Introduction
In 2016, the Supreme Court of Canada (“SCC”) released their decision in Canada (Attorney General) v Fairmont Hotels Inc., 2016 SCC 56 (“Fairmont”), in which they restricted the availability of rectification, an equitable remedy whereby the court corrects error(s) in the written terms of an agreement. In Fairmont, the SCC held that rectification is not available to undo tax plans solely because the plans create unintended tax consequences.
More recently, in Canada (Attorney General) v Collins Family Trust, 2022 SCC 26 (“Collins”), the SCC upheld this ruling, finding that other equitable remedies, such as rescission, an equitable remedy whereby the court retroactively cancels a transaction or nullifies an agreement, is also not available to parties seeking to undo tax plans solely because the plans have created adverse tax consequences.
Rectification is typically used to rectify mistakes in written agreements when the intent of the parties was improperly drafted, whereas rescission is typically used to annul written agreements entirely.
Canada (Attorney General) v Collins Family Trust
In Collins, two parties had set up a tax plan to reduce their tax liability. These plans allowed the operating company to move large amounts of money into a holding company which was also the settlor and beneficiary of a newly created family trust (the “Plans”).
The Plans were based upon a common interpretation of the Income Tax Act (the “ITA”) at the time that the Plans were created, specifically that section 75(2) of the ITA could be used by corporations to avoid taxes on dividends if they were paid to a family trust. However, after the Plans were implemented, the Tax Court of Canada released their decision in Sommerer v. The Queen, 2011 TCC 212[1] aff’d on appeal 2012 FCA 207 (“Sommerer”), which employed an alternative interpretation of section 75(2), and found that the attribution rules in section 75(2) of the ITA don’t apply when property is sold to the trust for fair market value, as opposed to being gifted to the trust.[2] As a result of the decision in Sommerer, tax plans which relied on the prior interpretation of section 75(2) no longer achieved their intended goals and the Canada Revenue Agency began to re-assess these transactions.
In Collins, the SCC adopted the interpretation of section 75(2) of the ITA from Sommerer and denied the request for recession, finding that taxpayers should be taxed on what they actually did, not what they wish they had done in hindsight. Collins confirms that retrospective tax planning is not allowed.
Further restriction of equitable remedies
The heart of the issue in Collins was whether the equitable remedy of rescission was available to the taxpayers, despite rectification not being available under Fairmont. The majority found that adverse tax consequences are outside of equity’s domain as there is nothing unconscionable or otherwise unfair about the operation of a tax statute or transactions which are freely undertaken.
The SCC adopted the principles from Fairmont as principles of general application which preclude equitable relief of any nature when it is sought to avoid unintended tax liability that has arisen by the ordinary application of tax statutes to freely agreed upon transactions.
Recent application of Collins
Collins was recently adopted in British Columbia. In Williams Moving & Storage (B.C.) Ltd. (Re), 2023 BCSC 205, the British Columbia Supreme Court considered whether a bankruptcy order could be rectified in order to strike out qualifying language in the definition of an “unaffected creditor” as it created adverse tax consequences. The court applied Collins and confirmed that rectification should not be granted in situations where a party wants to modify an instrument merely because they discovered that its operation generates adverse and unplanned tax liability.[3]
Exceptions in specific circumstances
Although the SCC has now made it clear that the equitable remedies of rectification and rescission are limited when it comes to estate and tax planning, there are some recognized exceptions to this rule.
In Royal Trust Corporation of Canada v Horner, 2022 BCSC 859, the court considered whether to rectify a trust document that had not been signed by the settlor of the trust. The settlor’s lawyers had prepared seven documents for her to sign regarding her estate plan, however, only six were signed as one of the documents that she signed was a duplicate. By the time this mistake was discovered, the settlor no longer had capacity to manage her financial affairs.
The court found that the settlor’s failure to sign the document was an inadvertent mistake which, if not corrected, would result in her estate being distributed in a manner contrary to her testamentary wishes. In order to rectify this potential injustice, the court granted rectification of the trust document, deeming it signed by the settlor.[4]
Although not explicitly mentioned in this case, this situation can be distinguished from Collins and Fairmont in the fact that this is not retroactively changing an estate planning decision, this is just rectifying the documents to reflect what was actually intended to be done by the parties involved. In Fairmont, it was acknowledged that rectification allows a court to give effect to the parties’ true intentions, rather than an erroneous transcription of those true intentions. In this case, all that was being done was giving proper legal effect to the settlor’s true intentions at the time that she signed her estate plan documents, and therefore the court was amendable to granting rectification.
Key takeaways
Now that the SCC has made it clear that certain equitable remedies, including rectification and rescission, are not available to individuals and entities trying to retro-actively revise their tax plans, it is incredibly important that taxpayers and lawyers alike pay extra care when structuring their transactions. Although taxpayers can arrange their finances as they see fit to reduce their tax liability, if they experience adverse tax consequences as an effect, they must bear that responsibility.
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[1] Aff’d on appeal Sommerer v Canada, 2012 FCA 207
[2] Ibid at paras 57-58.
[3] Williams Moving & Storage (B.C.) Ltd. (Re), 2023 BCSC 205 at para 64.
[4] Royal Trust Corporation of Canada v Horner, 2022 BCSC 859 at para 6.
