In Fairmont Hotels Inc. (2016 SCC 56) and Jean Coutu Group (2016 SCC 55) the Supreme Court of Canada (the “SCC”) clarified the law of rectification. The result might be disappointing for taxpayers and tax practitioners alike, yet the decisions bring Ontario back in line with the rest of Canada by establishing that an application for rectification refer to a detailed intention.
Fairmont engaged in foreign exchange hedging arrangement starting 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 (the “OCA”), Fairmont was granted rectification on the basis of Juliar ((2000, 50 OR (3d) 728, leave to appeal to SCC refused, [2000] SCCA No. 621).
The SCC over-turned Juliar, ruling that a general continuing intention of tax neutrality is simply not enough to justify rectification. Rather, the party seeking rectification must both show an error in the recording of the agreement in a legal instrument, and show 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.
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”.
In Jean Coutu Group, the appellant was a Quebec corporation who wanted to freeze the value of its US 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 (“FAPI”); 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.
At the SCC, Wagner J. found that a general intention of tax neutrality cannot serve as a basis for modifying the written documents expressing an agreement.
The SCC 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.
The ultimate message of Jean CoutuGroup 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.
By way of commentary, these cases clarify the scope of rectification. We now know that a general intention to avoid tax will not be enough to merit rectification. We expect that there will now be fewer rectification cases and that winning on the technical aspects of a case at the TCC will become more critical.
Tax practitioners should remember that while 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 agreed to, but 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 and John G. Bassindale
Millar Kreklewetz LLP
A version of this article appeared in the January 2017 issue of Canadian Tax Highlights