Introduction: What is “Rescission”?
Rescission allows for a transaction to be retroactively cancelled, annulled, or set aside in circumstances where there has been a unilateral mistake by parties. In order to qualify for rescission as a remedy, the mistake must have created some injustice for the transacting parties. If rescission is granted by the court, the transaction at issue is cancelled and parties are returned as close as possible to their positions pre-contract.
As an equitable remedy, rescission is entirely at the court’s discretion to award. It is important to identify as well that not every court has the power to award equitable remedies. The Tax Court of Canada, which hears a majority of the tax law disputes in Canada, is a statutory court. It does not possess the inherent jurisdiction to rule on equitable matters and cannot award rescission for any taxpayer involved in a Tax Court of Canada dispute. The provincial superior courts have equitable jurisdiction, and so any appeal for rescission must be brought to these separate courts.
Rescission is an attractive remedy for taxpayers who have run afoul of the CRA and of Canadian tax laws because of a genuine error made between parties adopting tax planning measures. The ability to invoke “mistake” in response to a tax reassessment would allow for a window to potentially escape unintended tax liability caused by a misunderstanding or misinterpretation of Canadian tax law. It should be unsurprising then that Canadian courts have not been eager to encourage this kind of abusive behaviour, and that rescission has been restricted as a remedy for Canadian taxpayers who, in the court’s view, unfairly take advantage of the system. With the ruling in Collins Family Trust v Canada (Attorney General), 2020 BCCA 196, new life has been afforded to rescission as an equitable remedy in tax cases. If you are facing a tax reassessment and are interested in how this decision may affect your potential options, you should consult an expert Canadian tax lawyer.
Rescission for Tax Cases, as Viewed Historically by Canadian Courts
A pair of companion cases from the Supreme Court of Canada had largely extinguished the right to claim rescission for many failed tax plans. Canada (Attorney General) v Fairmont Hotels Inc., 2016 SCC 56, and Jean Coutu Group (PJC) Inc v Canada (Attorney General), 2016 SCC 55, both concerned the equitable remedy of rectification for a taxpayer (whereby the courts can order that a written document be corrected to reflect its original intentions). For tax planning purposes and for rescission as a remedy, these rulings became very significant. The Supreme Court established two crucial principles for taxpayers appealing the unintended consequences of their tax planning:
- A taxpayer should be taxed on what was actually done, and not what was intended. In the words of Justice Russell Brown in Fairmont, “[rectification] is not equity’s version of a mulligan.”
- It is impermissible for a court to ‘re-write’ a transaction or contract simply to achieve an intended tax objective.
Although these rulings focused specifically on the remedy of rectification, the language of those judgements had been taken by Canadian courts as a universal declaration on applying equitable remedies to tax law disputes. There were several decisions Canada-wide following the results in Fairmont and Jean Coutu where courts refused to exercise equitable jurisdiction and award rescission on the principles laid out by the Supreme Court of Canada in Fairmont and Jean Coutu.
The Collins Family Trust Decision and the Potential Revival of Rescission
In 2020, the British Columbia Court of Appeal issued the first ruling since Fairmont and Jean Coutu that recognized rescission as an equitable remedy in tax cases. In Collins Family Trust v. Canada (Attorney General), 2020 BCCA 196, the Court of Appeal upheld a lower trial ruling issuing a rescission order concerning a taxpayer’s complicated tax planning trust arrangement.
The plan itself was highly involved. The appellants incorporated a holding company for a family business and executed a family trust. The holding company made a small loan to the trust, which was used to purchase shares of the holding company. The purpose of these transactions was to allow the holding company to issue dividends from the profits of the family business on the shares purchased by the trust. The family intended to take advantage of attribution rules under Subsection 75(2) and inter-corporate dividend deductions under Subsection 112(1) of the Income Tax Act. It was assumed that the dividend income received by the trust from the companies would be attributed to the holding company under Subsection 75(2), and with applicable dividend deductions the retained earnings of the family business could be successfully moved to the trust without paying any income tax.
The CRA’s interpretation of the law had been consistent with this view for several years. It was only until the ruling in Sommerer v The Queen, 2011 TCC 212, which narrowed the applicability of Subsection 75(2), that the CRA’s interest turned toward the family trust. The CRA ultimately reassessed the trust’s tax returns on grounds the dividend income it had received was subject to tax. The CRA viewed the tax planning structure as highly aggressive and that Subsection 75(2) could not preclude inclusion of dividend income into the trust’s income. The CRA as a consequence considered the tax plan in violation of the General Anti-Avoidance Rule (GAAR) under Section 245 of the Income Tax Act because it was an unintended abuse of the Act’s provisions.
