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
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.
1 2012 QCCS 2745.
2 Québec (Sous-ministre du Revenu) c.
Services environnementaux AES inc., 2011 QCCA
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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