http://www.canlii.org/en/bc/bcca/doc/2015/2015bcca222/2015bcca222.html 
Re Pallen Trust (May 20, 2015 – 2015 BCCA 222, Newbury J.).
This commentary is provided by guest contributor, Rebecca Jones, of Lenczner Slaght LLP.
The areas of rectification and rescission are closely related and are among the most important recent adjuncts to tax litigation outside the context of statutory tax appeals. The
Pallen Trust decision may well be a harbinger of other areas where the courts will assist taxpayers who have inadvertently run aground on the shoals of evolving jurisprudence in the Tax Court of Canada or the Federal Court of Appeal. It is illustrative of a certain synergy between the traditional tax litigation bar and the mainstream civil litigation bar.
Précis: Is rescission on the ground of mistake available to a taxpayer where the mistake concerns the tax consequences of a commercial transaction?
The Court of Appeal of British Columbia recently addressed this question in
Re Pallen Trust.
The case arose out of the following facts. In 2008, New Integrated, a corporation, paid dividends to a discretionary trust, which it had set up as part of a re-organization. The re-organization was intended to shield New Integrated’s investments and equity from future risks, and to allow the Trust to reap tax benefits flowing from the application of s. 75(2) of the
Income Tax Act. At the time, it was generally accepted that the transfer of property to a discretionary trust would trigger s. 75(2), irrespective of the method of transfer.
In 2012, the Federal Court of Appeal in
R v Sommerer held that a trust could not benefit from s. 75(2) where it had purchased property at fair market value. After the
Sommerer decision, the Canada Revenue Agency reassessed the Trust, and imposed a tax liability of $552,867.
In the Court below, the Trust was successful in obtaining an order rescinding the payment of dividends on the ground of a mistake of law. The CRA appealed, claiming that:
1) the chambers judge erred in applying the test for rescission;
2) the CRA would have reassessed the trust even before the Sommerer decision; and,
3) the chambers judge erred in rescinding the transaction ab initio.
The Court of Appeal dismissed the appeal on all three grounds.
Decision: The Court of Appeal followed the Supreme Court of the United Kingdom’s decision in
Pitt v. Holt, and held that a “causative mistake of significant gravity” that is “basic to the transaction” can warrant rescission of a taxpayer’s transaction in rare cases. The Court of Appeal noted that prior to
Sommerer, the CRA’s interpretation bulletins suggested that the applicability of s. 75(2) did not depend on whether the income received by a trust was by way of a purchase or gift. While taxpayers are expected to accept the consequences of their tax planning, and while tax avoidance aims should be discouraged, the facts in this case “did not involve ‘aggressive’ tax planning gone wrong.” The Court of Appeal held that, to the contrary, “the Pallen re-organization fit squarely within an attribution rule that CRA had consistently stated would apply to the dividends.”
The Court of Appeal therefore affirmed the judgment below, and held that fairness required the equitable remedy of rescission. Where a transaction is rescinded, it is void
ab initio.
The Court of Appeal’s decision highlights a court’s power to grant equitable relief to taxpayers who make decisions on the basis of a mistake of law. The Court of Appeal made clear, however, that courts should apply a fact-driven inquiry to ensure that rescission is rare and that the “social evil” of aggressive tax avoidance continues to be disincentivized.
The Court of Appeal of British Columbia’s decision upholding the rescission order was clearly motivated, first and foremost, by its finding that the taxpayer had been “induced by CRA’s own published bulletins.” Going forward, we can expect lower courts to provide further guidance on how to apply the fact-driven inquiry required by the Court of Appeal.