Canada’s highest court hears submissions on the equitable remedy of rectification

On May 18, 2016, the Supreme Court of Canada heard submissions on two rectification cases: Attorney General of Canada v. Fairmont Hotels Inc., et al. (‘Fairmont’) and Jean Coutu Group (PJC) Inc. v. Attorney General of Canada (‘Coutu’). We have watched the hearing and are providing this report with our preliminary opinions. As Coutu is based on the civil law of Quebec, our report will focus primarily on the Fairmont portion of the hearing.

Position of Canada

Canada emphasized that rectification is an exceptional and narrow remedy, not to be used to reverse engineer a desired tax outcome, or as a means of trying each road to a desired tax outcome.

Canada’s position is that the Ontario Court of Appeal (“ONCA”) erred by finding that rectification was available to Fairmont by merely showing that Fairmont had a continuing intention to achieve tax neutrality, coupled with Fairmont’s intention not to redeem shares. Further, Canada asserts the ONCA erred in deciding it was not necessary for the parties to determine the exact method for achieving Fairmont’s tax neutrality.

Canada made three primary arguments during their submissions:

1. Fairmont’s decision to take steps to terminate the reciprocal loan arrangement, which included the redemption of shares, was a deliberate and documented decision, and no errors were made in implementing that decision as intended.
2. The ONCA decision departed from the principle that rectification is fundamentally restorative in nature. They failed to apply Performance Industries Ltd.^[1] and Shafron^[2], both of which required that there must be a prior oral agreement with identifiable terms.
3. AES^[3] shows that an approach to rectification that seeks to restore the parties to their original intention is well adapted to tax planning and so there is no need to craft a relaxed approach to rectifications in the tax context. Tax liabilities arise from the legal relationships created by the taxpayer.

The Court’s questions focused primarily on the distinction of intended steps and intended consequences. The argument Canada put forward was that the Court should be looking at the intended steps as opposed to what the intended consequence of those steps was. It is not sufficient to simply show that there was a continuing intention to be tax neutral, there has to be a high degree of specificity in what steps the parties planned to take in order to achieve that tax neutrality. If the intended steps are implemented correctly, regardless of whether or not the intended tax consequence was achieved, Canada’s position is that such transactions would not give rise to rectification.

Justice Abella in particular seemed to find the distinction between intended steps and consequences to be artificial, however she was the only Justice to question this line of reasoning in any meaningful way.

Position of Fairmont

In its submissions, Fairmont agreed that merely stating a desire to be tax neutral is not sufficient to support a claim rectification. However, the case law is clear that a precise intention to take specific steps to achieve intended tax consequences is not necessary.

Fairmont argued that in planning the transactions that gave rise to the unintended tax consequences, they had been sufficiently specific to what the tax consequence was supposed to be. The transactions were to be implemented in such a way that any foreign exchange gains would be offset by foreign exchange losses.

Chief Justice McLaughlin pointed out that their intended consequence, however written, was synonymous with achieving tax neutrality. Fairmont’s response to her point was that the intended tax consequences were specific to the circumstances of the transaction, and therefore can be distinguished from simply intending for the transactions to be tax neutral.

Justice Cromwell, in his comments, indicated that he was not convinced that the facts of Fairmont demonstrate a mistake that can be remedied with rectification. His point was that when Fairmont was deciding how to implement their intention, they decided on share redemption, and that is how they executed it.

Justice Moldaver, made the following paraphrased remark during his questions, “Seems to me that you’re just turning the government into an insurer. If we had known what we should have known going into this, we would have done it differently.” Fairmont’s counsel agreed that if the intention was just to achieve the best tax consequence, then this would be correct and rectification would not be an available remedy. However, Fairmont argued that the intended tax consequences had been carefully crafted and that if there is a plan, and it goes wrong in implementation then it does give rise to rectification. They further argued that if rectification in those circumstances was denied, the government would be unjustly enriched.

General Remarks

Watching the proceeding, it appears that the Justices had more difficulty with the arguments put forward by Coutu and Fairmont than with Canada’s argument. The future of rectification is uncertain as it relates to tax consequences of implemented transactions. One thing that is clear is that there must be specificity in what the tax consequences were intended to be, and what steps the parties intended to use to implement those consequences.