Mandel1 was a failed attempt to seek relief from the adverse tax consequences of a reorganization. Viewed from a high level, the two applicants (Mandel and Pike) structured their holdings through family trusts, then faced a material tax liability as their 21st anniversary approached, due to the anticipated deemed realization under subsection 104(4) of the Income Tax Act (Canada) ('ITA').2 They sought to defer their tax exposure through a restructuring, which included subscribing for shares in what were defined as 'Child Corporations'. The Canada Revenue Agency ('CRA') raised substantial tax assessments based on the assertion that the applicants each received taxable benefits under subsection 15(1) in connection with receiving those Child Corporation shares. The applicants filed notices of objection. They then brought applications before the Ontario Superior Court of Justice ('Ontario Court') to seek a declaration that the shares were not validly issued because they were not paid for, and an order accordingly rectifying the share register of each corporation.
The Ontario Court was called upon to consider three issues:
- Whether the Ontario Court had jurisdiction over the matters raised by the application;
- Were the applicants entitled to a declaration that they never held shares in the Child Corporations; and
- Were the applicants entitled to rectification of the corporate records of the Child Corporations?
The short answers were:
- The Ontario Court refused jurisdiction because the issues that were raised are within the jurisdiction of the Tax Court of Canada ('TCC');
- It would not be appropriate to make a declaration that the shares were not validly issued, because of conflicting evidence, and the validity of the shares could in any case be considered by the TCC; and
- Rectification would be predicated on the same evidence as the request for a declaration and, in any case, rectification would be inappropriate in the circumstances.
The applicants' families each owned 25% of an operating company. In the 1990s, they transferred their operating company shares to a holding company, the shares of which were held by their family trusts for the benefit of each of their children. As the 21 year deemed disposition date approached, the family trusts reorganized to seek to defer the immediate tax implications of that rule. The judgment set out the following steps as an example of the transactions undertaken for a single beneficiary (the same steps were taken for all):
- A Child Corporation was incorporated, of which the applicant was the first director and Class 'A' voting shareholder, and corporate documents were signed confirming that the subscription price had been fully paid.
- The family trust distributed to 'child' 700 Class D shares of the holding company (which, as noted, held operating company shares), and child rolled those shares into their respective Child Corporation under section 85 of the ITA, in exchange for 100 non-voting common shares.
- Next, the applicant subscribed for 100,000 Class B convertible shares of the Child Corporation, and corporate documents were signed confirming that the subscription price had been fully paid.
As a result of these transactions, each of the applicants controlled each Child Corporation.
Other than seeking to achieve tax deferral, the reorganizations served an asset protection purpose: in the event that any child suffered a marriage failure, the former spouse's claim could be diluted by the 100,000 convertible shares.
Following the reorganizations described above, the applicants and children acted as though the applicants were shareholders of each of the Child Corporations and myriad paperwork appeared to confirm that fact. That said, the Child Corporations' financial statements showed receivables equal to the cumulative share prices (being $110). However, those statements also confirmed that the shares were issued and showed $110 of shareholders' equity in those shares.
The CRA proposed to assess each of the applicants for just under $15M in connection with the reorganization, on the basis that they each received taxable benefits under subsection 15(1) resulting from receiving their controlling interests in the Child Corporations. The CRA issued notices of reassessment and as noted above the applicants filed notices of objection. Shortly thereafter, they made their applications to Ontario Court seeking a declaration that the Child Corporation shares were never validly issued because they were not paid for and an order rectifying the share register of each corporation accordingly.
The Ontario Court noted the straightforward proposition that if the requested relief was granted, there would be no factual basis for the reassessments. The Ontario Court correctly noted that when the CRA does not respond to an income tax notice of objection within 90 days, the taxpayer has a direct appeal route to the TCC. At the time the application was heard by the Ontario Court, the applicants had the option to directly appeal to the TCC, which they had not yet done.
Analysis and Comments
The TCC's jurisdiction is confirmed in section 12 of the Tax Court of Canada Act3 and includes exclusive original jurisdiction to hear tax appeals. Section 12 clearly and unequivocally ousts the jurisdiction of the Federal Court and any provincial Courts to consider the correctness of a tax assessment.4 However, the TCC is obligated to recognize and give effect to orders issued by the provincial superior courts.5 Thus, the interaction of superior court orders with tax matters is generally clear cut: the TCC applies the law to the facts as it finds them to determine the correctness of a tax assessment, which is a task within its exclusive purview; but when a superior court grants an order (within its jurisdiction) which establishes facts with retroactive effect, the TCC is bound by that order.
Ordinarily, if a taxpayer is assessed in connection with a mistaken transaction, a protective objection should be filed, with notice provided to the CRA's appeals branch that a superior court application is being commenced. The CRA's policy is to hold the objection in abeyance pending the outcome of the court application, since the outcome of the application may be determinative of the assessment and objection. Stated another way, there would typically be no basis for proceeding simultaneously with an assessment dispute and a superior court application.
