SCC Update on Tax Rectification – Toronto Tax Lawyer Analysis – Part II

Part I of this article provided background on the doctrine of rectification and how it is used in the Canadian tax context. This part II will review the facts of Canada (Attorney General) v. Fairmont Hotels Inc. and the decisions made by the lower courts.

Facts – Canada (Attorney General) v. Fairmont Hotels Inc.

In 2002, Fairmont Hotels and its subsidiaries assisted Legacy Hotels REIT in financing the purchase of two hotels in the United States through a reciprocal loan arrangement. Since the financing was to be done in US currency, Fairmont was concerned about tax liability that could arise from changes in the exchange rate. As a result, the transaction was structured to achieve foreign exchange tax neutrality. This was achieved by ensuring that any loss from foreign exchange fluctuations would be offset by a corresponding gain and vice versa. If you are concerned about the tax implications of foreign exchange fluctuations on your business, consider reaching out to one of our top Toronto tax lawyers.

In 2006, Fairmont Hotels was acquired by Kingdom Hotels International and Colony Capital LLC. This acquisition threatened to cause Fairmont Hotels and its subsidiaries involved in the reciprocal loan arrangement to realize a deemed foreign exchange loss without the corresponding gains. That would compromise the ability of the structure to provide foreign exchange tax neutrality. Fairmont responded to this by executing a plan that fixed the problem for Fairmont itself, but deferred solving the problem for its subsidiaries until a later date. If you are involved in the purchase or sale of a business and would like to know more about tax traps and planning opportunities, please contact one of our experienced Toronto tax lawyers.

In 2007, Legacy Hotels REIT decided to sell the hotels and requested on short notice that Fairmont unwind the reciprocal loan agreement. Fairmont proceeded to do this without realizing that since they never fixed the foreign exchange tax neutrality problem for the subsidiaries, they would face adverse tax consequences. The Canada Revenue Agency uncovered this fact as part of the tax audit of Fairmont’s 2007 tax returns. Fairmont then applied to the court to rectify the director’s resolutions they used to unwind the reciprocal loan agreement so as to maintain the foreign exchange tax neutrality the structure was originally designed to ensure.

Judicial History – Canada (Attorney General) v. Fairmont Hotels Inc

The Ontario Superior Court of Justice found in favour of Fairmont Hotels. The Superior Court found that Fairmont a continuing intention to maintain foreign exchange tax neutrality and that Fairmont did not have a specific plan as to how they would achieve that outcome. Relying on Juliar v. Canada (Attorney General), the Superior Court found that it was not necessary for Fairmont to have a specific plan in mind to qualify for rectification. The Superior Court took the position that Fairmont’s continuing intention to maintain foreign exchange tax neutrality meant that their rectification request was not an instance of retroactive tax planning and that denying Fairmont’s application would give the Canada Revenue Agency an unintended gain.

The Ontario Court of Appeal also found in favour of Fairmont Hotels. The Court of Appeal found that the critical component for rectification is the continuing intention to undertake a transaction on a specific tax basis. According to the Court of Appeal, rectification does not require the parties to know the precise mechanics or specific means by which they would achieve their intended tax result so long as the intention to achieve that tax result can be demonstrated. Please continue to part III of this Toronto tax lawyer tax rectification article which will discuss the Supreme Court of Canada’s decision and its implications for taxpayers.

Read previous part of this article SCC Update on Tax Rectification Part 1.

SCC Update on Tax Rectification – Toronto Tax Lawyer Analysis – Part II

Tax Rectification – Toronto Tax Lawyer Analysis – Part I

Tax rectification is a remedy that can be sought when a legal document fails to reflect the tax intent of the parties to that document. When granted the court will retroactively alter the text of the document to reflect the original intentions of the parties. Rectification has been used extensively for the purposes of fixing tax problems by having the court alter the documents which gave rise to the mistake. It should also be noted that although the parties to an agreement can agree to amend the agreement, that amendment is not effective retroactively against the CRA unless an order from the court granting rectification is obtained. If you have a tax problem, please contact one of our experienced Toronto tax lawyers to discuss if rectification may be available to provide you with tax help.

