Juridical acts (e.g., contracts) implementing commercial transactions or corporate restructuring sometimes trigger tax consequences that conflict with the intentions of the parties. The judicial correction of such juridical acts (their "rectification" in Common Law) may be the only means available to taxpayers to avoid such consequences.

On March 4, 2011, the Québec Court of Appeal rendered an important decision in Revenu Québec and the Canada Revenue Agency v. Services Environnementaux AES Inc. et al., relying for the first time upon the Civil Code of Québec to correct a juridical act vitiated by a substantive error causing unexpected tax consequences.

The facts of the case were not contested. The taxpayers, a corporation and its wholly owned subsidiary, exchanged shares as part of a reorganization of capital which resulted in unexpected tax consequences due to an error in the computation of the adjusted cost base of the subsidiary's shares. The taxpayers' intent was always to effect the reorganization on a tax-deferred basis, that is, without immediate tax consequences.

The taxpayers sought the rectification of the relevant juridical acts in order to implement their intention to carry out the reorganization without immediate tax consequences and to render it enforceable against the tax authorities.

The main issue before the Court of Appeal was whether Québec civil law or the inherent powers of the Superior Court authorized the rectification. The Court of Appeal held that, where a contract does not contain an error vitiating the consent of the parties, but gives rise to a result that is inconsistent with their intentions, the articles of the Civil Code of Québec dealing with the interpretation of contracts authorize the Superior Court to give effect to those intentions by correcting the wording of the contract insofar as the rights of third parties are not adversely affected.

The Court of Appeal upheld the judgment of the Superior Court granting the correction and held that the tax authorities would not be adversely affected by the correction, as the tax legislation provided a mechanism allowing for share exchanges without immediate tax impact, from which the taxpayers would have benefited, had they not made an error in the computation of the adjusted cost base of the shares.

These findings mark a major departure from the earlier dominant interpretation of Québec law on the issue, which only permitted the correction of a juridical act when vitiated by a clerical error or an error in a calculation or designation, but not by an error of substance. The decision confirms the existence, in Québec civil law, of a broad judicial discretion for the correction of juridical acts, without introducing the common law notion of rectification into Québec law.

It should also be noted that the Québec Business Corporations Act, like the previous Companies Act, allows for the rectification of juridical acts governed by such legislation, including certificates of amalgamation or dissolution, in case they were obtained in error as a result of the ignorance of some material fact. The recent Superior Court decision in Remer Holdings confirms that an error concerning the tax consequences of a corporate restructuring can be characterized as a material fact and allowed the Superior Court to rectify certain juridical acts to give effect to the intentions of the parties.

In conclusion, the decision of the Québec Court of Appeal in Services Environnementaux AES Inc. completes the arsenal belonging to taxpayers seeking the correction of juridical acts that have resulted in unexpected tax consequences by giving full effect to the intentions of the parties, despite their errors, where the relevant tax legislation would have permitted the conclusion sought by the parties had the errors not been committed.

It will be interesting to see whether the taxation authorities will attempt to appeal this decision to the Supreme Court of Canada.

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