On Aug. 20, 2015, the Manitoba Court of Appeal ("MCA") dismissed the appeal in the JAFT Corp v, Jones et al.1 rescission case. The application judge declined to exercise jurisdiction on the basis of parallel proceedings in the Tax Court of Canada ("TCC") and her alternative position that rescission was not available in any case. The appellants, JAFT Corporation ("JAFT") and two individuals who were directors, shareholders and employees, unsuccessfully appealed to the MCA. A third employee was a respondent who did not oppose. The Attorney General of Canada intervened, opposed, and was successful in the application and on appeal.
The TCC appeals concerned CRA third party assessments for source deductions. The rescission application sought to have employment contracts and compensation rescinded for 2005 and 2006. The three employees worked for JAFT between 2003 and 2006. They agreed in 2004 that they would be paid if/when their work met the requirements of the SR&ED program. It was agreed that if a claim was denied, their compensation was to be repaid to JAFT. The 2003 and 2004 SR&ED claims included salaries that were payable but unpaid which would be paid out when the SR&ED funds were received. The CRA audited those SR&ED filings and took the position that contingent salaries could not be part of a claim. Consequently, to address this concern, JAFT paid salaries in 2005 and 2006. However, JAFT was not able to pay salaries in 2005 and 2006. Therefore the salaries were paid without source withholdings and immediately loaned back to JAFT. The expectation was that source deductions could be remitted when the SR&ED tax credits were received. However, JAFT's 2005 and 2006 SR&ED claims were denied, leading to notices of objection being filed with the CRA. The notices of objection were not appealed, but third party assessments for source deductions were appealed to the TCC.
In 2007, the loans to JAFT were repaid, the employees refunded their compensation, and the company sought to amend T4s to eliminate the salaries paid out. The CRA assessed JAFT and two directors for source deductions and refused to accept amended T4s. Further, personal deductions for repaid salaries were denied. The rescission application was commenced on the basis that the tax liabilities were unexpected, unforeseen and unintended, since the parties believed they would receive SR&ED tax credits for 2005 and 2006 and that unremitted source deductions would have been covered by SR&ED tax credits. JAFT argued it would not have paid salaries if it knew its SR&ED claims would be denied and thought that salaries could be later reversed if necessary.
The Crown argued that JAFT was seeking to circumvent the TCC process. This raised a jurisdictional question: the Crown argued that the TCC may make ancillary findings to determine tax appeals, including determining legal rights between parties in the course of determining the correctness of an assessment. JAFT argued that the TCC lacks equitable jurisdiction and the application was not meant to circumvent the TCC. The application judge stated that Courts should be reluctant to exercise jurisdiction where the TCC has parallel jurisdiction and agreed that the TCC would have ancillary jurisdiction. The application judge held that rescinding the employment contracts would have an effect on JAFT's pending TCC appeals and refused to grant rescission.
The application's judge was correct that the TCC makes ancillary determinations to determine the correctness of an assessment, assuming a court of competent jurisdiction had not already ruled. However, respectfully, the application judge's reasoning may be criticized: had the judge granted rescission, the TCC would have been bound - and bound by a determination it could not make. While the merits of the rescission application may have been lacking, in my respectful view the application judge should have exercised her jurisdiction.
Although the application was determined on jurisdictional grounds, the application judge also considered the rescission argument. The judge confirmed that the equitable doctrine of rescission is broader than the common law doctrine of void ab initio, and also confirmed the availability of rescission in Canadian law. However, the judge relied on the rectification case 771225 Ontario Inc. v. Bramco Holdings Co.2 to confirm that Courts will not rewrite history to allow more favourable tax treatment. In the application judge's view, the applicants in JAFT did not intend the taxation results they sought. However, they did contemplate that their SR&ED claims could be reduced or denied and the employment agreements contemplated what would occur if claims were denied. The problem was that JAFT did not withhold and remit source deductions as required and chose to pay salaries without remittances, despite acknowledged uncertainties. The application judge held that JAFT was closer to Bramco than to other leading cases and the relief was more a matter of hindsight rather than intention - thus, the relief was retroactive tax planning.
