Introduction - Ontario Superior Court of Justice rejects taxpayers' rectification application as attempt to engage in "retroactive tax planning"
The applicants, Mr. Mandel and Ms. Pike, were assessed by the Canada Revenue Agency (the "CRA") as having received shareholder benefits under subsection 15(1) of the Income Tax Act (the "Tax Act") amounting to approximately $15 million each in 2019. Mr. Mandel and Ms. Pike, and their families, each held approximately 25% in Welded Tube of Canada ("OpCo"), a successful steel pipe and tube manufacturer. In the 1990s, each applicant created a family trust, which held shares in a holding company ("HoldCo"), which in turn owned the applicants' shares in OpCo. In 2014, to defer significant tax liability that would have materialized from the deemed disposition of the trusts' assets after 21 years, the applicants rolled the assets into corporations created for each of their children ("ChildCo"). The applicants subscribed for 1,000 Class A voting shares, and 100,000 Class B convertible shares in each ChildCo, whereas each child transferred 700 Class D voting shares in HoldCo in exchange for 100 non-voting common shares in their ChildCo. The corporate records indicated that the applicants purchased their shares in each ChildCo for $110, however the ledgers of each ChildCo contained a "Sundry Receivables" account in the amount of $110.
After the CRA reassessment in 2019, the applicants contended that they received shares in each ChildCo, but never actually paid for them, therefore, they were not shareholders. The basis of their argument was subsection 23(3) of the Ontario Business Corporations Act (the "Business Corporations Act"), which requires shares to be fully paid for prior to issuance. Prior to the hearing, in February 2020, each of the children became controlling shareholders of their particular ChildCo.
Mr. Mandel and Ms. Pike brought an application to the Ontario Superior Court of Justice (the "Court"), asking for:
- A declaratory order that shares of each ChildCo were never legally issued to them; and
- A rectifying order to amend the corporate records of each ChildCo to reflect that the applicants were never legally issued shares.
The core issue was whether the applicants were shareholders of each ChildCo. If they were shareholders, the applicants could be subject to an income inclusion of approximately $15 million dollars each for receiving shareholder benefits under subsection 15(1) of the Tax Act. The CRA assessed the applicants on the basis that they received a taxable benefit when they were issued controlling shares in each ChildCo. The applicants were issued 100,00 Class B convertible shares at a nominal price, which might only have been converted in the event of a divorce for any of the children, to dilute the claim of the child's former spouse.
The Court first considered whether it had jurisdiction to consider the application, ultimately deciding that it did not. In the alternative, the Court considered whether the declaration and rectification remedies were appropriate under the circumstances, and again decided against the applicants. The Court explained that to allow the application would result in impermissible "retroactive tax planning."
The Tax Court of Canada is the correct forum for tax disputes
The CRA's position on this matter was that the Tax Court of Canada (the "Tax Court") was the proper forum for this dispute due to its expertise in tax law. Conversely, the applicants argued that the Ontario Superior Court of Justice was the proper forum because the Tax Court did not have jurisdiction to grant the requested rectification remedy. The Court sided with the CRA, finding that the applicants were attempting to force the outcome of a tax dispute before they pursued the remedies available under the Tax Act.
The Court explained that the context of the application is a tax assessment, which prima facie brings it in the jurisdiction of the Tax Court. Although the Tax Court does not have jurisdiction with respect to the rectification remedy, it does have jurisdiction to grant the declaratory remedy sought under subsection 23(3) of the Business Corporations Act. The Tax Court's specialized expertise would allow them to consider whether, for tax purposes, the applicants should be considered controlling shareholders of each ChildCo for the relevant taxation periods.
The Court, in Baxter v Attorney General of Canada et al., 2013 ONSC 3153, previously declined to find that it had jurisdiction to declare that a taxpayer held shares in trust after being reassessed by the CRA. Furthermore, the Court cited the Ontario Court of Appeal in Danso-Coffey v Ontario, 2010 ONCA 171 ("Coffey"), which cautioned Superior Courts from exercising jurisdiction in tax disputes. In Coffey, the applicant was assessed by the CRA on the basis that she was a director of a corporation, however, the Court of Appeal declared that she was not a director.
In Mandel the Court distinguished the matter on the ground that the applicant in Coffey had legitimate reasons, aside from tax assessment, for seeking a declaration that she was not a director. In addition, there was evidence that she was not aware that she was a director, and never intended to be a director, of the corporation. The Court found that those factors did not apply to Mr. Mandel and Ms. Pike. Therefore, the Court concluded that it did not have jurisdiction to grant the remedies sought by the applicants in this matter.
Declaratory remedy in a tax dispute requires the expertise of the Tax Court
The Court went on to consider the declaratory remedy sought by the applicants, in the event that the Court erred in finding that it did not have jurisdiction to decide the matter. The applicants sought an order declaring that they are not, and have never been, shareholders of each ChildCo. They relied on subsection 23(3) of the Business Corporations Act, which requires shares to be fully paid for prior to issuance. The Court established that the declaratory remedy would require a factual determination of whether the shares were actually paid for. The Supreme Court of Canada, in Ewert v Canada, 2018 SCC 30, stated that the declaratory remedy is ultimately discretionary. In this case, the Court found that there was unexplained conflicting information regarding whether the shares were paid for, an absence of dispute between the shareholders, and potential unknown consequences in granting the retroactive declaration sought by the applicants. As a result, the Court declined to grant the declaration that the applicants are not, and have never been, shareholders of each ChildCo.
Rectification remedies are inappropriate when sought for "retroactive tax planning" purposes
Lastly, the Court considered whether the rectification remedy was available to the applicants. The applicants submitted that under subsection 250(1) of the Business Corporations Act, the Court had jurisdiction to rectify the shareholder registers of each ChildCo to reflect that shares had never validly been issued to them. The Court relied heavily on its analysis under the declaratory remedy to find that the rectification remedy was not available. The Court went on to state that the rectification remedy is available where parties intended to redeem or issue shares, and the documentation did not accurately reflect that intention. In this case, however, the documentation accurately reflected the intention of the applicants to issue shares. In Canada (Attorney General) v Fairmont Hotels Inc, 2016 SCC 56, the Supreme Court of Canada held that rectification does not apply where it would give effect to "retroactive tax planning." Otherwise, taxpayers would be allowed to recast entire transactions where an intended tax benefit does not materialize. The Court found that the applicants intended to be controlling shareholders of each ChildCo, with the objective of deferring adverse tax consequences, which was accurately reflected in the documentation. Consequently, the Court declined to grant a rectifying order in favour of the applicants.
Pro tax tips - Tax planning is a prudent element of complex corporate transactions
The Tax Act is a complex piece of federal legislation, requiring special consideration prior to carrying out complex corporate transactions. Considering all the tax implications of a particular course of action helps to avoid unintended tax liability. Furthermore, courts are hesitant to engage in retroactive tax planning. Our experienced Canadian tax lawyers can provide tax planning advice on how to minimize or defer tax liabilities resulting from corporate transactions or on the advisability of trying a rectification application to correct unintended tax consequences of an improperly documented transaction.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.