Canada: Rectification In A Tax Context: The Intention Standard Prevails

A drafting mistake in an agreement can result in significant and unintended tax consequences. In the recent case of Baytex Energy Ltd. v. Canada (Attorney General) (Baytex), the Court of Queen's Bench of Alberta (Court) considered whether the equitable remedy of rectification was available to address mistakes in certain written agreements that, if unchanged, could have resulted in tax payable on additional income of over C$528-million. Baytex Energy Ltd. (BEL), Baytex Energy Corp. (BEC) and Baytex Energy Partnership (collectively the Applicants) obtained a rectification order from the Court to ensure that the written agreements fully and properly reflected the clear intention of the Applicants.


The Applicants were originally subject to a complicated royalty regime under the Income Tax Act (Canada) (ITA) that ended on December 31, 2006 (Pre-2007 Royalty Regime). Very generally, under the Pre-2007 Royalty Regime, an oil and gas producer was required to include the Crown's share of production from an oil and gas well in the producer's income for tax purposes (referred to by the court as "phantom income" because the producer never earned such income and was denied any deduction for royalties or freehold mineral taxes paid to the Crown). However, the phantom income could be transferred from the producer to another party that was entitled to receive the net cash flow from production.

BEL entered into a written net profits interest agreement (NPI Agreement) with Baytex Energy Trust (the Trust, being the predecessor to BEC) to address the Pre-2007 Royalty Regime. In simplified terms, the NPI Agreement provided that:

  1. BEL would pay to the Trust an amount equal to 99 per cent of BEL's net cash flow and income from its oil and gas operations;
  2. the Trust would reimburse BEL 99 per cent of all non-deductible Crown royalties; and
  3. these amounts could be set-off.

These transactions were completed each month, thereby allowing the Trust to distribute cash received from BEL to its unitholders as a monthly distribution. BEL explained the arrangement, and the intention behind it, in an information circular.

The Applicants' Intention & Mistakes in Documents

At the time the NPI Agreement was entered into and while the Pre-2007 Royalty Regime applied, BEL intended to transfer 99 per cent of its net cash flow and income from oil and gas operations to the Trust for monthly distributions by the Trust. The Trust, in turn, intended to reimburse BEL 99 per cent of all non-deductible Crown royalties. Moreover, it was intended that BEL would also transfer 99 per cent of the phantom income to the Trust, which was to be set-off against the non-deductible Crown royalties by offsetting journal entries. In addition, BEL and the Trust were aware that the Pre-2007 Royalty Regime was going to be completely phased out at the end of 2006 and also intended to cease the offsetting transfers of the phantom income and reimbursements effective January 1, 2007, as there was no business reason to engage in such transactions after that date.

However, the NPI Agreement failed to fully document the Applicants' specific intention because it did not expressly provide that: (i) BEL would transfer 99 per cent of the phantom income to the Trust while the Pre-2007 Royalty Regime was in effect, and (ii) the monthly transfers of the phantom income and related reimbursements (and the routine administrative practice of making offsetting journal entries) would end with the cessation of the Pre-2007 Royalty Regime.

Indeed, BEL and the Trust mistakenly continued the practice of making offsetting journal entries well after the end of the Pre-2007 Royalty Regime. Once this was discovered in 2008, the parties amended the NPI Agreement to be consistent with their practice (2008 Amendments) after being informed by their tax advisers that the offsetting entries would have no adverse tax consequences following the elimination of the Pre-2007 Royalty Regime. The Canada Revenue Agency (CRA) took a different view, concluding that the Trust earned C$528-million of income.



Rectification generally allows parties to fix a written contract where the parties agreed on its terms but by mistake wrote them down incorrectly; i.e., the contract must be shown to not accord with the parties' true intention driving its formation. Accordingly, Justice J.A. Strekaf held that the Applicants had to overcome three "hurdles":

  1. the existence and content of a prior oral agreement;
  2. that the written document does not correspond with the prior oral agreement; and
  3. the precise form in which the written instrument can be made to express the prior intention.