The taxpayers applied for rescission of the tax plan with the courts. The British Columbia Court of Appeal ultimately upheld the British Columbia Superior Court’s rescission order granting a reversal of the plan. It did so on the ruling made in Re Pallen Trust, which predated both Fairmont and Jean Coutu and which had virtually identical facts to those on appeal in Collins Family Trust. The Court of Appeal concluded it would be unjust to apply the principles of Fairmont and Jean Coutu too broadly. In the Court of Appeal’s view, the rulings in Fairmont and Jean Coutu only stood for the principle that retroactive tax planning could not be accomplished by rectification to achieve a different tax consequence. The Court of Appeal had concluded that even though there may be a tax advantage to gain from rescission, there would be few good reasons for denying the remedy as long as the elements necessary for the award were met.
The Court of Appeal reiterated that the test for granting rescission, in the context of a voluntary transfer of property, would be that a mistake of sufficient importance had occurred and that it would be unconscionable, unjust or unfair to not correct the mistake concerning:
- The legal character or nature of the transaction, or;
- Some matter of fact or law which is basic to the transaction
The Court of Appeal accepted that aggressive tax planning could be a factor in evaluating whether to grant rescission, because it would be much harder to justify unconscionability for a transaction that was intended to skirt tax laws. However, on the facts of Collins Family Trust the arrangement was intended to achieve creditor protection of assets in addition to tax benefits. The courts accepted that neither intention was dominant, and that the appeal for rescission was not purely tax motivated. As well, the parties had not asked for a modification to the agreement itself but rather were seeking a nullification and to be restored to their original position. The courts would therefore not be as complicit in retroactive tax planning for the family.
Pro Tax Tip: Jurisdiction Remains an Issue
The ruling in Collins Family Trust is bound to be a persuasive argument for all Canadian courts moving forward when faced with similar matters. It is important to recognize, however, that the decisions made by the British Columbia Court of Appeal are not binding on provincial courts outside of British Columbia. The Ontario Court of Appeal recently delivered a decision in Canada Life Insurance Company of Canada, 2018 ONCA 562, where the Court of Appeal adopted the opposite perspective and ultimately refused to exercise equitable jurisdiction and grant a rescission order. The Court of Appeal accepted a broad perspective on the rulings in Fairmont and Jean Coutu and concluded that any retroactive tax planning made by order of rescission was impermissible. The Court of Appeal concluded that the core of retroactive tax planning was avoidance of unjust enrichment, and so achieving intended tax consequences was just as impermissible as avoiding unintended tax consequences.
Even more troubling, the Ontario Court of Appeal concluded that it should decline to exercise its equitable jurisdiction because the taxpayer had alternative remedies to address the consequences of its tax planning mistakes. This included a Notice of Objection to appeal its tax assessment and a potential action against its professional tax advisor personally, which are both unlikely to satisfactorily resolve the dispute and may open the doors for extended professional liability.
If you or your business are intent on taking advantage of tax planning opportunities under the Canadian Income Tax Act, you should consult with a Canadian expert tax lawyer. Only an experienced Canadian tax lawyer can navigate the intricacies of Canadian tax planning law and help to advise you on whether the CRA may object to your plans.
- What is rescission?
“Rescission” is an equitable remedy. A court may order rescission in order to reverse a particular transaction, or nullify a contract, with the intention of bringing parties back to the positions that they were in prior to the transaction/contract occurred. Only a court with equitable jurisdiction, typically a provincial superior court, has the power to award rescission.
- What did the B.C. Court of Appeal find in Collins Family Trust?
The B.C. Court of Appeal found that rescission as a remedy could still be available in the context of a tax planning dispute. Rescission had not been extinguished as a remedy by the Supreme Court of Canada’s decisions in Fairmont and Jean Coutu, which dealt narrowly with the remedy of rectification. Where the outcome would be unconscionable or unfair to the taxpayer, the test for rescission may still be satisfied, even if there is a tax advantage in awarding the remedy.
- What might the decision in Collins Family Trust mean for taxpayers?
The decision in Collins Family Trust signals that the remedy of rescission may still be available to a taxpayer whose plans runs afoul of the CRA. The decision in Collins Family Trust is so far only authoritative in B.C., but it provides a compelling argument for any taxpayer facing a similar dispute in another Canadian jurisdiction.