1. Introduction
In the last couple of decades Canadian courts have had to decide a large number of cases in which taxpayers have sought to undo tax plans because, as it turned out, the plans failed to achieve what was intended, namely, a reduction or avoidance of tax liability. The legal vehicles to achieve this result have been generally the equitable remedies of rectification and rescission. In the latest case to come before the courts, Canada (Attorney General) v Collins Family Trust,[1] the majority of the Supreme Court of Canada has limited greatly the availability of these equitable remedies.
In 2008, two companies (independently of each other) used the same tax advisor to devise a plan to protect corporate assets from creditors without incurring tax liability. The plans took advantage of the attribution rules in s 75(2) and the inter-corporate dividend deduction in s 112(1) of the Income Tax Act.[2] This was done by incorporating a holding company in each case. It subscribed for shares in the operating company for a nominal amount. The holding company was the settlor and beneficiary of a newly created family trust. Funds were lent to the trust to purchase at the nominal fair market value from the holding company its new shares in the operating company. The latter then paid dividends to the trust and the dividends were attributed to the holding company under s. 75(2). The holding company in turn claimed a deduction in respect of the dividends under s. 112(1). The plan resulted in moving large sums of money to the family trust without paying income tax.
The plans were based on the interpretation of these sections published by the Canada Revenue Agency (CRA”) at the time. However, in Sommerer v The Queen,[3] the courts held that the attribution rules in s. 75(2) did not apply when the property was sold to the trust, as distinct from being given to the trust. The CRA then began to reassess a number of trusts that had taken advantage of the pre-Sommerer understanding of the attribution rules.
The first case was Re Pallen Trust,[4] which involved a similar set of transactions as those in the present case. When the CRA reassessed the taxpayer, it applied to rescind the dividends. The courts applied the test for rescission stated in Pitt v Holt[5] and granted the application. Newbury JA said that the case did not involve ‘aggressive’ tax planning but applied a rule that the CRA had consistently stated applied to the dividends.
Then, in Canada (Attorney General) v Fairmont Hotels Inc[6] and its companion case, Jean Coutu Group (PJC) Inc v Canada (Attorney General)[7] the Supreme Court of Canada held that the equitable remedy of rectification is not available when a taxpayer seeks to engage in retroactive tax planning. It held that taxpayers should be taxed based on what they agreed to do and did, not on what they could have done or later wished they had done.[8]
2. Facts
In Collins the CRA reassessed the taxpayers and they, relying on Pallen, brought an application to rescind the dividends paid by their operating companies to the trusts. The chambers judge expressed concern that the Fairmont and Coutu cases had significantly undermined Pallen but held that he was bound by it and granted the applications. The Court of Appeal affirmed that decision but held that the chamber judge’s concern about Pallen having been undermined was misplaced. The Court of Appeal held that Fairmont and Coutu had a narrow application, that rectification was still available in appropriate situations even if it saved tax, that they did not hold that other equitable remedies are precluded, and that they did not undermine Pallen. The Attorney General appealed on two grounds: (1) that the courts below erred in adopting the test for equitable rescission stated in Pitt; and (2) if Pitt governed, the courts below erred in applying it.
The Supreme Court of Canada allowed the appeal. The majority decision was written by Brown J and concurred in by all the other judges, except Côté J, who dissented. Justice Brown held that the appeal could be disposed of solely on the first ground and did not address the second ground.
3. Majority Reasons
Justice Brown summarized the reasons for allowing the appeal in the following terms (para 7):
… a limiting principle of equity and, relatedly, principles of tax law stated in Fairmont Hotels and Jean Coutu are irreconcilable with the conclusion in Pitt v. Holt. Equity has no place here, there being nothing unconscionable or otherwise unfair about the operation of a tax statute on transactions freely undertaken. It follows that the prohibition against retroactive tax planning, as stated in Fairmont Hotels and Jean Coutu, should be understood broadly, precluding any equitable remedy by which it might be achieved, including rescission.
He stated that the Court of Appeal should not have imported the reasoning of Pitt, which concluded that equity can relieve a tax mistake. The importation was incompatible with Canadian law, because it was barred by a limiting principle of equity, as well as by principles of Canadian tax law.
