Canada: 551928 Manitoba Ltd. (Re) 2018 BCSC 1482 – Successful Rectification Case Comment By A Toronto Tax Lawyer

Last Updated: October 1 2018

B.C. Court Grants Rectification for a Corporation’s Incorrectly Calculated Capital Dividend Account Balance

The judgement of the Supreme Court of British Columbia for the petition application 551928 Manitoba Ltd. (Re) was recently released, and provides a reasonable and sound decision in favour of the taxpayer. The case involved 551928 Manitoba Ltd. (“the Corporation”), which hired accountants to estimate its full capital dividend account balance. The Corporation later realized that the accountants had made an error in their calculation and brought a petition forward to rectify the corresponding director’s resolution.

The responding party, the Attorney General of Canada (“AGC”), brought forward weak arguments to deny the rectification. The Honourable Justice Branch skilfully eliminated all of these arguments by intricately applying the common law, and in some instances, common sense.

The Facts of the Case

The directors of the Corporation were planning to sell property in Manitoba in September of 2015 and to subsequently distribute the maximum amount of their capital dividend account balance to the Corporation’s shareholders. The directors retained accountants to calculate the Corporation’s capital dividend account balance after the sale. The capital dividend account balance before the sale was $24,119. The accountants calculated the following additions to the balance: $89,093 from the non-taxable portion of the capital gain from the disposition of the capital property and $184,880 derived from the disposition of eligible capital property. The accountants therefore advised the directors of the Corporation that the total capital dividend account balance after the sale would be $298,092 immediately before December 31, 2015, and that this amount may be distributed to the Corporation’s shareholders on a tax-free basis.

However, based on Canadian tax legislation at the time, the amount derived from the disposition of eligible capital property could only be included in the Corporation’s capital dividend account balance at the end of its taxation year, which would have been August 31, 2016. As this was unknown to the directors of the Corporation at the time, they declared a resolution for a capital dividend payable of $298,092 on December 31, 2015.

In early December of 2015, the Corporation’s accountants sent the election form required to distribute a capital dividend to the Canada Revenue Agency (“CRA”), with a copy of the resolution and the calculation of the Corporation’s capital dividend account balance immediately before December 31, 2015.

In June of 2017, the CRA sent a notice of assessment to the Corporation which indicated a tax liability equal to 60% of which the amount of the dividend declared by the director’s resolution exceeded the total capital dividend account balance immediately before the issuance of the dividend. It was at this time that the directors of the Corporation realized the accountants had made an error in their calculation of the Corporation’s capital dividend account balance.

The Most Notable Order Requested by the Corporation: Rectification of the Resolution

The most notable order requested in this case was the rectification of the resolution of the directors which contained the inaccurate dividend payable amount. Rectification is a legal remedy which corrects errors in the terms of written legal instruments.

The Court Applied the Common Law Test for Rectification

The court referred to the leading Supreme Court of Canada case on rectification, Canada (Attorney General) v. Fairmont Hotels Inc., 2016 SCC 56 to outline the applicable common law test. This case provides that rectification can be granted if the error on the legal instrument resulted from a mistake common to both or all parties to an agreement, there was a prior agreement with definite and ascertainable terms, this agreement was still in effect at the time the instrument was executed, the instrument failed to accurately record the agreement, and if the instrument is rectified it would carry out the parties’ prior agreement.

The court found that a definite and ascertainable agreement existed between the directors to distribute the entire capital dividend account after the sale. With this, the remainder of the criteria can be deduced as having been met.

For greater certainty, the court reviewed the wording of the resolution and found the following:

  • it began with “whereas the company has a capital dividend account of the amount of $298,092”, implying that the full amount of the capital dividend account was to be distributed,
  • it indicated the resolution provides that that amount was to be paid “from the company’s capital dividend account pursuant to 83(2)” and indicated the paperwork be completed “in order to have the rules set forth in subsection 83(2) apply to the full amount of the dividend”. However, due to the error, 83(2) could not apply to the specifically declared amount, which provided evidence that the instrument failed to accurately record the agreement.

The court also considered the policy reasons for why rectification should not be granted. For example, precedent case law indicates rectification should not be granted where it is being requested for purposes of “bold tax planning”; the reversal of an unplanned tax liability which resulted from the legal agreement; where the taxpayer was reckless, failed to act with due diligence or “should have known better”; or where it would result in “wholly rewriting or unwinding a complex mechanism or series of business transactions”. The court found that none of these applied to the Corporation’s case, and included the conclusion that asking accountants to advise them of the correct figure was in itself diligent. Thus, the error was in the calculation, and not in the Corporation’s judgement.

The Attorney General of Canada’s Weak Arguments

The AGC brought forth predominantly weak arguments in this case. The lawyer for the AGC argued that there was no agreement which was definite and ascertainable because providing direction to accountants to distribute the maximum amount of the capital dividend account did not qualify as an agreement. The court justly considered the agreement between the directors of the Corporation to be the agreement at issue.

The AGC also argued that the directors had agreed to the specific figure provided by the accountants and thus the agreement should not be granted justification. Justice Branch’s more intricate analysis found that this viewpoint is inconsistent with the evidence of the directors, the evidence from the accountants, and the language of the Resolution.

The AGC also suggested the following remedies alternative to the provision of a rectification order:

  • The Corporation should apply for a remission through an Order in Council. The court found that accomplishing this is restrictive, uncertain, complex and slow, and thus not suitable.
  • The Corporation should pursue a professional negligence lawsuit. The court recognized this avenue would be expensive, slow and uncertain, and thus once again not suitable.
  • The Corporation should elect to treat the excess amount declared as taxable dividends. In response, the court siding with the taxpayer pointed out the obvious: that this would still result in a tax liability for the shareholders.

The Court’s Decision

As the arguments brought forth by the Corporation far outweighed those brought forth by the AGC the Court granted the order for rectification to the Corporation.

Tips For Taxpayers Preparing Legal Agreements which Could Affect their Tax Liability

Taxpayers should remember that for rectification to be granted for a legal agreement which contains error, the parties must have had an agreement in mind with definite and ascertainable terms which was not reflected in the legal agreement. The court can determine if this was the case by reviewing the facts of the case, including the wording of the agreement.

When a legal agreement is being prepared which includes an amount which will be reported for tax purposes, ensure to hire certified professionals, including an accountant and Canadian tax lawyer, to review the agreement based on their professional expertise..

Hiring a tax lawyer and accountant also deflects due diligence requirements from the taxpayer to the certified professionals for legal purposes. In many cases such as this one, taxpayers are considered to have exercised due diligence about a matter when they hire a professional expert for advice.

More generally, when a legal agreement must be prepared which could affect a taxpayer’s past or future tax liability, it is in the taxpayer’s best interest to have an expert Canadian tax lawyer draft the agreement. The tax lawyer will both make the taxpayer aware of and also minimize any future legal risks which could negatively affect the taxpayer’s liability.

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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