Last June 19, the Superior Court of Québec rendered an interesting judgment on tax rectification in the case of Mac's Convenience Stores inc. c. Couche-Tard inc.,1 applying certain aspects of the teachings laid down by the Québec Court of Appeal in 2011 in the decisions in Services environnementaux AES inc.2 ("AES") and Riopel.3
The facts of the case were as follows. During 2005, Mac's Convenience Store inc. ("MAC's") contracted an interest-bearing loan of about $185M from the US company, Sildel Corporation ("SILDEL"). Between 2006 and 2008, MAC's paid about $22M in interest to SILDEL, which MAC's deducted in accordance with the provisions of the Income Tax Act (Canada)4 (the "ITA"). On April 25, 2006, MAC's declared and paid a dividend to Couche-Tard inc. ("CTI") in order to redistribute funds within the group, ultimately to allow a portion of MAC's debt to be repaid.
Briefly, under the rules of the ITA, when a Canadian corporation contracts an interest bearing loan from a specified non-resident, the deductibility of interest on the loan is denied when the debt-to-equity ratio of the debtor corporation exceeds the maximum permitted ratio of 2:1 (henceforth 1.5:15) (the "Thin Capitalization Rules"). The dividend of $136M declared and paid by MAC's to CTI reduced MAC's equity by the same amount, triggering the application of the Thin Capitalization Rules. Thus, MAC's was denied the entire amount of the deduction of interest paid on the loan. MAC's therefore sought to cancel the dividend of $136M declared and paid on April 25, 2006 by replacing it with a reduction in capital, which would not affect its equity capital or compromise the deductibility of the interest.
The judgments in AES and Riopel teach us that one of the criteria to be considered in order for an application for rectification to be granted is the existence of a difference between the common intention of the parties and their intention as reflected in the written legal instruments. In the cases of Riopel and AES, there was a significant divergence between the parties' true intention and the agreement supporting the transaction. This enabled the court, in both cases, to rule in favour of the taxpayers and rectify the legal instruments concluded by the parties.
In the MAC's case, the resolution by MAC's directors to declare a dividend of about $136M did accurately reflect MAC's intention to pay a dividend. The evidence showed that there had been no discussion between the parties involved regarding the consequences of the payment of a dividend and the potential application of the Thin Capitalization Rules. The negative tax consequences only occurred because the payment of the dividend took place in the year after the loan was granted, thereby strengthening the argument that there was no divergence between the taxpayer's intention and the documents giving effect to this intention. Without the deduction of the interest paid to SILDEL, Revenue Québec would never have issued a notice of assessment. The court concluded that the transactions completed on April 25, 2006 accurately reflected the parties' intention and therefore declined to grant the application for rectification on the grounds that such an application cannot be used to rewrite the tax history of a file.
This case has been appealed and its final outcome is therefore not known at this time. Nevertheless, it shows once again the preponderant role which professionals must play in certain transactions and the care they must exercise in doing so.
Footnotes
1 2012 QCCS 2745.
2 Québec (Sous-ministre du Revenu) c. Services environnementaux AES inc., 2011 QCCA 394.
3 Riopel c. Agence du revenu du Canada, 2011 QCCA 954.
4 R.S.C., 1985, c.1 (5th Supp.).
5 This measure applies to the taxation years of corporations which start after 2012.
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