The Supreme Court of Canada significantly limits the use of equitable remedies in tax cases
Each provincial superior court in Canada has jurisdiction to grant equitable remedies, including rescission and rectification. In the tax context, these remedies had historically been sought to "alter" or "undo" transactions that had given rise to unintended tax consequences. When rescission is granted, the transaction at issue is cancelled and the parties are returned to their pre-contract positions. Rectification, on the other hand, amends legal documentation to ensure that it conforms to the actual agreements parties have entered into.
Recent Supreme Court of Canada (SCC) jurisprudence has called into serious question the availability of rescission in matters where unintended tax consequences arise. At the Supreme Court of British Columbia in Collins Family Trust v. Canada (Attorney General), 2019 BCSC 1030 aff'd 2020 BCCA 196 [Collins], the judge granted the remedy of rescission on the basis that he was bound by the British Columbia Court of Appeal's (the BCCA) decision in Re Pallen Trust, 2015 BCCA 222 aff'g 2014 BCSC 305 [Pallen], a case that had considered a virtually identical situation.
The Court granted the recission order despite expressing its doubt that Pallen was still good law in light of the SCCs decisions in Canada (Attorney General) v. Fairmont Hotels Inc., 2016 SCC 56 [Fairmont] and Jean Coutu Group (PJC) Inc. v. Canada (Attorney General), 2016 SCC 55 [Jean Coutu], which had greatly limited the availability of the other but related equitable remedy of rectification.
The Crown's appeal to the BCCA was denied. In dismissing the Crown's appeal, the BCCA affirmed the decision in Pallen and had, arguably, given new life to the equitable remedy of rescission in tax cases for situations where a tax plan brings about unintended tax consequences.
Fast forward to June 17, 2022, when the SCC reversed the decisions of the British Columbia courts below. The SCC held that the subject taxpayers could not resort to equity in order to undo or modify a concluded transaction to avoid a tax liability arising from the ordinary operation of a tax statute. The effect of this broad application appears to prohibit relief in equity in order to accomplish "retroactive tax planning," even where the taxpayer could not reasonably have anticipated the negative tax result.
Background to the Appeal
The SCC's decisions in Fairmont and Jean Coutu on the other but related equitable remedy of rectification were released as companion cases after the BCCA’s decision in Pallen and before the British Colombia courts’ decisions in Collins. Before Fairmont and Jean Coutu, taxpayers relied on the Ontario Court of Appeal (ONCA) decision in Canada (Attorney General) v. Juliar, 2000 DTC 6589 (ONCA) to rectify errors in documents and transactions designed to achieve, but that failed to achieve, a specific tax result. Fairmont overruled Juliar and, together with Jean Coutu, greatly limited the availability of rectification in tax cases to situations where a legal instrument does not properly record and express the intentions of the contracting parties.
Shortly after Fairmont and Jean Coutu, the Alberta Court of Appeal (ABCA) dismissed an appeal from a decision dismissing a rectification request in Harvest Operations Corp v. Attorney General of Canada, 2017 ABCA 393 [Harvest]. Consistent with Fairmont, the ABCA would not rectify instruments that it found accurately reflected the true agreement of the parties but resulted in unanticipated adverse tax consequences.
The case of Canada Life Insurance Company of Canada v. Canada (Attorney General), 2018 ONCA 562 rev'g 2015 ONSC 281, which was an appeal from an order granting rectification, was held in abeyance until after the decision in Fairmont was released by the SCC. Following Fairmont, the parties agreed that rectification was no longer available as Fairmont changed the law and restricted the scope of rectification. The applicant, though, cross-appealed and sought two alternative remedies to achieve its intended tax purposes — (i) using the Court's equitable jurisdiction to relieve a party from the effects of its mistake; and (ii) relief based on rescission.
The ONCA considered the applicant to be seeking rectification by a different name and to be precluded by the reasoning in Fairmont. The Court noted that rescission is an all-or-nothing remedy and, in this instance, the applicant was seeking to rescind only part of the transaction at issue because rescinding the entire transaction also would not have achieved the desired tax results. The ONCA addressed Pallen, but considered it unnecessary to determine whether Pallen remained good law following the decisions in Fairmont and Jean Coutu. The Court allowed the appeal setting aside the rectification order and dismissed the cross-appeal.
The SCC's Decision in Collins
An eight-judge majority ruled in favour of the Crown in Collins. It held that the principles articulated in Fairmont and Jean Coutu were not limited to rectification but were broadly applicable to all equitable remedies in the context of tax mistakes, including the sought-after remedy of recission. The effect of this broad application is to generally prohibit relief in equity in order to accomplish what would be considered "retroactive tax planning," even where the taxpayer could not reasonably have anticipated the negative tax result. In Collins, both the taxpayer and the Canada Revenue Agency through its stated positions interpreted certain tax laws in the same manner, and the taxpayer relied on this interpretation when structuring the transactions at issue in Collins; this interpretation was subsequently held to be incorrect by the Tax Court in a different decision, giving rise to the application for recession in Collins.
In particular, the majority described the relevant principles of general application arising out of Fairmont and Jean Coutu as follows:
- Tax consequences do not flow from contracting parties’ motivations or objectives. Rather, they flow from the freely chosen legal relationships, as established by their transactions.
- While a taxpayer should not be denied a sought‑after fiscal objective that they could achieve on the ordinary operation of a tax statute, this proposition also cuts the other way: taxpayers should not be judicially accorded a benefit denied by that same ordinary statutory operation, based solely on what they would have done had they known better (and even if the proper application of the law changes).
- The proper inquiry is no more the "windfall" for the public treasury when a taxpayer loses a benefit than it is the "windfall" for a taxpayer when it secures a benefit. The inquiry, rather, is what the taxpayer agreed to do.
- A court may not modify an instrument merely because a party discovered that its operation generates an adverse and unplanned tax liability.
The majority dismissed reliance on older English case-law, as the old case law lacked the prohibition against retroactive tax planning that is set out in Fairmont and Jean Coutu. Furthermore, the Court noted that pursuant to Canadian law, the Minister of National Revenue is obligated to apply the provisions of the Income Tax Act (Canada) to the transactions taxpayers performed. This is a fundamental feature of the Canadian tax system that ensures that the public has confidence that the Minister of National Revenue is administering the same tax laws in the same way for everyone, without inconsistent exercises of discretion that could undermine the integrity of the system as a whole.
The effect of the SCC’s decision is to considerably limit the availability of the equitable remedies of recession and rectification in tax contexts to (potentially) only those cases where the test for rectification established in Fairmont and Jean Coutu can be met. This could include, for example, establishing clerical mistakes in a written agreement or producing clear and compelling evidence that an agreement or transaction was improperly recorded.
Another alternative is applying for a remission of tax under section 23 of the Financial Administration Act (Canada). The BCCA in Collins noted, however, that seeking a remission of tax under this provision is not practical, adequate, or appropriate in the circumstances, and that it is highly unlikely that the Minister of National Revenue would recommend a remission of tax on facts similar to Collins.
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