It is well known that a GST/HST-registered person can purchase certain types of commercial real property without paying GST/HST to the vendor. Under subsection 221(2) of the Excise Tax Act (Canada) (ETA), subject to certain exclusions, a supplier of real property by way of sale is not required to charge and collect GST/HST. Rather, under subsection 228(4) of the ETA, the purchaser self-assesses the tax. In cases where the real property will be used exclusively in GST/HST commercial activities, the purchaser is often eligible for a full, offsetting input tax credit (ITC) resulting in no net payment to the government.
But what happens if the purchaser forgets to make that magic phone call (or fax the appropriate form) to the Canada Revenue Agency (CRA) to obtain the GST/HST registration?
In the case of Re 0741508 B.C. Ltd. and 0768723 B.C. Ltd., each of the appellants conveyed real property to a partnership in May 2011. It was understood by the parties that there would be no net HST payable on these conveyances due to the offsetting input tax credit. As such, following the purchase of these parcels of land, the partnership paid the applicable property transfer tax, but did not pay HST.
In 2013, the CRA commenced an audit of the appellants and discovered that at the time of the sale, the partnership was not registered under the ETA. The British Columbia Supreme Court (Court) accepted that the failure to register was due to a misunderstanding between the appellants' sole shareholder, his lawyer and his in-house accountant. The total amount of the reassessments of the two appellants for failing to collect GST/HST from the partnership, including interest and gross negligence penalties, was nearly C$6.2 million.
It was an undisputed fact that had B.C. not eliminated the HST on April 1, 2013, the partnership could have registered at the present time and would have been entitled to an ITC for the full amount of HST payable on the transaction. However, because the province reverted back to a GST and PST regime, the partnership would now only be entitled to five per cent of the tax paid, not the full 12 per cent.
It appeared that the only way to avoid the significant losses due to the HST assessment was to rescind the transactions entirely.
There are two lines of case law regarding when equitable rescission of a contract is available in the case of a mistake. The more stringent line of cases holds that rescission may be granted only in instances where the mistake is as to the legal effect of the transaction itself and not merely an error in the understanding of its consequences. This approach was taken in 771225 Ontario Inc. v. Bramco Holdings Co. Ltd. where an assessed land transfer tax was found merely to be a consequence of the transaction, so no relief was available.
The Court found that the HST was triggered in this case only as a result of the mistake in failing to register the partnership for GST/HST purposes, which distinguished the present case from Bramco. Furthermore, the decision in Re: Pallen Trust, where the Court followed the subsequent United Kingdom case of Pitt v. Commissioners for Her Majesty's Revenue and Customs, supported a less rigid approach to the equitable doctrine of rescission than the approach in Bramco. Justice Linda Loo accepted that the approach to determining whether to rescind a voluntary transaction was to see whether there was a "causative mistake of sufficient gravity" as to "the legal character or nature of a transaction, or as to some matter of fact or law which is basic to the transaction" and it would be unconscionable, unjust or unfair not to correct the mistake.
As proposed by the appellants, and accepted by Justice Loo, the fourfold test can be articulated as follows:
- There is a mistake of sufficient causative gravity that would make it unjust, unconscionable or unfair to leave the mistake uncorrected
- There is no adequate legal remedy available
- The rescission is not an attempt to rewrite history
- There is no prejudice to third parties.
Mistake of Sufficient Causative Gravity
The Court relied on a recital of the undisputed facts to establish that there was a mistake on the part of the appellants' sole shareholder, his lawyer and his in-house accountant in failing to register the partnership. They collectively knew that the partnership had to be registered and "mistakenly" assumed it had. There was no direct discussion as to whether this was a sufficiently grave mistake; however, the mistake was agreed to have resulted in a liability totalling more than C$6 million, which appears to have satisfied the Court in this regard.
Adequate Legal Remedy
The Court held that no adequate legal remedy existed for the appellants. The CRA argued that a remedy existed under the ETA to allow the partnership to register and claim ITCs to offset the taxes payable by the appellants. However, the CRA agreed that since B.C. had transitioned to a GST/PST regime, only five per cent was available as an ITC. In oral argument, the CRA conceded that there was only an adequate legal remedy "in theory," which the Court interpreted to mean that there was no adequate legal remedy "in fact."
Accordingly, the Court rejected the CRA's argument that being able to recover five per cent of the taxes paid, rather than 12 per cent, amounts to an adequate legal remedy.
Retroactive Tax Planning
The Court accepted that it was always the intention of the appellants that the partnership would be registered under the ETA and that there would be no net GST/HST payable.
The Court found that an order rescinding the transactions would not result in prejudice to either of the appellants or their directors, officers, partners or shareholders. In fact, rescission would assist the appellants and the partnership by removing an unexpected and punitive tax liability of over C$6 million.
UNJUST, UNCONSCIONABLE AND UNFAIR
The Court granted the rescission on the basis that "leaving the mistake uncorrected would be unjust, unconscionable and unfair," there is no adequate legal remedy available, this is not an attempt at retroactive tax planning and there is no prejudice to third parties.
Although there was no adequate legal remedy, there was clearly an administrative remedy available if the CRA was willing to cooperate, namely, retroactive registration of the partnership. Under its current administrative policy, the CRA will allow retroactive registration for a person back 30 days from the date of filing. If a person has collected GST/HST without being registered, the CRA will register the person for GST/HST purposes even beyond the 30-day period. On audit, if the CRA finds that a person should have been registered for GST/HST purposes and assesses the person for GST/HST that the person failed to collect, the CRA will open a GST/HST account back to the date of the GST/HST assessed.
It would make sense for the CRA to modify its administrative policy further in light of the Court's finding that it would be "unjust, unconscionable and unfair" to leave the mistake in circumstances of this case uncorrected. Rather than forcing the taxpayer to rescind the entire transaction, the simple fix in this case would have been for the CRA to simply register the partnership retroactively for GST/HST purposes.
One ironic detail in this case is that the CRA argued, inter alia, that equitable rescission should not be available because the appellants did not have "clean hands" due to the fact that they were delinquent with respect to their income tax filings. The Court rejected this argument on the basis that it is "a long stretch of the imagination" to suggest that these returns are related to the claim. Meanwhile, the CRA stood to gain millions of dollars from a taxpayer who made a simple mistake and merely forgot to make that magic phone call.
The authors wish to thank David Bristow (Student-at-Law) for his assistance in preparing this article.
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.