INTRODUCTION
Rectification is an equitable remedy that allows judicial corrections of a document that, by error in writing, does not reflect the true intentions of the parties. Rectification changes a document's mistaken expression of that intention. Rectification is restorative, versus "retroactive". In terms of timing, it acts from the creation of an instrument forward. Rectification applications are becoming more common as a means of taxpayers' defence against the Canada Revenue Agency ("CRA"). This trend has been growing in large part since the year 2000, due to the leading case of Juliar v. Canada.1
In Juliar, shares in a company were transferred by its owners to their daughters and the daughters' husbands on a tax-deferred basis. One couple decided to transfer shares to a family holding company. The couple received promissory notes from the holding company rather than shares, as the tax advisor mistakenly believed the initial transfer from the father to the daughter involved payment of tax on a capital gain, so that no tax consequences would result irrespective of whether cash, promissory notes, or shares were used. CRA advised the couple that the transactions brought the shares under the umbrella of section 84.1 of the Income Tax Act2 (the "Act") — and a disposition of property resulting in a deemed dividend. CRA consequently assessed the couple for the resulting tax liability. The couple brought an application for rectification, which was allowed on the basis that the intention to defer tax liability was a fundamental aspect of the transaction from its inception. The Minister of National Revenue appealed to the Ontario Court of Appeal, which found that the trial judge did not error in concluding the primary intention of was that of deferring tax liability on the transaction. The Court of Appeal concluded that rectification was the appropriate remedy because, in the absence of the error, the transaction would have been effected under section 85 of the Act rather than section 84.1. The Court highlighted that rectification should not be refused simply because the purpose of seeking it is to enable the parties to obtain a legitimate tax advantage, which was their intention at time of executing the instrument.3
Since Juliar, the courts have explored the evidential requirements of rectification in cases such as McPeake Family Trust4 and Kanji Family Trust.5 In McPeake and Kanji, the courts emphasized the importance of corroborative evidence, or the presence of more that one source, speaking to the common intention of the parties to avoid the payment of tax at the time the trust's creation. Further exploration of this judicial concept occurred in the Supreme Court of Canada decisions of Agence du Revenu du Quebec v. Services Enviornnementaux AES Inc., et al. and in Agence du Revenu du Quebec v. Jean Riopel, et al.6 Here, the Supreme Court upheld the lower Court's decisions that rectification was available to correct documents under Quebec civil law.7 The above cases stand for the following propositions: 1) the evidentiary requirements of rectification continue to evolve as the courts face new fact scenarios; and 2) the scope of rectification is broad and extends to Quebec civil law.
NOTICE IN RECTIFICATION PROCEEDINGS
In terms of notice requirements and rectification, the law remains in a state of flux.8 Whether one provides notice of an application is governed by the applicable civil procedure rules. In terms of a practice point, it is recommended that one provide CRA and the Department of Justice with notice of rectification applications. However, in the case of Canada (Attorney General) v. Brogan Family Trust,9 the Ontario Superior Court spoke to the issue and found that notice to CRA was not required in that instance.
BACKGROUND FACTS
In Brogan, a family trust agreement was settled in 2004. In 2010, the trustees became aware of an error in the trust made by the lawyer who prepared it, which prevented distribution to certain beneficiaries. The trustees retained a tax litigation expert to bring an application to rectify the lawyer's implementation error. The tax litigation expert was of the opinion that notice to the Crown was unnecessary. The application proceeded before McLean J. in November 2010 and was successful. At the hearing, McLean J. was made aware that the Crown was not served.10
Just before the rectification order was granted, the trust sold a business related to it. The trust reported the allocation of proceeds to its beneficiaries on its 2010 income tax return, as did the beneficiaries. CRA became aware of the rectification proceedings in the course of a 2012 audit arising from the sale of the business and, in the process, audited the trust. Specifically, CRA became aware of the rectification order in July 2012, and received a copy of the order in August 2012.11 In May 2013, CRA brought a motion to set aside the rectification order.
