Rely On The CRA At Your Personal Peril: The (un)Availability Of Equitable Treatments In The Tax Context – Tax Authorities

Introduction

The Supreme Court of Canada

(“SCC“)’s recent decision in Canada (Attorney General) v. Collins Family

Trust, 2022 SCC

26(“Collins“) has seemingly

closed the loop on the (lack of) availability of equitable remedies

in cases involving income tax.

Many taxpayers and tax practitioners are aware that one of the

Canada Revenue Agency (“CRA“)’s

responsibilities is to administer the Income Tax Act 1

(the, “Act“). In doing so, the CRA often

provides their interpretive views on various provisions of the Act,

which generally is helpful and appreciated. What is important for

all to understand, however, is that the CRA is not an authority

when it comes to interpreting the Act. Many tax cases at various

levels of the courts have affirmed this time and time again

2. Perhaps Justice D.G.H. Bowman said it best:

“The appellant argues with great conviction that he

should be entitled to rely on advice given by the CCRA and relied

upon by him in good faith. I agree that the result may

seem a little shocking to taxpayers who seek guidance from

government officials whom they expect to be able to give correct

advice. Unfortunately such officials are not infallible and the

court cannot be bound by erroneous departmental

interpretations. 3”

Is it really fair or reasonable that a taxpayer relying on a

long-standing interpretation published by the CRA must suffer

adverse tax consequences when a court later determines that this

interpretation was incorrect? That is precisely what occurred in

Collins. That case is the latest and, ostensibly, final

judicial decision on whether there are other avenues a taxpayer can

take to seek relief from adverse tax consequences of having

completed a transaction in reliance upon a CRA-approved

interpretation of the Act that is incorrect.

The SCC denied Collins Family Trust (the

Trust“) the ability to undo a

transaction that had been completed in reliance on an

interpretation of the Act that had long been accepted as correct by

both the tax community and, explicitly, by the CRA. The main issue

in Collins revolves around whether the equitable remedy of

“rescission” of a series of transactions (which, if

granted, would have cancelled the transactions altogether and

returned the parties to their respective original pre-transaction

positions) should be available to the Trust, in the context of an

asset protection plan involving tax planning. The asset protection

and avoidance of tax liabilities objectives of the plan were of

equal importance (i.e., this plan was not primarily tax

motivated).

The Collins decision is another step in furthering the

burden put on taxpayers to understand, interpret and comply with

the myriad of complex provisions of the Income Tax Act. Even basic

tax planning transactions frequently have very complex technical

elements, all of which must be followed, and honest mistakes will

occur. Equitable remedies used to be available to correct these

mistakes, but this is no longer the case. Now more than ever it is

essential for taxpayers to have obtained professional tax planning

advice from technically competent firms prior to completing

transactions.

Background

To provide greater context of the legal environment leading up

to the Collins decision, a timeline may be

appropriate:

  • 2008: The Trust was involved in a series of transactions

    pursuant to which it purchased shares of a corporation

    (“Opco“) from another corporation

    (“Holdco“) at fair market value. Opco

    subsequently declared dividends on its outstanding shares that were

    owned by the Trust (which dividends were expected to be attributed

    to Holdco pursuant to subsection 75(2), based on the CRA’s

    long-standing published interpretations 4). The expected

    result was that Holdco would include the dividends in its income

    (claiming an offsetting deduction pursuant to subsection 112(1))

    and the majority of the cash or assets resulting from the

    Trust’s receipt of those dividends would remain with the Trust

    (thereby protecting that cash or assets from claims that could be

    brought by creditors of Opco).
  • 2011: The Tax Court of Canada ruled in an unrelated case

    (Sommerer 5) that the long-standing CRA

    interpretation was incorrect, and that the subsection 75(2)

    attribution provision does not apply to property that is

    sold to a trust at fair market value by a person other than the

    settlor of the trust. The CRA was in the process of

    appealing the Sommerer decision at the same time as

    it was reassessing the Trust on the basis that the

    Sommerer decision was correct! The reassessment issued by

    the CRA to the Trust required that the dividends paid to the Trust

    be included in its income for income tax purposes, which would be

    subject to tax at the highest marginal personal tax rates.
  • 2012: The Federal Court of Appeal upheld the

    Sommerer
  • 2015: The British Columbia Court of Appeal

    (“BCCA“) granted rescission in the

    Pallen 6 case, which had substantially the same

    facts and transactions as Collins. The BCCA upheld the

    decision that the taxpayer should be able to rescind the dividends

    and place the parties back to their original position. The Court in

    the Pallen case determined that to subject the taxpayer to

    the CRA’s reassessment only after the Sommerer

    decision was unfair:

“What took this case “into the zone of

unfairness” in the chambers judge’s mind was the existence

of the “common general understanding” regarding the

operation of s. 75(2). Had the understanding been less certain, he

said, the assumption of risk-taking on the part of the trustee

would likely have led him to the opposite conclusion.”

