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Quebec (Agence du Revenu) v. Services Environnementaux AES inc. et al.[1] (November 28, 2013) was a decision involving rectification of transactions to correct unintended tax consequences:
A. Services Environnementaux AES inc.
[3] The first appeal is that of Services Environnementaux AES inc. (“AES”) and Centre technologique AES inc. (“Centre technologique”). The evidence concerning the transactions that gave rise to the dispute between the tax authorities and AES is summarized in admissions the parties agreed on and filed in the Superior Court.
[4] AES is a corporation that was constituted in 1993 under Part IA of the Companies Act, R.S.Q., c. C‑38. Centre technologique was created in 1997 under the same statute as a wholly owned subsidiary of AES. In 1998, in a reorganization of the business, AES agreed to transfer 25 percent of its shares in Centre technologique’s capital stock to an investor, Groupe Sani‑Gestion. For the purposes of that investment, AES and Centre technologique entered into a reorganization and tax planning agreement and instructed their tax advisors to implement it. To ensure that the agreement would be tax‑neutral, AES and Centre technologique made use of certain provisions on exchanges of shares set out in s. 86 of the Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.), and ss. 541 to 543 of the Taxation Act, R.S.Q., c. I‑3. Under those provisions, a taxpayer may defer the tax impact of an exchange of shares on condition, inter alia, that the consideration other than shares does not exceed the adjusted cost base (“ACB”) of the shares received.
[5] An error, attributed to AES’s advisors, was made in valuing the ACB of the transferred shares: it was valued at $1,217,029, whereas its actual value was only $96,001. Relying on that incorrect valuation, AES exchanged its 1,217,029 voting shares in Centre technologique’s capital stock for 4,500,000 voting participating shares in Centre technologique and a demand note from Centre technologique for $1,217,028. Centre technologique repaid the amount of that note to AES between December 18, 1998 and September 30, 1999. In 2000, the tax authorities added a taxable capital gain of $840,770 to the income reported by AES for the taxation year ending on September 30, 1999.
[6] Notices of assessment were issued, and notices of objection were filed. That aspect of the case is not before this Court, which must consider the consequences of the attempt made by AES and Centre technologique to correct a transaction that could not be tax‑neutral as the parties had intended, because of the error made in carrying it out. On November 1, 2001, after AES had objected to the notices of assessment, the parties agreed to cancel and take back the note for $1,217,028. A new note dated December 11, 1998 was to be issued in the amount of $95,000 together with 1,122,029 Class C shares with a value of $1,122,029. AES and Centre technologique then presented a motion in the Quebec Superior Court for rectification and for a declaratory judgment. They asked that court to amend the original agreements so that they would reflect the parties’ original intention, to make them retroactive to the original transaction date, that is, to December 1998, and to declare that the amendments could be set up against third parties. The Deputy Minister of Revenue of Quebec, who has now been succeeded by the ARQ, contested the motion and asked that it be dismissed, as did the CRA.
B. Riopel
[7] In 2004, the respondents Jean Riopel and Christiane Archambault, who had been married since 1984, owned 60 percent and 40 percent, respectively, of the shares of a corporation called Déchiquetage Mobile JR inc. (“Déchiquetage Mobile”). In July 2004, all Déchiquetage Mobile’s assets were sold to third parties. The only asset then consisted of the proceeds of the sale of those assets. At the time, Mr. Riopel was also the sole shareholder in a holding company, Entreprise J.P.F. Riopel inc. (“JPF”).
[8] On the recommendation of their accountant, Mr. Riopel and Ms. Archambault agreed to amalgamate Déchiquetage Mobile and JPF. Mr. Riopel was to become the sole shareholder of the company that would result from the amalgamation, as Ms. Archambault was to transfer all her interests in Déchiquetage Mobile to him for an agreed price. The intention was that the transaction would have no tax consequences for Ms. Archambault. The accountant and a tax lawyer were instructed to carry out this plan.
[9] On September 1, 2004, the advisors of Ms. Archambault and Mr. Riopel presented them with a detailed plan for the amalgamation of the two companies and the transfer of interests and for the deferral of the tax impact of the transaction. First of all, on October 30, 2004, Ms. Archambault was to sell her shares in Déchiquetage Mobile to Mr. Riopel for $720,000. That price was to be paid in part with a note for $335,000, which corresponded to the ACB of Ms. Archambault’s shares. The balance of the sale price, which was equal to the difference between the fair market value of the shares and their ACB, or $385,000, was to be paid by issuing 385,000 preferred shares in JPF with a redemption price of $385,000. On November 1, 2004, the articles of amalgamation and certificate of amalgamation of Déchiquetage Mobile and JPF were to be completed and the two companies were to be amalgamated; the new company’s name was to be Entreprise J.P.F. Riopel inc. (“JPF‑2”). On November 4, 2004, JPF‑2 was to repay the amount of the $335,000 note to Ms. Archambault and redeem her preferred shares, whose total value was $385,000. According to the tax lawyer, that redemption would generate a deemed dividend of $385,000, but the dividend would have no tax consequences, because it was to be paid out of JPF‑2’s capital dividend account.
