Rescission decision lacks precision

The remedies of rescission and rectification were unavailable to the taxpayers in the Alberta application RJ McLeod Investments Inc. v McLeod.^[1] The McLeod judgment includes common themes and highlights ongoing problems in these kinds of matters:

1. rescission or rectification are carefully guarded and discretionary judicial remedies, and the outcome of an application is fact-driven;
2. applications typically flounder when a Court concludes that a taxpayer is seeking to engage in retroactive tax planning;
3. as a remedy granted in the Provincial Superior Courts, rescission is not applied harmoniously across Canada; and
4. Courts continue to be bewitched and bewildered by the potential impact of adequate alternative legal remedies on whether rescission should be granted.

Facts

As noted above, rescission applications are fact-specific. The facts in McLeod are summarized as follows:

• RJ McLeod Investments Inc. ("RJM") is an investment holding company incorporated under the laws of Alberta;
• Mr. McLeod is the president, sole director and sole shareholder of RJM, and is a lawyer specializing in real property law;
• McLeod and RJM has changed tax advisors in 2009 and again in August 2014;
• according to McLeod, he was advised by his (former) accountants in August, 2013 that RJM had a capital dividend account ("CDA") balance of $564,027, so therefore RJM could elect tax-free treatment of dividends to the extent of that CDA balance;
• allegedly, the accountants as of 2013 failed to recognize that RJM had paid a capital dividend of $641,649 to McLeod in 2007 (when he was advised by a previous firm), thus RJM did not have the CDA balance McLeod thought was available when RJM declared dividends in September, 2013 ($200,000 paid in cash), March, 2013 ($200,000 paid in cash) and September, 2014 ($150,000 for which he took back a note) (collectively, the "Dividends"); and
• McLeod asserted that he:
  • did not actually need the funds from the Dividends, and that they were co-mingled and invested together with his personal funds;
  • would not have authorized the Dividends had he known that RJM had no CDA balance;
  • did not accept responsibility for the mistaken calculation of the CDA balance and that he relied on the advice of his then-accountants that the Dividends would be tax-free;
  • prepared the necessary resolutions using language recommended by his then-accountants, and accepted no responsibility for the resolutions' wording; and
  • did not understand the wording of the resolutions including, among other things, a term that if a dividend in excess of the CDA balance was declared, that RJM intended the excess portion to be an eligible dividend and, if necessary, a non-eligible dividend, as the case may be.

In January, 2015, the Canada Revenue Agency ("CRA") informed RJM that it had made excessive capital dividend elections, so the Dividends would be subject to punitive Part III tax unless RJM elected to treat the Dividends as taxable. In June, 2017, McLeod and RJM sued their former accounting advisors (Messrs. Luna and MacFarlane) in connection with "alleged breaches of duty and negligence" relating to the CDA matter. The two accountants filed their statements of defense in 2018 and 2019. There was predictable finger-pointing in all directions. The litigation was put on hold when, in September, 2020, the rescission application was filed. The Alberta Court did not make an issue of the delay between the discovery of the problem in 2015 and the 2020 application seeking rescission, although it does seem like a lengthy delay.^[2]

RJM and McLeod argued that the Dividends were only paid on the basis that they were tax-free, and that it would be unconscionable, unfair and/or inequitable that tax should be payable because of the accountants' mistake. Thus, they sought equitable relief in the form of rescission.

The Court's analysis

The Court relied on Stone's Jewellery Ltd v Arora^[3] and Beazer v Tollestrup Estate,^[4] both Alberta cases, as well as on Supreme Court jurisprudence. The Court disregarded Collins Family Trust v Canada (AG)^[5] as a non-binding authority from another jurisdiction but, oddly, in another breath cited the Ontario case Canada Life Insurance Company of Canada v Canada (AG).^[6]

The Court stated that the purpose of rescission is to eliminate an unfair benefit to one party to a contract due to a mistake, which is achieved by cancelling and unwinding the contract and putting the parties back to their pre-contract positions. While the Court described the test for rescission of a contract, it also said that this case was not about contract rescission after all (which was correct, since the case concerned the declaration and payment of a dividend). The test for contractual rescission from Stone's Jewellery was nonetheless set out and applied, as follows:^[7]

• the applicant must have made a mistake with respect to a contract;
• it would be unfair, unjust or unconscionable to not correct the mistake;
• there is no other adequate legal remedy available;
• the remedy must not be a form of retroactive tax planning; and
• there must be no prejudice to third parties.

Despite the puzzling approach, the Alberta Court's formulation of the test for rescission in McLeod bore some resemblance to the test articulated in BC case law, which relies on the following formulation: "… a court may rescind a voluntary disposition where it is found that it [sic] a mistake of sufficient causative gravity was made that would make it unconscionable, unjust or unfair to leave the mistake uncorrected."^[8] BC cases will also consider whether an adequate alternative legal remedy was available, and the frequently cited authority of Pitt v. Holt^[9] made reference to the requirement of no prejudice to third parties. Whether a prohibition against retroactive tax planning is part of BC rescission case law is dubious, since the rescission orders were granted in Collins Family Trust and Pallen Trust to unwind tax plans that were deliberately implemented based on a generally accepted legal interpretation that was refuted in The Queen v. Sommerer.^[10]

