Mar 17, 2025
Introduction – A sound plan with a flawed execution
In January 2025, the Ontario Court of Appeal ruled on the case of Pyxis Real Estate Equities Inc. v. Attorney General of Canada, 2025 ONCA 65, effectively overturning the decision of the Ontario Superior Court of Justice in 2024 ONSC 2039. This case involves Mr. Jubb and his four corporations. The corporate structure is completely vertical, where a corporation is the sole shareholder of the corporation below it, and Mr. Jubb, at the top, owns 100% of Holdco and so on.
Mr. Jubb asked his accountants to devise a strategy that would allow him to pay off the shareholder loan he owed to Holdco and leave the remaining balance to him, all on a tax-free basis. The accountants came up with a plan that involved Pyxis, the corporation at the bottom of the chain, paying tax-free capital dividends to its sole corporate shareholder, and the capital dividends moving up the chain one by one to reach Mr. Jubb. The intended amount to finally arrive at Mr. Jubb was $1.4 million, allowing him to pay off a $1.2 million shareholder loan and to keep $200,000 for himself tax-free.
To implement the plan, Mr. Jubb instructed his accountants to review the historical tax and accounting records of the corporations to determine the capital dividend account of each one. The calculated capital dividends to be distributed by Pyxis was $1.4 million, and this $1.4 million would move all the way up the chain to Mr. Jubb. However, the accountants did not review the historical records as instructed and, therefore, were not aware that one of the corporations, Edgecombe, had a capital dividend account deficit of $300,000. To offset Edgecombe’s deficit, the capital dividends distributed from Pyxis should have been 1.7 million, which was not an issue because Pyxis had a capital dividend account balance of $45 million.
A memorandum outlining the plan was prepared by the accountants, and it only mentioned $1.4 million of capital dividends to be distributed by Pyxis up the chain. The plan was executed according to the memorandum. However, the CRA later determined that Edgecombe’s capital dividend distribution exceeded its account balance by $300,000 and assessed Edgecombe for 60% of the excess capital dividends. The taxpayer thus applied for a rectification order.
Requirements and application of rectification order
A rectification order is an equitable remedy available to correct an error in a written legal instrument. The legal test for rectification is not in dispute:
- There must be a prior agreement that is definite and ascertainable;
- The agreement is still in effect at the time when the rectification is sought;
- The written instrument fails to record the prior agreement; and
- The written instrument can be corrected in order to carry out the prior agreement.
The taxpayer and the CRA disagreed on how the test could be applied. The Ontario Superior Court of Justice sided with the taxpayer, finding that the objective of the transactions recorded in the memorandum was to distribute capital dividends of $1.4 million to Mr. Jubb. The execution was thwarted because of the accountants’ error. But the error can be corrected because Pyxis has more than enough capital dividend balance to allow $1.7 million to be distributed and offset Edgecombe’s deficit.
In supporting its decision, the Superior Court relied on Hanley Park Developments, 2020 ONCA 273 (Hanley). In Hanley, the developer entered into an easement agreement with the neighbouring property owner (who was also the vendor of the land the developer purchased for development) for parts 1 to 4 of a reference plan. The developer later found out that the easement also required part 5 and applied for rectification. The Ontario Court of Appeal held that the agreement or transaction must be viewed as a whole, recognized the objective of the easement (to provide road access to the project), and allowed the rectification.
The Superior Court distinguished the case at bar with Canada Life Insurance, 2018 ONCA 562, and Pole Trail Ranch, 2020 ONSC 7050. In those cases, the structures of the transactions were flawed to start with whereas rectification may not be employed to fix a flawed structure or change the structure altogether. On the other hand, the structure in this case was sound.
Rectification order not for salvaging what the parties hoped to achieve
The Ontario Court of Appeal reversed the decision of the Superior Court, emphasized the principle of a rectification order which is to correct an instrument, where the instrument fails to correctly record the parties’ agreement, and not to salvage what the parties hoped to achieve. In the case at bar, the memorandum recorded the plan for each corporation to distribute $1.4 million in capital dividends upwards, which was what was actually agreed to at the time and what was accordingly carried out. To change the distribution amount is really to change the agreement.
The Court of Appeal also distinguished Hanley. The Court reiterated the equitable nature of the rectification order where the use of an equitable remedy cannot be separated from the “unfair and unconscionable” conduct of one of the parties, which was accused of the land vendor in Hanley.
Pro Tax Tip – Rectification order cannot replace due diligence
Ultimately, what the Court of Appeal ruled is that a rectification order cannot save the parties from their failure to conduct due diligence. The $1.4 million capital dividends distribution was the agreement, albeit resulting from a mistake.
The taxpayer can take action against the accountants for their negligence, but with respect to the agreement, the court cannot cure the negligence for the taxpayer. This case highlights the importance of due diligence in tax planning and transactions. Taxpayers are always recommended to seek consultation with experienced Canadian tax lawyers in order to prepare and carry out the plan and transactions in good order and in compliance with Canadian tax laws.
FAQ
Q: The preamble of the written agreement clearly states the parties’ objective. Can a rectification order be made to fix an error?
While the legal test for rectification is well established, the application depends on the facts in each situation. A well-stated objective is certainly a factor in considering what was actually agreed to by the parties, but it is not grounds for rectification if the details in the written agreement correctly reflect the specifics accepted by the parties. Thus, it is imperative for the parties to conduct their due diligence and record the correct details in the agreement.
Q: The parties relied on consultants in drafting the agreement and the consultants failed to record the correct details in the agreement. Can a rectification be made?
Failure of the drafters to record the actual agreement between the parties is grounds for rectification. But again, the application of the rectification order depends on the facts in each situation. It is improper to give a blanket judgment to a question of facts. When it comes to tax planning and litigation, the parties must seek counsel from experienced Canadian tax lawyers to analyze the circumstances and provide tailored advice.
DISCLAIMER: This article just provides broad information. It is only up to date as of the posting date. It has not been updated and may be out of date. It does not give legal advice and should not be relied on. Every tax scenario is unique to its circumstances and will differ from the instances described in the article. If you have specific legal questions, you should seek the advice of a Canadian tax lawyer.
