What is Rectification ?

  • Rectification is one of the equitable remedies available to a superior court of a province to relieve against that which is unfair, unconscionable, or unjust
  • Rectification has traditionally been considered an equitable remedy that is available to correct a written agreement when the parties were in agreement on the terms of their contract but, by mistake, wrote them down incorrectly
  • It is a remedy, however, that may be used in appropriate circumstances to avoid an adverse tax consequence from a completed transaction

The elements that must be proven to obtain a rectification order are as follows:

  • The parties had a common intention before making the written instrument alleged to be deficient;
  • This common intention continued unchanged at the time the written instrument was executed;
  • The written instrument mistakenly did not conform to the prior common intention; and
  • The party seeking relief can show the precise form in which the written instrument can be made to express the prior common intention.

Canada (Attorney General) v. Fairmont Hotels Inc.

When is rectification available to avoid adverse tax consequences ?

  • Fairmont and two of its Canadian subsidiaries entered into a financing arrangement with a Legacy Hotels REIT to manage two U.S. hotels acquired by Legacy
  • The financing was done in U.S. dollars, and to avoid FX exposure, Fairmont entered into a reciprocal U.S. dollar loan with Legacy through its subsidiaries
  • When Fairmont was acquired by arm's length investors, Fairmont and its subsidiaries were faced with an FX loss
  • Plan proposed whereby Fairmont but not its two subsidiaries would trigger FX gains and losses in the same year – but dealing with the exposure of the two subsidiaries was deferred

Canada (Attorney General) v. Fairmont Hotels Inc. ...cont'd

  • When Legacy went to sell the two U.S. hotels, it requested Fairmont to unwind the reciprocal loans, which Fairmont did by redeeming its shares in its subsidiaries
  • Unexpectedly, a CRA audit revealed that the redemption triggered taxable gains
  • Fairmont sought rectification on the basis that the original intention of Fairmont and its subsidiaries was tax neutrality, and this share redemption resulted in an inadvertent negative tax consequence, contrary to the parties' original intention
  • The lower courts followed the precedent in Juliar v. Canada (Attorney General), in which the issuance of shares was substituted for debt in order to avoid a taxable deemed dividend, in accordance with the parties' original intention to have a tax‐ neutral transaction
  • However, the Supreme Court of Canada drew back from that extension of the applicable jurisprudence
  • The Court rejected tax neutrality as a sufficient basis for rectification
  • Rectification is limited to cases where the agreement between the parties was not correctly recorded in the final instrument
  • It does not undo unanticipated effects of that agreement; a court cannot change the agreement to salvage what a party hoped to achieve

What can we learn from this case ?

  • In order to seek equitable relief from unintended tax consequences, the taxpayer must prove the existence of the traditional elements the courts have looked for, namely:
    • The parties had a common intention before making the written instrument alleged to be deficient;
    • This common intention continued unchanged at the time the written instrument was executed;
    • The written instrument mistakenly did not conform to the prior common intention; and
    • The party seeking relief can show the precise form in which the written instrument can be made to express the prior common intention.

BC Trust v. Attorney General for Canada

How do the rectification rules apply to trusts where unintended tax consequences arise ?

  • The trustees of a BC trust allocated its income from 2002 to 2011 to an Alberta trust which was a beneficiary, but when audited by the CRA and faced with disallowances, decided not to allocate its income in 2012
  • The trustees settled the dispute for the earlier years and applied to Court for rectification to permit the trustees to pass a resolution to allocate the trust's income in 2012 to the Alberta trust

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