Author: Henry Shew CPA, CA, TEP, CPA (Washington), MAcc
Editors: Peter Weissman FCPA, FCA, TEP and Matthew Cho CPA, CA, TEP
Rectification, in simple terms, is a legal process where an entity petitions the court to change previously executed written documents. In the tax world, rectification may be used by a taxpayer to change the terms of a legal document to alter the tax results of a transaction, but is generally regarded by practitioners as a bit of a “Hail Mary” as it is an expensive and time consuming exercise with uncertain results. The fact that the threshold for granting a rectification order is quite high does not help the cause. This threshold was further elevated by the judgement in Fairmont Hotels, 2016 SCC 56, which narrowed the scope of rectification. However, it appears that at least one provincial court is showing a willingness to interpret the tests laid out in Fairmont in a taxpayer friendly manner.
Two weeks ago, the British Columbia Court of Appeal confirmed a win for taxpayers on rectification (5551928 Manitoba, 2019 BCCA 376). This case was tried after the Fairmont decision. In the Fairmont case, the Supreme Court of Canada required the taxpayers to demonstrate prior agreement with “definite and ascertainable” terms in order to grant rectification. It was once famously said by Justice Brown that “rectification is not equity’s version of a mulligan.”
The case facts in 5551928 Manitoba were rather straight forward. Before the repeal of the eligible capital property (ECP) regime in 2017, the taxpayer had an addition to its capital dividend account (CDA) through a disposition of ECP. The taxpayer did not know that the non-taxable portion of the capital gain was not credited to CDA until the end of the taxpayer’s taxation year. Based on advice of its advisors, capital dividends were declared before the said taxation year-end. CRA assessed a penalty under Part III and the taxpayer sought a rectification order to reverse the director’s resolution regarding the payment of the capital dividend.
One important point about this case is the wording of the director’s resolution. The resolution shows 1) the purported CDA balance, 2) the intention that the dividend is to be paid from CDA and 3) the directors intend to apply the election on the full amount of CDA. The trial judge believes that the three elements shown in the director’s resolution demonstrated that the agreement to “clean out” the CDA was “sufficiently precise, definite and ascertainable.” The trial judge also closed the case with a few comments worth noting: 1) the case involved was not “bold tax planning”, 2) the taxpayer was not seeking to reverse any unplanned tax liability because the premise of the agreement was to issue a planned tax-free capital dividend, 3) the taxpayer was not reckless as he acted with due diligence, 4) there was no “error in judgement” and 5) there was no need to unwind a complex transaction.
The British Columbia Court of Appeal re-affirmed the decision of the lower court. The appellate judge confirmed that the intention was properly recorded from the three crucial sentences in the director’s resolution. The appellate judge does not believe that Fairmont prevents the court from granting rectification simply because the motive in passing a resolution is to obtain a particular tax result. It appears that as long the original intention is present, the narrow test in Fairmont may still provide a remedy to the taxpayer.
Rectification is not only limited to “fixing” CDA elections. It may also apply to other situations. The case of 5551928 Manitoba shows us that rectification is possible in situations where the original intention is appropriately documented, reflected in legal documents and taxpayers undertake due diligence, and that the rectification is to achieve the original intention. Although this case does not set a legal precedent outside of British Columbia, it is welcoming to know that at least one provincial court applied the Fairmont test in a taxpayer friendly fashion. Certainly, given the resources required in a rectification request, taxpayers should exhaust alternate remedies before considering it. If you have situations that you believe rectification may be the only choice, a Cadesky Tax representative would be happy to assist you.