(a) The Limiting Principle of Equity
With respect to the limiting principle of equity, Brown J took into account the origins of equity. It was developed to grant relief from the restrictions of common law when relief was called for as a matter of conscience, fairness, and unconscionable conduct. That definition of equity limits equity’s scope at the same time. If there is no unconscionability or unfairness, the court cannot resort to equity. And that is the case with tax laws: ‘there is nothing unconscionable or unfair in the ordinary operation of tax statutes to transactions freely agreed upon’ (para 11). Justice Brown therefore concluded, ‘On this ground alone Pitt v Holt and Re Pallen Trust cannot … be taken as stating the law of British Columbia’ (para 11).[9] He also followed Fairmont, where the Supreme Court stated, ‘Tax consequences flow from freely chosen legal arrangements, not from the intended or united effects of those arrangements, whether upon the taxpayer or upon the public treasury’.[10]
Thus, Brown J drew the following principles from Fairmont and Coutu:
(a) tax consequences do not flow from contracting parties’ motivations or objectives. Rather, they flow from the freely chosen legal relationships, as established by their transactions (Jean Coutu , at para. 41; Fairmont Hotels, at para. 24);
(b) while a taxpayer should not be denied a sought-after fiscal objective which they should achieve on the ordinary operation of a tax statute, this proposition also cuts the other way: taxpayers should not be judicially accorded a benefit denied by that same ordinary statutory operation, based solely on what they would have done had they known better (Fairmont Hotels, at para. 23, citing Shell Canada , at para. 45; Jean Coutu, at para. 41);
(c) the proper inquiry is no more into the “windfall” for the public treasury when a taxpayer loses a benefit than it is into the “windfall” for a taxpayer when it secures a benefit. The inquiry, rather, is into what the taxpayer agreed to do (Fairmont Hotels, at para. 24);
(d) a court may not modify an instrument merely because a party discovered that its operation generates an adverse and unplanned tax liability (Fairmont Hotels, at para. 3; Jean Coutu, at para. 41).
Justice Brown then went on to hold that these principles are of general application and are not restricted to denying requests for rectification. He relied on certain cases in which Courts of Appeal followed Fairmont and Coutu that came to the same conclusion.[11] He therefore summarized his conclusion on the point of the limiting principle of equity as follows:
22 I agree with the conclusion in Canada Life that Fairmont Hotels and Jean Coutu bar a taxpayer from resorting to equity in order to undo or alter or in any way modify a concluded transaction or its documentation to avoid a tax liability arising from the ordinary operation of a tax statute. The statements of principle in those judgments — that tax consequences flow from legal relationships, that taxpayers’ liabilities should be governed by the ordinary operation of tax statutes and on what the taxpayer agreed to do, and that legal instruments cannot be modified merely because they generated an adverse tax liability — are categorical, and not restricted to cases where rectification is sought. To be clear: they are of general application, precluding equitable relief altogether when sought to avoid an unintended tax liability that has arisen by the ordinary application of tax statutes to freely agreed upon transactions. There is no room for distinguishing Fairmont Hotels or Jean Coutu based upon the particular remedy sought. While a court may exercise its equitable jurisdiction to grant relief against mistakes in appropriate cases, it simply cannot do so to achieve the objective of avoiding an unintended tax liability.
(b) Principles of Canadian Tax Law
On this point Justice Brown stated (para 24) that that the Court of Appeal should not have relied on the conclusion in Pitt that equity can grant relief from a tax mistake, and that tax consequences are relevant in determining whether a taxpayer is able to satisfy the test for rescission. According to Pitt a taxpayer can do so if there is ‘a causative mistake of sufficient gravity … either as to the legal character or nature of a transaction, or as to some matter of fact or law which is basic to the transaction’.[12] However, according to Brown J, that contradicts the principles he just stated that the Minister is bound to apply the Act and a court cannot override that by resorting equity.
He then went on to point out that Pitt did not account for Canadian law, which requires the Minister of National Revenue to apply the ITA to the transactions in question. Section 220(1) of the Act imposes a duty on the Minister to administer and enforce the Act and does not confer any discretion on the Minister.
