So You Screwed Up Your Clients Tax Plan! Now What? Rectification, - - PowerPoint PPT Presentation

So You Screwed Up Your Client’s Tax Plan! Now What? Rectification, Rescission & Other Remedies

Agenda

1. Rectification 2. Implead 3. Mistake 4. Rescission 5. Remission Orders 6. Declaratory Judgment 7. Voluntary Disclosure

What is Rectification?

• It is an Equitable Remedy
• Rectification permits a Court of Equity:

̶ To correct the wording ̶

• f an “instrument”

̶ where its terms do not reflect the “real bargain”

• The purpose of rectification is to ensure that written agreements accurately reflect

the original intention of the parties

What is Rectification? – Cont’d

• Core Case:

̶ Canada (Attorney General) v. Fairmont Hotels Inc. ̶ (2016 SCC 56) (“Fairmont”) ̶ “Rectification is not equity’s version of a mulligan. Courts rectify instruments which do not correctly record agreements. Courts do not ‘rectify’ agreements where their faithful recording in an instrument has led to an undesirable or otherwise unexpected

• utcome”
• Brown J. at para. 39

What may be Rectified?

• An Instrument
• Written legal document defining rights, duties, entitlements or liabilities

̶ Directors resolutions, invoices, share purchase agreements ̶ Articles of Association, Amendment, Amalgamation

Why Rectify?

• Self help may be ineffective
• Sussex Square Apartments Ltd. v. R (99 DTC 443 (TCC) aff’d 2000 DTC 644

(FCA))

̶ Modification of agreements tax effective ̶ Only if ratified in superior court

• S & D International Group Inc. v. Canada (2011 ABQB 230)

̶ “Cancellation agreements” ineffective ̶ Taxpayer still allowed to rectify

Why Rectify – Cont’d

• Contrast:

̶ Twomey v. R. (2012 TCC 310) ̶ Simple recording error ̶ corrected by amended resolution ̶ No need to rectify

Why Rectify – Cont’d

• Retroactivity:

̶ Court orders rectification “nunc pro tunc” = “now for then” ̶ Rectified instrument effective as at the date of the original transaction ̶ See Winclare Management Services Ltd. v. Canada (2009 5 CTC 278)

• Binding on the CRA and the Tax Court

̶ See Dale v R (97 DTC 5252) ̶ But CRA may argue it is not bound unless served with application

Statutory Rectification

• Canadian corporate statutes contain mechanisms

̶ administrator can fix errors in certain corporate documents

• For example, section 265 of the Canada Business Corporations Act provides that:

“If there is an error in articles, a notice, a certificate or other document, the directors or shareholders of the corporation shall, on the request of the Director, pass the resolutions and send to the Director the documents required to comply with this Act, and take such

• ther steps as the Director may reasonably require so that the Director may correct the

document.”

̶ The “Director” = Administrator of CBCA

Statutory Rectification – Cont’d

• CBCA subsection 265(6)
• Director may issue a corrected certificate or file the corrected articles, notice or
• ther document if the application is accepted

̶ This suggests that the document must be capable of issuance or filing by the Director ̶ Case law suggests corporate statutes may be limited to errors ̶ That require correction in order to comply with the corporate law legislation ̶ See: Allsco Building Supplies Ltd. v. McAllister (1990), NBQB)

Statutory Rectification – Cont’d

• Various corporate statutes codify

̶ The courts ability to grant rectification ̶ In certain circumstances

• Some statutes broader than others
• I.e., the BC Corporations Act defines “basic records” as articles, notice of articles
• r memorandum, minutes of any meeting of shareholders or directors, any

resolution passed by shareholders etc.

