In 5551928 Manitoba Ltd. (Re) (2018 BCSC 1482; aff'd 2019 BCCA 376; herein referred to as "Manitoba"), the court allowed a claim for an order rectifying a directors' resolution declaring a dividend from the capital dividend account (CDA) of a private corporation. On October 30, 2019, the BCCA dismissed the attorney general's appeal. (For additional background on the lower court's decision and other recent decisions involving rectification, see "Rectification: Where Are We Now?" Canadian Tax Focus, May 2019.)
The BCSC's Decision in Manitoba
The attorney general appealed the BCSC's decision in Manitoba on the following grounds:
- the BCSC misapplied the test for rectification by focusing on "intention as to [the] tax consequences" of the resolution rather than on whether it correctly recorded the unilateral act that the directors resolved to undertake; and
- the BCSC gave insufficient weight to the availability of alternative remedies.
The Application of Fairmont Hotels
The BCCA distinguished Manitoba from Fairmont Hotels (2016 SCC 56) on the basis that the taxpayer in Manitoba did not request rectification after discovering an adverse tax consequence; once that consequence was discovered, the parties sought to change their agreements. In Manitoba, rectification was requested to properly accomplish the directors' original intention (a tax-free distribution out of the corporation's CDA), fitting within the narrow test in Fairmont Hotels.
Further, the BCCA found that the test for rectification applied equally to written instruments (such as "unilateral" resolutions) and arm's-length agreements. In both contexts, rectification requires that the parties who signed the document show that they had a definite and ascertainable intention when they signed it, and that the document failed to reflect that intention because of a mistake. Although the resolution was premised on a mistaken fact regarding the quantum of the CDA balance, the ascertainable intention to "clean out" the CDA by the directors was properly recorded in the resolution.
The BCCA found that the BCSC's determination that the possible alternative remedies (such as a remission order, a professional negligence suit against the accountant who made the mistake, or an election to treat the excess amount declared as a taxable dividend) "involved such risk and expense that they did not outweigh the equities that favoured rectification." The BCCA commented that equity would not force upon a party an "alternative" that is neither practical nor certain and whose cost might well exceed the penalty imposed. Accordingly, the BCCA found that rectification was the appropriate and reasonable remedy, and the attorney general's appeal was dismissed.
The Manitoba decision is a welcome development for taxpayers who may be forced to turn to equitable relief to fix unintended tax mistakes. Advisers initially feared that the SCC's landmark decision in Fairmont Hotels would eliminate rectification in the tax context. Subsequent appellate-level decisions that considered Fairmont Hotels denied the requested relief and did not appear promising (see, for example, Harvest Operations, 2017 ABCA 393, and Canada Life, 2018 ONCA 562). It can be argued, however, that the facts surrounding such earlier decisions did not fit the legal test for rectification (that is, the relief requested would result in a different transaction altogether), and that rectification was appropriately denied.
Despite this jurisprudence, I suggest that although Fairmont Hotels may have narrowed the legal test for rectification, the decision did not eliminate rectification or other equitable remedies (such as rescission) altogether. Manitoba and other recent BC cases appear to support this position. In 2019, the BCSC granted both rectification (Crean, 2019 BCSC 146) and rescission (Collins Family Trust, 2019 BCSC 1030); when combined with Manitoba, those decisions suggest that the pendulum may be swinging in favour of taxpayers and away from earlier decisions in which Fairmont Hotels was used to deny equitable relief.
The courts in British Columbia appear to have resolved the apparent conflict between the legal test and the policy concerns raised in Fairmont, and they are prepared to grant equitable relief in appropriate cases. It remains to be seen whether more complex planning fits within the Fairmont Hotels framework, but it is clear that rectification remains available to allow parties to complete transactions when the documents fail to properly execute their plan but demonstrate a prior ascertainable agreement.
Is Rescission Next?
Although the Manitoba decision demonstrates that rectification is still possible in certain circumstances, it is unclear whether this will be the case with rescission. Unlike rectification, which can modify an instrument, rescission can be used to set aside an instrument entirely. Accordingly, the test for rescission is different from that of rectification. Equitable rescission affords relief for a fundamental mistake if it would be unconscionable, unjust, or unfair to leave the mistake uncorrected.
Prior to Fairmont Hotels, rescission was granted in Re Pallen Trust (2015 BCCA 222) and Stone's Jewellery (2009 ABQB 656). The BCCA in Pallen Trust specifically found that rescission involved a fact-focused analysis that could address any concerns about aggressive tax avoidance. Even though both decisions carefully considered retroactive tax planning (and concluded that neither circumstance involved aggressive tax planning gone wrong), it was unclear how those decisions would be reconciled with Fairmont Hotels.
In Canada Life, the OCA found that rescission was not available in the circumstances of that case. However, the court specifically declined to comment on whether Pallen Trust remained good law following Fairmont Hotels. In Collins Family Trust, the BCSC followed Pallen Trust and granted the taxpayer's petition for rescission. In doing so, however, the BCSC stated that Fairmont Hotels may have undermined the precedential value of Pallen Trust, but the court left it to the BCCA to determine whether the 2015 decision remained good law. A request for leave to appeal the decision in Collins Family Trust was filed on July 24, 2019. It appears that taxpayers and advisers may have an answer if the appeal is ultimately heard.
The case law surrounding equitable relief in the tax context continues to evolve. There is no doubt that the courts have reconciled Fairmont Hotels and are comfortable granting rectification for tax mistakes under the Fairmont Hotels framework.
The BCCA may cause the pendulum to swing further if it determines that Pallen Trust is still good law in light of Fairmont Hotels. I remain of the view that Fairmont Hotels should not automatically overrule Pallen Trust. Rather, the policy considerations identified in Fairmont Hotels should be considered and applied in a fact-intensive and objective analysis in each specific circumstance (as they were in Pallen Trust and Stone's Jewellery).
Originally Published by Tax for the Owner-Manager
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