Rectification in Tax and Estate Matters Part I – Tax

Confucius said “A man who has committed a mistake and doesn’t correct it is committing another mistake.”

When we are dealing with tax and estate matters, even a simple mistake may have disastrous consequences. One way such a mistake may be corrected is by way of a rectification order.  Indeed, rectification is an important remedy that allows for the correction of errors or mistakes in legal instruments that have resulted in an unintended result.  This newsletter will review the doctrine of rectification as it applies to tax matters.  Our next newsletter will focus on rectification in estate matters.

What is Rectification?

A rectification order is an equitable remedy to correct errors in legal instruments that do not reflect the true intention of the parties resulting in unintended and, likely, unfortunate results.  A rectification order allows the affected parties to rectify the terms of a transaction as was initially intended by the parties. The effect of the rectification is retroactive.

The remedy of rectification is available only under certain defined circumstances; essentially to correct a mistake. However, rectification is not permitted if the intention of the parties is simply to alter the terms of an instrument nor can it be invoked in an attempt to correct every mistake in order to alter unwanted results.

In order for a rectification order to be granted, one must file an Application to the Superior Court of Ontario; only a court may grant such remedy.  Interestingly, the Tax Court of Canada cannot grant equitable remedies, and, as a result, rectification of a tax matter can only be heard by the appropriate forum, the Superior Court of Ontario.  The duty of the Court is to examine the evidence and assess the facts in order to determine whether the application is truly one to correct a mistake which result in an unintended legal effect or an undesirable legal consequence.  The Court must ensure that the parties are not just changing their minds “in the middle of a transaction.” The evidence is the key to the determination.

To be successful in obtaining a rectification order, one must establish:

1. the existence and nature of the common intention of the parties prior to preparation of the instrument alleged to be deficient;
2. that the common intention remained unchanged at the time the document was made; and
3. that the instrument, by mistake, does not reflect that initial common intention.

If one can prove the above, the Court may grant a rectification order thus restoring the party(ies) to their initial common intention.  Applicants should be aware that rectification orders are a discretionary remedy granted at the discretion of the Court and one should not anticipate the granting of an order.

Rectification in Tax Matters

In tax matters where unintended tax consequences arise as a result of a mistake, rectification may be a valuable tool, if not a “life saver,” for taxpayers who find themselves in a situation where their tax planning went awry.

Although the equitable doctrine of rectification is not new, it only truly emerged as a valuable tool in tax matters in the last decade or so.  The leading case, Canada v. Juliar, has been a key decision in establishing such remedy to taxpayers. Indeed, in Juliar, the Court granted a rectification order in a tax matter which ultimately fixed a mistake in a document intended for tax planning purposes. The granting of the rectification order enabled the taxpayer to avoid having to face a tax liability from an unanticipated outcome. Interestingly, the Court had no issue with the fact that the taxpayers’ intention throughout the transaction was to avoid immediate tax consequences.

Since the Juliar decision, the law and the doctrine of rectification in tax matters has expanded considerably.  Taxpayers appear to show a willingness to consider an application for rectification to correct/rectify transactions that achieved unintended tax consequences. Notably, the jurisprudence has acknowledged that the avoidance of tax is a legitimate intention in rectification matters involving a tax issue.  As a result, rectification may be available where transactions that resulted in unintended tax consequences might be altered in order to achieve the initial tax intention; that is the avoidance or minimization of tax.

A more recent decision from the Supreme Court of British Columbia, McPeake v. Canada, is also instructive as to how and when granting a rectification order may be appropriate in tax matters.  The McPeake decision is consistent with prior cases where the taxpayers demonstrate an intention to avoid tax but the documents or transactions failed to reflect their true intentions.

The McPeake decision stands out also on the basis that in tax matters, the taxpayers must convince the Court that their initial intention was to avoid tax.  Another interesting point of that decision is the fact that the Court accepted that it ought to consider the unfairness or harm the taxpayer may suffer should the rectification order not be granted (thus allowing a tax liability to arise although the avoidance of such liability is what gave rise to the transaction in the first place).

Rectification Application and the Crown

The Crown also distinguishes between an error in implementation and an error in tax planning and the Agency will vigorously oppose rectification orders disguised as an attempt to implement a form of retroactive tax planning.

The Crown’s position is that a taxpayer requesting a rectification order should provide the Agency with notice of the application; especially in instances where the rectification application is being made on the basis that the taxpayer is alleging unintended tax consequences.

However, whether or not the Crown should be notified of any particular application for rectification is a dilemma for the taxpayer and his lawyer to resolve.  There is a valid argument to be made that since the Crown may not be a party to the original instrument and the original transaction, it has no interest in the application to rectify the written instrument and the transactions. There is jurisprudence where the Court has said that notice to the Crown was “appropriate” or a matter of courtesy; however, the Court has never said it is mandatory.

In reality, the decision of whether to serve notice to the Crown or not is essentially a matter of assessing the basis of the application and ultimately, it is a strategic decision. Further, should one serve notice to the Crown, they risk having the Crown oppose the application.  However, opting not to serve notice may result in the judge requesting notice be served prior to rendering his or her decision.  Having to serve the Crown after the initial application is likely to raise suspicion from the Crown.

It is important to know that the Department of Justice has a rectification committee which discusses and decides whether to oppose an application.  The CRA and the Department of Justice have established a procedure to be followed when applying to the Court for a rectification order; notably, that a letter be sent to the Director of the Tax Services Office advising rectification will be sough, that the CRA should be named as a party in the Motion and that the Department of Justice be served with the Notice of Motion.

Once served, the rectification committee will review and discuss the merit of the application and inform the party(ies) whether it intends to oppose the application.

Conclusion

In tax matters, an application for a rectification order remains a valuable tool for taxpayers and should be considered when adverse tax consequences are erroneously triggered by an error or errors in implementing a transaction.

An application for a rectification should be considered by tax advisors, including accountants, lawyers and any other tax advisors.  Indeed, rectification may be the key to correct an oversight in their tax planning memorandum or an error in the drafting of an instrument.  Rectification may translate into a lifeline for their mistake, thus avoiding a liability; something well worth considering.

Ultimately, the original intent is the key determining factor in the decision whether to grant a rectification order.

In our next newsletter, we will address rectification in estate matters.

Tierney Stauffer LLP would be glad to assist and advise you.  If you have any questions, please do not hesitate to contact us.

Sébastien Desmarais
LL.B., LL.L., J.D.
Lawyer, Tierney Stauffer LLP
This article is provided  as an information resource and is not intended to replace advice from a quaified legal professional and should not be relied upon to make decisions. In all cases, contact your legal professional for advice on any matter  referenced in this document before making decisions. Any use of this document does not constitute a lawyer-client relationship.