[10] Unfortunately, the transaction did not unfold as planned. The parties’ advisors made a series of errors in preparing the juridical acts required to implement the plan they had recommended to their clients. The articles of amalgamation filed with the Inspector General of Financial Institutions, which were dated November 1, 2004, made no mention of the transfer of Ms. Archambault’s shares, which was supposed to have taken place on October 30. The amalgamation therefore preceded the sale of the shares, contrary to what had been planned, which meant that the transaction was not tax‑neutral as the parties had intended.
[11] To correct the situation and preserve the transaction’s tax effectiveness, the accountant and the tax lawyer decided on October 27, 2004 to change the legal documentation that had already been prepared, but they did not breathe a word of this to their clients. They kept November 1, 2004 as the formal amalgamation date, but restructured the planned transaction in the documents they prepared. Ms. Archambault’s shares in Déchiquetage Mobile were converted to 720 common shares in JPF‑2. On November 2, 2004, after the amalgamation, JPF‑2 redeemed Ms. Archambault’s 720 shares using the rollover provisions in the tax legislation. To pay the purchase price, JPF‑2 provided a $335,000 demand note and issued 385,000 redeemable no par value preferred shares. On November 2, Mr. Riopel and Ms. Archambault signed all the necessary contracts and documents, but their advisors did not explain to them the nature of the changes that had been made to the original plan. Moreover, they acknowledged that they had not read the documents at the time of the closing of the transaction. JPF‑2 subsequently repaid the note owed to Ms. Archambault and redeemed her preferred shares for $385,000.
[12] Suddenly, in January 2007, Ms. Archambault received notices of assessment from the CRA and from Quebec’s Ministère du Revenu. Ms. Archambault was deemed to have been paid a $335,000 taxable dividend, and an amount of about $150,000 in tax arrears was claimed from her, plus the usual interest. These notices of assessment meant that, in the tax authorities’ opinion, the tax plan contained errors and could not meet its objective.
[13] The respondents filed a notice of objection to the notices of assessment in accordance with the applicable tax legislation. That aspect of the case remains unresolved. After receiving the notices of assessment, the respondents began, in the Quebec Superior Court, a proceeding called a [translation] “Motion to institute a proceeding in rectification of contract”. According to them, the purpose of the proceeding was to obtain recognition of the agreement they had actually reached so that the documents would reflect their true intention. In bringing the proceeding, they intended to give effect to the original terms of the transaction by amending or replacing the documents signed on November 2, 2004 at their tax advisors’ office.
[14] The respondents asked, first, that the date of the sale of their shares be changed retroactively from November 2 to October 30, 2004. The sale would thus be deemed to have taken place on the latter date, that is, before the amalgamation. They also asked in their motion for changes to the schedules to the articles of amalgamation that would modify the share classes established on November 2. In addition, they requested consequential changes to the T2057 and TP‑518 tax forms they had filed after the amalgamation. Finally, they asked for a change to the price of the transferred shares, as well as to the classes and numbers of those shares, to make these terms consistent with the tax plan that had originally been agreed upon. The purpose of all these changes was to ensure that the respondent Archambault would not be deemed to have been paid a taxable dividend as a result of the transfer of the shares.
[15] In the respondents’ view, their motion represented a simple request for rectification of a contract in order to correct writings that were inconsistent with their actual agreement. Both the ARQ and the CRA contested the admissibility of and basis for the respondents’ motion. They argued that the possibility of making such a motion in the Superior Court was not provided for in Quebec’s rules of civil procedure and that the so‑called application for rectification was completely foreign to Quebec’s law of obligations.
The AES motion was granted by the Superior Court and affirmed by a unanimous Court of Appeal. The Riopel motion was denied by the Superior Court on the basis of lack of jurisdiction but this decision was reversed by the Court of Appeal. The Agence du Revenu appealed both cases to the Supreme Court of Canada; the Attorney General of Canada appeared as an Intervenor.
The Agence du Revenu argued that civil law limited rectification to errors of a clerical nature; the Attorney General of Canada agreed and also argued that common law courts had unduly extended the doctrine of rectification in tax matters:
[22] The ARQ takes the same position in both AES and Riopel while noting the distinctive features of their respective fact situations. In brief, the ARQ first argues that there is nothing in the Code of Civil Procedure, R.S.Q., c. C-25, that authorizes the Superior Court to consider the type of motion the respondents have made. The C.C.P. does not authorize a court to rectify or amend a contract. The basis for a power to do so would have to be found in the substantive law established in the C.C.Q. However, the ARQ argues, the power to interpret contracts provided for in art. 1425, on which the Court of Appeal relied in granting the applications, does not apply in these cases, since they do not involve interpretation in the true sense. Only “clerical” errors can be corrected under art. 1425, but the errors relied on by the respondents are not clerical errors. According to the ARQ, the errors alleged by the taxpayers relate only to the economic consequences of their transactions and do not even form a basis for an action to annul for one of the causes provided for in the C.C.Q. Thus, the ARQ submits that it can still rely on the agreements in the form in which they were originally set down in writing and that the changes subsequently made to their wording to record the “original” agreement may not be set up against it.
