The problem and the fix
A taxpayer intends to undertake a transaction on a tax-efficient basis. But the transaction gets papered wrong, and the intended tax treatment is not achieved. Can the law of contract save the taxpayer by allowing a court to rewrite the contract documents retroactively in order to achieve the original intention of tax efficiency?
For over a decade the answer in common law Canada has been yes, through the equitable doctrine of rectification. The basic concept underlying rectification is that where a written agreement has incorrectly recorded the parties’ prior oral agreement, the court has the power in equity to correct the written agreement so that it accords with the parties’ actual intentions. Since the 2000 decision of the Ontario Court of Appeal in Attorney General of Canada v. Juliar (2000), 50 O.R. (3d) 728 (C.A.), leave to appeal to S.C.C. refused May 24, 2001, it has been established that rectification is available to fix unintended tax consequences, provided of course that the requirements for rectification are met. Since Juliar, such applications have become relatively frequent in common law provinces, and at the federal level the Canada Revenue Agency has created a committee process to vet rectification proceedings and decide whether the CRA will oppose.
But the situation in Quebec has not been so clear. Until the decision of the Supreme Court of Canada in Québec (Agence du Revenu) v. Services Environnementaux AES inc., there was a vigorous debate as to whether the law of obligations in Quebec permitted a rectification-like remedy at all, much less in the tax context. AES has settled this debate by answering yes. Importantly, the common law doctrine of rectification has not been adopted into Quebec law; rather the decision is entirely based on civil law contract principles.
However, the results under both systems should be the same. In general and in matters of contractual interpretation in particular, Quebec courts and their common law counterparts often use different paths of reasoning to get to the same results. For example, in contractual interpretation the civil law focuses on the parties’ subjective intentions while the common law focuses on their objective intentions – a major theoretical difference. But when it comes to actually interpreting contracts, the two approaches come to remarkably similar outcomes. AES is an example of that phenomenon.
AES involved two appeals. In both cases there had been a clear intention to undertake transactions on a tax efficient basis which had been defeated when the parties’ advisors made errors in drafting the contracts to give effect to the transactions. In both cases, Quebec revenue authorities issued assessments adverse to the taxpayers, pointing to the tax outcome of the transactions as papered. In both cases, the taxpayers went to court seeking orders retroactively revising their contracts to achieve the originally intended tax results. Importantly, the evidence of the parties’ common intention was clear in both cases. At the trial level, one taxpayer succeeded and the other failed; the divergence in results turned entirely on the question of whether the remedy that was sought existed under Quebec law. The cases were appealed separately, and in both cases the Quebec Court of Appeal found the remedy to be available at law and granted it on the evidence. The Supreme Court of Canada then heard both appeals together, unanimously affirming the decisions of the Court of Appeal in a decision authored by Justice LeBel.
The Supreme Court’s analysis, firmly rooted in civil law principles, began with a discussion of the concept of a contract under Quebec law. A contract is an agreement of wills for the purpose of carrying out juridical operations. What is important is the common intention of the parties, which is not the same as the expression (either oral or written) of the declared will. A contract is formed by a meeting of the parties’ minds, with the contract being distinct from its physical medium. The agreement lies in the common intention, despite the importance of the declaration of Thus where there is a divergence between the parties’ common intention and the declaration of that intention – as was clearly established on the evidence – the former must prevail. Correction of the writing results in giving effect to the actual will of the parties. The fix works. Contract law can save taxpayers from inadvertent missteps causing them unintended tax bills.
But not always. Common law rectification cases often emphasize the extraordinary nature of the remedy, expressing concern not to open the floodgates to after-the-fact efforts to get out of a bad bargain (examples of this phenomenon include Performance Industries Ltd. v. Sylvan Lake Golf & Tennis Club Ltd., 2002 SCC 19 at paras. 35 and 40 and Royal Bank of Canada v. El-Bris Limited, 2008 ONCA 601 at paras. 35 and 36). AES did the same by expressing “certain reservations and a word of warning”: “Taxpayers should not view this recognition of the primacy of the parties’ internal will – or common intention – as an invitation to engage in bold tax planning on the assumption that if will always be possible for them to redo their contracts retroactively should that planning fail.” In both Quebec and common law provinces, the fix only works if there truly has been an error in writing down the parties’ intentions. The fix does not work to revise a transaction that turns out, in retrospect, was not structured in the best manner from a tax perspective.
The fate of Juliar
There is one further aspect of AES that is worth noting. The Attorney General of Canada intervened to argue that the common law Juliar line of cases permitting rectification in the tax context should be overruled on the basis that it is inconsistent with Supreme Court doctrine on rectification (in Juliar itself, leave to appeal was denied). The Court declined that invitation, holding that cases under Quebec law were not an appropriate forum for a reconsideration of the common law remedy of rectification.
AES is significant for three reasons.
First, AES eliminates all doubt that a rectification-like remedy exists under the law of obligations in Quebec.
Second, in the tax context, Quebec law is now aligned with the common law under Juliar, in outcome even if not in the exact path of reasoning. It is now the case that throughout Canada, written contracts that erroneously record the parties’ common intentions and create unintended adverse tax consequences can be retroactively corrected by the courts to fix the tax problem and achieve the originally intended result.
Third, of interest for the future is the intervention of the Attorney General of Canada. The federal Department of Justice – defending the interests of the federal fisc – is clearly not happy with the development of the common law since Juliar. Having taken a run at that case law in AES, will they do so again in a common law case? Or, Quebec law having now recognized a remedy that is functionally although not theoretically the same as rectification, will the Department of Justice now accept that Juliar is here to stay?