To account for the delay in commencing the motion, CRA cited internal office confusion, and the inexperience of the auditor as it related to rectification matters. CRA asserted that the auditor in question did not know the order was obtained without notice until March 2013.12
ISSUES BEFORE THE COURT
The issues raised were whether:
- CRA brought the motion forthwith as required by the rules;
- CRA had standing to bring the motion as a party affected by the judgment as required by the rules; and
- the respondent trustees breached a requirement in that CRA should have been served with the rectification application.13
The respondent trustees argued that the rectification application was made to correct the lawyer's error, and therefore notice to CRA was unnecessary. The trustees further argued that the delay on CRA's part was unreasonable, and that McLean J. was made aware that CRA was not served with the motion and exercised his discretion to proceed with the application.14 CRA argued that its interests were affected since the rectification was to reduce tax payable to it and, as a result, it should have received notice of the application. CRA argued that the delay on its part was not inordinate due to the previously mentioned internal confusion. CRA further argued that the contents of its information circulars and common practice dictated that CRA must be provided with notice of all rectification applications.15
CONCLUSION AND ANALYSIS
The Court dismissed the motion as it found that CRA was not a party affected by the rectification order. The Court explained that there was no obligation for the trust to file a return until the end of the year when the tax liability could be ascertained, which was after the rectification order was obtained.16 The Court rejected CRA's argument that tax liability was established at the moment of sale. The Court further commented that to accept CRA's argument would in principle implicate CRA as a tax collector in virtually every proceeding in courts involving damages for several types of proceedings ranging from termination of employment claims, to family law matters or to the sale of a business. CRA did not bring the motion forthwith as required, and the procedural delays were not sufficient reason to allow lateness.17 In conclusion, the Court found that there was no statutory requirement that CRA be made a party in the proceedings and CRA is only required to be given notice of proposed rectification proceedings when its legal interests might be directly affected by the outcome.18
COMMENTARY
The Court's analysis as it relates to when a party is affected by a judgment is interesting. The Court's logic appears to be as follows: 1) liability for tax, if any, is ascertained when a return is filed or when an assessment is issued; 2) liability for tax indicates whether CRA is a creditor, or not; and 3) CRA was not a creditor at the time the application was made before McLean J. and therefore no notice to CRA was required. The Court further commented that CRA has an interest when the order sought affects an instrument made in order to avoid the payment of tax.19 Therefore, the Court appears to find that CRA is to be provided notice when it is a creditor of the parties seeking rectification, or the instrument to which rectification is sought was made to avoid the payment of tax. This finding is defendable from a practical viewpoint; however, subsection 152(3) of the Act contemplates such an argument and provides that liability for tax is not affected by an incorrect or incomplete assessment or the absence of an assessment. The difficulty in this case lies in its timelines. In particular, the rectification order was obtained before the return was filed, and an assessment issued, and occurred in a fashion that is reverse to what is typically seen in rectification proceedings. As a result, the findings of Brogan may be unique to its facts.
Principles of natural justice indicate that CRA should receive notice of litigation when its rights are affected. Further judicial consideration of Brogan will no doubt refine what scenarios warrant notice to CRA as it relates to rectification applications.
Originally published by Taxes & Wealth Management, March 2015 | Issue 8-1.
Footnotes
1. (2000), 50 O.R. (3d) 728 (C.A.) ["Juliar"].
2. R.S.C. 1985, c. 1 (5th Supp.), as amended ["Act"].
3. Juliar at para. 25.
4. 2012 BCSC 132 ["McPeake"].
5. 2013 ONSC 781 ["Kanji"].
6. 2013 SCC 65 ["Services Enviornnementaux AES Inc."].
7. Ibid. at para. 53.
8. In Aim Funds Management Inc. v. Aim Trimark Corporate Class Inc., [2009] O.J. No. 2408 (Ont. S.C.J.), the Court granted CRA intervener status, with rights of cross-examination in that rectification proceeding. As well, in Columbia North Realty Co., (Re), 2005 NSSC 212, the Court held that CRA should be provided with notice of the rectification application before the Court. Notwithstanding this, recent case law, as explored in this article, suggests otherwise.
9. 2014 ONCS 6354 ["Brogan"].
10. Ibid. at para. 4.
11. Ibid. at para. 6.
12. Ibid. at para. 7.
13. Ibid. at para. 8.
14. Ibid. at para. 10.
15. Ibid. at para. 9.
16. Ibid. at para. 13.
17. Ibid. at para. 18.
18. Ibid. at para. 22.
19. Ibid. at para. 15.
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