Canada: Canada (Attorney General) v. Fairmont Hotels Inc. – SCC Update on Tax Rectification

Last Updated: May 17 2017

Background – Rectification and Taxation

Tax rectification is a remedy that can be sought when a legal document fails to reflect the tax intent of the parties to that document. When granted the court will retroactively alter the text of the document to reflect the original intentions of the parties. Rectification has been used extensively for the purposes of fixing tax problems by having the court alter the documents which gave rise to the mistake. It should also be noted that although the parties to an agreement can agree to amend the agreement, that amendment is not effective retroactively against the CRA unless an order from the court granting rectification is obtained. If you have a tax problem, please contact one of our experienced Toronto tax lawyers to discuss if rectification may be available to provide you with tax help.

The key tax rectification case until Fairmont Hotels was Juliar v. Canada (Attorney General), where the taxpayer was involved in reorganizing a family business. The taxpayer was a party to a written agreement that exchanged shares for promissory notes. The parties had intended for the transaction to occur on a tax deferred basis, but it turned out that the value of the promissory notes exceeded that of the shares, which resulted in a deemed dividend. If the taxpayer had proceeded by way of a share for share exchange then the transaction would have been completed on a tax deferred basis. The taxpayer then successfully applied to the court to rectify the transaction by altering the written agreement so that it was a share for share exchange on the grounds that the original written agreement failed to reflect the parties’ intention for the transaction to proceed on a tax deferred basis. Our expert Toronto Tax Lawyers can help in properly implementing a tax reorganization.

Canada (Attorney Genera) v. Fairmont Hotels Inc., the Supreme Court of Canada’s latest decision on rectification, is a significant development because it narrows the scope of when taxpayers can ask the court for rectification. Court orders for rectification will no longer be available in situations similar to Juliar v. Canada (Attorney General). Despite this, there is still room for the doctrine of rectification to be relevant in the Canadian tax context. In light of this decision, taxpayers will need to adopt new strategies both to avoid the need for rectification orders and to be able to obtain one if necessary. If you would like to learn more about how to respond to the Supreme Court of Canada’s decision, please contact one of our experienced Toronto tax lawyers.

Facts – Canada (Attorney General) v. Fairmont Hotels Inc.

In 2002, Fairmont Hotels and its subsidiaries assisted Legacy Hotels REIT in financing the purchase of two hotels in the United States through a reciprocal loan arrangement. Since the financing was to be done in US currency, Fairmont was concerned about tax liability that could arise from changes in the exchange rate. As a result, the transaction was structured to achieve foreign exchange tax neutrality. This was achieved by ensuring that any loss from foreign exchange fluctuations would be offset by a corresponding gain and vice versa. If you are concerned about the tax implications of foreign exchange fluctuations on your business, consider reaching out to one of our top Toronto tax lawyers.

In 2006, Fairmont Hotels was acquired by Kingdom Hotels International and Colony Capital LLC. This acquisition threatened to cause Fairmont Hotels and its subsidiaries involved in the reciprocal loan arrangement to realize a deemed foreign exchange loss without the corresponding gains. That would compromise the ability of the structure to provide foreign exchange tax neutrality. Fairmont responded to this by executing a plan that fixed the problem for Fairmont itself, but deferred solving the problem for its subsidiaries until a later date. If you are involved in the purchase or sale of a business and would like to know more about tax traps and planning opportunities, please contact one of our experienced Toronto tax lawyers.

In 2007, Legacy Hotels REIT decided to sell the hotels and requested on short notice that Fairmont unwind the reciprocal loan agreement. Fairmont proceeded to do this without realizing that since they never fixed the foreign exchange tax neutrality problem for the subsidiaries, they would face adverse tax consequences. The Canada Revenue Agency uncovered this fact as part of the tax audit of Fairmont’s 2007 tax returns. Fairmont then applied to the court to rectify the director’s resolutions they used to unwind the reciprocal loan agreement so as to maintain the foreign exchange tax neutrality the structure was originally designed to ensure.

