The Supreme Court of Canada recently endorsed a fundamental
principle in Canadian tax law – namely that absent sham or
statutory recharacterization rules, "tax law applies to
transactions governed by, and the nature and legal consequences of
which are determined by reference to, the common law or the civil
law" (Québec (Agence du Revenu)
v Services Environnementaux AES inc., 2013 SCC 65 at
para 45). The case involved dual appeals under Québec's
civil law for what in common law terms would be a
"rectification" to correct, after the fact, erroneous
transaction documentation that failed to achieve the taxpayers'
objective to complete the transactions on a tax-deferred basis, as
permitted by the relevant tax provisions.
The taxpayers in each case succeeded at the Supreme Court on the
basis that it was the common intention of the respective parties to
effect the transactions on a tax-deferred basis even though as a
consequence of incorrect documentation that did not occur in the
first instance. The parties were allowed to correct their
documentation with effect from the original relevant dates and the
corrected versions of the documentation were binding on the tax
This case may be significant beyond the rectification context
insofar as it endorses the commonly understood view that tax law
consequences follow the private law, such as contracts, absent sham
(i.e., fraud) or explicit statutory recharacterization
rules. In particular, elements of the OECD's BEPS Action Plan
and recent initiatives on transfer pricing of intangibles promote
an approach that favours economic substance over legal and
beneficial ownership as documented in legal agreements among member
companies in a multi-national group. For example, the latest draft
intangibles transfer pricing guidelines from the OECD seek to treat
affiliated companies that do not own valuable IP but contribute to
its value through R&D or other services as entitled to share in
the residual return from IP, i.e., as the legal and
beneficial owner of the IP would and not simply to an arm's
length fee for their services.
The Supreme Court's endorsement
in AES that tax results are predicated on
private law contracts should assist taxpayers in defending their
tax and transfer pricing planning, including respecting the legal
and beneficial owner of IP as the party entitled to retain the
residual return from IP, unless CRA can successfully override the
arrangements through the specific recharacterization transfer
pricing rule, which only applies in cases where the transactions
would not have been entered into by arm's length parties and
did not have a bona fide non-tax purpose, or the
general anti-avoidance rule (GAAR) directed against abusive tax
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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