On June 21, 2018, the Ontario Court of Appeal handed down a decision in the case of Canada Life Insurance Company of Canada v. the Attorney General of Canada and Her Majesty the Queen in the Right of Ontario. This is a very troubling decision for taxpayers and their professional advisors. The facts are briefly as follows. The Canada Life Insurance Company of Canada (“CLICC”) and certain of its affiliates carried out a series of transactions and events in December 2007. The purpose of the transactions was to realize a tax loss to offset unrealized foreign exchange gains accrued in the same taxation year. The Canada Revenue Agency (the “CRA”) disallowed the claimed loss in the reassessment of CLICC’s taxes for 2007. Asserting that it had proceeded on the basis of erroneous advice from its tax advisor, CLICC applied to the courts for an order setting aside the transactions and replacing them with other steps retroactive to the date of the original transaction.
The problem arose because the tax loss was to be triggered by the winding up of a limited partnership. The mistake was that the general partner of the limited partnership, CLICC GP, was also wound up at the same time that the partnership was wound up. This resulted in the limited partner, CLICC, carrying on the business of the limited partnership alone within three months of the dissolution of the partnership.
CLICC originally applied for an order rectifying the transaction so as to move the winding-up of the general partnership from December 31, 2007 to April 30, 2008. The taxpayer was successful in its application before the application judge. However, the Attorney General appealed the decision. While the appeal was pending, the Supreme Court of Canada, in the case of the Fairmont Hotels, overruled previous decisions which permitted rectification. The change in law restricted the scope of the equitable remedy of rectification to the correction of written agreements.
Accordingly, CLICC sought relief on the basis of the Court’s inherent jurisdiction in equity or on the basis that the transactions should be rescinded pursuant to the doctrine of equitable rescission. The particular rescission related to the winding-up of the general partner on December 31, 2007.
The Ontario Court of Appeal concluded that the relief sought by way of the inherent jurisdiction of the court or by way of rescission involved the same relief, albeit by a different name, as the Supreme Court of Canada rejected in the Fairmont Hotels case.
The application judge concluded that CLICC and other parties to the transaction shared a common and continuing intention for CLICC in its 2007 taxation year to realize a deductible tax loss of approximately $168,000,000 inherent in its partnership interest in the limited partnership. The application judge concluded that this was not a case of retroactive tax planning, as the intention was always to create a taxable loss in the 2007 taxation year in order to offset the unrealized taxable gain arising from certain accrued foreign exchange gains. CLICC also maintained that the Canada Revenue Agency suffered no prejudice and would only be deprived of an unwarranted benefit or windfall gain to which it would not be entitled but for the mistake. In refusing to grant relief to the taxpayer, the Ontario Court of Appeal relied on Bramco Holdings Co. which held that any equitable jurisdiction that a court may have to relieve against a mistake cannot be invoked in order to retroactively alter a transaction to achieve a tax planning objective. According to the Ontario Court of Appeal, the Supreme Court of Canada signalled that retroactive tax planning by order of the Superior Court exercising its equitable jurisdiction is impermissible.
The Court of Appeal referred to TCR Holding Corporation v. Ontario where the Court may have recognized that other equitable remedies remain generally available even when rectification is not. However, it distinguished that case on the basis that TCR Holding did not authorize such equitable remedies for the purposes of impermissible retroactive tax planning.
The Bramco case which was relied on by the Court of Appeal as the basis for saying that equitable remedies should not be used to effect retroactive tax planning is clearly distinguishable on its facts from the CLICC case. In Bramco, a transaction was entered into to minimize certain income tax consequences. No regard was paid to the consequences of the transactions in respect of land transfer tax. After the transaction was completed, it was recognized that there was considerable land transfer tax payable. Accordingly, the effect of the equitable relief granted in the Bramco case involved retroactive tax planning because no consideration had been given to possible land transfer tax consequences.