Judicial History - Canada (Attorney General) v. Fairmont Hotels Inc.

The Ontario Superior Court of Justice found in favour of Fairmont Hotels. The Superior Court found that Fairmont a continuing intention to maintain foreign exchange tax neutrality and that Fairmont did not have a specific plan as to how they would achieve that outcome. Relying on Juliar v. Canada (Attorney General), the Superior Court found that it was not necessary for Fairmont to have a specific plan in mind to qualify for rectification. The Superior Court took the position that Fairmont’s continuing intention to maintain foreign exchange tax neutrality meant that their rectification request was not an instance of retroactive tax planning and that denying Fairmont’s application would give the Canada Revenue Agency an unintended gain.

The Ontario Court of Appeal also found in favour of Fairmont Hotels. The Court of Appeal found that the critical component for rectification is the continuing intention to undertake a transaction on a specific tax basis. According to the Court of Appeal, rectification does not require the parties to know the precise mechanics or specific means by which they would achieve their intended tax result so long as the intention to achieve that tax result can be demonstrated.

Supreme Court of Canada Decision - Canada (Attorney General) v. Fairmont Hotels Inc

The Supreme Court of Canada allowed the CRA appeal and found that Fairmont did not meet the requirements for rectification. Although Fairmont demonstrated a continuing intention to maintain foreign exchange tax neutrality, that intention alone is not sufficient to qualify for rectification. The Supreme Court emphasized that the role of rectification is to correct errors in the recording the terms of an agreement in a written instrument. The parties must have had an agreement in mind with definite and ascertainable terms which they failed to accurately record as a written instrument. In such situations, the Court will use rectification to alter the written instrument so it reflects the terms of the antecedent agreement.

The Supreme Court took the position that it is relevant that Fairmont never had a specific plan in mind as to how they were going to achieve foreign exchange tax neutrality for their subsidiaries. This meant that there wasn’t an agreement with definite and ascertainable terms that Fairmont failed to record. Fairmont’s desire to protect its subsidiaries and maintain tax neutrality by unspecified means was not sufficient to qualify for rectification. The Supreme Court stated that cases like Juliar v. Canada (Attorney General) which allowed taxpayers to qualify for rectification on the basis of their tax objectives for a transaction alone are inconsistent with the Supreme Court’s jurisprudence in Performance Industries Ltd. v. Sylvan Lake Golf & Tennis Club Ltd. and Shafron v. KRG Insurance Brokers (Western) Inc. which emphasize that rectification’s role is to restore the parties to an agreement to their original bargain, not repair an error in judgement. The Supreme Court also relied on the principle established in Shell Canada Ltd. v. Canada that taxpayers should expect to be taxed based on what they actually did, not what they could have done. If you would like a more in depth explanation of this tax rectification decision and how it impacts you, please contact one of our knowledgeable Toronto tax lawyers.

This decision is significant because the lower courts have frequently proved willing to grant rectification on the basis of an intention to achieve a certain tax result even in the absence of the parties having worked out the means of properly achieve that result at the time of the transaction. This decision will likely narrow the scope of tax problems that can be fixed through rectification. Taxpayers will need to be able persuade the Court that they had a specific plan in mind that would achieve their tax objectives for the transaction, and not merely that they had those specific tax objectives. This makes proper tax planning involving a detailed written tax planning memo which sets out the taxpayer’s objectives and the intended means for achieving them even more essential than prior to the decision. Without such a written tax plan it is unlikely that rectification will be granted. If you need help determining how changes to the law of tax rectification will impact your tax situation, please consider speaking with one of our expert Toronto tax lawyers.

The information is thought to be current to date of posting. Income tax law changes frequently and content may no longer reflect the current state of the law. This document is not intended to create an attorney-client relationship. You should not act or rely on any information in this document without first seeking legal advice. This material is intended for general information purposes only and does not constitute legal advice. If you have any specific questions on any legal matter, you should consult a professional legal services provider.

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