Graymar Equipment (2008) Inc v Canada (Attorney General) (March 18, 2014 – 2014 ABQB 154) was a rectification application arising out of a complicated debt restructuring:
[3] Mr. Giles, a director of Graymar and of FRPDI Investments (GP) Inc (which is FRPDI LP’s general partner) deposes to the truth of the Originating Application which states (inter alia) the following:
(1) In 2008, FRPDI LP through various entities (including Graymar, of which FRPDI LP was the sole shareholder) acquired a marine contractor business (the “business”) specializing in pile and dredge work in British Columbia, and carried on through a group of companies.
(2) The business was acquired through a partnership, which allowed profits from the business to be passed up and out to the investors.
(3) A substantial amount of the purchase price was funded in part by arm’s length bank debt owed to a syndicate led by the Canadian Imperial Bank of Commerce (“CIBC”), and loans from the various investors.
(4) The business performed less well than had been hoped, and was not able to abide by its covenant to the CIBC-led syndicate. Negotiations with CIBC resulted in a debt restructuring agreement under which the partners of FRPDI LP would contribute an additional $10,000,000.00 of partnership capital to reduce the debt owed to the lending syndicate.
[4] Implementing the debt restructuring agreement entailed a complex series of transactions among various related entities, including the Applicants, which are fully described in the Originating Application. The Attorney General describes the process as comprising at least 141 steps, which the Applicants do not dispute. I will not recount them, but will refer to this series of transactions collectively as the “2010 Debt Restructuring”.
[5] The 2010 Debt Restructuring concluded with an increased subscription by FRPDI LP (of $14,390,921.00) in Graymar’s common shares, and a corresponding increased amount of debt (in the form of a shareholder’s loan of $14,390,921.00) owed by FRPDI LP to Graymar.
Three years after the completion of the restructuring a major tax problem was detected during the course of a CRA audit:
[7] The arrangement sought for approval responds to what the Applicants say was FRPDI LP’s inadvertent failure to repay the shareholder’s loan to Graymar prior to December 31, 2011. This omission was detected in June 2013 in the course of an audit conducted by the Canada Revenue Agency (“CRA”). CRA has reassessed FRPDI LP’s direct partners (including several Canadian corporations and a mutual fund trust) as well as the partners of other partnerships that indirectly hold an interest in FRPDI LP by accounting for the shareholder’s loan as income.
[8] This arises because FRPDI LP is the sole shareholder of Graymar, and not all partners of FRPDI LP are corporations resident in Canada. Consequently, were the loan to remain unpaid (as it was here) at the end of the taxation year following the year in which it was made (that is, December 31, 2011), the loan amount would be included in the income of the shareholder in the year the loan was received by operation of Section 15(2) of the
Income Tax Act, RSC 1985, c 1.
[9] Mr Giles’ evidence is that he does not “specifically recall advice from any advisors that indicated that FRPDI LP needed to repay [the loan] by December 31, 2011.”
[10] Mr Duholke’s evidence is consistent with that of Mr Giles. He deposes that he was, at the time of the 2010 Debt Restructuring, aware of the effect of Section 15(2), but that he “do[es] not recall receiving advice or considering that issue such that the repayment of the [loan] would be added to the steps ….” Nor does Mr Duholke recall receiving advice from Mr Pashkowich, a chartered accountant with Ernst & Young LLP, specifically dealing with the loan at the conclusion of the series of transactions comprising the 2010 Debt Restructuring.
[11] Mr Pashkowich deposes that he has no recollection, or notes or emails documenting, “oral advice I may have given with respect to the requirement for [FRPDI LP] to repay the amount of $14,390,321 to [Graymar] so that adverse and unintended tax consequences would not result for the [partners] of FRPDI LP.” He attaches a memorandum dated June 18, 2010 and prepared by Caroline Morin (a senior manager at Ernest & Young LLP) on his instructions and advice, and for his review, documenting his “conclusions with respect to the tax consequences of [the 2010 Debt Restructuring]. This memorandum, which was for Ernst & Young LLP’s internal use only, notes the effect of Section 15(2) of the
Income Tax Act, and that FRPDI LP must repay the loan by (effectively) December 31, 2011 or face negative income tax implications.
[12] Mr Pashkowich acknowledges that he “did not follow up with respect to this matter”, as he “was not further advising FRPDI LP or Graymar subsequent to the closing of the 2010 Debt Restructuring.” He also refers to the “inadvertence” of Graymar and FRPDI LP “[in] not considering [Section 15(2)].”
[13] While the memorandum attached to Mr Pashkowich’s affidavit appears intended to record advice which Ernst & Young LLP actually provided, his ambiguous reference to “oral advice I may have given” is not inconsistent with the otherwise unchallenged evidence of Mr Giles and Mr Duholke that they do not recall receiving such advice. For present purposes, I will assume that Mr Pashkowich did not advise Mr Giles and Mr Duholke about the necessity of repaying the shareholder’s loan by December 31, 2011.