The Ontario Court of Appeal rejected the CLICC’s argument that the transactions did not involve retroactive tax planning because it was always intended to generate a loss for tax purposes. This was the basis on which the application judge granted rectification in the first instance.
The Ontario Court of Appeal dealt rather harshly with this argument by stating that the argument has no merit. It noted that retroactive tax planning is not limited to attempts to secure a more favourable tax consequence than one had originally hoped to generate. It includes attempts to change one’s affairs so that tax consequences that were intended but which were prevented by a mistake can be achieved.
Returning to TCR Holding where it was held that equitable relief could be granted where rectification was not possible. It was distinguishable by the Ontario Court of Appeal in the CLICC case because TCR Holding was not motivated by tax considerations but to avoid an unintended windfall to a third party creditor whose position had been improved as a result of the amalgamation that took place between the debtor company and another company in the corporate group. The Court of Appeal stated that the avoidance of unjust enrichment, and not unintended tax consequences, was the foundation of the Court’s intervention in equity.
It is difficult to articulate why there should be a difference between a creditor who unjustly benefits from a transaction and that of the CRA. Absent the mistake there would not have been any tax payable. Clearly, that is an example of a windfall.
The Ontario Court of Appeal also rejected the application on the basis that CLICC was seeking rescission of a contract as opposed to a voluntary disposition of property. In prior cases, the Courts gave equitable relief to permit the rescission of a voluntary settlement. In this case, the Ontario Court of Appeal held there had not been a voluntary transfer of property from the general partner to CLICC as a voluntary distribution. Since this was not a gratuitous transfer but was effected under a contract, namely, the general conveyance and assumption agreement whereby CLICC GP agreed for viable consideration to sell, transfer and assign and set over to CLICC its right, title and interest and benefit of every nature in and to its undertaking, property assets and rights. The general conveyance document is merely a matter of form in that the true distribution of the property on a winding-up of a corporation was effected by virtue of a shareholders resolution. The general conveyance is a mere standard form agreement. To characterize the transaction as contractual ignores what is clearly the substance of the transaction, and also what it is statutorily referred to, namely, a voluntary dissolution.
The Ontario Court of Appeal articulated its reasons for declining to exercise its equitable jurisdiction for two reasons. First, it said that CLICC has adequate alternative remedies to address the adverse tax consequences from the mistake. It could file a notice of objection to appeal to the Tax Court its tax assessment. Such a remedy is unrealistic given the nature of the mistake and the improbability of success in the Tax Court is the reason why an application for equitable relief was given.
The Court also stated that under Section 23 of the Financial Administration Act, CLICC can apply to the Minister for a remission of tax. However, the CRA’s internal guidelines state that the director will “generally recommend approval to the Minister in only four circumstances: 1) extreme hardship, 2) incorrect action or advice by the CRA, 3) a financial setback combined with extenuating factors, or 4) an outcome that is the unintended result of legislation.” The mistake in the CLICC case does not fit into those categories and therefore it is unlikely that the CRA would recommend a remission order to the Minister and equally unlikely that a remission order would be granted.
Lastly, the Court of Appeal noted that it has a potential legal action against its professional advisor. In this regard, it should be observed that actions against a professional advisor that is an accounting firm are not very practical in that accounting firms are able to limit their liability in the case of negligence to the amount of their fees charged. Moreover, given the size of many transactions and the amount of monies involved, the action against the professional advisor will involve the law firm seeking indemnification from its insurer. This is very unsatisfactory for a variety of reasons. Insurers are known to resist paying under insurance contracts either asserting that there was no negligence on behalf of the law firm or by asserting that the professional advisor has not complied with the requirements of the insurance policy by the delay in advising the insurer of the potential liability. This results in enormous stress and anxiety being borne by the taxpayer and by the professional advisor as such issues can drag on for years before a resolution. Given the complexity of the Income Tax Act mistakes frequently occur even by the most accomplished professionals in transactions that are not otherwise abusive.