In a pair of recent decisions, the Supreme Court of Canada narrowed the scope of situations where courts can rectify a transaction that carries unintended tax consequences for the parties. It dismissed one appeal on grounds that retroactive tax planning was not permitted, and allowed another where it outlined when an equitable remedy of rectification is available.
In Jean Coutu Group (PJC) Inc. v. Canada (Attorney General), a civil law matter in Quebec, the case involved a subsidiary of PJC Canada, which invested in a chain of pharmacies in the United States. Due to fluctuations in the U.S. to Canadian dollar exchange rate, there were variations in the value of the investment. To attenuate its investors' negative perceptions of these variations, PJC Canada sought advice from professional advisors to neutralize the currency exchange fluctuations without incurring any adverse tax consequences. Though they found a way to neutralize the effects of the exchange rate fluctuations, the transaction was set up in such a way that 2.2 million dollars' worth of unanticipated tax consequences followed. PJC Canada sought the Superior Court's help to rectify the documents under article 1425 of the Civil code of Quebec (C.c.Q.).
The trial judge allowed PJC Canada to rectify its documents since the intention was clearly to solve the exchange rate fluctuations problem without incurring any fiscal consequences. The court found that PJC Canada was not trying to rewrite the tax history that ensued. It simply wanted to correct unforeseen tax consequences.
On appeal, the judges reversed the decision stating that "parties can restore their agreement to what it should have been where they made a mistake in expressing the transaction in writing, not where they made a mistake in the transaction itself"1. PJC Canada’s intention to keep the transactions tax-neutral wasn’t so clear as to retroactively modify the agreement and cancel the unintended tax consequences.
The Supreme Court of Canada confirmed the Court of Appeal of Quebec's decision stating that article 1425 of the C.c.Q., which addresses interpreting the common intention of the parties to a contract, does not allow amending written instruments to reflect tax neutral intentions related to obligations whose objects are not clearly defined. Citing Quebec (Agence du revenu) v. Services Environnementaux AES inc., a recent successful civil law rectification case heard by the Supreme Court, the Court reaffirmed that a contract is based on the common intention of the parties, not on their declared intentions. In the case of PJC Canada, however, the general intention of having tax neutral transactions was not clearly defined and therefore offered no basis to amend the documents to avoid the unintended and unforeseen tax consequences.
Ultimately, in the PJC decision, the highest court found that there was no connection between the general intent and clearly defined obligations. The mistake in the contract resided in the set of transactions chosen, not in the terms of the contract. Consequently, rectification was not granted.
Similarly, in Canada (Attorney General) v. Fairmont Hotels Inc., likely of more interest in common law jurisdictions, a common continuing intention was not enough to grant rectification. In this companion case, Fairmont sought to avoid a tax liability by asking for rectification of directors' resolutions. The trial judge and the Court of Appeal of Ontario both granted the rectification based on the parties' tax neutral intention; the Supreme Court disagreed, but provided guidance on when rectification may be granted:
Rectification is an equitable remedy designed to correct errors in the recording of terms in written legal instruments. Where the error is said to result from a mistake common to both or all parties to the agreement, rectification is available upon the court being satisfied that, on a balance of probabilities, there was a prior agreement whose terms are definite and ascertainable; that the agreement was still in effect at the time the instrument was executed; that the instrument fails to accurately record the agreement; and that the instrument, if rectified, would carry out the parties’ prior agreement2.
In its recap of the case, the Court stated that where the error results from a mistake by all parties, rectification will be granted if the Court is satisfied that there was a prior agreement:
- Whose terms are definite and ascertainable;
- That the agreement was still in effect at the time the instrument was executed;
- That it fails to accurately record the agreement; that the instrument,
- If rectified, would carry out the parties' prior agreement.
The Court further highlighted two significant tax policy concerns. First, citing Shell Canada Ltd. v. Canada, it reminds us that taxpayers must be taxed in accordance with what they did, not with what could have been done. Second, the amendment of the documents would set a precedent allowing retroactive tax planning. Taxpayers could rely on article 1425 C.c.Q. as a kind of catchall insurance for their mistakes, hardly a desirable precedent. Aggrieved taxpayers should instead consider bringing a claim against their advisors in the event of unintended tax consequences, if there are grounds to justify it.
Finally, it is now clear that there is finally some convergence on how the courts are expected to interpret rules surrounding rectification in both civil law and common law jurisdictions.
The author wishes to thank Daniel-Nicolas El Khoury, Marketing Intern, for his contribution