Rectification and the vanishing prospects for common sense and compassion
John Sorenson of Gowling WLG asks whether the Glenmac decision demonstrates a tax system that is just, equitable and fair
John A. Sorensen is a partner at Gowling WLG in Toronto. He is the Canadian co-leader of Gowling WLG’s Tax Dispute Resolution team and part of the firm's Tax Group.
THE compelling and sympathetic facts in Glenmac1 were not sufficient to dissuade the Alberta Court of Queen's Bench from applying a strict interpretation of the Supreme Court of Canada's ("SCC") rectification guidance from Fairmont Hotels.2 The Alberta Court's dismissal of the rectification application is disappointing, but not entirely unexpected given the current rigors of the legal test. However, as discussed below, whether in the circumstances the strict application of Fairmont Hotels achieved a just outcome is questionable.
Glenmac Corporation Ltd. ("Glenmac") was a real estate holding company, the directors of which were Jack Carter ("Jack"), David Carter and Jack's lawyer. Jack established the Jack Carter Alter Ego Trust (2009) ("Trust") and it held Glenmac's Class A preferred shares. The trustees were Jack and his lawyer. The rectification application concerned the timing for the redemption of the Glenmac Class A preferred shares. As explained further below, the timing was impacted by the preparation and filing of an election under subsection 83(2) of the Income Tax Act (Canada) ("Act"), to treat the deemed dividend arising from the redemption as a tax-free capital dividend.
The story began sadly with Jack being diagnosed with a terminal illness in February, 2011. Together with his professional advisors, he discussed some tax planning opportunities involving Glenmac and the Trust. This led to the decision to redeem the Class A shares and make the capital dividend election. On April 26, 2011, Jack signed a resolution to redeem the shares for $10.5 million. The resolution affirmed that Glenmac would make the election. The date of the redemption set out in the resolution was a key fact and the ultimate problem that gave rise to the application seeking rectification: the resolution affirmed that the shares would be redeemed on May 2, 2011. Regrettably, Jack passed away on May 1, which was sooner than anyone had expected. Because the Class A preferred shares had not been redeemed by the date of his passing, there was an adverse, unplanned tax consequence in connection with the deemed disposition and reacquisition of a decedent's capital assets upon death.3
In the rectification application, Glenmac and the Trust took the position that including the May 2 date was a mistake. They argued that the intention was that the resolution be effective as soon as possible, namely, on April 26 when it was signed, and not the effective date that they placed on the document, being May 2. The reason why the resolution was executed on April 26, but effective as of May 2, was evidently to allow the accountants some time to prepare and file the necessary election form with the Canada Revenue Agency. In other words, the stated effective date was merely an administrative convenience that did not derogate from the intention that the redemption of the shares in fact be effected earlier.
