SCC Confirms the Ability of Taxpayers to Seek Rectification to Remedy Errors that May Impact Tax Positions

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Uninteded tax consequences of a contract can be avoided by rectification, the Supreme Court of Canada ruled in Québec v Services Environnementaux AES inc., 2013 SCC 65 (AES).

AES is the first substantive decision of the Supreme Court on rectification in the tax context.  The issue before the Court was whether the Superior Court of Québec could correct a written instrument that did not reflect the parties’ intentions.  While decided under the Civil Code of Québec (C.C.Q.), the principles articulated by the Court should be relevant to the common law doctrine of rectification applicable in other provinces.

AES involved corporate reorganizations that were intended by the parties to be implemented on a tax deferred basis.  Certain errors in carrying out the reorganizations resulted in unintended tax consequences.  In both cases, the taxpayers filed applications in the Québec Superior Court seeking rectification of the written instruments for the transactions to accord with their true intentions, which would result in implementing the reorganization without any immediate tax consequences.  The conflicting decisions of the Québec Superior Court were appealed to the Québec Court of Appeal, which granted rectification in both cases.

The Supreme Court of Canada dismissed the taxing authority’s appeal of the rectification order. Writing for the Court, Justice LeBel confirmed that parties to a transaction are entitled to correct an error by mutual consent and amend or annul the contract and the documents recording it.  The Court held that in a rectification application under the C.C.Q., the court is to determine the common intention of the parties and to intervene and remedy any errors.  Tax authorities do not have the right to have an erroneous document continue to apply in the face of the existence of an established error where it has been shown that the document relied on by the tax authorities are inconsistent with the parties’ true intention.  Justice LeBel confirmed that unless otherwise provided for in the taxing legislation, tax law is based in the underlying commercial principles established by the common law and civil law.  Consequently, in common law jurisdictions, taxpayers should continue to have recourse to the equitable doctrine of rectification to correct any errors in the written instruments underlying a transaction in order to eliminate any unintended negative tax consequences.

With the Supreme Court’s decision in AES, taxpayers can feel some comfort that any errors in the implementation of a transaction that results in unintended tax consequences can be remedied by having counsel make an application to the court.  However, in bringing this application, taxpayers and their counsel must ensure that they have put before the court sufficient evidence to prove that the parties had a common intention to implement the transaction on a tax effective basis before the transaction was carried out.  As stated by Justice LeBel: “Taxpayers should not view this recognition of the primacy of the parties’…common intention…as an invitation to  engage in bold tax planning on the assumption that it will always be possible for them to undo their contracts retroactively should that planning fail.”