This article was drafted with the assistance of summer law student Eric Turcotte.
In the recent decision of Canada (Attorney General) v Collins Family Trust, 2022 SCC 26 [Collins Trust], the Supreme Court of Canada rejected the use of equitable remedies such as rescission to undo or alter transactions that resulted in unintended tax liability. The decision means taxpayers will have more difficulty finding relief from the consequences of tax-planning mistakes.
Facts: Undesirable Tax Consequences
Collins Trust concerned two different taxpayers who engaged the same tax advisor in 2008 to devise a plan to protect their assets from creditors without incurring income tax liability. The tax plan used a related operating company, holding company and family trust in such a way that the dividend payments from the operating companies to the trusts would be tax free.
The plan relied on the attribution rules in s. 75(2) and the inter‑corporate dividend deduction in s. 112(1) of the Income Tax Act, RSC 1985, c 1 (5th Supp). At the time, the tax-neutral basis of this plan was generally consistent with how tax practitioners and the Canada Revenue Agency (CRA) interpreted the relevant provisions. However, the Tax Court of Canada later held in Sommerer v The Queen, 2011 TCC 212, aff’d 2012 FCA 207 that this type of plan incurred tax liability. Facing reassessments from the CRA, both taxpayers sought the equitable remedy of rescission, which would permit them to undo the transactions and dividend payments.
Recent Changes in the Availability of Equitable Remedies for Tax Liabilities
Underlying the ruling in Collins Trust is the 2016 decisions of Fairmont Hotels Inc v Canada, 2016 SCC 56 [Fairmont] and Jean Coutu Group (PJC) Inc v Canada, 2016 SCC 55 [Jean Coutu] where the Supreme Court similarly limited the use of rectification to correct tax mistakes.
While rescission allows taxpayers to undo transactions as if they never happened, rectification allows a taxpayer to amend its transactions. Before Fairmont, taxpayers used rectification to amend or replace their chosen transaction method to avoid any unexpected or unwanted tax consequences that subsequently arose. In Fairmont, the Supreme Court returned rectification to its historical use of correcting errors in written instruments (generally, a contract) that did not accord with their underlying agreements (generally, oral). The Supreme Court held that rectification could not be used as a tool for retroactive tax planning, but instead was only available where the circumstances met the general rectification test.
In the pre-Fairmont decision of Re Pallen Trust, 2015 BCCA 222, the British Columbia Court of Appeal granted rescission for the same type of tax plan as considered in Collins Trust. The Court relied on Pitt v Holt, [2013] UKSC 26, a leading case from the United Kingdom, which held that in certain circumstances rescission may relieve tax consequences that arose from a mistake. In Collins Trust, now post-Fairmont, the chambers judge held that Re Pallen Trust remained binding to provide the same remedy in largely the same type of circumstances. However, the court noted its concern that Fairmont undermined the foundations of Re Pallen Trust.
The British Columbia Court of Appeal affirmed the chambers judge’s decision. The Court read Fairmont narrowly as precluding rectification in the tax context, but not equitable remedies more generally. Conversely, before this decision, the Ontario Court of Appeal in Canada Life Insurance Co of Canada v Canada (Attorney General), 2018 ONCA 562 came to the opposite conclusion in holding that Fairmont stood generally for the rejection of the use of equitable remedies, including recission, to remedy tax planning mistakes and related unwanted tax liabilities.
The Decision: A Clear Message on the Availability of Equitable Remedies
Justice Brown—writing for the eight-to-one majority—allowed the appeal. At the heart of his denial of recission to remedy tax mistakes are two principles from his earlier decision in Fairmont. First, equitable remedies are not available where sought to achieve retroactive tax planning. Second, taxpayers should be taxed based on what they actually agreed to do and did, and not on what they could have done or later wished they had done.
