In Canada (Attorney General) v. Collins Family Trust (2022 SCC 26), the Supreme Court of Canada (SCC) effectively closed the door on the equitable remedy of rescission where the result would amount to retroactive tax planning.
The taxpayer relied on a widely-accepted – and CRA endorsed – interpretation of a certain provision the Income Tax Act (ITA) when structuring its affairs. Subsequently, an unrelated court decision identified that the relevant provision had been misinterpreted and established the proper interpretation. Applying the proper interpretation to the taxpayer’s transaction resulted in unintended tax consequences. The taxpayer sought to rescind the transaction on the basis that it would not have completed the transaction but for the widely-accepted, but incorrect, interpretation.
The SCC held that the remedy of rescission was not available to the taxpayer. Rescission is an equitable remedy that undoes a transaction with the aim of putting the impacted parties in the same position they would be had the transaction not occurred. The SCC held that equitable remedies, such as rescission, are appropriate “where it would be unconscionable or unfair to allow the common law to operate in favour of the party seeking enforcement of the transaction.” (paragraph 11) However, there is nothing unfair about parties being taxed based on transactions they completed. Taxpayers must recognize that there is always a risk of a change in the interpretation or application of the law that may result in adverse tax consequences, even for years that have passed.
Background of the case
Rite-Ways Metals Ltd. implemented a structure involving the Collins Family Trust (the Trust) with the aim of protecting its assets from creditors without incurring tax liability. When the structure was set up in 2008, it was believed to allow for tax-free amounts to be paid to the Trust due to the widely-accepted interpretation of the trust attribution rule in subsection 75(2) of the ITA. However, in 2011, a court decision corrected the interpretation of the trust attribution rule. Under the new interpretation, the trust attribution rule did not apply to the Trust, meaning the amounts the Trust received were taxable dividends.
The Trust applied for rescission to undo the structure. Both lower courts granted the rescission remedy. The government appealed these decisions to the SCC.
Supreme Court of Canada’s Findings
The SCC declined to grant the remedy of rescission. The SCC reiterated some basic concepts of the Canadian tax system:
- The CRA is bound to apply tax legislation as it is drafted by parliament and interpreted by the courts.
- Taxes result directly from the legal relationships or transactions established by the taxpayer.
The SCC held that the courts cannot modify a legal agreement, instrument or legal relationship between taxpayers just because a party discovered that there was an adverse or unplanned tax liability. Either the parties failed to conduct the appropriate due diligence to avoid such tax liability, or they are – like the Trust – negatively impacted by the ordinary operation of the Canadian legal system. Regardless, modifying the agreement would result in the courts participating in retroactive tax planning, which the SCC sought to prevent: “It follows that the prohibition against retroactive tax planning […] should be understood broadly [to preclude] any equitable remedy by which it might be achieved, including rescission.” (paragraph 7)
Does the SCC’s decision affect rectification?
Aside from rescission, another equitable remedy taxpayers often attempt to use to avoid unintended tax consequences is rectification. Where rescission seeks to undo a transaction, rectification seeks to alter an instrument recording a legal agreement where the instrument does not correctly reflect the intent of the parties to that agreement. The SCC referred to its prior decisions on rectification where it held that granting rectification was not possible if the result is retroactive tax planning. Rectification is still available provided that the purpose of the rectification is to cure the instrument of its failure to reflect the intent of the parties and not to engage in retroactive tax planning. Granting rectification to fix the instrument for non-tax reasons could equally result in a benefit to the CRA.
When are equitable remedies available?
Collins Family Trust likely closes the door on rescission and on using equitable remedies to avoid unforeseen or unintended tax consequences. Instead, equitable remedies should only be available where the legal agreements do not reflect the parties’ agreement and the tax impact is purely incidental. To allow otherwise would lead to retroactive tax planning.