• Court may make any order requiring company to correct basic records

Corporate Statutes

• Contrast with Alberta
• Subsection 244(1) Alberta Business Corporations Act allows rectification in the

following context:

̶ “If the name of a person is alleged to be or to have been wrongly entered or retained in, or wrongly deleted or omitted from, the registers or other records of a corporation, the corporation, a security holder of the corporation or any aggrieved person may apply to the Court for an order that the registers or records be rectified”

Income Tax Act and Rectification

• Rectification is not a statutory remedy under the Income Tax Act
• The same principles apply whether the reason for the request rectification is tax
• r non tax related.
• Rectification remains an equitable remedy
• Granted by way of an application to Court for an order

History of Rectification (non-tax)

• Leading non-tax case: Performance Industries v Sylvan Lake Golf and Tennis Club, (2002

SCC 19) (“Sylvan”)

"The court's task in a rectification case is corrective, not speculative. It is to restore the parties to their original bargain, not to rectify a belatedly recognized error of judgment by one party or the other”

• Per Sylvan: “general, common intention”
• Sufficient basis for rectification
• Sylvan provided “wide door” to rectification

History and Rectification

• In Shafron v KRG Insurance Brokers (Western Inc.) (2009 SCR 6) (“Shafron”),

the SCC stated that:

̶ “…rectification is used to restore what the parties’ agreement actually was, were it not for the error in the written agreement.” (at para. 57)

• Prior to Fairmont, the leading decision on tax matters as it related to rectification

was Juliar v. Canada (Attorney General) ((2000) 50 OR (3d) 728) (“Juliar”)

Fairmont

• Fairmont Hotels Inc. held an interest in a Canadian real estate investment Trust,

Legacy Hotels REIT

• Fairmont and its affiliates entered into reciprocal U.S. currency loan agreements

to provide financing to Legacy, which was acquiring properties in the U.S.

• Instead of financing the purchase of the hotels directly, Legacy moved the

financing through Fairmont Group corporations, and Fairmont would obtain the management contract for the hotels

• The loans were designated in USD, which exposed Fairmont Group to foreign

exchange tax liabilities

Fairmont – Cont’d

• The financing structure was set up to fully hedge the Fairmont Group’s foreign

exchange exposure, and the tax and financial advisors spent significant time planning the structures to ensure they would achieve the parties’ tax objectives

• In 2006, a plan was created which would have allowed for Fairmont and its

affiliates’ foreign exchange exposures to be continue to be fully hedged for tax purposes, and would have allowed for the affiliates to redeem their shares without realizing taxable foreign exchange gains

• The plan was slightly modified which would provide that Fairmont’s Foreign

exchange was fully hedged, but not that of its affiliates

Fairmont – Cont’d

• In 2007, Fairmont Group mistakenly assumed the 2006 plan was implemented
• Transactions were reported as if the plan had been implemented
• This resulted in large unanticipated foreign exchange gains that were not hedged

by accrued foreign exchange losses

• Fairmont sought rectification of the directors’ resolutions that implemented the

share redemptions and termination of loans

• Fairmont argued that the intent from 2002 onwards was to have the reciprocal

loan transactions and unwinding on a tax neutral basis

Fairmont – Cont’d

• Ontario Superior Court allowed the application, following Juliar
• Court of Appeal upheld the Superior Court decision, stating:

̶ "[I]n these circumstances, it was unnecessary that the respondent prove that it had determined to use a specific transactional device – loans – to achieve the intended tax result. That the respondent mistakenly failed to employ an appropriate transactional device to achieve the intended tax result does not alter the nature of the respondent's settled tax plan: tax neutrality in its dealings with Legacy and no redemptions of the preference shares in question"

Supreme Court of Canada

• SCC overturned the decision, stating that:

̶ “Juliar is irreconcilable with this Court’s jurisprudence and with the narrowly confined circumstances to which this court has restricted the availability of rectification”

• When there is a common mistake, a court may grant rectification upon the court being

satisfied on a balance of probabilities that:

̶ The parties had reached a prior agreement whose terms are definite and ascertainable; ̶ The agreement was still effective when the instrument was executed; ̶ The instrument failed to accurately record the prior agreement; and ̶ If rectified, the instrument would carry out the agreement as intended

General Principles

• Rectification is limited solely to cases where a written instrument has incorrectly

recorded the parties’ antecedent agreement

• Rectification aligns the written instrument with the parties agreed to do, and not

what, with the benefit of hindsight, they should have agreed to do

• A common and continuing intention to achieve a particular tax consequence (i.e.

tax deferred transaction) is not sufficient on its own to grant rectification

• A relaxed approach to the doctrine of rectification in relation to executed contracts

is inappropriate and would undermine the confidence of the commercial world in written contracts

Jean Couteau Group (PJC) Inc. v. Attorney General fo Canada (2016 SCC 55)

