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Fairmont: SCC Revises Common Law Test for Tax Rectifications

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In a 7-2 decision in AG (Canada) v. Fairmont Hotels Inc. (2016 SCC 56), the Supreme Court of Canada has modified the common law test for rectification where the taxpayer has suffered an unintended and adverse tax result. The Court also clarified the standard of proof in respect of evidence of the parties’ intent on a rectification application.

A general intent to avoid or minimize tax is no longer sufficient to support an application for rectification.

In the companion case of Jean Coutu Group (PJC) Inc. v. AG (Canada), the Supreme Court reached a similar conclusion regarding tax intent and the modification of documents under the Quebec Civil Code (we shall follow-up with another post on this decision).

In Fairmont, the taxpayer brought an application to rectify certain share redemptions and to substitute a loan arrangement. The taxpayer argued that its intent at all times was to unwind some earlier loan arrangements on a tax-neutral basis.

The Ontario Superior Court of Justice (2014 ONSC 7302) cited Juliar et. al. v A.G. (Canada) (50 O.R. 3d 728) (Ont. C.A.) (Dentons was counsel to the successful taxpayers in Juliar) and other tax rectification cases. The Superior Court of Justice allowed the taxpayer’s application and unwound the impugned steps in the transaction and substituted the proper steps that accorded with the parties’ intention to avoid tax.

The Ontario Court of Appeal dismissed the Crown’s appeal (2015 ONCA 441).

See our previous posts on Fairmont here and here.

In the Supreme Court, the Crown argued that the result in Juliar conflicts with the Supreme Court’s decision in Performance Industries. The Crown urged the Court to import the requirements from Performance Industries to tax rectification cases.

In response, the taxpayer noted that Juliar (and most other tax rectification applications) are cases of mutual mistake, whereas Performance Industries was a case of unilateral mistake. Previous lower court decisions had rejected this attempt to import the Performance Industries requirements to tax rectifications. Further, the taxpayer noted the irony that the Crown was suggesting the result in Performance Industries should limit the availability of rectification when the Court’s decision in that case had in fact broadened the application of rectification as a remedy.

For the majority, Justice Brown stated that, under the new stricter test for tax rectification, a court may not modify an instrument merely because a party has discovered that its operation generates an adverse and unplanned tax liability. The Court stated:

[16] As I have recounted, both courts below considered the Court of Appeal’s decision in Juliar, coupled with the chambers judge’s findings, to be dispositive. In my respectful view, however, Juliar is irreconcilable with this Court’s jurisprudence and with the narrowly confined circumstances to which this Court has restricted the availability of rectification. …

[23] … Juliar does not account for this Court’s direction, in Shell Canada Ltd. v. Canada[1999] 3 S.C.R. 622, at para. 45, that a taxpayer should expect to be taxed “based on what it actually did, not based on what it could have done”. While this statement in Shell Canada was applied to support the proposition that a taxpayer should not be denied a sought-after fiscal objective merely because others had not availed themselves of the same advantage, it cuts the other way, too:  taxpayers should not be judicially accorded a benefit based solely on what they would have done had they known better. …

[30] This Court’s statement in Performance Industries (at para. 31) that “[r]ectification is predicated on the existence of a prior oral contract whose terms are definite and ascertainable” is to the same effect. The point, again, is that rectification corrects the recording in an instrument of an agreement (here, to redeem shares). Rectification does not operate simply because an agreement failed to achieve an intended effect (here, tax neutrality) — irrespective of whether the intention to achieve that effect was “common” and “continuing”. …

On the standard of proof, the Court stated:

[36] In my view, the applicable standard of proof to be applied to evidence adduced in support of a grant of rectification is that which McDougall identifies as the standard generally applicable to all civil cases: the balance of probabilities. But this merely addresses the standard, and not the quality of evidence by which that standard is to be discharged. As the Court also said in McDougall (at para. 46), “evidence must always be sufficiently clear, convincing and cogent”. A party seeking rectification faces a difficult task in meeting this standard, because the evidence must satisfy a court that the true substance of its unilateral intention or agreement with another party was not accurately recorded in the instrument to which it nonetheless subscribed. A court will typically require evidence exhibiting a high degree of clarity, persuasiveness and cogency before substituting the terms of a written instrument with those said to form the party’s true, if only orally expressed, intended course of action.

In conclusion, the Court stated:

[38] To summarize, rectification is an equitable remedy designed to correct errors in the recording of terms in written legal instruments. Where the error is said to result from a mistake common to both or all parties to the agreement, rectification is available upon the court being satisfied that, on a balance of probabilities, there was a prior agreement whose terms are definite and ascertainable; that the agreement was still in effect at the time the instrument was executed; that the instrument fails to accurately record the agreement; and that the instrument, if rectified, would carry out the parties’ prior agreement.

The Court allowed the Crown’s appeal, with the result that the taxpayer’s application for rectification of the impugned transactions failed.

In dissent, Justice Abella stated that, in her view, there was no reason to impose a stricter standard in tax cases, and on the facts of the Fairmont case rectification should have been granted:

[71] It is true that a taxpayer should expect to be taxed based on what is actually done, not based on what could have been done (Shell Canada Ltd. v. Canada, [1999] 3 S.C.R. 622, at para. 45), but this principle does not deprive equity of a role where what a party or parties genuinely intended to do was transcribed or implemented incorrectly.

[72] On the other hand, parties should not be given carte blanche to exploit rectification for purposes of engaging in retroactive tax planning.  Courts will not permit parties to undo decisions simply because they have come to regret them later.  Allowing parties to rewrite documents and restructure their affairs based solely on a generalized and all-encompassing preference for paying lower taxes is not consistent with the equitable principles that inform rectification. …

[83] The requirements for rectification in the tax context articulated in AES are, in my respectful view, functionally equivalent to the test under the common law.  Civil law and common law rectification in the tax context are clearly based on analogous principles, namely, that the true intention of the parties has primacy over errors in the transcription or implementation of that agreement, subject to a need for precision and the rights of third parties who detrimentally rely on the agreement.

[84] That means that there is no principled basis in either the common or civil law for a stricter standard in the tax context simply because it is the government which is positioned to benefit from a mistake.  The tax department is not entitled to play “Gotcha” any more than any other third party who did not rely to its detriment on the mistake.

The implications of the Supreme Court’s decisions in Fairmont and Jean Coutu are far-reaching, as they significantly change the threshold requirements for granting rectification in tax cases.

The result in these cases also raises the issue of whether other equitable remedies (i.e., rescission, declaratory orders, etc.) may be available, and whether taxpayers may seek alternative remedies if the requirements for rectification may not be satisfied.

The broader impact of the Court’s decision in Fairmont is also unclear. Fairmont was a case in which the taxpayer sought to correct various documents relating to steps in a commercial transaction. How will the Fairmont principles in respect of intent in the commercial context impact rectification applications in respect of wills and trusts?

Tax professionals should consider this new test for tax rectifications to determine the appropriate manner for correcting mistakes that result in unintended and adverse tax consequences.

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