7

  • 2016: The SCC, in the Fairmont Hotels 8 and

    Jean Coutu 9 cases, found that the equitable

    remedy of rectification (amending a transaction to reflect the

    parties’ intentions) is not available where the intended tax

    result was not achieved. In Fairmont Hotels, the taxpayers

    intended that certain transactions be carried out in a tax neutral

    manner, however, the transactions entered into resulted in the

    taxpayers incurring tax. The SCC determined that rectification

    should be available to “correct” a transaction only where

    the transaction was not implemented as agreed upon, and that

    rectification should not be available to correct a transaction in

    order to achieve the intended result. Following the

    SCC’s decisions in the Fairmont Hotels and Jean

    Coutu cases, many tax practitioners were hopeful that the

    denial of the equitable remedy of rectification in those cases

    would not preclude a grant of the different equitable remedy of

    rescission from continuing to be available in the case of

    transactions that were entered into under a mistaken assumption

    about the facts or the law.
  • 2019: The British Columbia Supreme Court granted rescission in

    the Collins case based on the BCCA’s decision in

    Pallen, which the Court felt bound to follow (otherwise it

    appears rescission may not have been granted).
  • 2020: The BCCA decided that rescission should be available in

    the Collins case and that the Fairmont Hotels

    case should be interpreted narrowly, as to apply to rectification

    only and not to all types of equitable remedies.
  • 2022: The SCC reversed the BCCA Collins decision,

    finding that rescission should not be available to annul the

    transactions and that the Trust should be subject to tax on the

    dividends paid to it. In the majority decision, the SCC held:

. the Minister was bound to apply

Parliament’s direction in the

Act, as interpreted by a court of law, unless and

until that interpretation is judged to be incorrect by a higher

court. Unless a statute gives the

Minister the power to deviate from that direction,

the Minister may not

deviate; nor may

a court undermine that direction by resort to equity,

since there is nothing unconscionable or unfair about the

Minister administering the Act

as Parliament directs. Equity

is the conscience of the common law, not

of Parliament. 10

The one dissenting Justice disagreed, however, stating:

“In my view, what takes this case into the zone of

unfairness is not the application of the law, but rather the

CRA’s discretionary decision to reassess the taxpayers based on

a retroactive approach to s. 75(2). Unfairness results when the CRA

reverses a longstanding interpretation and then seeks to reassess a

taxpayer retroactively.” 11

Debating the merits of the dissenting Justice’s position may

be appealing, however any such discussion would be purely academic

as the majority of the SCC found in favour of the Crown and the law

of the land is now that Fairmont Hotels should be

interpreted broadly as to be applicable to all types of equitable

remedies.

Takeaway

Taxpayers and tax advisors need to be aware that there are four

main principles that should be applied to determine whether any

equitable remedy is available to a taxpayer:

  1. Tax consequences do not result from a taxpayer’s

    motivations or objectives. Rather, the tax consequences result from

    the freely chosen legal relationships, as established by their

    transactions;
  1. Taxpayers should not be denied the benefit of minimizing their

    tax liability, which would be achieved based on the ordinary

    operation of the Act, however, this also cuts the other way:

    taxpayers should not be afforded relief from an increased tax

    liability by that same ordinary statutory operation, based solely

    on what they would have done had they known better;
  1. It is not a question of whether the Crown or the taxpayer would

    receive a benefit; rather, the question is what did the taxpayer

    agree to do, and that alone is what will dictate the tax

    consequences; and
  1. A court may not modify an agreement (or other instrument)

    merely because a party discovers that it results in an adverse and

    unplanned tax liability.

The key takeaway is that it will be nearly impossible to obtain

any equitable relief in the tax context unless the high bar set-out

in Fairmont Hotels is met, whereby mistakes may be

corrected only where:

  1. it can be established to a court’s satisfaction that a

    document does not accurately record an agreement, or
  1. a party can show that another party knew or ought to have known

    about a mistake and derived a benefit from the mistake (amounting

    to fraud).