• Companion case to Fairmont, in the context of the Quebec Civil Code
• Test parallels that in Fairmont, requiring the contracting parties to have actually

intended to take specific measures to avoid undesirable tax consequences

• Civil code is not confined to only clerical errors

Post Fairmont Jurisprudence

• BC Trust v. Canada (Attorney General) (2017 BCSC 209): the applicant

requested a rectification order allowing the trustees to retroactively allocate income to a beneficiary and amend its 2012 tax return

• Did not make an allocation to the beneficiary due to an ongoing dispute with

CRA, where the CRA was proposing to designate two trusts as a single trust

• Court denied rectification, observing that the Trustees were using hindsight in

wanting to take a different action, and that there was no written agreement or document, including the T3 Tax Return, which incorrectly recorded the petitioner's interests at the time

Crean v Canada (Attorney General), 2019 BCSC 146

• Two brothers entered into an agreement that provided for one brother to sell half
• f Opco’s shares to other brother
• Agreement specified that the transaction would be structured, to the extent

possible, so that the brother receives capital gains treatment for tax purposes

• Brothers took agreement to their tax advisor, who created a step plan for the sale
• The advisor did not consider the application of section 84.1 of the Act, which

resulted in a deemed dividend, reversing capital gains treatment

Crean

• Brothers applied to the court for rectification on the basis that the tax adviser had

made a “mistake” in interpreting and implementing the true intention of the

• riginal agreement
• Crown argued that the brothers wanted rectification of an instrument that had

provided them with adverse tax consequences, and that the claim that the adviser had made a mistake was disingenuous

• Petitioners pointed to the language of the actual agreement, which explicitly

provided that it would be sale to one brother by the other. They argued that the transactions that were implemented were inconsistent with the true agreement

Crean - Conclusion

• Court, in following Fairmont, supported a grant of rectification, accepting that the
• riginal agreement written by the brothers as determinative evidence of the actual

agreement

• The written instruments could be amended to support the original intention of the

parties

Other Cases

• In 5551928 Manitoba Ltd. (Re), 2018 BCSC 1482 the Court allowed the rectification of a resolution

that was based on a mis-calculation of the capital dividend account balance in order to avoid the imposition of Part III tax.

• In Buyting, 2017 NBQB 190) the Court rectified a land transfer deed in order to avoid a tax

assessment relating to that individual's shareholder loan account.

• In both cases the taxpayers were able to point to documents showing a clear intent to achieve a

specific tax outcome or a specific transaction that was utterly incompatible with what was put into effect.

• In contrast there has been no enthusiasm from provincial courts to grant rectification to allow

taxpayers to do what they “ought to have done”; e.g. ̶ to convert a shareholder loan into a return of capital (TechnoComm Solutions Inc., 2019 ONSC 924); ̶ to substitute the name of a corporate borrower with its parent company's name and add additional steps in a complex transaction (Harvest Operations, 2017 ABCA 393)

To Implead or not to Implead?

• According to Bourgault (2019 TCC 6) the CRA must be made a party to a court action, or

“impleaded “ in order for it to be bound by the rectification or declaratory decision.

• The taxpayer took their issue before the Quebec Superior Court, where the judge allowed the
• rectification. The taxpayer had not implead the CRA, but had informed them of the case. Despite

having a rectification judgment, the CRA did not adjust the relevant assessments against the taxpayer, arguing that it was not bound by a judgment to which it had not been impleaded.

• The TCC ruled in favour of the CRA on this issue, but agreed with the decision of the Quebec

Superior Court that rectification ought to have been granted, and as a result, the TCC allowed the appeal of the assessments. The decision has not been appealed.

• In Brogan Family Trust (2014 ONSC 6354),

the Court held that the CRA was bound by a declaratory order, despite the fact that the CRA had not been impleaded. However, in Brogan, the CRA had yet to issue a notice of assessment, that would have made it a creditor of the trust. As a result, the CRA had as of that time no legal interest in the proceedings, but would be bound by its

• utcome.
• The case law appears to suggest that the time to seek rectification is before the CRA has noticed

the mistake.