[14] Given the drastic tax disadvantage which the operation of Section 15(2) would impose upon the Applicants, I also accept Mr Giles’ unchallenged evidence that, had he been advised as to the effect of Section 15(2), the Applicants “would have agreed to have [the loan] repaid before December 31, 2011.”
The rectification sought by the applicants was as follows:
[15] The Applicants seek approval of the following arrangement:
(1) A resolution of Graymar’s directors dated June 4, 2010, returning $14,390,921.00 of capital in respect of its issued common shares to FRPDI LP; and
(2) Payment of that same amount by way of a set-off against the $14,390,921.00 owing by FRPDI LP to Graymar (again, to be given retroactive effect to June 4, 2010) pursuant to the shareholder’s loan.
The court reviewed the jurisprudence on rectification extensively. In the end it rejected the application because the avoidance of a taxable shareholder benefit never formed part of the original business intention behind the 2010 debt restructuring:
D. Are the Applicants Entitled to Rectification?
[74] Whether the Applicants are entitled to rectification (and in turn to approval of the arrangement under Section 193 of the
Business Corporations Act) depends upon their satisfying me that the omission from the 2010 Debt Restructuring of a provision for repayment of the shareholder’s loan by December 31, 2011 was an error that, as a consequence, obstructed the intention which drove them to undertake the 2010 Debt Restructuring in the first place.
[75] The evidence here is not of the kind put before Brown J in Kanji. There, the court had nothing before it from (for example) tax advice providers which supported the evidence of the taxpayer, which left what Brown J described (at para 34) as “an element of uncertainty”. Here, however, I have the evidence not only of Mr Giles on behalf of the Applicants, but also of Mr Dulholke and Mr Pashkowich (although Mr Pashkowich did not depose to the purpose underlying the 2010 Debt Restructuring). The reason Brown J stressed the importance of having such evidence was that, in cases where the transaction sought to be rectified could have been motivated by concerns other than tax avoidance, courts should be slow to infer a driving motivation of tax avoidance solely on the basis of the taxpayer’s own evidence. (Kanji at para 36.) This is particularly so when that evidence is given in response to a negative income tax consequence.
[76] I agree with Brown J that rectification is available to avoid a tax disadvantage for a transaction only where it is established on sufficient evidence that avoiding that tax disadvantage was the original motivation for the transaction. And, I share his concern that courts should be wary about inferring a motivation of tax avoidance solely on the taxpayer’s own evidence. That concern does not, however, arise here. The reason for this is not because the Applicants have adduced sufficient evidence of a motivation of tax avoidance, although they have not. Rather, it is because their evidence speaks exclusively to a completely different motivation. Mr Giles deposes that the Applicants’ intention in undertaking the 2010 Debt Restructuring was to reduce the business’s external debt owed to its lending syndicate, which would then reduce the interest rate on loans owed by FRPDI LP to its partners. This was also Mr Duholke’s evidence.
[77] This leaves me not with the frail evidentiary basis which Brown J found insufficient in
Kanji, but with
no evidentiary basis to support the inference that the Applicants had a specific and common tax avoidance intention underlying the 2010 Debt Restructuring, which was then obstructed by the omission of the shareholder’s resolution and payment contemplated in the proposed arrangement.
[78] I have already said that I accept Mr Giles’ evidence that timely repayment of the shareholder’s loan would have been effected had he been advised as to the tax disadvantage the Applicants would incur by failing to repay it by December 31, 2011. This is, however, and for reasons I have already expressed, an insufficient basis to establish that tax avoidance originally drove the 2010 Debt Restructuring.
[79] In the result, I find that the proposed arrangement lacks a valid business purpose. It seeks to engage in precisely the retroactive tax planning that courts discourage, and misuses the remedy of rectification in a fashion precluded by the Supreme Court in
Performance Industries and
Shafron. It seeks not to restore the Applicants’ original intention in undertaking the 2010 Debt Restructuring, but to avoid a belatedly recognized and unanticipated consequence of achieving the original intended result. The Applicants are not entitled to rectification, and are therefore not entitled to an order approving the proposed arrangement.
[80] Because it is not possible to grant rectification here in any event, I need not consider whether the purpose of Section 15(2) of the
Income Tax Act is served by its operation in these circumstances. That consideration would only arise in deciding, were I able to grant rectification, whether I should do so.
Comment: On one level this case seems to be somewhat at odds with recent tax-related jurisprudence on rectification, e.g., Re Pallen Trust:
http://www.courts.gov.bc.ca/jdb-txt/SC/14/03/2014BCSC0305.htm 
Seen on that level, the 2010 transaction was premised on a mistake, i.e., the necessity to repay the shareholder loan in a timely manner should have been an integral part of the planning. The concept of a “valid business purpose” is particularly jarring since that concept has been largely discredited in Canadian tax jurisprudence for many years. However it could also be argued that the failure to repay the loan is an unrelated transaction, i.e., that it had no bearing on the deal struck by the parties in 2010 and was purely a matter for unilateral action by FRPDI LP and Graymar in 2011. One assumes that this case will be appealed and it will be interesting to see the result on appeal.