Johnson v. Her Majesty The Queen.

The issue in Johnson was the tax treatment of receipts from a Ponzi scheme. The Tax Court (2011 TCC 540) allowed the taxpayer’s appeal and held that the receipts were not income from a source for the purpose of paragraph 3(a) of the Income Tax Act. The Federal Court of Appeal (2012 FCA 253) reversed the lower court’s decision, allowing the Crown’s appeal.

I commented on the decisions of the Tax Court and the Federal Court of Appeal in the March 2013 Ontario Bar Association Tax Section newsletter.

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Supreme Court dismisses leave application in Johnson v. The Queen

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