The Ontario Court of Appeal’s decision in Juliar et al v Canada (Attorney General)1 is considered to be the leading Ontario case on the availability of rectification for tax mistakes. Some commentators have observed that the law on rectification in the context of tax mistakes may be developing independently from, and more broadly than, rectification generally.2

Whether it is or not, and, in particular, whether the analysis and holding in Juliar is consistent with the Supreme Court of Canada’s (“SCC”) jurisprudence on rectification in Performance Industries Ltd v Sylvan Lake Golf & Tennis Club Ltd 3 and Shafron v KRG Insurance Brokers (Western) Inc4 was considered recently in the Alberta Court of the Queen’s Bench decision in Graymar Equipment (2008) Inc v Canada (Attorney General)5. In Graymar, the Alberta Court held that only tax consequences expressly identified at the time of the transaction are the proper object of rectification. On the status of Juliar, the Alberta Court said:

[66] ...Juliar sits uneasily with the Supreme Court’s direction in Performance Industries and Shafron that rectification is granted to restore a transaction to its original purpose, and not to avoid an unintended effect. A transaction which does not succeed in achieving its goal of avoiding tax is not the same thing as a transaction whose goal is other than tax avoidance but which unexpectedly results in a tax disadvantage. While, therefore, rectification is available in order to avoid a tax disadvantage which the parties had originally transacted to avoid, it is not available to avoid an unintended tax disadvantage which the parties had not anticipated at the time of transaction.

Graymar appears to hold that an unanticipated or unintended tax consequence cannot be remedied through rectification because the fact that it was unintended or unanticipated means that the parties did not advert to it and therefore did not incorporate it as an objective of their transaction.

The tax mistake in Graymar led to the unintended application of subsection 15(2) of the Income Tax Act (“ITA”) in the context of a debt restructuring transaction, the main purpose of which was to reduce interest expense. Although tax counsel did see the subsection 15(2) issue, the issue was not given a significant profile and, it appears, was not taken into account in the design of the transaction.

The Alberta Court in Graymar drew a distinction between intended consequences and unintended consequences, between the objectives of a transaction and the assumptions underlying the decision to carry it out in a certain way:

[73] ...the problem with the inferential leap made in Juliar between the fact of the transaction and a conclusion that the transaction’s purpose was tax avoidance was that it was based not on evidence of the purpose, but on evidence of whether the parties would have carried out that purpose in the way they did, had they known of the associated tax disadvantage. Again, for the purposes of a rectification order as it has been preconditioned by the Supreme Court, such evidence is irrelevant. Taking it into account conflates the parties’ intent in entering into a transaction with the assumptions they made in doing so. Just as a transaction which does not succeed in achieving its goal of avoiding tax is not the same thing as a transaction whose goal is other than tax avoidance but which unexpectedly results in a tax disadvantage, the intent of avoiding tax is not the same thing as the assumption that a tax liability would not be incurred.

It should be noted that the SCC denied leave to appeal in Juliar. The novelty of Juliar was the broadening of the application of rectification from documents – agreements and trusts, typically - to transactions. Accepting that development, as the SCC implicitly did, there is little difference, in our view, in the context of an application for rectification, between a fundamental assumption of a transaction and an objective of a transaction. If parties to a transaction assume that steps designed to carry it out do not give rise to untoward tax consequences (which they invariably do) does it make an absolute or categorical difference for the purposes of rectification that there is no memorandum to all parties saying, “It is a purpose of this transaction that there are no untoward tax consequences?” Does not the fundamental assumption that untoward tax consequences would not be engaged at least assist in proving that they intended that there would be no untoward tax consequences? Or is it irrelevant as the Alberta Court in Graymar appears to hold?

The Ontario Superior Court of Justice’s decision in Kaleidescape v Computershare6 is interesting because it appears to grasp this point implicitly. The Court in Kaleidescape also required an intention to achieve a particular tax result:

[22] Pursuant to the jurisprudence, rectification can be applied where parties had an agreement to achieve a specific tax outcome but failed to implement their plan properly. To the extent that the written agreement or instrument does not carry out the clear intention to produce a particular tax result, and where that particular result was a primary objective of the transaction, this Court has the discretion to rectify that instrument. In cases where the document is sought to be rectified to avoid taxation, it must be established that the original purpose of the transaction was to avoid taxation in a particular way, not simply to avoid an unexpected tax disadvantage.

Graymar and Kaleidescape, with respect, are correct that intention is fundamental to rectification. Rectification addresses mistakes in documents and transactions that result in the frustration of the parties’ proven intentions. According to Performance, at least where an agreement is concerned, rectification is “predicated on the existence of a prior oral contract whose terms are definite and ascertainable”; its purpose, “to restore the parties to their original bargain, not to rectify a belatedly recognized error of judgment”.7

The difference between Kaleidescape and Graymar, in our view, is that the Ontario Court in Kaleidescape was able to conclude, “based on an entire reading of the record and history of the applicants” that the “intention throughout” was to ensure a certain result, in that case, eligibility for enhanced SR&ED credits by maintaining CCPC status. Admittedly, in Kaleidescape, there was evidence that the applicant was advised that it would retain its eligibility for the enhanced SR&ED tax credits after the transaction. Perhaps this fact made all the difference in proving the intention of the parties. The question, though, is whether the assumption that it would not be lost was irrelevant on the issue of intention (à la Graymar),  not whether it was sufficient evidence.

The highly-complicated nature of Canadian income tax law has led and will continue to lead to many inadvertent errors in structuring transactions. It is likely justified to be concerned about the possible volume of cases where parties seek to obtain relief from untoward tax consequences. It is not clear, in our view, however, what the limits to relief should be. One constant refrain is that rectification should not be used for “retroactive tax planning.” That is definitely a pejorative way of putting the problem. However, it is not entirely clear what the “retroactive tax planning” line is or whether the principle underlying it is even engaged where a poorly designed transaction leads to substantial untoward tax consequences. In our view, the distinction between assumptions and objectives, at least as deployed in Graymar, is probably not, with respect, the correct line. Juliar, again respectfully, is to be preferred because the fundamental assumptions of  the parties in regard to tax neutrality are relevant on the issue of intention:

[28] ...It is possible, even probable, that no one mentioned income tax throughout the nine or 10 months in issue. The plain and obvious fact, however, is that the proposed division had to be carried out on a no immediate tax basis or not at all.

Notwithstanding this conclusion, it will always be helpful in the context of an application for rectification that there is in fact written evidence of an express intention with respect to the specific tax points in issue. But, in our view, this would be in addition to the parties’ typical assumption that there are no untoward tax consequences in the design of the transaction.