By implication, therefore, if not in fact, Brown J refers to differences between UK and Canadian tax law to distinguish Pitt. The distinction is not impossible, but with great respect, it requires a sounder basis. Foreign law is a question of fact, not law, and therefore it must be proved if the domestic court is to place reliance on it. I understand that the Attorney General stated in its written argument (for the first time at any of the three levels of court) that there are such differences. Justice Brown apparently accepted that as fact. Since the UK law was not proved, Justice Brown should have applied the well-known principle that, in the absence of evidence to the contrary, the foreign law is assumed to be the same as the domestic (Canadian) law.[13] In that case, it seems to me, the Supreme Court should have concluded that Pitt allowed the equitable remedy of rescission to reverse a transaction despite the lack of a discretion on the part of the tax authorities. Thus, Pitt would have to be treated as valid law.
Regardless, although Brown J did not use this precise language, the effect of the decision was to overrule Pallen.
4. Minority Reasons
Justice Côté disagreed that Fairmont and Coutu disposed of the appeal. As she stated in summary (para 30):
… rescission is, in strictly limited circumstances, an available remedy in Canadian law that can be used to unwind transactions that were undertaken on the basis of a mistaken assumption, even if permitting it would effectively relieve the taxpayer from payment of unexpected taxes.
She stated (para 35) that the majority in Fairmont did not say that equitable remedies can never be granted in a tax context. Rather, as the majority stated of the remedy of rectification in Fairmont, ‘it is to be applied in a tax context just as it is in a non-tax context’.[14] She went on to state that neither Fairmont nor Coutu preclude the availability of equitable remedies in a tax context (para 39). Nor did they specifically address the availability of rescission in such a context (para 40).
Justice Côté disagreed with the view of Brown J. that the test for equitable rescission for mistake stated in Pitt, namely, that tax consequences are relevant when deciding whether a party to a voluntary disposition of property can satisfy the test for rescission, cannot be adopted in Canada. That test is compatible with Canadian law, in her view (paras 44-45).
Justice Côté also addressed the unfairness caused by the CRA’s reassessing the taxpayers in Pallen and in this case after Sommerer on the basis of a retroactive application of s. 75(2) after it had previously taken the view that the actions of the taxpayers complied with that section. In her view, the Minister was not bound to reassess the taxpayers in these cases. It had discretion to do so, and unfairness resulted when the CRA reversed its long-standing interpretation of the section.
Moreover, she stated that the transactions did not constitute abusive tax avoidance or aggressive tax planning. Nor did the taxpayers assume the risk that the CRA would reverse its position. The only risk it assumed was that the GAAR could potentially apply, as explained in their accountants’ advice.
—
[1] 2022 SCC 26, reversing Collins Family Trust v Canada (Attorney General), 2020 BCCA 196, 59 ETR 4th 1, which affirmed the decision of Giachi J, 2019 BCSC 1030, 48 ETR 4th 101 (‘Collins’).
[2]RSC 1985, c 1 (5th Supp) (‘ITA’).
[3] 2011 TCC 212, affirmed 2012 FCA 207 (‘Sommerer’).
[4] 2015 BCCA 22 (‘Pallen’).
[5] 2013] UKSC 26, [2013] 2 AC 108 (‘Pitt’).
[6] 2016 SCC 56, [2016] 2 SCR 720 (‘Fairmont’).
[7]2016 SCC 55, [2016] 2 SCR 670 (‘Coutu’).
[8] Fairmont, paras 23-24, citing Shell Canada Ltd v Canada, [1999] 3 SCR 622, para 45 (‘Shell’)
[9] On this point Justice Brown also cited the point made by Shell, previously adopted by Fairmont, and summarized in the text at footnote 8, supra.
[10]Fairmont, para 24.
[11] Canada Life Insurance Company of Canada v Canada (Attorney General), 2018 ONCA 562; Harvest Operations Corp v Attorney General of Canada, 2017 ABCA 393.
[12] Pitt, paras 122, 132.
[13] For an example of the application of this principle, see Baker v Archer-Shee, [1927] AC 844 (HL). See also the more recent cases, Lear v Lear, 1974 CarswellOnt 167, 5 OR 2d 572 (CA), and Royal Bank v Neher, 1985 CarswellAlta 137, [1985] 5 WWR 667 (QB). The principle can only be waived by statute. See, e.g., Children’s Law Act, RSN 1990, c C-13, s 53.
[14] Fairmont, para 25.
