Introduction
In Fairmont Hotels Inc. (2016 SCC 56) and Jean Coutu Group (2016 SCC 55) the Supreme Court of Canada added some much-needed clarity to the law of rectification. Although the result might be disappointing for taxpayers and tax practitioners alike, these decisions bring Ontario back in line with the rest of Canada by establishing that an application for rectification must be supported by a detailed intention.
Fairmont
On the facts of the Fairmont case, Fairmont started engaging in a foreign exchange hedging arrangement in 2002-2003. In 2006, Fairmont was purchased and taken private and, thanks to some tax planning, avoided a deemed foreign exchange loss, although the potential exposure of its subsidiaries was “kicked down the road” to be dealt with another day. In 2007, Fairmont moved to terminate the hedging arrangement in order to sell two hotels, but Fairmont’s tax advisors had misremembered the details of the 2006 tax plan, and accidentally triggered a foreign exchange gain which was discovered by a CRA audit.
At both the Ontario Superior Court and Court of Appeal, Fairmont was granted rectification on the basis of Juliar ((2000, 50 OR (3d) 728, leave to appeal to SCC refused, [2000] SCCA No. 621). Juliar had established that rectification was available where the parties: (i) had a “common continuing intention” that a transaction avoid immediate tax liability; and (ii) had chosen the wrong mechanism to achieve that result. Since Fairmont had a continuing general intention that its various transactions be “tax and accounting neutral” the lower courts allowed rectification to correct the choice of mechanism.
At the SCC, Brown J. began with a review of rectification, concluding that rectification was available to correct a legal instrument in order to accord with the true agreement between the parties. The SCC then considered the Ontario Court of Appeal decision in Juliar, and noted that the reasoning in the case “[presented] several difficulties,” had broadened the availability of rectification significantly in Ontario, and “allowed for impermissible retroactive tax planning.”
In essentially over-turning Juliar, the SCC ruled that a general continuing intention of tax neutrality is simply not enough to justify rectification. Rather, the party seeking rectification must show both an error in the recording of the agreement in a legal instrument (such as a contract), and how the instrument should be rectified to correctly record what the parties intended to do.
The SCC took the position that rectification is not available where the agreement between the parties was itself an imprecise general intention. In this regard, the SCC quoted Lord Denning, “rectification is concerned with contracts and documents, not with intentions.”
Applying the law to the facts, the SCC concluded that Fairmount’s application for rectification “should have been dismissed, since they could not show having reached a prior agreement with definite and ascertainable terms.”
Jean Coutu Group
In the second case, Jean Coutu Group, the appellant was a Quebec corporation which wanted to freeze the value of its U.S. subsidiary for accounting purposes and at the same time reduce adverse tax consequences. Upon obtaining professional advice, the corporation executed a series of planned transactions. Unfortunately, the corporation’s advisors had overlooked the Foreign Accrual Property Income; the result was an unexpected income inclusion. Upon receiving a large income tax assessment, the corporation requested the civil law equivalent to “rectification” from the Quebec Superior Court pursuant to article 1425 of the Civil Code of Quebec which provides that contractual interpretation should focus on the common intention of the contracting parties as opposed to the literal expression of that intention.
The Quebec Superior Court granted the appellant’s motion, but the Quebec Court of Appeal overturned this decision and held that the parties were seeking to rewrite the tax history. The Court of Appeal concluded that the corporation’s intention that the transaction be tax neutral was “insufficiently determinate to serve as the basis of a modified agreement” to avoid the unforeseen tax consequences.
At the SCC, Wagner J. reviewed the civil law provisions underlying rectification, and found that “a general intention of tax neutrality, in the absence of a precise juridical operation and a determinate or determinable prestation or prestations, cannot give rise to a common intention … and serve as a basis for modifying the written documents expressing that agreement.”
The SCC applied the civil law test for rectification to the facts of the case and described the corporation’s predicament as one where “there was a mistake in the transactions agreed to, not in the way they were expressed.” The SCC held that because the written documents accurately expressed the specific transactions which were agreed to, no modifications were possible under art. 1425.
Of note, Wagner J. discussed how the SCC’s decision in Jean Coutu Group was consistent with tax policy. In this regard, he noted that: (i) it is a fundamental principal of the Canadian tax system that “tax consequences flow from the legal relationships or transactions established by taxpayers;” (ii) the Duke of Westminster principle says that “taxpayers have the right to order their affairs to minimize tax payable;” and (iii) based on these principals, taxpayers who fail to structure their affairs properly may pay more tax.
The ultimate message of Jean Coutu Group is that rectification will not generally be available to taxpayers who have agreed to a specific tax plan and then experience an unintended tax consequence. Tax consequences flow from the decisions made by taxpayers, not from their intentions, motivations, or objectives.
Commentary
By way of commentary, these cases clarify the scope of rectification – particularly in Ontario where the Ontario Superior Courts were required to apply the Ontario Court of Appeal decision in Juliar. We now know that a general intention to avoid tax will not be enough to merit rectification. Accordingly we expect that there will now be fewer rectification cases – particularly in Ontario – and likely more Tax Court of Canada litigation instead. At a minimum, winning on the technical aspects of a case at the Tax Court of Canada will become more critical as taxpayers can no longer rely on the principles from Juliar for rectification.
Tax practitioners should remember that while the SCC ruled against rectification in Jean Coutu Group, the SCC did affirm that the insertion of additional transactions can be part of rectification– albeit only where those additional transactions were originally agreed to, but were, for some reason, mistakenly omitted during implementation. This aspect of the SCC’s decision may prove useful in future cases involving more than just “corrections.”
Robert G. Kreklewetz is a partner and John G. Bassindale an associate at Millar Kreklewetz LLP