Tension and trends in tax-driven rectification: Graymar Equipment (2008) Inc and Fairmont Hotels Inc

The Ontario Court of Appeal's decision in Juliar et al v Canada (Attorney General)[1] has long been the leading Ontario case on rectification of tax mistakes. Some commentators have observed that the law on rectification in the context of tax mistakes may be developing independently from, and more broadly than, rectification generally.[2] In numerous cases, counsel for the Canada Revenue Agency ("CRA") have tried to marginalize or undermine Juliar, ostensibly on the basis that it is challenging to reconcile with the Supreme Court of Canada's ("SCC") rectification cases.

Whether Juliar is consistent with the SCC's decisions in Performance Industries Ltd v Sylvan Lake Golf & Tennis Club Ltd[3] and Shafron v KRG Insurance Brokers (Western) Inc[4] was considered in the Alberta Court of the Queen's Bench decision in Graymar Equipment (2008) Inc v Canada (Attorney General).[5] In Graymar, the Alberta Court held that only tax consequences expressly identified at the time of the transaction are the proper object of rectification. On the status of Juliar, the Alberta Court said:

[66] ... Juliar sits uneasily with the Supreme Court's direction in Performance Industries and Shafron that rectification is granted to restore a transaction to its original purpose, and not to avoid an unintended effect. A transaction which does not succeed in achieving its goal of avoiding tax is not the same thing as a transaction whose goal is other than tax avoidance but which unexpectedly results in a tax disadvantage. While, therefore, rectification is available in order to avoid a tax disadvantage which the parties had originally transacted to avoid, it is not available to avoid an unintended tax disadvantage which the parties had not anticipated at the time of transaction.

Graymar appears to hold that an unanticipated or unintended tax consequence cannot be rectified because the parties did not advert to the particular tax issue in question and therefore did not make avoiding the consequence an objective of their transaction.

The tax mistake in Graymar led to the unintended application of ss. 15(2) of the Income Tax Act in the context of a debt restructuring transaction, the main purpose of which was to reduce interest expense. Although the taxpayer's advisors saw the ss. 15(2) issue, the issue was not given a significant profile and, it appears, was not taken into account in the design of the transaction.

The Alberta Court in Graymar drew a distinction between intended consequences and unintended consequences, between the objectives of a transaction and the assumptions underlying the decision to carry it out in a certain way:

[73] ... the problem with the inferential leap made in Juliar between the fact of the transaction and a conclusion that the transaction's purpose was tax avoidance was that it was based not on evidence of the purpose, but on evidence of whether the parties would have carried out that purpose in the way they did, had they known of the associated tax disadvantage. Again, for the purposes of a rectification order as it has been preconditioned by the Supreme Court, such evidence is irrelevant. Taking it into account conflates the parties' intent in entering into a transaction with the assumptions they made in doing so. Just as a transaction which does not succeed in achieving its goal of avoiding tax is not the same thing as a transaction whose goal is other than tax avoidance but which unexpectedly results in a tax disadvantage, the intent of avoiding tax is not the same thing as the assumption that a tax liability would not be incurred.

The SCC denied leave to appeal in Juliar and that case has been consistently applied in Ontario since it was decided. The novelty of Juliar was the broadening of the application of rectification from documents – agreements and trusts, typically - to transactions. Accepting that development, as the SCC implicitly did, there is little difference between a fundamental assumption of a transaction and an expressed objective of a transaction, as set out in a transaction document. The practical reality of commercial transactional work is that parties expect their advisors to work towards tax efficient results and naturally assume that the steps they take would not result in an untoward tax consequence. That being the case, rhetorically speaking does it make an absolute or categorical difference if there is no memorandum to all parties confirming, "It is a purpose of this transaction that there are no untoward tax consequences?" In our view, the fundamental assumption against untoward tax consequences would be a proper subject for judicial notice to assist in establishing parties' intentions in a commercial transaction involving related parties.

The recent Ontario Court of Appeal's decision in Fairmont Hotels Inc v Attorney General of Canada[6] grasps this point implicitly. The Ontario Court in Fairmont also required an intention to achieve a particular tax result:

[6] ... the respondent had a continuing intention from 2002 onwards that its loan arrangements with Legacy would be carried out on a tax and accounting neutral basis through a plan whereby any foreign exchange gains would be offset by corresponding foreign exchange losses.

In Fairmont, counsel for the CRA argued that the applications judge misapplied the test for rectification, by focusing exclusively on Fairmont's tax intentions and ignoring the prerequisite that, to obtain rectification, it must be demonstrated that the parties agreed as to the terms of the relevant contract, but recorded them incorrectly. Moreover, counsel argued that to avoid impermissible retroactive tax planning, Fairmont had to prove it settled on a concrete plan to meet its tax objective before any mistake in its implementation efforts was discovered. The Ontario Court rejected that argument, holding it was unnecessary that Fairmont prove it intended to use a specific transactional device to achieve tax neutrality.

Graymar and Fairmont are correct that intention is fundamental to rectification. Rectification addresses mistakes in documents and transactions that result in the frustration of the parties' proven intentions. According to Performance Industries, at least where an agreement is concerned, rectification is "predicated on the existence of a prior oral contract whose terms are definite and ascertainable"; and its purpose is "to restore the parties to their original bargain, not to rectify a belatedly recognized error of judgment".

The difference between Fairmont and Graymar, in our view, is that the Ontario Court in Fairmont applied Juliar and held that it:

[10] … does not require that the party seeking rectification must have determined the precise mechanics or means by which the party's settled intention to achieve a specific tax outcome would be realized. Juliar holds, in effect, that the critical requirement for rectification is proof of a continuing specific intention to undertake a transaction or transactions on a particular tax basis.

Inevitably, the complexity of Canadian income tax has led and will continue to lead to inadvertent mistakes in structuring transactions from time to time. While it is justified to be concerned about the possible volume of cases where parties seek to obtain relief from untoward tax consequences, it is not clear, in our view, what the limits to relief should be. The frequent but arguably pejorative refrain is that rectification should not be used for "retroactive tax planning." However, it is not entirely clear where the "retroactive tax planning" line lies, or whether the principle underlying it is even engaged where a taxpayer with no particular knowledge of taxation law engages professional tax advisors who implement a transaction leading to substantial untoward tax consequences. In our view, the distinction between assumptions and objectives, at least as deployed in Graymar, is not, with respect, the correct line.[7] Juliar, again respectfully, is to be preferred because the fundamental assumptions of the parties in regard to tax neutrality are relevant to the issue of intention:

[28] . . . It is possible, even probable, that no one mentioned income tax throughout the nine or 10 months in issue. The plain and obvious fact, however, is that the proposed division had to be carried out on a no immediate tax basis or not at all.

Notwithstanding this conclusion, it will always be helpful in the context of an application seeking rectification that there is written evidence of an express intention with respect to the specific tax points in issue. However, in our view, this should merely supplement the parties' practically invariable assumption that no untoward tax consequences would flow from the design of the transaction.