The Court relied on these principles to hold that Pitt v Holt was irreconcilable with Fairmont and Jean Coutu. Rather, Fairmont and Jean Coutu should be read as precluding any equitable remedy by which retroactive tax planning might be achieved, including rescission. More specifically, Pitt v Holt was distinguishable as it arose from jurisprudence lacking the bar on retroactive tax planning. Further, the British tax administration system permits additional discretion in collection.
To be clear, the Supreme Court reaffirmed the long-standing principle that taxpayers may arrange their affairs to minimize the amount of tax payable. Yet, just as the courts are held to apply the ordinary operations of tax statutes, taxpayers are taxed according to how they agree to arrange their affairs rather than how they could or should have arranged them to pay less tax. Indeed, the Court noted there was nothing unconscionable or otherwise unfair about the operation of a tax statute on transactions freely undertaken, even where it does not result in the general intention to avoid tax liability. Tax consequences flow from the parties’ freely chosen legal relationship in the form of transactions, not from the underlying motivations or objectives. Consequently, although taxpayers may arrange their affairs to minimize tax liability, once those arrangements are made, equity will not step in to modify the arrangements to correct any unintended adverse tax consequences arising from the ordinary operation of tax statutes.
Equity remains available to correct mistakes, but only where the underlying test is met. For example, the Supreme Court cited Re Slocock’s Will Trusts, [1979] 1 All ER 358 (Ch D) where rectification was granted to correct a deed that failed to record the terms of the parties’ original agreement. The Supreme Court noted that the improved tax consequences in Re Slocock’s Will Trusts flowed from the original chosen agreement that was simply incorrectly recorded. It was only incidental that the correction also avoided the unintended tax liability that arose from the mistake.
In comparison, Justice Côté in dissent, as she was in Jean Coutu and Fairmont, would have dismissed the appeal. Justice Côté emphasized that equitable remedies, including rectification and rescission, remain available in the tax context where the requirements for the remedy are met. Further, she emphasized that the decision in Fairmont did not address rescission as it is a distinct remedy from rectification. Ultimately, Justice Côté found Pitt v Holt could be adopted in Canada. Therefore, she would have held that rescission remains available to remedy a mistake, but not to correct for mere ignorance or a misprediction in tax planning.
How Can Taxpayers Respond to Tax Planning Mistakes?
If a taxpayer or their hired tax practitioner either incorrectly predicts the tax consequences of a transaction or makes a mistake on the underlying facts or law, the Supreme Court’s decision in Collins Trust makes it clear that the mere fact that this resulted in adverse tax consequences does not justify equity-based relief. The taxpayer would instead need to demonstrate that they meet the requirements for the remedy independently from their desired tax consequences.
Nevertheless, a taxpayer is not without recourse. The lower courts considered whether there was an alternative remedy to rescission. Notably, a taxpayer may sue their tax practitioner for negligence or ask the Governor in Council to grant statutory remission to forgive their tax debt. Yet, the British Columbia Court of Appeal held the existence of these remedies did not bar the availability of rescission as the remedies were not realistic. Indeed, remission is an exceptional remedy granted in rare circumstances. Further, CRA indicates a mistake in tax planning does not qualify for remission. Similarly, a claim for negligence against a tax practitioner may be time consuming and expensive, and may be groundless depending on the circumstances. Although the majority in Collins Trust did not address this issue, the dissent affirmed the unrealistic nature of these remedies in that particular situation. Therefore, taxpayers may need to increasingly rely on competent tax advice. Alternatively, taxpayers may seek a non-binding advance tax ruling from the CRA on a particular transaction.
The Supreme Court of Canada’s decision adds increased risk in tax planning and tax litigation. Our Tax Litigation & Tax Dispute Resolution and Taxation Group would be happy to assist you in determining the effect of this decision on you and your organization.
Note: This article is of a general nature only and is not exhaustive of all possible legal rights or remedies. In addition, laws may change over time and should be interpreted only in the context of particular circumstances such that these materials are not intended to be relied upon or taken as legal advice or opinion. Readers should consult a legal professional for specific advice in any particular situation.