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Written by: Albert Oosterhoff
Posted on: July 26, 2022
Categories: Commentary, WEL Newsletter
1. Introduction
In the last couple of decades Canadian courts have had to decide a large number of cases in which taxpayers have sought to undo tax plans because, as it turned out, the plans failed to achieve what was intended, namely, a reduction or avoidance of tax liability. The legal vehicles to achieve this result have been generally the equitable remedies of rectification and rescission. In the latest case to come before the courts, Canada (Attorney General) v Collins Family Trust,[1] the majority of the Supreme Court of Canada has limited greatly the availability of these equitable remedies.
In 2008, two companies (independently of each other) used the same tax advisor to devise a plan to protect corporate assets from creditors without incurring tax liability. The plans took advantage of the attribution rules in s 75(2) and the inter-corporate dividend deduction in s 112(1) of the Income Tax Act.[2] This was done by incorporating a holding company in each case. It subscribed for shares in the operating company for a nominal amount. The holding company was the settlor and beneficiary of a newly created family trust. Funds were lent to the trust to purchase at the nominal fair market value from the holding company its new shares in the operating company. The latter then paid dividends to the trust and the dividends were attributed to the holding company under s. 75(2). The holding company in turn claimed a deduction in respect of the dividends under s. 112(1). The plan resulted in moving large sums of money to the family trust without paying income tax.
The plans were based on the interpretation of these sections published by the Canada Revenue Agency (CRA”) at the time. However, in Sommerer v The Queen,[3] the courts held that the attribution rules in s. 75(2) did not apply when the property was sold to the trust, as distinct from being given to the trust. The CRA then began to reassess a number of trusts that had taken advantage of the pre-Sommerer understanding of the attribution rules.
The first case was Re Pallen Trust,[4] which involved a similar set of transactions as those in the present case. When the CRA reassessed the taxpayer, it applied to rescind the dividends. The courts applied the test for rescission stated in Pitt v Holt[5] and granted the application. Newbury JA said that the case did not involve ‘aggressive’ tax planning but applied a rule that the CRA had consistently stated applied to the dividends.
Then, in Canada (Attorney General) v Fairmont Hotels Inc[6] and its companion case, Jean Coutu Group (PJC) Inc v Canada (Attorney General)[7] the Supreme Court of Canada held that the equitable remedy of rectification is not available when a taxpayer seeks to engage in retroactive tax planning. It held that taxpayers should be taxed based on what they agreed to do and did, not on what they could have done or later wished they had done.[8]
2. Facts
In Collins the CRA reassessed the taxpayers and they, relying on Pallen, brought an application to rescind the dividends paid by their operating companies to the trusts. The chambers judge expressed concern that the Fairmont and Coutu cases had significantly undermined Pallen but held that he was bound by it and granted the applications. The Court of Appeal affirmed that decision but held that the chamber judge’s concern about Pallen having been undermined was misplaced. The Court of Appeal held that Fairmont and Coutu had a narrow application, that rectification was still available in appropriate situations even if it saved tax, that they did not hold that other equitable remedies are precluded, and that they did not undermine Pallen. The Attorney General appealed on two grounds: (1) that the courts below erred in adopting the test for equitable rescission stated in Pitt; and (2) if Pitt governed, the courts below erred in applying it.
The Supreme Court of Canada allowed the appeal. The majority decision was written by Brown J and concurred in by all the other judges, except Côté J, who dissented. Justice Brown held that the appeal could be disposed of solely on the first ground and did not address the second ground.
3. Majority Reasons
Justice Brown summarized the reasons for allowing the appeal in the following terms (para 7):
… a limiting principle of equity and, relatedly, principles of tax law stated in Fairmont Hotels and Jean Coutu are irreconcilable with the conclusion in Pitt v. Holt. Equity has no place here, there being nothing unconscionable or otherwise unfair about the operation of a tax statute on transactions freely undertaken. It follows that the prohibition against retroactive tax planning, as stated in Fairmont Hotels and Jean Coutu, should be understood broadly, precluding any equitable remedy by which it might be achieved, including rescission.
He stated that the Court of Appeal should not have imported the reasoning of Pitt, which concluded that equity can relieve a tax mistake. The importation was incompatible with Canadian law, because it was barred by a limiting principle of equity, as well as by principles of Canadian tax law.