In considering the first hurdle, Justice Strekaf held that there was "uncontroverted evidence" (including from BEL's information circular and BEC's chief financial officer) of a prior oral agreement that reflected the Applicants' clear intention to transfer 99 per cent of the net cash flow and income (including 99 per cent of the phantom income) to the Trust (with an offsetting adjustment) prior to January 1, 2007, and to stop the transfer of the phantom income after that date. Simply stated, the Applicants were able to prove that their original and specific intention was to navigate the Pre-2007 Royalty Regime to avoid any adverse tax consequences and to cease the practice of offsetting journal entries post-2006.

In respect of the second hurdle, the Court accepted that none of the following was in accordance with the Applicants' intention:

  1. the NPI Agreement;
  2. the continuation of the administrative practice of making offsetting journal entries for the transfers of the phantom income and reimbursements after the Pre-2007 Royalty Regime ended; and
  3. the 2008 Amendments, which confirmed that practice based on the professional advisers' erroneous advice that the entries would have no adverse tax consequences.

Justice Strekaf rejected the CRA's submission that the 2008 Amendments recorded the Applicants' intention perfectly because the Applicants "consciously agreed" that they would document their administrative practice of making offsetting journal entries. Justice Strekaf stated: "This situation is analogous to a land transaction in which the parties think that the legal description in their executed agreement might be incorrect and ask a surveyor to provide them with the correct legal description. If the surveyor then provides them with an incorrect legal description and they amend the agreement accordingly, should they be precluded from seeking rectification if it becomes apparent that the surveyor was wrong?"

The third hurdle was not in dispute in this case. The Court concluded that the requirements for rectification had been satisfied.


Justice Strekaf also requested that the parties address whether rescission might be available to cancel the 2008 Amendments. Rescission voids a contract. The Court decided that while the 2008 Amendments were intended to clarify the NPI Agreement and avoid adverse tax consequences, they had the opposite effect. This was deemed to be a fundamental mistake that went to the root of the contract and therefore rescission was also an available remedy.


There are at least two takeaways or reminders from the Baytex case.

First, in deciding whether to grant a rectification request, a court will closely examine the evidence of the intention of the parties. In Baytex, Justice Strekaf accepted the "uncontroverted evidence" of the Applicants' original and specific intention to navigate the complex Pre-2007 Royalty Regime, allowing the Trust to make monthly distributions to its unitholders.

Second, where parties have intended specific tax consequences, but failed to properly record the terms of their agreement, rectification can be available regardless that the specific result sought affects tax obligations. In other words, rectification of an agreement is properly used to prevent unexpected and accidental windfalls to taxation authorities. At the same time, courts have warned that "the intent of avoiding tax is not the same thing as the assumption that a tax liability would not be incurred" (see Graymar Equipment (2008) Inc. v. Canada (Attorney General)). Generally, rectification cannot apply where the parties had no intention to avoid the tax consequences at issue and cannot be used to engage in retroactive tax planning. This could occur where there was no intention to avoid a tax at the time the agreement was entered into, and the parties seek rectification to, using the benefit of hindsight, ameliorate their tax situation and either avoid adverse tax consequences or take advantage of beneficial tax planning opportunities.

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.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

Events from this Firm
27 Oct 2016, Seminar, Toronto, Canada

Please join members of the Blakes Commercial Real Estate group as they discuss five key provisions of a commercial real estate purchase agreement that are often the subject of much negotiation but are sometimes misunderstood.

1 Nov 2016, Seminar, Toronto, Canada

What is the emotional culture of your organization?

Every organization and workplace has an emotional culture that can have an impact on everything from employee performance to customer or client satisfaction.

3 Nov 2016, Seminar, Toronto, Canada

Join leading lawyers from the Blakes Pensions, Benefits & Executive Compensation group as they discuss recent updates and legal developments in pension and employee benefits law as well as strategies to identify and minimize common risks.

In association with
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at and we will use commercially reasonable efforts to determine and correct the problem promptly.