Rescission without Taxation
The Supreme Court of Canada provides clarity and definition to the application of equitable remedies in tax law disputes
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On June 17th, 2022, the Supreme Court of Canada (“SCC”), in an 8-1 majority authored by Justice Brown in Canada (Attorney General) v Collins Family Trust, held that the equitable remedy of rescission is not available in instances of an honest mistake of fact regarding laws of taxation.
Background
Todd Collins and Floyd Cochran, two principals for two separate corporations, devised a tax plan to protect their corporate assets from creditors without attracting tax liability. This plan relied on s. 75 (2) and s. 112 (1) of the Income Tax Act (“Act”) and utilized a holding company to purchase shares from an operating company through an established family trust. The established family trust, for which the holding company was a beneficiary, would purchase shares in the operating company, the latter of which would then pay dividends to the trusts and attribute it to the holding company. This rather clever and complicated web of legal relationships was designed to move funds from point A to point B without the payment of income taxes.
In 2011, the Tax Court of Canada (“TCC”), reaffirmed by the Federal Court of Appeal (“FCA”) in Sommerer v The Queen, held that the attribution rules in s.75 (2) were inapplicable to property that was sold, rather than gifted or settled to a trust, thus closing the loophole the two principals relied on to avoid attracting income tax liabilities. This change in the authoritative interpretation of the law led to a reassessment of the principals’ returns, and the retroactive imposition of tax liabilities with respect to the dividends paid to the trusts.
The Respondent principals then sued for rescission of all the transactions which led to the dividends being paid out. This action was granted by the chambers judge, and, following an appeal by the Applicant Attorney General of Canada, was affirmed by the Court of Appeal for British Columbia (“BCCA”). The Applicant then, following a further appeal to the SCC, was granted leave shortly thereafter.
Majority Opinion
The majority opinion was authored by Justice Brown and supported by seven other justices. At issue was whether taxpayers were or were not barred from obtaining equitable relief — in the form of rescission — to avoid the unexpected consequences arising from what the majority would describe as the ‘ordinary operation’ of the Act.
The Court held that, as a matter of principle, taxpayers should be taxed based on what they actually agreed to do (and did) and not, as the Respondents are requesting, what they could have done or should have done.
This holding was paired with the Court’s reliance on the principle established in their 2016 rulings in Canada (Attorney General) v Fairmont Hotels Inc. and Jean Coutu Group (PJC) Inc. v Canada (Attorney General), which affirmed that equity cannot relieve tax mistakes. Undergirding this principle is the contention that the ordinary operation of tax statutes, applying to transactions freely agreed upon and entered into, cannot generate an unconscionable or unfair outcome requiring the intervention of the courts of equity. Moreover, an adjacent principle established in the Fairmont Hotels and Jean Coutu decisions, prohibiting retroactive tax planning, would also preclude the granting of equitable relief on the facts of this case.
To conclude, the Court also made clear that the United Kingdom Supreme Court’s (“UKSC”) decision in Pitt v Holt in 2013, relied upon by the BCCA in reaffirming the trial court’s decision, was irreconcilable with the SCC’s holdings in Fairmont Hotels and Jean Coutu, and therefore not applicable in the case at bar.
Dissenting Opinion
The dissenting opinion was authored by Justice Côté, the lone maverick judge in this decision. Justice Côté disagreed with the majority’s contention that rescission, without reservation, cannot serve as an equitable remedy with respect to tax mistakes. Instead, Côté held that, should a taxpayer meet general test for an equitable remedy, the courts have discretion to grant the equitable remedy of rescission should certain conditions be met.
Côté had a diverging interpretation of the principles established in Fairmont Hotels and Jean Coutu, considering its prohibitions applicable specifically to the remedy of rectification. A corollary of this interpretation is Côté’s view that the UKSC’s decision in Pitt v Holt, which recognized the applicability of the equitable remedy of rescission for mistakes made in unilateral transactions, is a persuasive authority in Canadian law. With respect to the facts of the case, Côté also held that a common — rather than specific — intention to limit or avoid tax liability lacks the precision to infer an existing, definite, and ascertainable prior agreement.
The major break between the majority and dissenting opinions in this case concern their respective views on the appropriate boundaries of rescission. For Côté, rescission requires a transaction that was entered into based on a mistaken assumption about either the facts or the law (including in the context of tax law) and is designed to restore parties back to their original positions. For the majority, mistaken assumptions about certain facts and certain laws preclude the application of the equitable remedy, including, in this case, rules of attribution in the Act.
Having established her view of the law of rescission, Côté then proceeded to outline the specific test, conditions, and scope of the equitable remedy of rescission, finding it applicable on the facts of this case.
Key Takeaway
Beyond the niceties of contract law in the tax context, this case illustrates the court’s broader pivot towards limiting the intervention of courts of equity in domains which are primarily the purview of Parliament and the executive branch. The Court’s willingness to view the Canadian Revenue Agency’s (“CRA”) 180-degree shift on the interpretation of s. 75 (2), while still arguing in favour of the original interpretation in the FCA, as not constituting unfairness, evinces an unwillingness to apply a jurisprudential straitjacket to the Federal Government’s ability to modulate their tax policy within the confines of the Act. It broadcasts a word of caution to tax advisors, lawyers, and parties intending to enter into contracts to form their agreements in anticipation of possible oscillations in the direction of tax policy that may materially affect their agreements while remaining in compliance with governing statutes. It also requires a new level of restraint in assuming courts of equity will step in to correct what parties may consider unfair or unconscionable circumstances, demanding a greater degree of diligence in the drafting of agreements by legal counsel.