Introduction – What is Equitable Rescission and Why Might a Tax Lawyer Plead Equitable Rescission
Generally speaking, the Income Tax Act, as well as the common law doctrine laid down in Duke of Westminster, made it permissible for taxpayers to enter into transactions where the primary purpose of the transaction is minimizing the taxpayer's tax liabilities. However, sometimes taxpayers mistakenly enter into transactions which they thought would minimize their tax liabilities, but the actual transaction failed to accomplish its objective. The mistake may be due to a mistake of law or a mistake of fact.
Consider the following example: Taxpayer A intended to transfer his land property to Corporation Bco for Bco to develop and eventually sell to third parties in the commercial real estate market. Bco is expected to pay HST on the transfer, but Bco is also expected to receive an Input Tax Credit under the Excise Tax Act. However, unbeknownst to A, Bco was not registered under the Excise Tax Act for HST purposes. Therefore, Bco is not entitled to claim Input Tax Credits, contrary to the intention of A and Bco.
In such scenarios, there are typically three possible remedies for the taxpayers to mitigate their unwanted tax liabilities: rectification, common law doctrines of mistakes, and equitable rescission. However, the Canadian Supreme Court severely restricted the scope of the rectification in tax cases, notably in Canada (Attorney General) v. Fairmont Hotels Inc. This article will examine how equitable rescission can be applied in tax cases and how it differs from the common law doctrine of mistakes.
Equitable Rescission vs. Common Law Doctrine of Mistakes
Generally speaking, once the offer, acceptance, and consideration requirements of a contract are met, the Court will consider such a contract to be enforceable and legally binding. Any doctrine that serves to render a validly formed contract void or voidable will be carefully construed by the Court so as not to undermine that general assumption. The doctrine of mistake is one of such doctrines.
The common law doctrine of mistakes narrowly construes mistake as an error, which is fundamental in character, that goes to the root of the contract. Only such a mistake will destroy the intent of the party in question, so as to invalidate offer or acceptance. Only such a mistake will destroy the apparent agreement of the parties, that is, will undermine the appearance of consensus, which is manifested to the outside world by their language and conduct. Justice Wells, in R. v. Ontario Flue-cured Tobacco Growers' Marketing Board, summarized the common-law understanding of mistake as one of 'false and fundamental assumption' under which the parties contracted.
When the criteria for the common law doctrine of mistake are satisfied, the contract between the parties becomes void from the beginning (ab initio). However, it is often difficult to make the case that the existence of an unintended tax obligation will satisfy the high standard of mistake as set out above. However, the doctrine of equitable rescission arguably allows parties to render a contract voidable on alternative grounds.
The doctrine of equitable rescission is usually traced to the 1950 UK case of Solle v. Butcher. It has two criteria for its application:
- First, the mistake must go to the legal effect of the transaction rather than a non-legal consequence.
- Second, there must be no other legal remedies available.
The standard for the equitable remedy of rescission is lower than the common law doctrine of mistakes. As Mr. Justice Thompson in McMaster University v. Wilchar Construction Ltd. stated, "If the contract is void at common law, equity will also treat it as a nullity. Equity, however, will intervene in certain cases to relieve against the rigours of the common law, even though the mistake would not be operative at law. ... In equity, to admit of correction, mistake need not relate to the essential substance of the contract, and provided that there is mistake as to the promise or as to some material term of the contract, if the Court finds that there has been honest, even though inadvertent, mistake, it will afford relief in any case where it considers that it would be unfair, unjust or unconscionable not to correct it;"
The Effect of Equitable Rescission
Rescission is a remedy, not a cause of action, which means it can only be used in defense against an unwanted legal consequence of the contract. Further, rescission cannot be done for a part or parts of a contract. If the Court determines it is equitable to apply the rescission remedy, the entire contract must be rescinded. The effect of rescission will be to restore the parties to their original financial positions had the contract never been made in the first place, which would often involve more than the nullification of the unintended tax consequences. The consequence of the Court granting equitable rescission would involve returning properties involved in a contract to their original owners, compensation for the use of the property by one party to the other, and reimbursement of expenses that are incurred in connection to the rescinded contract.
Equitable Rescission in Tax Context
In Juliar, the Ontario Court of Appeal established that the court should not refuse equitable relief simply because the sole purpose of seeking the relief is to enable the parties to obtain a legitimate tax advantage, which was their common intention to obtain at the outset of the transaction. As long as the intended tax-planning transaction is perfectly legal, the fact that the mistake only goes to the tax consequence of the transaction is not itself a reason for the Court to decline the application of equitable rescission.
Therefore, the application of equitable rescission in tax context can be complicated by the application of the General Anti-Avoidance Rule(GAAR) where the taxpayer is required to prove that the intended tax-planning transaction does not fall under the GAAR before establishing that the Court should apply equitable rescission to the contract that failed to give effect to the intended transaction.
To add additional complexities to the application of equitable rescission in the tax context, case law such as Gibbon seems to suggest a rather vague distinction between unwanted tax consequences as a legal effect and unwanted tax consequences as a mere consequence. Gibbon ruled that equitable rescission will be granted for a mistake where the mistake is as to the effect of the transaction itself and not merely as to its consequences or the advantages to be gained by entering into it. The distinction seems to point towards the degree to which the taxpayer can prove the intended effect of the transaction. As Bramco Holdings Co. Ltd. states, the Courts will not use rescission to undo the intended transaction and put in place one which would have been done had the original contracting party had the opportunity to form the intention.
Tax Tips – Great Peace and the Possibility of Equitable Rescission No Longer Being Good Law in Canada
It should be noted that the UK Supreme Court had ruled that equitable rescission is no longer good law in its 2002 decision Great Peace Shipping Limited v. Tsavliris (International) Limited. The Court ruled that the equitable doctrine of rescission is an intrusion upon the common law doctrine of mistakes and the two doctrines cannot be reconciled with each other. Solle v. Butcher and equitable rescission is, therefore, no longer good law. The adoption of Great Peace in Canadian courts was only given marginal mention by the BC Supreme Court in 0741508 B.C. Ltd. and 0768723 B.C. Ltd (Re). In that case, the CRA did not plead that equitable rescission should no longer be good law in Canada, and the Court mentioned Great Peace as a possible direction in the development of the equitable rescission doctrine but declined to give consideration whether the reasons given in Great Peace should be adopted.
However, it remains open for CRA or private litigants to plead Great Peace as persuasive authority in future cases as to undermine the existence of equitable rescission in Canada. If youthat has the wrong tax entered into a transaction that has the wrong tax results, please contact one of our top Canadian tax lawyers to give you the most up-to-date analysis of equitable rescission and its applicability to your situation.