(a) The Limiting Principle of Equity
With respect to the limiting principle of equity, Brown J took into account the origins of equity. It was developed to grant relief from the restrictions of common law when relief was called for as a matter of conscience, fairness, and unconscionable conduct. That definition of equity limits equity’s scope at the same time. If there is no unconscionability or unfairness, the court cannot resort to equity. And that is the case with tax laws: ‘there is nothing unconscionable or unfair in the ordinary operation of tax statutes to transactions freely agreed upon’ (para 11). Justice Brown therefore concluded, ‘On this ground alone Pitt v Holt and Re Pallen Trust cannot … be taken as stating the law of British Columbia’ (para 11).[9] He also followed Fairmont, where the Supreme Court stated, ‘Tax consequences flow from freely chosen legal arrangements, not from the intended or united effects of those arrangements, whether upon the taxpayer or upon the public treasury’.[10]
Thus, Brown J drew the following principles from Fairmont and Coutu:
(a) tax consequences do not flow from contracting parties’ motivations or objectives. Rather, they flow from the freely chosen legal relationships, as established by their transactions (Jean Coutu , at para. 41; Fairmont Hotels, at para. 24);
(b) while a taxpayer should not be denied a sought-after fiscal objective which they should achieve on the ordinary operation of a tax statute, this proposition also cuts the other way: taxpayers should not be judicially accorded a benefit denied by that same ordinary statutory operation, based solely on what they would have done had they known better (Fairmont Hotels, at para. 23, citing Shell Canada , at para. 45; Jean Coutu, at para. 41);
(c) the proper inquiry is no more into the “windfall” for the public treasury when a taxpayer loses a benefit than it is into the “windfall” for a taxpayer when it secures a benefit. The inquiry, rather, is into what the taxpayer agreed to do (Fairmont Hotels, at para. 24);
(d) a court may not modify an instrument merely because a party discovered that its operation generates an adverse and unplanned tax liability (Fairmont Hotels, at para. 3; Jean Coutu, at para. 41).
Justice Brown then went on to hold that these principles are of general application and are not restricted to denying requests for rectification. He relied on certain cases in which Courts of Appeal followed Fairmont and Coutu that came to the same conclusion.[11] He therefore summarized his conclusion on the point of the limiting principle of equity as follows:
22 I agree with the conclusion in Canada Life that Fairmont Hotels and Jean Coutu bar a taxpayer from resorting to equity in order to undo or alter or in any way modify a concluded transaction or its documentation to avoid a tax liability arising from the ordinary operation of a tax statute. The statements of principle in those judgments — that tax consequences flow from legal relationships, that taxpayers’ liabilities should be governed by the ordinary operation of tax statutes and on what the taxpayer agreed to do, and that legal instruments cannot be modified merely because they generated an adverse tax liability — are categorical, and not restricted to cases where rectification is sought. To be clear: they are of general application, precluding equitable relief altogether when sought to avoid an unintended tax liability that has arisen by the ordinary application of tax statutes to freely agreed upon transactions. There is no room for distinguishing Fairmont Hotels or Jean Coutu based upon the particular remedy sought. While a court may exercise its equitable jurisdiction to grant relief against mistakes in appropriate cases, it simply cannot do so to achieve the objective of avoiding an unintended tax liability.
(b) Principles of Canadian Tax Law
On this point Justice Brown stated (para 24) that that the Court of Appeal should not have relied on the conclusion in Pitt that equity can grant relief from a tax mistake, and that tax consequences are relevant in determining whether a taxpayer is able to satisfy the test for rescission. According to Pitt a taxpayer can do so if there is ‘a causative mistake of sufficient gravity … either as to the legal character or nature of a transaction, or as to some matter of fact or law which is basic to the transaction’.[12] However, according to Brown J, that contradicts the principles he just stated that the Minister is bound to apply the Act and a court cannot override that by resorting equity.
He then went on to point out that Pitt did not account for Canadian law, which requires the Minister of National Revenue to apply the ITA to the transactions in question. Section 220(1) of the Act imposes a duty on the Minister to administer and enforce the Act and does not confer any discretion on the Minister.