[23] The Attorney General of Canada has intervened in both the appeals in support of the ARQ. According to him, the power of the courts to correct supposedly defective writings is limited in Quebec civil law to the correction of clerical errors. Thus, the proceedings instituted in Riopel and in AES have no basis in the civil law. He agrees with the ARQ that the Court of Appeal gave too broad a scope to the power to interpret contracts provided for in art. 1425 C.C.Q. Finally, the Attorney General of Canada criticizes the common law courts for unduly extending the concept of rectification in tax cases since the Ontario Court of Appeal’s decision in Canada (Attorney General) v. Juliar (2000), 50 O.R. (3d) 728. In any event, he argues, this concept of rectification does not apply in the civil law context. In his view, this Court should even intervene to correct that part of the case law and bring it into line with the Court’s most recent decisions in this regard.
The Supreme Court rejected the narrow construction of the civil law proposed by Agence du Revenu and dismissed the appeal, while at the same time warning taxpayers that this result should not be interpreted as a carte blanche invitation to engage in aggressive retrospective tax planning:
[53] The common intention of the parties was expressed erroneously in all the writings prepared to carry out the tax plans on which they had agreed. The Court of Appeal held that it was possible to remedy those errors and correctly identified the common intention of the parties. I would not interfere with its decisions.
[54] However, the judicial recognition of the validity of the amendments made by the parties in this case to the writings recording their agreements must be accompanied by certain reservations and a word of warning. Taxpayers should not view this recognition of the primacy of the parties’ internal will — or common intention — as an invitation to engage in bold tax planning on the assumption that it will always be possible for them to redo their contracts retroactively should that planning fail. A taxpayer’s intention to reduce his or her tax liability would not on its own constitute the object of an obligation within the meaning of art. 1373 C.C.Q., since it would not be sufficiently determinate or determinable. Nor would it even constitute the object of a contract within the meaning of art. 1412 C.C.Q. Absent a more precise and more clearly defined object, no contract would be formed. In such a case, art. 1425 could not be relied on to justify seeking the common intention of the parties in order to give effect to that intention despite the words of the writings prepared to record it. As I mentioned above, the agreements between the parties in both appeals were validly formed in that, according to evidence that the ARQ did not contradict, they provided for obligations whose objects were sufficiently determinable. These agreements provided, for the corporations in question, for the establishment of determinate structures that would, had they been drawn up properly, have made it possible to meet the objectives being pursued by the parties. The subsequent amendments did not alter the nature of the structures contemplated at the outset. All they did was amend writings that were supposed to give effect to the common intention, an intention that had been clearly defined and that related to obligations whose objects were determinate or determinable.
In addition, the court made the following observations about the interaction of rectification and the application of tax statutes:
[44] Nevertheless, the dispute in the two appeals before us necessarily concerns the ARQ and the CRA. Because of their situations, it must be asked whether they can rely on acquired rights to have an erroneous writing continue to apply even though the existence of an error has been established and it has been shown that the documents filed with the tax authorities are inconsistent with the parties’ true intention.
[45] For such a conclusion to be reached, it would have to be found that, once the respondents completed their operations, the revenue agencies became special assignees that were entitled to collect part of the economic proceeds of the transactions, and that they could rely forever on the parties’ declared will. I do not dispute the fact that the tax collection procedures, remedies and types of security established by law to facilitate the recovery of tax debts give the agencies rights in the proceeds of a variety of juridical operations. For example, they may become assignees of a series of claims or holders of rights in a trust in respect of certain property affected by transactions. Under the civil law itself, the agencies can also prove that simulation existed and demonstrate the true nature of transactions they allege to be shams. In addition, tax legislation may recharacterize contractual or economic transactions for its own purposes by overriding the legal categories established by the common law and the civil law. With the exception of such situations, however, tax law applies to transactions governed by, and the nature and legal consequences of which are determined by reference to, the common law or the civil law.
[Emphasis added]
Thus it would appear that the Supreme Court has cautiously endorsed rectification as normally controlling the application of tax law.[2] The court’s comments on this matter may be seen as obiter but the reader should recall that obiter in the Supreme Court of Canada is usually binding on lower courts:
R. v. Prokofiew, 2010 ONCA 423, paras. 18-35 per Doherty JA.
Comment: This is another practical, business friendly decision of the Supreme Court of Canada which should generally be regarded as welcome news to the private tax community.
[1] 2013 SCC 65.
[2] The Attorney General of Canada invited the court to review the manner in which subsequent decisions have applied Juliar but the court declined to do so on the basis that Juliar was grounded upon common law principles and AES and Riopel were based on civil law.