These restrictions are very limiting and will likely not be

applicable in the vast majority of cases. What this means for

taxpayers is that they need to be aware and have a thorough

understanding of the consequences of any tax planning transactions,

“eyes wide open” so to speak. Furthermore, it is

imperative to understand that CRA published interpretations should

not invariably be relied upon; while they often are helpful and

welcomed, they could be incorrect. The advice of skilled tax

professionals definitely should be obtained in both planning and

implementing a transaction.

For tax practitioners, consider adding a caution to engagement

agreements regarding the risk of relying on CRA published opinions

regardless of how long-standing they may be, and have conversations

with clients emphasizing that the CRA’s published

interpretations are neither law nor binding on the CRA. It is also

of paramount importance that any tax planning transaction be

implemented precisely as intended and be rigorously reviewed.

A Word about Advance Tax Rulings

Advance tax rulings provided by the CRA still have a purpose in

the tax arena as they allow taxpayers the ability to have the CRA

provide its view on whether a proposed transaction will provide the

result the taxpayer is expecting. Technically speaking, advance tax

rulings have always been non-binding on the CRA, however their past

practice has been to honour the rulings provided with certain

reasonable caveats. The use of advance tax rulings may reduce the

risk of having a transaction be reassessed by the CRA, however,

even the dissenting opinion in Collins provided “But

even if the respondents had asked for an advance ruling, the

CRA’s advance rulings do not constitute law and are not binding

on the courts” 12. Advance tax rulings may provide

insight into how the CRA currently views a transaction; they do not

afford protection from the CRA’s misinterpretations of tax

law.

End of the Road?

The SCC ruling, in the wake of the Collins decision,

has effectively shut the door to any equitable remedies to alter

the tax consequences of “mistakes”. However, one ray of

hope remains. In his reasons for judgment, Justice Brown stated:

“If there is to be a remedy, it lies with Parliament, not a

court of equity” 13. It is open to provincial

legislatures to take measures to statutorily empower their

respective provincial courts to issue orders of rectification,

rescission and other equitable remedies where the context of a

transaction can be taken into account and discretion used by a

court to decide whether to correct a mistake where it would be

unfair to leave it uncorrected, or to hold taxpayers accountable

where the facts support a finding that “retroactive tax

planning” is sought.

Provincial courts could be handed these tools and many in the

tax community (including our Firm) are reaching out to their

respective provinces to make the case to provide the courts with

these tools. However, until such time, Collins and

Fairmont Hotels are law in Canada so taxpayers will be

required to bear the tax burdens of their transactions regardless

of the circumstances surrounding them.

Footnotes

1. The Income Tax Act, RSC 1985, c.1 (5th Supp.), as

amended.

2. Moulton v. R., 2002 CarswellNat 262, (2002) 2

C.T.C. 2395, 2002 D.T.C. 3848(TCC).

Goldstein v. R., (1995) 2 C.T.C. 2036, 1995 CarswellNat

438 (TCC);

Watanabe v. R., 1999 CarswellNat 459, (1999) 2 C.T.C.

2962, 99 D.T.C. 822 (TCC);

Michaud v. R., 2011 CarswellNat 5422, 2011 TCC 573, 2012

D.T.C. 1048 (TCC); and

Wellington v. R. (2004), 2004 TCC 313, 2004 CarswellNat

1107, (2004) 3 C.T.C. 2402, 2004 CarswellNat 5802 (TCC) to name a

few.

3. Moulton v. R., 2002 CarswellNat 262, (2002) 2

C.T.C. 2395, 2002 D.T.C. 3848 (TCC) at para 11

4. E.g., Technical Interpretation Bulletin IT-369R, CRA

Views 9332575, CRA Views 2002-0118255, CRA Views 2004-0086941C6,

and CRA Views 2001-0116045.

5. Sommerer v. R. (2011), 2011 CarswellNat 1157,

2011 CarswellNat 4026, 204 A.C.W.S. (3d) 674, (2011) 4 C.T.C. 2068,

2011 D.T.C. 1162 (Eng.), 2011 TCC 212, 2011 CCI 212

((T.C.C.)).

6. Pallen Trust, Re, CarswellBC 1326, 2015 BCCA

222.

7. Ibid at para 56.

8. Canada (Attorney General) v. Fairmont Hotels

Inc., 2016 CarswellOnt 19252, 2016 SCC 56.

9. Jean Coutu Group (PJC) Inc. v. Canada (Attorney

General), 2016 CarswellQue 11182, 2016 SCC 55.

10. Collins at para 26.

11. Ibid at para 80.

12. Collins at para 89.

13. Ibid at para 11.

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