Two companion cases recently decided by the Supreme Court of Canada ("SCC") 1 confirm that contractual errors with tax consequences may be corrected under Québec civil law, as is the case throughout the rest of Canada. While civil law in Quebec is governed by the Civil Code of Québec ("CCQ"), all other Canadian provinces are common law jurisdictions. The cases are significant because they confirm that the Québec Superior Court has jurisdiction to consider these kinds of applications. The cases also provided guidance regarding the proof required to establish the underlying mistake.
The SCC appeal arose from Québec Court of Appeal ("QCA") decisions relating to corporate transactions that resulted in unintended tax consequences because of errors made by advisors.
Services environmentaux AES Inc. agreed to transfer 25% of its shares in Centre Techologique AES Inc. to a third party. To ensure that the agreement was tax neutral, the parties made use of the adjusted cost base ("ACB") formula outlined in section 86 of the Income Tax Act ("ITA"). The parties mistakenly believed that the ACB was $1,217,028. The actual ACB was only $96,001. The transaction resulted in the assessment of an unexpected taxable capital gain of $840,770.
In the second case, Mr. Riopel and his wife, Ms. Archambault, sought to amalgamate two corporations. Mr. Riopel was the sole shareholder of one of the amalgamating corporations and held a 60% interest in the second corporation. Ms. Archambault's shares were to be transferred to her husband prior to amalgamation to defer tax. However, due to a series of errors by the advisors of the parties, the shares were not transferred as contemplated and a deemed dividend of $335,000 was accordingly assessed against Ms Archambault.
Québec Superior Court and Québec Court of Appeal
In both cases, the taxpayers had an overriding intention to defer the tax consequences of the transactions. After being reassessed, the taxpayers brought forward applications to the Superior Court of Québec. The Court delivered contradictory judgments, modifying the contracts in one case and refusing to do so in the other. The QCA allowed the contracts to be corrected in both cases. The Agence du Revenu Du Québec ("ARQ") appealed to the SCC.
Issues at the SCC
The SCC outlined the two main issues on appeal as:
- Does the Québec Code of Civil Procedure allow the Québec Superior Court to consider these types of matters and accordingly rectify or amend contracts?
- What is the scope of the Courts' authority to correct errors in contracts under the CCQ?
The issue before the SCC was whether, under the law of obligations as applicable in Québec, amendments would be allowed to correct mistaken documents so that taxpayers could be assessed on the basis of the corrections.
The ARQ, supported by the Attorney General of Canada ("AG") as intevenor, predictably argued that the Court lacked jurisdiction and that while the CCQ allowed clerical errors to be corrected, the taxpayers' errors were more than simply clerical. The taxpayers argued otherwise and further stressed that they were not seeking to import the equitable doctrine of rectification into Québec law. Rather, they argued that the CCQ and the civilian law of obligations were consistent with retroactively amending mistaken documents and that such amendment would bind tax authorities.
In addition to arguing that rectification does not exist in the civil law, the AG argued that the QCA overreached and conferred overbroad powers to the Superior Court to interpret contracts. Moreover, the AG requested that the SCC limit the common law doctrine of rectification, requesting in particular that the SCC review the decision in Juliar v. Canada (Attorney General)2 ("Juliar"), a leading rectification authority, on the basis that the rectification doctrine had overbroad application in tax cases.
The SCC held in the taxpayers' favour and dismissed the ARQ's appeals. The SCC held that the Superior Court had jurisdiction to consider cases in which documents do not reflect the parties' true intentions. In the SCC's view, the Superior Court had jurisdiction under the substantive legal principles that was not precluded by the provincial rules of civil procedure.
According to the SCC, contract law is governed by the law of obligations, under which a contract is an agreement of wills for the purpose of carrying out juridicial operations, based on the principle of consensualism. The common intention of the parties is not equivalent to the way the parties' will is expressed, whether orally or in writing – in other words, no physical medium is required for a contract to exist. Further, once an agreement of wills is reached, the contract merely establishes the applicable rules to carry out the underlying operations or plans. The SCC confirmed that parties are free as between themselves to amend or annul contracts and underlying documents and may freely acknowledge and correct common errors, subject to the rights of any third parties.
