Insights & Articles
Correcting Tax Mistakes Using Rectification
Corporate transactions such as share transfers, rollovers, capital dividend transactions, and amalgamations, to name a few, can occasionally have tax consequences for the parties involved that were not intended at the time that the transaction was conceived. In recent years, the Courts have responded with increasing regularity to assist taxpayers who are confronted with unintended tax consequences from transactions in which they are involved. In the right circumstances, the Courts can, through a Rectification Order, correct an error in the transaction documents so that the intended tax consequences are achieved.
Rectification is an equitable remedy pursuant to which the courts can retroactively change the terms of a document so that the written terms correspond with the intentions of the parties. Rectification cannot be used to change the transaction itself, only the way that the transaction was documented.
While Rectification has frequently been used to fix defective contracts, it has also been used to retroactively correct a range of other documents, including:
· Articles of Amalgamation,
· Articles of Amendment,
· corporate resolutions,
· share transfers,
· trust deeds, and
· collective agreements.
In the income tax context, Rectification is used with respect to a variety of transactions, including, for example, capital dividend transactions. A capital dividend is a type of dividend that can, if certain procedures prescribed in the Income Tax Act (Canada) are followed, be paid out to the shareholders of a corporation on a tax-free basis. If, however, a corporation declares and pays a capital dividend to its shareholders in excess of the amount available in its capital dividend account, the corporation will be liable for a significant penalty tax and the transaction will not have proceeded on a tax-free basis as intended. Depending on the circumstances resulting in the overpayment, Rectification may be available to correct the documents implementing the transaction so that intended tax results can be achieved by the parties.
In order to obtain a Rectification Order, the party seeking it must establish:
1. that the written document in issue does not reflect the true intentions of the parties; and
2. that the parties shared a common, continuing intention up to the time of signing the document concerning a matter that is not reflected in the document.
Returning to the capital dividend example, if the parties to the transaction intended to declare and pay a capital dividend to the extent possible, but due to an error in the calculations of the corporation’s capital dividend account, a dividend was declared and paid in excess of the amount actually available, the intention of the parties to declare and pay a tax-free capital dividend to the extent possible may be sufficient to support a claim for Rectification. If the Order sought is granted, the capital dividend will retroactively be reduced to correspond with the actual balance available in the corporation’s capital dividend account, thereby achieving the intended tax consequences.
Rectification can be a very helpful tool for taxpayers faced with unexpected tax consequences, however it cannot be used in retroactive tax planning. That is, it cannot be used to achieve a result that was not intended originally but which has become desirable or was first considered after the fact. Our firm has successfully pursued numerous Rectification applications in an income tax context and we would be happy to assist you in any way we can. For more information about Rectification and whether it is a remedy that may be of assistance to you, please contact Keith Trussler or Linda Smits at 519-672-5666 to arrange for a consultation.