Errors are part of life. Individuals as well as corporations do commit errors. "Errare humanum est" goes the saying. It is possible in civil and corporate law to rectify certain errors that may have very costly tax consequences. It is not a universal remedy, but sometimes it is the way to save a lot of money.
Civil law can provide remedies to errors that have unforeseen tax consequences
In Jean Coutu Group (PJC) Inc. v Attorney General of Canada (2016 SCC 55), the Supreme Court specified and enhanced the civil law test applicable to rectification of a written instrument where the taxpayer has suffered an unintended and adverse tax result. The good news is that the Court recognizes that it is possible to rectify errors that lead to unforeseen tax result. The bad news is that the Court rejected Jean Coutu’s application.
Rectification of contracts is possible under the Civil Code of Québec. The contract is the law of the parties, and if it can be proved clearly that the contract or series of contracts does not represent the parties’ intention, then it can be possible to modify aspects of it.
Of course, everybody understands that parties to a contract can modify it. In the case of unintended tax result, the realization of the error in general occurs when tax authorities issue a reassessment. It is too late unless you can petition the Court to amend or rectify retroactively the deeds that cause the unforeseen tax result. The tax authorities will accept the modifications, but they can also fight the corporation’s application, as was the case in Jean Coutu.
Tax laws apply to a situation that exists in the civil and corporate realities. Corporations created under the federal law or the Québec law can petition the Courts to rectify irregularities in the statutes, for example. Unless the tax law, within the limits of the Constitutional jurisdiction of the Parliament that enacted it, prevent or put aside an act or situation created by civil or corporate laws, these laws have precedence on tax laws.
Section 8.1 of the Interpretation Act says :
Both the common law and the civil law are equally authoritative and recognized sources of the law of property and civil rights in Canada and, unless otherwise provided by law, if in interpreting an enactment it is necessary to refer to a province’s rules, principles or concepts forming part of the law of property and civil rights, reference must be made to the rules, principles and concepts in force in the province at the time the enactment is being applied.
The Supreme Court latest decision on the matter
In Jean Coutu, the Supreme Court defined the issue as follows:
[14] This appeal raises the following key issue: Where parties agree to undertake one or several transactions with a general intention that tax consequences thereof be neutral, but where unintended and unforeseen tax consequences result, does art. 1425 C.C.Q. allow the written documents recording and implementing their agreement to be amended with retroactive effect to make them consistent with that intention of tax neutrality?
Further :
A contract is created by “an agreement of wills by which one or several persons obligate themselves to one or several other persons to perform a prestation” (see Article 1378 of the C.C.Q.), which prestation must be “possible and determinate or determinable” (see Article 1378 of the C.C.Q.), and must have a cause (see Article 1410 of the C.C.Q.) and an object (see Article 1412 of the C.C.Q.).
Finally:
[24] In my opinion, when unintended tax consequences result from a contract whose desired consequences, whether in whole or in part, are tax avoidance, deferral or minimization, amendments to the expression of the agreement in accordance with art. 1425 C.C.Q. can be available only under two conditions. First, if the unintended tax consequences were originally and specifically sought to be avoided, through sufficiently precise obligations which objects, the prestation to execute, are determinate or determinable; and second, when the obligations, if properly expressed and the corresponding prestations, if properly executed, would have succeeded in doing so. This is because contractual interpretation focuses on what the contracting parties actually agreed to do, not on what their motivations were in entering into an agreement or the consequences they intended it to have.
Justice Côté was dissenting of the majority’s decision (7-2), saying that the majority interpretation of the Civil Code is putting aside the fact that contracts can be expressed orally without recourse to written instruments.
Thus, the law of the land is now to the effect that the burden of proof of a taxpayer wishing to rectify an error is heavier.
Situations where rectification applications were granted
- Cancellation of a corporate resolution declaring too high a capital dividend (huge penalty)
- Modification of documents pertaining to a reorganization under 86 of the Income Tax Act. The rectification modified substantially the division between the number of shares issued and a nonshare consideration (i.e. boot);
- The taxpayer considered, both in fiscal returns as well as in its record books, losses as being capital losses, but petitioned the Court for the said losses be characterized as non-capital losses.
- Cancellation of the sale agreement between two affiliated companies, because it could have negative tax results, when the parties clearly wanted to avoid such negative tax results. The petitioner avowed objective was to oppose the rectification judgment to tax authorities;
Sometimes as in Jean Coutu, the rectification fails to convince the court :
- The court concluded that it could not cancel an exchange contract between a city and a municipal organism. The error was inexcusable, on the one hand, and the agreed cancellation could not be retroactive, on the other hand.