The SCC stated that requiring legal formalities complicates the legal environment of contracts and brings into play evidentiary requirements impacting on third parties whose interests may be affected by the contract. However, in the cases before the SCC, evidence was adduced without objection, so the requirements of evidence law were not engaged.
Applying the principles to the facts, the SCC concluded that in Riopel the agreement of wills between the parties was not properly implemented because of errors by advisors. Similarly, in AES, the parties' agreement was vitiated by an incorrect ACB calculation, which error would have served under the law of obligations as a basis for annulling the contract. Rather than annul, the parties agreed to amend the documents that recorded and implemented their agreement, so as to restore the documentary integrity of their previous agreement. The SCC held that the Courts could act based on fundamental principles of contract. Despite the weight given to "authentic acts", a Court may rectify such acts where they include incorrect statements, to make the acts consistent with the parties' intentions. "Private writing" may also express parties' common intentions. However, where the writing is proven erroneous, it may be corrected.
The SCC considered the relevance of affected third parties within the civilian law of obligations and concluded that tax authorities do not have the right to benefit from a fundamental contractual error after it has been corrected by mutual consent. In our view, this was a correct and predictable result.
However, the SCC emphasized that Article 1425 of the CCQ cannot be relied upon if the common intention of the parties is not sufficiently determinable. The SCC clearly stated "if a writing contains an error, particularly one that can as here, be attributed to the taxpayer's professional advisor, the court must, once the error is proved in accordance with the rules of evidence in civil matters, note the error and ensure that it is remedied."3
The SCC was also quite careful to point out that the tax consequences of its judgment were beyond the scope of the case before it. The SCC thus affirmed that the process for challenging notices of assessment is limited to the Courts with statutory jurisdiction, which jurisdiction cannot be circumvented. Consequently, the SCC did not purport to adjudicate the actual tax consequences to either of the parties, but merely the juridical acts that led to the notices of assessment.
Review of Juliar
The SCC declined to comment on the Juliar decision by simply stating that "the two appeals heard by this Court are governed by Québec civil law and are not appropriate cases in which to reconsider the common law remedy of rectification."4
Overall, these decisions are welcome. Juliar made the remedy of rectification in tax cases available in common law jurisdictions and it would be unfair if the same type of relief was not available to taxpayers engaging in transactions governed by the CCQ.
With these decisions, the SCC has come to the sensible conclusion that mistakes happen and that revenue agencies should not receive windfalls as a result. However, the SCC also provided the important caveat that taxpayers should not view these decisions and the possibility of correcting mistakes as an invitation to engage in bold tax planning initiatives on the assumption that the concept of rectification will always come to the rescue. In the SCC's view, a general intention to reduce tax liability would not on its own constitute the object of an obligation, nor would it even constitute the object of a contract under the CCQ. Consequently, in such a situation, Article 1425 of the CCQ could not be relied on to justify seeking to give effect to the parties' common intentions. Thus, the scope of Québec contract correction does not appear to be as broad as the common law doctrine of "tax rectification", which in some cases has allowed taxpayers to substantially restructure their arrangements.
1. Agence du Revenu du Quebec v. Services environnementaux AES Inc., 2009 QCCS 790; aff'd. 2011 QCCA 394; aff'd. 2013 SCC 65; and Agence du Revenu du Quebec v. Jean Riopel., 2010 QCCS 1576; rev'd. 2011 QCCA 954; aff'd. 2013 SCC 65.
2. Juliar v. Canada (Attorney General), 46 OR (3d) 146 (Ont. SCJ); aff'd. 50 OR (3d) 728 (ONCA); leave to appeal to the SCC refused on May 24, 2001.
3. Ibid at para 52.
4. Ibid at para 55.
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