Supreme Court of Canada Confirms No Retroactive Tax Planning Allowed

Lawyers and accountants advise clients on options for organizing their personal and business affairs in a tax-efficient way. Clients enter into arrangements and transactions, making choices based on their understanding of what the outcome will be. Typically, it’s as was expected – but sometimes, it’s not. When that happens, can clients revisit their choices? In its June 17, 2022, decision in Canada (Attorney General) v. Collins Family Trust, the Supreme Court of Canada confirmed that Canadian superior courts will not grant an equitable remedy, either rectification or rescission, to undo or alter a concluded transaction or its documentation absent any implementation error, and if solely intended to avoid a tax liability arising from the ordinary operation of a tax statute – even if the tax rules change after the transaction was implemented. So while tax planning continues to have value, there’s always a risk: a tax strategy that’s good today, might not be good tomorrow.

“Equitable” Remedies 

It’s well established that Canadian courts can grant orders to protect against unfair outcomes, such as those resulting from fraud, unconscionable transactions, and undue influence. Each Canadian superior court is both a court of law and a “court of equity”. Thus, although a contract (and contract law) might dictate a certain outcome, a court can alter that outcome if it appears to be unconscionable or unfair. But while the outcomes dictated by taxation laws might be seen to be unfair, courts have held that the ordinary operation of a tax laws isn’t a basis for equitable relief.

Rectification. Until December 2016, the courts of most Canadian provinces were quite permissive in terms of allowing individuals to re-engineer their affairs if an unexpected negative outcome was encountered, acting further to the court’s equitable jurisdiction to rectify documents and transactions. However, in its December 2016 decisions in Jean Coutu Group (PJC) Inc. v. Canada (Attorney General) and Canada (Attorney General) v. Fairmont Hotels Inc., the Supreme Court of Canada tightened the situations in which courts can grant “rectification” orders: a judge can correct errors that occurred in the implementation of a pre-existing plan; a judge can’t engage in “retroactive planning” by rectifying documents and transactions, creating and effecting a new plan.

Rescission. Rescission, like rectification, is a means by which a superior court can ensure the application of the law doesn’t effect an inequitable outcome by unwinding or voiding a contract completely. The Fairmont Hotels decision left an important question unanswered: If a transaction couldn’t be rectified, could it nevertheless be rescinded? 

Collins Family Trust

In Collins Family Trust, an accountant proposed a plan that would provide a number of benefits, including tax efficiency. The plan included the incorporation of a holding company and, the creation of a family trust. The holding company was to be the beneficiary of the family trust. The family trust borrowed funds from the holding company to purchase shares of the operating company. The family trust then earned dividends on its operating company shares. The family trust intended to pass its income to the holding company, and to do so without paying income tax, by operation of subsections 75(2) and 112(1) of the Income Tax Act. The holding company could then manage its affairs in a flexible and tax-efficient manner. Unfortunately, after this structure was set up, the Tax Court of Canada decided subsection 75(2) wasn’t available for such a structure. This decision caused the Collins family structure to fail to achieve its intended outcome: the family trust became liable to pay income tax immediately – and at the highest marginal rate.

Trial & Appeal. The Collins Family Trust applied to the B.C. Supreme Court for orders to rescind the agreements that created the structure on the basis it was inequitable not to rescind the transactions in view of the change in the tax consequences. Following the 2015 B.C. Court of Appeal decision in in Pallen Trust that a taxpayer’s mistake regarding the interpretation of a particular subsection of the Income Tax Act was a sufficient basis for the Court to grant rescission, the B.C. Supreme Court granted the rescission order. The Attorney General of Canada appealed to the B.C. Court of Appeal, but was unsuccessful.

Supreme Court of Canada. The Attorney General obtained leave to appeal to the Supreme Court of Canada – and succeeded. The Supreme Court of Canada framed the issue as whether a taxpayer can obtain the equitable remedy of rescission to reverse a series of transactions to avoid unanticipated adverse tax consequences. The Court recognized that, in deciding the case, it must decide whether Pallen Trust (and other earlier decisions, such as the 2013 U.K. case of Pitt v. Holt) remained correct in the face of Fairmont Hotels. The Court held the limits on the rectification remedy it confirmed in Fairmont Hotels apply to all forms of equitable relief: equity is available to correct negative outcomes due to errors made in the implementation of a plan, but there is a general prohibition on retroactive tax planning by way of equitable remedies. And the simple operation of a tax statute, absent any implementation error, is not a matter calling for an equitable remedy:

Tax consequences do not flow from parties’ motivations or objectives. Rather, they flow from their freely chosen legal relationships, as established by their transactions. A taxpayer should neither be denied nor judicially accorded a benefit based solely on what they would have done had they known better. 

Please contact your McInnes Cooper lawyer or any member of our Tax Solutions Team @ McInnes Cooper to discuss how we can help you mitigate the risks to your tax planning structures.