Mistake

• Stone’s Jewellry v. Arora (2009 ABQB 656)
• Land transferred – thought to be capital property
• Parties believed ss. 85(1) applied – deferral was fundamental
• CRA assessed land as inventory  ineligible for rollover
• Rectification not available

Mistake – Cont’d

• Common law mistake

̶ Fundamental mistake going to the root of the contract ̶ Contract void ab initio

• Equitable Mistake – Rescission

̶ Fundamental, honest … inadvertent mistake ̶ Unfair, unjust, unconscionable not to correct it ̶ Contract is voidable ̶ No effect on third parties

Rescission

• Another Equitable Remedy
• Allows a contractual party to cancel the contract
• Parties may rescind if victims of vitiating factor:

̶ misrepresentation ̶ mistake ̶ duress ̶ undue influence

Rescission – Cont’d

• Goal:

̶ Bring the parties, as far as possible … ̶ Back to the position they were before they entered into a contract

• the status quo ante

Rescission Denied

• Canada Life Insurance Company of Canada (“CLICC”) v Canada (2018 ONCA

562)

• CLICC and certain affiliates carried out transactions in December 2007

̶ To realize a tax loss to offset accrued and unrealized foreign exchange gains

• CRA disallowed the loss on reassessment
• CLICC said it had proceeded on tax adviser’s erroneous advice

Rescission Denied – Cont’d

• CLICC applied for a judicial order to set aside the transaction
• Retroactively replace the transactions
• Problem:

̶ Tax loss was to be triggered by a limited partnership’s windup ̶ Mistake occurred: the general partner was wound up at same time

• Result: CLICC carried on business alone for three months:

̶ Transaction tax-deferred rollover ̶ No loss realized

Rescission Denied – Cont’d

• Ontario Court of Appeal (“ONCA”) denied rescission
• CLICC sought rescission of a contract and not of a voluntary property disposition
• Per ONCA, CLICC had adequate alternative remedies:

(i) file a notice of objection and appeal to it stax assessment (ii) file for a remission of tax - section 23 of the federal Financial Administration Act (iii) Potential legal action against its professional adviser(s)

Remission Orders

• Financial Administration Act s. 23:

“…. Remission of taxes and penalties

• (2) The Governor in Council may, on the recommendation of the appropriate Minister,

remit any tax or penalty, including any interest paid or payable thereon, where the Governor in Council considers that the collection of the tax or the enforcement of the penalty is unreasonable or unjust or that it is otherwise in the public interest to remit the tax or penalty. ….

Remission Orders – Cont’d

• Per CRA Guidelines, Remission Orders will only be recommended to the

Minister:

̶ Unintended results of litigation; ̶ Financial setback coupled with extenuating factors; ̶ Incorrect action or advice by CRA officials; and ̶ Extreme Hardship

• I.e., Remission Orders  very difficult to obtain

Declaratory Judgment (Relief)

• Judgment from a court that defines the rights of the parties regarding the legal

question presented

• Different do not order a party to take any action or award any damages for

violations of the law

• Declaratory judgments state whether the parties may seek or are entitled to relief

Declaratory Judgment (Relief) – Cont’d

• Declaratory judgments are conclusive and legally binding, but do not have

preclusive effect if:

̶ A later lawsuit involves issues other than those specifically litigated and ruled on in the declaratory judgment action ̶ A party sought other relief in addition to declaratory relief, such as injunctive relief, in the declaratory judgment action

Declaratory Relief

• Sheila Holmes Spousal Trust (2013) ABQB 489
• Alberta Spousal Trust
• Interprovincial Tax Arbitrage
• Court refused to issue declaration on the validity of a trust or its provincial

residence

• Should go to full trial
• TCC has jurisdiction to determine all issues

̶ Judicial Efficiency

Voluntary Disclosure

• Since March of 2018, the new process has made voluntary disclosures less

palatable in general

• Little understanding as to what the CRA will allow vs. what it will insist on

penalizing as a practical matter

• Given issue with “impleading”, perhaps even less incentive now to let the CRA

know what happened before you have tried everything else

Summary

1. Rectification – Corrects instruments which do not correctly record agreements 2. Implead – May be better to seek rectification before CRA has noticed mistake 3. Rescission – Misrepresentation, Mistake, Duress and Undue Influence  Difficult to Obtain 4. Remission Orders  Very difficult to obtain 5. Declaratory Judgment  Challenging to Obtain 6. Voluntary Disclosure  Less palatable since March 2018