In Mandel, the Ontario Court considered the argument that subsection 23(3) of the Ontario Business Corporations Act ('OBCA') requires that shares be paid for before they can be issued, but held that the TCC has the jurisdiction to interpret that provision. The Ontario Court noted that the TCC does not have the jurisdiction to rectify records, but that rectification was not available in any case. Although the Ontario Court certainly has jurisdiction to interpret the OBCA, it relied on the overall context to determine which court should rule on the interpretation of subsection 23(3): the application for declaratory relief and rectification arose only because of a tax assessment; the TCC is better placed to determine tax issues and has specialized expertise to deal with corporate structuring and related tax consequences; thus the TCC is best positioned to come to a conclusion about the impact of subsection 23(3) of the OBCA on the tax assessment. Therefore, while in any other case the Ontario Court would be open to interpreting the OBCA, where the underlying issue is an income tax assessment, the Ontario Court will respect the integrity of the tax appeal system that was implemented by Parliament, rather than allowing incidental litigation to undermine that system.
The applicants sought a declaration that they had never been shareholders, despite the corporate records showing that they were, based on the largely unsupported assertion that they never paid for the shares. They argued that failing to pay for shares renders them void, because subsection 23(3) of the OBCA requires that shares be paid for before they can be issued. The Ontario Court dealt with this argument in the event that its conclusion about jurisdiction was challenged.
The provision reads as follows:
A share shall not be issued until the consideration for the share is fully paid in money or in property or past service that is not less in value than the fair equivalent of the money that the corporation would have received if the share had been issued for money.
The language of the provision appears mandatory - thou shalt not issue before payment. However, the Ontario Court held that interpreting the provision was not quite so obvious and depends on the context and purpose for which the section is being applied. In my view, this is a fair statement. The provision may be interpreted as a rule that may bear consequences for those in breach, as opposed to being a rule that voids the share issuance altogether. One can easily imagine someone who owns appreciated shares arguing that their shares are valid despite a cloud over the status of their payment.
Further, Mandel was not, strictly speaking, a case involving only legal interpretation: factually, it was not clear whether the shares were paid for or not. In this regard, subsection 139(3) of the OBCA provides that corporate records are admissible in evidence as proof, in the absence of evidence to the contrary, of the facts stated therein. On one hand, corporate records showed the shares as having been paid for, but on the other hand there was a contrary assertion. Consequently, the application judge was left with task of weighing conflicting evidence. Again, this exercise was context-specific: the context was a tax assessment, not a dispute about corporate control or any other issue. Had there been a shareholder dispute or a matter involving the ability of the Child Corporations to conduct their business, the Ontario Court may have been motivated to intervene. However, the Ontario Court declined where the substance of the dispute was a tax assessment and deferred to the TCC, which was well positioned to rule. In this sense, the Ontario Court bled together the jurisdictional question with the context for interpreting the evidence.
In connection with seeking a declaration that the Child Corporation shares were never issued, the applicants sought to have the corporate records rectified, relying on subsection 250(1) of the OBCA. While the Ontario Court's refusal to declare that the shares were never issued was obviously fatal to the request for rectification, the Ontario Court buttressed its conclusion by stating that rectification is available to fix mistaken documents that do not reflect the parties' intentions. However, in this case, the corporate records accurately reflected the parties' intent. Rectification does not subsist to allow people to sidestep the consequences of their intended actions.
The applicants argued that statutory rectification differs from equitable rectification and what they were seeking was an order recognizing that, as a matter of law, the shares were not issued. Again, the Ontario Court noted that there was conflicting evidence about what had actually occurred. Further, the Ontario Court stated that no authority was provided for the proposition that rectification of records under the OBCA was different than equitable rectification. If anything, the Ontario Court held that case law supported the proposition that the principles informing equitable rectification applied to rectification of corporate records under the OBCA, including that rectification must be used cautiously, because freely rewriting agreements may undermine confidence in contractual relations and retroactive tax planning is impermissible. The Ontario Court held that rectification was not an appropriate remedy, because the corporate records accurately reflected the parties' intentions. The highest and best position advanced by the applicants was that their intention was not realized because they did not pay for their shares. If any remedy would be appropriate, it would be to allow the late payment of the share price.
The outcome of this application was clearly a disappointment for the taxpayers and private tax practitioners would have surely been popping champagne corks if the Ontario Court granted relief. There is little basis to criticize the Ontario Court's reasoning. It makes sense that where a provincial superior Court and the TCC are both within their jurisdiction to conduct factual and legal analyses, where the matter in substance concerns a tax assessment it should be left to the TCC to decide, to avoid a sideshow of incidental litigation in future cases. The Ontario Court's further discussion of declaratory relief and rectification was obiter and, in any case, the result was fact-driven. That said, the question of whether shares are valid or void, where the underlying statutory provisions were violated, is intriguing. One could certainly envision a scenario in which a shareholder would strongly argue for validity if there was a mere oversight in paying some nominal subscription price. Moreover, it seems too cute by half to seek relief from an onerous tax assessment by virtue of having mistakenly failed to pay a nominal price. Arguing before a Court that you outsmarted yourself is a tricky proposition. Finally, the conclusion that statutory rectification should be interpreted consonant with equitable rectification is justified - why should a taxpayer be entitled to relief under a corporate law statute that would not be allowed under Supreme Court of Canada jurisprudence?
1. Robert Mandel et al v. 1909975 Ontario Inc. et al, 2020 ONSC 5343 ('Mandel') (under appeal as of October 5, 2020).
2. Unless otherwise noted, all statutory references are to the ITA.
3. RSC, 1985, c. T-2.
4. See, for example, Sorbara v. Canada (Attorney General), 93 O.R. (3d) 241 (aff'd 2009 ONCA 506; leave denied November 5, 2009).
5. Dale v. R, 97 DTC 5252 (FCA), at paragraph 10.
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