Correcting Tax Mistakes: Will Rescission Supplant Rectification?

Now that Canada (Attorney General) v. Fairmont Hotels Inc. (2016 SCC 56) and Jean Coutu Group (PJC) Inc. v. Canada (Attorney General) (2016 SCC 55) have severely restricted the availability of rectification in tax cases, will rescission fill the void? In Collins Family Trust v. Canada (Attorney General) (2019 BCSC 1030), the BC Supreme Court held that the grant of rescission in Re Pallen Trust (2015 BCCA 222), which was decided before Fairmont and Jean Coutu, is still good law in British Columbia. The BCSC held that it was bound by that decision (because the facts were virtually identical) and that it is up to the BCCA (if the decision is appealed) to decide whether Re Pallen is no longer good law.

Rescission is an equitable remedy under which a transaction may be retroactively cancelled, annulled, or set aside in circumstances where a mistake of sufficient gravity has been made that it would be unconscionable, unjust, or unfair to leave it uncorrected. When rescission is granted, the transaction or document at issue is cancelled and the parties are returned to their respective pre-contract positions. In certain circumstances, rescission can be a useful tool for undoing transactions that lead to unintended and undesirable tax consequences.

Both Collins and Re Pallen involved a tax plan whereby a private company's ("Opco's") shares were sold by a corporation ("Holdco") to a trust with the intent to trigger the application of subsection 75(2). Dividends could then be paid by Opco to the trust and the dividend income would be attributed to Holdco under subsection 75(2). No tax would be paid on the dividend income since Holdco would take a deduction under subsection 112(1). The plans were compromised with the release of the TCC's decision in Sommerer v. The Queen (2011 TCC 212), which held that the FMV sale of property to a trust does not trigger subsection 75(2). This reversed the general understanding of tax practitioners and the CRA at the time, and led the CRA to reassess the petitioners in Re Pallen and Collins. The petitioners therefore sought rescission to undo the payment of the dividends by Opco.

The BCSC acknowledged that Fairmont and Jean Coutu are rectification cases and that rectification and rescission are different remedies with different tests. However, the court added that rectification and rescission are both equitable remedies that should not lead to "dramatically different results" (concurring with Canada Life Insurance Company of Canada v. Canada (Attorney General), 2018 ONCA 562 and Harvest Operations Corp. v. Attorney General of Canada, 2017 ABCA 393). In the BCSC's view, the principles expressed in Fairmont and Jean Coutu were intended to apply generally to all tax cases, rather than being limited to cases involving rectification. The BCSC found that the rescission petitions before it in Collins infringed both of the following general principles established in Fairmont and Jean Coutu:

  1. taxpayers should be taxed on what they actually did, not what they intended to do; and
  2. it is not permissible to retroactively alter a transaction to achieve an intended tax objective.
Nevertheless, the BCSC followed Re Pallen and granted the application for rescission. It held that, notwithstanding its views that Re Pallen had been seriously undermined by Fairmont and Jean Coutu, Re Pallen had not been expressly overruled. In Re Pallen, the court had granted rescission on the basis that the tax results were basic to the transaction, there was a causative mistake, the gravity of the mistake was significant, and no third parties were prejudiced.

Marshall Haughey and Wade Ritchie
Bennett Jones LLP, Calgary

Canadian Tax Focus
Volume 9, Number 3, August 2019
©2019, Canadian Tax Foundation