The Alberta Court surveyed the leading case law on the rectification remedy and cited the following principles from the SCC in Fairmont Hotels:
If by mistake a legal instrument does not accord with the true agreement it was intended to record — because a term has been omitted, an unwanted term included, or a term incorrectly expresses the parties' agreement — a court may exercise its equitable jurisdiction to rectify the instrument so as to make it accord with the parties' true agreement. Alternatively put, rectification allows a court to achieve correspondence between the parties' agreement and the substance of a legal instrument intended to record that agreement, when there is a discrepancy between the two. Its purpose is to give effect to the parties' true intentions, rather than to an erroneous transcription of those true intentions.4
The SCC described rectification as a "potent remedy" that must be used with "great caution", further stating:
To summarize, rectification is an equitable remedy designed to correct errors in the recording of terms in written legal instruments. Where the error is said to result from a mistake common to both or all parties to the agreement, rectification is available upon the court being satisfied that, on a balance of probabilities, there was a prior agreement whose terms are definite and ascertainable; that the agreement was still in effect at the time the instrument was executed; that the instrument fails to accurately record the agreement; and that the instrument, if rectified, would carry out the parties' prior agreement ...5
Finally, with respect to intention versus results, the SCC stated:
Without disputing that tax neutrality was the parties' intention, for the reasons that follow it is my respectful view that both courts below erred in holding that this intention could support a grant of rectification. Rectification is limited to cases where the agreement between the parties was not correctly recorded in the instrument that became the final expression of their agreement ... It does not undo unanticipated effects of that agreement. While, therefore, a court may rectify an instrument which inaccurately records a party's agreement respecting what was to be done, it may not change the agreement in order to salvage what a party hoped to achieve. Moreover, these rules confining the availability of rectification are generally applicable, including where (as here) the unanticipated effect takes the form of a tax liability. To be clear, a court may not modify an instrument merely because a party has discovered that its operation generates an adverse and unplanned tax liability. ... [Citations omitted.]6
The Alberta Court evaluated the evidence to establish whether there was an agreement to redeem the shares on April 26 and the reason why May 2 was used. The Court held that the effective date of May 2 was deliberately chosen and purposefully inserted into the resolution. Thus, the mistake was not in recording May 2 as the effective date of the share redemption. Rather, the mistake was in assuming (wrongly, as it turned out) that there would be no supervening event, for example, Jack's passing. Therefore, to rectify the resolution would not align the document with anyone's prior intention, but rather would change the terms of the document to seek to salvage what the parties had allegedly sought to achieve. Consequently, the application to rectify the resolution was dismissed.
One main takeaway from this case may be that courts can be unwilling to inform rectification with compassion or with a high-level view of what was really going on. On one hand, the unfortunate outcome can simply be traced to a strict interpretation of Fairmont Hotels. On the other hand, the parties did formulate a specific intention to redeem the shares held in the Trust and properly utilize the capital dividend account balance to achieve a favorable tax outcome. Nothing about these basic steps was aggressive or inconsistent with any tax system norm or standard. It was quite the opposite. In terms of the timing, there was no familial, business, financial or tax reason that the resolution needed to take effect a week after it was signed. The reason was purely an administrative convenience. As mentioned, Jack was not deferring any decision or seeking any advantage (tax or otherwise) by signing the document with a later effective date.
Although a somewhat unpredictable event occurred in the interim, the fact remains that there was a clearly identified and entirely appropriate tax plan, intended to receive the benefit of a straightforward set of rules. A valid economic and tax result was specifically contemplated and a plan was struck. Rhetorically, why shouldn't the law of equity allow a fix to achieve a valid and fully intended outcome that was frustrated by a mistake that did not go to the heart of the planning, especially in such compelling and sympathetic circumstances? While the SCC's Fairmont Hotels guidance is of course binding law, the issue is whether an unbending interpretation and application of Fairmont Hotels is not fairly workable or can even be unjust, or whether the sharp edges might be sanded off it a bit. The question for us all to ask, as Canadian taxpayers and tax advisors and administrators, is whether an outcome like the one in Glenmac demonstrates a tax system that is just, equitable and fair. I would argue that it does not and that it instead represents the deprivation of the estate of a successful taxpayer and a corresponding unjustifiable windfall for the fisc, on what should have been an inconsequential basis unconnected to the legal substance of what was intended.
1. Glenmac Corporation Ltd and Jack Carter Alter Ego Trust (2009), 2021 ABQB 576 ("Glenmac").
2. Canada (Attorney General) v. Fairmont Hotels Inc., 2016 SCC 56 ("Fairmont Hotels").
3. To be clear, while the shares in question were held by the Trust, because it was an alter ego trust, the death of the settlor triggered a deemed disposition for the Trust.
4. At para. 12.
5. At para. 38.
6. At para. 3.
John A. Sorensen is a partner at Gowling WLG in Toronto. He is the Canadian co-leader of Gowling WLG’s Tax Dispute Resolution team and part of the firm's Tax Group. He specializes in tax and tax dispute resolution. Read the original article on GowlingWLG.com.