When parties to an agreement need to correct errors in the recording of their agreement, one solution is to go to court and seek a revision of the relevant documents through the equitable remedy of rectification. However, two decisions released by the Supreme Court of Canada in 2016 placed significant limits on the availability of rectification where unexpected tax consequences are involved.[1]
While the Supreme Court decisions initially created an impression that rectification was no longer an approach to be considered in the context of transactions with unintended tax consequences, a number of recent successful applications for rectification before the Ontario Superior Court demonstrate that rectification remains an appropriate remedy in the right circumstances. Key factors to success include providing the court with appropriate, detailed and clear supporting evidence as to the parties’ intentions and the mistake, as well as receiving, where possible, the cooperation of the Department of Justice’s rectification committee through a letter of non-opposition.[2]
Slightham
In 2023, Dentons successfully obtained a rectification order before the Ontario Superior Court (Commercial List) in Slightham et al. v. The Attorney General of Canada (Slightham).[3] The case involved two trusts, each of which had a family holding corporation (Holdco) as a beneficiary. The trusts owned shares of the family operating company (Opco). The structure was intended to allow dividends received by the trusts from Opco to be distributed to Holdco, thereby avoiding any tax on the dividends. However, a drafting error in the two trust deeds prohibited the trustees of the trusts from distributing to Holdco any dividends received from Opco, thereby vitiating the intended tax effects of the structure. The trustees of the trusts were unaware of the restriction and therefore approved the distribution of the Opco dividends to Holdco. The trusts then claimed deductions for distributed income. Canada Revenue Agency (CRA) denied the deductions claimed by the trusts on the grounds that the distributions were prohibited under the trust deeds. The trustees were compelled to seek an order from the Ontario Superior Court rectifying the two trust deeds on a retroactive basis. CRA reviewed the application record and did not oppose the order sought.
Osborne J concluded that rectification was appropriate in the circumstances on the basis that the trust deeds drafted did not reflect the true agreement of the parties to the trusts. In Osborne J’s view, the application record was clear that the parties were not trying to alter their agreement to avoid an unintended tax consequence. With the aid of affidavits from the parties and their advisors, corroborating contemporaneous documents, and evidence that spoke to the subsequent conduct of the applicants and advisors, the Ontario Superior Court held that a prior agreement existed and that the parties always intended that the trustees could allocate to Holdco dividends received by the trusts from Opco.
1691734 Ontario Inc.
In 2024, Dentons secured another successful rectification, this time under the statutory rectification remedy available under the Business Corporations Act (Ontario) (OBCA), in 1691734 Ontario Inc. et al. v. 1840671 Ontario Limited (1691734 Ontario Inc.).[4] In this case, two corporations amalgamated through a short-form horizontal amalgamation under the OBCA. Prior to the amalgamation, the shares of both predecessor corporations were transferred by two individuals to the same corporate shareholder (Holdco). Consequently, pursuant to subsection 177(2) of the OBCA, Holdco should have been the sole shareholder of the amalgamated corporation (Amalco). However, the post-amalgamation records of Amalco erroneously recorded the two individuals, rather than Holdco, as the shareholders of Amalco. As a result, the correct shareholder was omitted, and the incorrect shareholders were named, in the registers and records of Amalco.
Section 250 of the OBCA offers a statutory form of rectification, and is available where the name of a person is alleged to be or have been wrongly included in or excluded from the records of a corporation. The same guiding principles of equitable rectification apply when determining whether to grant equitable relief under section 250.[5] Holdco and Amalco brought an application to the Ontario Superior Court seeking rectification under this section. CRA reviewed the application record and took no position on the order sought.
With the aid of the material in the application record before him, Black J determined that a mistake was made at the time of preparing the corporate records, erroneously identifying the individuals rather than Holdco as the shareholders. Black J was satisfied that Holdco was intended to be sole shareholder and that the two individuals were never intended to be identified as shareholders. The record included affidavits from the impacted individuals, contemporaneous documents, and evidence that the parties conducted themselves following the amalgamation on the assumption that Holdco was correctly named shareholder, including paying dividends from Amalco to Holdco. The Ontario Superior Court granted rectification of Amalco’s registers and records to reflect the true shareholder of the corporation under section 250.
Pyxis Real Estate
Finally, the case of Pyxis Real Estate v. Attorney General of Canada (Pyxis Real Estate)[6] demonstrates that even in the face of CRA opposition, the court may still grant rectification where the facts support that there was genuine error in the recording of parties’ prior agreement. This case involved four corporations (each a Holdco) and an individual (the Owner) connected through a chain of sole shareholder-subsidiary relationships. The Owner was sole shareholder of the ultimate parent Holdco.
As part of a remuneration and corporate clean-up strategy, the Owner and his accountants planned to pay tax-free capital dividends up through all four corporations in order to pay out CA$1.4M to the Owner. Unfortunately, in determining the amounts to be paid up from each Holdco, the Owner’s accountants were unaware that one of the Holdcos (hereafter DeficitCo) had a capital dividend account (CDA) deficit. This meant that the capital dividend received by DeficitCo would need to be large enough to cover the deficit plus CA$1.4M if the Owner was going to receive a CA$1.4M capital dividend. CRA reassessed Part III tax against DeficitCo for paying a capital dividend in excess of its CDA balance and the Holdcos sought rectification to correct the documents and nullify the invalid payout.
CRA opposed rectification on the basis that there was no mistake in recording the terms of the agreement and that the Holdcos really sought retroactive tax planning. In CRA’s view, the terms of the planning memorandum used for the transaction were drafted based on a mistaken assumption of the accountants. Koehnen J, however, determined that in reviewing the memo as a whole, it was clear that the objective was to pay CA$1.4M to the Owner and take the steps required to achieve that objective. Such steps required eliminating DeficitCo’s CDA deficit and, per Koehnen J, the only way to give business efficacy to the transaction was for the amount of the original dividend to be increased to cover the CDA deficit. Accordingly, the Ontario Superior Court granted rectification amending the dividend documents to approve a higher capital dividend amount paid to DeficitCo, noting that it would not be equitable to impose adverse tax consequences on the Owner “because an accountant made a careless error in implementing and agreed upon structure and an agreed upon objective…”.[7]
Conclusion
Recent successes in Ontario rectification cases are an encouraging reminder that, in the right circumstances and with the proper supporting evidence, rectification remains a viable and effective remedy to address unintended drafting errors that may result in tax consequences. Dentons has continued to build its success in navigating the rectification process, which can be lengthy and complex. Our experienced legal counsel can ensure that a rectification application record is detailed, accurate and complete with the appropriate supporting evidence. If you would like to learn more, please reach out to Douglas Stewart or Hannah Bourgeois.
[1] Canada (Attorney General) v. Fairmont Hotels Inc., 2016 SCC 56 and Jean Coutu Group (PJC) Inc. v. Canada (Attorney General), 2016 SCC 55; see also Canada (Attorney General) v. Collins Family Trust, 2022 SCC 26.
[2] Note that the process of working with the Department of Justice to potentially obtain a letter of non-opposition can take at least several months and in many cases over a year.
[3] 2023 ONSC 6193; Dentons discussed this case previously in Douglas B.B. Stewart, “Down but not out: Rectification granted by the Ontario Superior Court to correct trust deeds” (November 23, 2023) Dentons Insight.
[4] CV-24-00726424-00CL (endorsement not published online).
[5] John Richard Southwell v. Carlgate Development Inc., Julie Anne Reis and Isabelle Margaret Southwell, 2024 ONSC 822 at para 59.
[6] 2024 ONSC 2039.
[7] Ibid at para 30.