By implication, therefore, if not in fact, Brown J refers to differences between UK and Canadian tax law to distinguish Pitt. The distinction is not impossible, but with great respect, it requires a sounder basis. Foreign law is a question of fact, not law, and therefore it must be proved if the domestic court is to place reliance on it. I understand that the Attorney General stated in its written argument (for the first time at any of the three levels of court) that there are such differences. Justice Brown apparently accepted that as fact. Since the UK law was not proved, Justice Brown should have applied the well-known principle that, in the absence of evidence to the contrary, the foreign law is assumed to be the same as the domestic (Canadian) law.[13] In that case, it seems to me, the Supreme Court should have concluded that Pitt allowed the equitable remedy of rescission to reverse a transaction despite the lack of a discretion on the part of the tax authorities. Thus, Pitt would have to be treated as valid law.
Regardless, although Brown J did not use this precise language, the effect of the decision was to overrule Pallen.
4. Minority Reasons
Justice Côté disagreed that Fairmont and Coutu disposed of the appeal. As she stated in summary (para 30):
… rescission is, in strictly limited circumstances, an available remedy in Canadian law that can be used to unwind transactions that were undertaken on the basis of a mistaken assumption, even if permitting it would effectively relieve the taxpayer from payment of unexpected taxes.
She stated (para 35) that the majority in Fairmont did not say that equitable remedies can never be granted in a tax context. Rather, as the majority stated of the remedy of rectification in Fairmont, ‘it is to be applied in a tax context just as it is in a non-tax context’.[14] She went on to state that neither Fairmont nor Coutu preclude the availability of equitable remedies in a tax context (para 39). Nor did they specifically address the availability of rescission in such a context (para 40).
Justice Côté disagreed with the view of Brown J. that the test for equitable rescission for mistake stated in Pitt, namely, that tax consequences are relevant when deciding whether a party to a voluntary disposition of property can satisfy the test for rescission, cannot be adopted in Canada. That test is compatible with Canadian law, in her view (paras 44-45).
Justice Côté also addressed the unfairness caused by the CRA’s reassessing the taxpayers in Pallen and in this case after Sommerer on the basis of a retroactive application of s. 75(2) after it had previously taken the view that the actions of the taxpayers complied with that section. In her view, the Minister was not bound to reassess the taxpayers in these cases. It had discretion to do so, and unfairness resulted when the CRA reversed its long-standing interpretation of the section.
Moreover, she stated that the transactions did not constitute abusive tax avoidance or aggressive tax planning. Nor did the taxpayers assume the risk that the CRA would reverse its position. The only risk it assumed was that the GAAR could potentially apply, as explained in their accountants’ advice.
—
[1] 2022 SCC 26, reversing Collins Family Trust v Canada (Attorney General), 2020 BCCA 196, 59 ETR 4th 1, which affirmed the decision of Giachi J, 2019 BCSC 1030, 48 ETR 4th 101 (‘Collins’).
[2]RSC 1985, c 1 (5th Supp) (‘ITA’).
[3] 2011 TCC 212, affirmed 2012 FCA 207 (‘Sommerer’).
[4] 2015 BCCA 22 (‘Pallen’).
[5] 2013] UKSC 26, [2013] 2 AC 108 (‘Pitt’).
[6] 2016 SCC 56, [2016] 2 SCR 720 (‘Fairmont’).
[7]2016 SCC 55, [2016] 2 SCR 670 (‘Coutu’).
[8] Fairmont, paras 23-24, citing Shell Canada Ltd v Canada, [1999] 3 SCR 622, para 45 (‘Shell’)
[9] On this point Justice Brown also cited the point made by Shell, previously adopted by Fairmont, and summarized in the text at footnote 8, supra.
[10]Fairmont, para 24.
[11] Canada Life Insurance Company of Canada v Canada (Attorney General), 2018 ONCA 562; Harvest Operations Corp v Attorney General of Canada, 2017 ABCA 393.
[12] Pitt, paras 122, 132.
[13] For an example of the application of this principle, see Baker v Archer-Shee, [1927] AC 844 (HL). See also the more recent cases, Lear v Lear, 1974 CarswellOnt 167, 5 OR 2d 572 (CA), and Royal Bank v Neher, 1985 CarswellAlta 137, [1985] 5 WWR 667 (QB). The principle can only be waived by statute. See, e.g., Children’s Law Act, RSN 1990, c C-13, s 53.
[14] Fairmont, para 25.
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