On March 4, 2011, in the Services environnementaux AES Inc. case, the Québec Court of Appeal ("QCA") has confirmed a decision of the Superior Court ("SC") which retroactively rectified documents that did not reflect the parties' intent and made them enforceable against tax authorities.
As part of a reorganization of their business, Services environnementaux AES Inc. ("AES") and Centre technologique AES Inc. ("Centre technologique") had entered into an agreement using statutory provisions allowing rollovers so as to obtain a tax deferral. However, the adjusted cost base of the transferred shares was mistakenly overstated and the Canada Revenue Agency assessed AES regarding the capital gain arising from such overstatement. In order to remedy this situation, AES and Centre technologique filed with the SC a motion for rectification of documents and declaratory judgment to enable them to modify the documents relating to the transaction. The SC allowed such modification and declared that same had retroactive effect and was enforceable against third parties and in particular the tax authorities.
On appeal, the main issue was whether the SC could allow the correction of a document bearing a contract in case of discrepancy between the common intention of the parties and their stated intention in the document. Revenue Québec argued that the SC could cancel the transaction if there was an error invalidating the consent of the parties but could not change it and that by changing same, the SC had introduced in the Quebec civil law the common law's equitable doctrine of rectification that allows the modification of a contract if it does not reflect the parties' intent.
The QCA rejected Revenue Québec's position and held that pursuant to article 1425 of the Civil Code of Québec, if there is a discrepancy between the common intention of the parties and their stated intention in the contract, a judge may take such discrepancy into account in giving effect to the contract, provided that the request is legitimate and that the proposed modification does not affect third parties' rights. Here, the parties only sought to make the documents consistent with the scenario involving no tax consequence that had been originally designed, and not to rewrite the transaction's tax consequences. No prejudice was caused to the tax authorities because the tax legislation provided for such scenario where the transaction would have no tax consequence and such would have been the case if the parties had proceeded in a manner consistent with their intention.
This decision constitutes an important development in Canada's and Québec's case law on retroactive rectification of documents that do not reflect the parties' intent and their enforceability against the tax authorities and will allow certain taxpayers to obtain rectification of their documents in order to remedy adverse tax consequences.