On appeal to the MCA, the Crown argued that rescission is discretionary and the judge correctly exercised her discretion. The MCA held a discretionary decision is reversible when a Court misdirects itself, arrives at a decision that is so clearly wrong that it amounts to an injustice, or where a Court gives insufficient or no weight to relevant matters. The MCA summarized case law regarding jurisdiction in cases that touch on tax assessment litigation: courts should be cautious with parallel litigation because the integrity of the assessment litigation system should be preserved; incidental litigation should not be used to circumvent the assessment litigation system that was set up by Parliament; if there is no dispute between the parties other than an underlying dispute with the CRA, this suggests incidental litigation intended to influence a TCC appeal; and judicial economy dictates that parallel proceedings should be discouraged.
The MCA confirmed the TCC does not have equitable jurisdiction, but may fashion alternative remedies: thus, the TCC could rule on whether the salary transactions and agreements between JAFT and the employees should be upheld. In the MCA's view, the TCC has broad powers to determine assessments including the validity or legal effect of a transaction and it does not matter whether the TCC can grant remedies such as rescission as long as it can grant adequate, if imperfect, remedies. The MCA cited commentary for the proposition that the TCC can decide a case as though the underlying transaction had been rectified. The MCA summarized the jurisdictional question as follows:
… the issue at the heart of this matter is whether the tax assessment is correct and the tax liability is owing. This is a matter for the Tax Court, which is a specialized court created by Parliament with expertise in tax matters. The application here was contrary to the principle of judicial economy as, whatever the outcome in the Court of Queen's Bench, the appeal of the tax assessments must still be heard by the Tax Court. Finally, while the Tax Court cannot grant an order of rescission that will be effective for all purposes, it can rule on the validity of the employment contracts, the development agreement and the salary transactions as part of its role in determining whether the tax assessments are correct. It will then use those determinations to decide whether to dismiss the appeal, vary or vacate the tax assessments or refer the matter back to the Minister. This, in my view, is an adequate alternative remedy.
JAFT has ramifications not only for the private bar, but also for Crown counsel, for the following reasons.
Private practitioners know that seeking rescission or rectification while objections are outstanding is acceptable and the CRA will hold objections in abeyance pending recission or rectification. However, after JAFT one may reasonably be concerned about whether a Superior Court would entertain an application seeking rescission or rectification after TCC proceedings are instituted. Thus, the decision to seek equitable relief should be made early in the dispute resolution process and likely before a TCC appeal is instituted.
On the other hand, although the Crown won JAFT, it may have opened a Pandora's box and with respect the MCA may have muddied rather than clarified the law. Rather than take the dangerous route of seeking equitable relief in the Superior Courts, taxpayers with pending TCC appeals may more frequently argue that they are not bound by mistaken transactions the results of which did not accord with their true intentions, without relying on equitable principles. If the TCC accepts the JAFT challenge and adopts a practice of disregarding transactions with unintended consequences (despite well-established principles of form over substance and the parol evidence rule) then Canadian tax law would enter a new, fuzzy phase of assessment litigation during which new principles of quasi-equitable TCC assessment litigation would be fashioned. On the other hand, if the TCC maintains a strict approach and holds taxpayers to the outcome of mistaken transactions, then taxpayers would be forced into the untenable position of not being able to rescind or rectify mistakes and not being able to obtain alternative relief in the TCC.
One wonders what the Crown will argue in the TCC appeal of JAFT and whether its argument will contradict its position in the JAFT rescission case. Stated another way, a skeptic might expect the Crown to argue in the TCC that the taxpayers were bound by their agreements and that Canadian tax law respects form and the integrity of contracts. A skeptical practitioner might expect the Crown to strenuously argue against the TCC fashioning faux equitable remedies in future litigation. In my respectful view, the TCC should accept the MCA decision in JAFT, as strongly argued by the Crown, and respectfully remind the Crown in each and every future case that the TCC has accepted its incidental jurisdiction with vigor - and thus fashion its own body of law around incidental "rectification" and "rescission" in assessment litigation.
1 2015 MBCA 77, on appeal from JAFT Corp. v. Canada (A.G.), 2014 MBQB 59 (collectively, "JAFT").
2 (1995), 21 OR (3d) 739 (CA) ("Bramco").