Rectification May Reduce Tax-Planning Negligence Claims
In McPeake v. Canada (2012 BCSC 132), the taxpayer was reassessed by the CRA because a trust deed was drafted without consideration of the attribution rule in subsection 75(2). The taxpayer was able to correct this problem by obtaining a rectification order from a court. The scope of the order was broader than a mere correction of inadvertent drafting mistakes; consequently, the case may have expanded the scope of rectification to cover corrections of tax-planning errors. The CRA has not appealed the decision.
Mr. M owned shares of a company. He wanted to have some of the gain on the eventual sale of the shares taxed in the hands of his family members, each of whom had access to a separate capital gains exemption. A trust was established for this purpose; however, deficiencies in the trust deed caused the gain on sale to be attributed back to Mr. M under subsection 75(2). The issue was that the deed provided for a potential reversion of the trust's assets to Mr. M (because he was acting as the sole trustee at the time the shares were sold). The trustees obtained an order to rectify the deed to correct this problem, without any opposition from the CRA.
Not long after, the CRA issued new reassessments on the basis that the order failed to correct all of the errors in the deed, and it took the position that the trust's income would still be attributed to Mr. M. The CRA relied on the fact that all decisions required the unanimous consent of the trustees and that Mr. M could become the sole trustee. In either case, Mr. M would have control over the disposition of the trust's assets and the selection of its beneficiaries. The trustees sought a second rectification order, and this time the CRA opposed the application.
The taxpayers successfully demonstrated that the trust had been established in anticipation of the future sale of the business with the goal of maximizing the available capital gains tax exemptions. The taxpayers contended that the application of the attribution rules was not deliberate and was merely the result of drafting errors. Dorgan J allowed the terms of the trust deed to be rectified (that is, corrected) so that the attribution rules would not apply. The basis of her order was that the intention of the parties was not properly implemented in the final deed.
The purpose of the equitable remedy of rectification is to fix a document that, as a consequence of an error, does not accurately reflect the parties' prior shared intention. Rectification, as commonly understood and applied, is used to correct mistakes made when there is a drafting error (for example, a wrong name on a contract) or when an incorrect fact is relied on (for example, a mistaken cost base of shares, as in Attorney General of Canada v. Juliar, 2000 CanLII 16883 (ONCA)), or when a class of shares not authorized in the articles of incorporation is issued as consideration in a section 85 rollover (as in Dale et al. v. The Queen, 97 DTC 525 (FCA)).
In McPeake, it appears that the advisers did not make a drafting error and did not rely on incorrect facts. Rather, it appears that they failed to review the potential application of subsection 75(2). The decision suggests that rectification may be successfully sought when there was a stated intention to obtain a tax result but the advisers failed to achieve that result because they did not consider relevant tax provisions.
Can it be argued that McPeake has expanded the concept of rectification to situations in which the parties can demonstrate that there was a shared general intention to avoid or reduce the application of income tax but no specific intention to avoid the application of particular tax rules? If that is the case, the decision may have created a special application of the remedy of rectification to income tax matters. It may also have provided a mechanism for tax advisers to reduce or avoid negligence claims by correcting tax-planning errors through rectification.
Heenan Blaikie LLP, Toronto