In any case, relying on Stone's Jewellery, the Alberta Court in McLeod reached the following conclusions:

• It was not unfair, unjust or unconscionable that the Dividends would result in tax liability, because McLeod was in a position to know whether he had received dividends before. Whether this is a fair application of the test is an open question, but the Court seems to intimate that a reasonably avoidable mistake might not be so easily relieved and suggests at least a nebulous due diligence requirement.
• The mistake was not in respect of the transaction itself, but rather its effect. In other words, the payment of Dividends was purposeful and the complaint concerned the result. This kind of conclusion can be problematic, but not necessarily fatal to an application for an equitable tax remedy (note that in Collins Family Trust at paragraph 56, the BC Court of Appeal held that while rectification is not concerned with consequences, rescission considers consequences to be relevant to the gravity of a mistake).
• There were alternative remedies ostensibly available:
  • First, RJM and McLeod had sued their former advisors and put the litigation on hold to pursue rescission.  
  • Second, the resolutions expressly contemplated treating any excess amount as taxable, and so electing had been an option to mitigate the tax result.
  • Third, the capital dividend election was seemingly revocable.
  • Fourth, a remission order application could have been filed under the Financial Administration Act.
  • The Court's view was that whether any of these remedies would be successful was not the point: the question was not whether they could succeed but rather whether there was a remedy at law (relying on Canada Life) – and thus there were adequate alternative remedies. Here the Court's statements are highly debatable, for the following reasons.
    • Admittedly, RJM and McLeod should not have sued first, but rather should have deferred that step and entered into a tolling agreement, to seek to sidestep the alternative legal remedy complaint. That said, the outcome of civil litigation (or any litigation) is almost invariably uncertain and in the facts of this case it is by no means clear that the taxpayers would prevail. The usual cart-horse issue also occurs: in a litigation context, a claimant should seek to mitigate damages. Thus, RJM and McLeod were obligated to seek rescission to mitigate damages in connection with the civil claim. For the Court to then state that suing is an adequate alternative remedy is to enshrine in the law a vicious little circularity.
    • The punitive Part III could be partially alleviated. But paying some tax is not an adequate remedy if the intention had been to pay no tax.
    • The capital dividend election may be revocable, but the circumstances of this case are in no way, shape or form consistent with the CRA's guidance on when such relief may be granted. Specifically, the CRA will typically refuse relief that it asserts is tantamount to retroactive tax planning.^[11] While strict reliance on a CRA policy is a reviewable error, the practical likelihood of successfully persuading the CRA to allow revocation of the election in this case hovers around nil. Further, it is unclear how revoking a tax form would clean up the resolutions and payments. This option is not actually an adequate legal remedy at all.
    • It is well-established that remission order applications proceed at the speed of continental drift and are a closely guarded remedy. The CRA's internal guidance from October, 2014 states that a taxpayer's mistake is not ordinarily the kind of extenuating factor that would allow for remission. Further, the following paragraph from Fink v Canada (Attorney General), 2019 FCA 276 is instructive:

      Subsection 23(2) of the Financial Administration Act, R.S.C. 1985, c. F-11, allows the federal government to provide full or partial relief from any tax or penalty, including interest paid or payable thereon, where the Governor in Council "considers that the collection of the tax or the enforcement of the penalty is unreasonable or unjust or that it is otherwise in the public interest to remit the tax or penalty." A remission order is an extraordinary remedy granted by the Governor in Council on the recommendation of the appropriate Minister. Remission orders are highly discretionary and are entitled to significant deference on judicial review.

One wonders what standard for "adequacy" is used in the context of the adequate alternative legal remedy. Certainly, from the taxpayer's subjective perspective, none of these remedies is remotely adequate. What about from the perspective of a revenue authority? No government lawyer should argue straight-faced that a notice of objection on its own is an adequate remedy, and the conclusion in Canada Life in this regard was highly questionable. Along the same lines, it is unreasonable for the Government of Canada to argue that seeking administrative relief is an adequate option when the CRA's own policy flagrantly contradicts that argument. Further, given the restrictive parameters and protracted timeframes for a remission application, arguing that remission is adequate in any way is unsupportable. The regrettable approach taken by the Alberta Court in McLeod seems to effectively disregard the word "adequate", opting instead for an approach bordering on absolute liability: any option other than rescission, regardless of how impractical or ineffective it may be, is better than rescission, so rescission cannot be granted. Respectfully, that cannot be the correct analysis because it essentially means that in Alberta, at least, a taxpayer would nearly always be precluded from obtaining rescission in a tax matter.

Despite the drawbacks in the reasoning in McLeod, the denial of rescission is probably the right outcome. There is no need to read between the lines – the main problem with the taxpayer's argument was plain to see: Mr. McLeod was a lawyer who drafted documents that included language that expressly contemplated and addressed a scenario in which an excessive capital dividend was declared. The case defined the meaning of the colloquial term "flyer". That said, McLeod highlights the need for the Supreme Court to speak to the rescission remedy, to achieve harmony across the provinces and ensure sound reasoning in future cases. Hopes are high that the pending appeal in Collins Family Trust will confirm a robust and effective rescission doctrine.

Should you have any specific questions about this article or would like to discuss it further, you can contact the author or a member of our Tax Dispute Resolution Group.

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