Most tax rectification cases address situations in which a professional advisor has made a mistake in the planning and execution of a transaction with the result that an unintended tax consequence follows (i.e., payment of a capital dividend at a time when the company did not have a sufficient balance in its capital dividend account).
These are the relatively simple cases. However, in certain situations, the taxpayer and the CRA may take a different view on the interpretation and effect of a document, which could lead to an unintended tax result. Does the doctrine of rectification operate in these situations?
This was the situation considered by the Ontario Superior Court of Justice in Kaleidescape Canada Inc. et al. v. Computershare Trust Company of Canada et al. (2014 ONSC 4983), in which the Court was asked to determine whether the parties intended that a company remain a Canadian-controlled private company (“CCPC”) for the purposes of obtaining certain scientific research and development tax credits under the Income Tax Act (Canada) (the “Act”).
The Court granted the rectification, and Kaleidescape is a helpful case for those situations in which the “mistake” in a transaction arises as a result of competing interpretations of a parties’ document(s).
Kaleidescape Canada Inc. (“K-Can”) was a research and development company in Waterloo, Ontario. Under the Act, a CCPC is a Canadian corporation that is not controlled by a public company or a non-resident (or a combination of such persons). K-Can was structured as a “deadlock” corporation so that it would not be controlled by a non-resident and therefore would qualify as a CCPC.
From 2006 to 2008, K-Can’s shareholdings were restructured. In 2008, K-Can shares were owned by Kaleidescape Inc. (“K-US”), a Delaware company with head offices in California, and Kaleidescape Canada Employment Trust (the “Trust”). Computershare Trust Company of Canada (“Computershare”) became the sole corporate trustee. A Restated and Amended Trust Deed was entered into with K-Can as the settlor and Computershare as the sole trustee.
K-US and Computershare held equal voting rights. Additionally, a unanimous shareholders agreement relieved K-Can’s directors of their powers and conferred those powers on the shareholders. There was no provision to resolve a deadlock, and neither the shareholders nor directors had the right to make unilateral decisions.
K-Can received notices from the CRA advising that, in its view, K-Can was not a CCPC for the tax years ending December 31, 2008 and December 31, 2009. As a result, K-Can’s federal SR&ED and Ontario ITCs were denied. The CRA’s position was that the combined effect of the provisions of the Restated and Amended Trust Deed was to give a non-resident authority to direct Computershare how to vote its shares of K-Can, such that a non-resident controlled K-Can and the definition of CCPC was not met.
In response to the CRA’s reassessments, K-Can and Computershare entered into a “Deed of Rectification”, which revised the wording of Restated and Amended Trust Deed to protect K-Can’s CCPC status.
At the rectification application hearing, the Applicants argued that their common and continuing intention at all times was to structure and operate the company in a manner that would establish and preserve its CCPC status. The Respondent argued that the Applicants could not prove common intention, did not admit that a mistake had been made, and could not show the precise form of a corrected document that would express their prior intention.
In its analysis, the Court cited only two non-tax cases dealing with rectification (Performance Industries Ltd. v. Sylvan Lake Golf and Tennis Club Ltd. (2002 SCC 19) and Shafron v. KRG Insurance Brokers (Western) Inc. (2009 SCC 6)). (For tax rectification cases see Juliar v. Canada (A.G.) ( O.J. No 3706), 771225 Ontario Inc. et al. v. Bramco Holdings Co. Ltd. et al. ( O.J. No 157), McPeake v. Canada (A.G.) (2012 BCSC 132), Graymar Equipment (2008) Inc. v. Canada (A.G.) (2014 ABQB 15), and Re: Pallen Trust (2014 BSCS 305)).
Turning the facts of the current case, in several short paragraphs the Court stated that, on the entire record and history of the Applicants, the intention throughout was to ensure that K-Can – as an R&D body, with no other functions than research and development – qualified for CCPC status and the relevant research tax credits.
The Court held that wording chosen in the Restated and Amended Trust Deed was chosen by mistake and did not give K-US de jure control over K-Can. In respect of the proposed correction, the Deed of Rectification corrected the mistake in the original wording. The Court stated that Deed made it clear that the decision-making body was the board of directors and that the trustee was only to accept a direction in written form.
The Court granted the rectification sought by the Applicants.