The key tax rectification case until Fairmont Hotels was Juliar v. Canada (Attorney General), where the taxpayer was involved in reorganizing a family business. The taxpayer was a party to a written agreement that exchanged shares for promissory notes. The parties had intended for the transaction to occur on a tax deferred basis, but it turned out that the value of the promissory notes exceeded that of the shares, which resulted in a deemed dividend. If the taxpayer had proceeded by way of a share for share exchange then the transaction would have been completed on a tax deferred basis. The taxpayer then successfully applied to the court to rectify the transaction by altering the written agreement so that it was a share for share exchange on the grounds that the original written agreement failed to reflect the parties’ intention for the transaction to proceed on a tax deferred basis. Our expert Toronto Tax Lawyers can help in properly implementing a tax reorganization.

Canada (Attorney Genera) v. Fairmont Hotels Inc., the Supreme Court of Canada’s latest decision on rectification, is a significant development because it narrows the scope of when taxpayers can ask the court for rectification. Court orders for rectification will no longer be available in situations similar to Juliar v. Canada (Attorney General). Despite this, there is still room for the doctrine of rectification to be relevant in the Canadian tax context. In light of this decision, taxpayers will need to adopt new strategies both to avoid the need for rectification orders and to be able to obtain one if necessary. If you would like to learn more about how to respond to the Supreme Court of Canada’s decision, please contact one of our experienced Toronto tax lawyers.

Part I of this article provided background on the doctrine of rectification and how it is used in the Canadian tax context. Part II will review the facts of Canada (Attorney General) v. Fairmont Hotels Inc. and the decisions made by the lower courts. Part III will discuss the Supreme Court of Canada’s decision and its consequences for taxpayers going forward.

Read the next part of this article by clicking on SCC Update on Tax Rectification.

Tax Rectification – Toronto Tax Lawyer Analysis – Part I

Requirement to File Income Tax Returns

File Income Tax Returns

Unfiled Tax Returns

The general obligation to file income tax returns is set out in section 150 of the Income Tax Act.

Corporation Income Tax Filings

All corporations resident in Canada have to file T2 income tax returns within 6 months of their year end.  There is no requirement that corporations have a calendar year end. Corporations that are not resident that are carrying on business in Canada or realize a capital gain during the year or dispose of taxable Canadian property also have an obligation to file a Canadian corporate tax return.

Trust and Estate Tax Returns

Trusts and estates have a calendar year end and are required to file T3 income tax returns within 90 days of the year end.

Individual Tax Returns

As a general rule individuals are required to file T1 tax returns by April 30 of each year, however there are exceptions. Individuals with self employment income have until June 15 to file their tax returns. If an individual had no taxable income during the year, there is no obligation to file a tax return unless the individual had a capital gain during the year of disposed of capital property, or unless CRA issues a demand to file a tax return under subsection 150(2).

Offences for Failure to File

Failure To File Offence

Failure to file a return is an offence under subsection 238(1) and is punishable by a fine of between $1,000 and $25,000 plus a possible jail sentence of up to 12 months.  These penalties are applicable for every failure to file and each unfiled year is a separate offence, so failure to file 3 years of returns would be subject to a minimum penalty of $3,000.

Tax Evasion Offence

If CRA can prove that the failure to file the income tax returns was a deliberate attempt to evade the payment of income taxes, they can and do bring tax evasion charges under paragraph 239(1)(d).  The penalties on conviction for income tax evasion are much more severe, with fines of between 50% to 200% of the tax evaded plus possible jail time of up to 2 years.  CRA may also elect to proceed by indictment under subsection 239(2) in which case the penalties increase to between 100% to 200% of the taxes evaded plus possible imprisonment of up to 5 years.

CRA Procedures

Requests and Demands to File Returns

CRA does not generally proceed to bring charges whenever it finds a taxpayer has failed to submit the required tax returns.  CRA’s policy is to encourage compliance with the Income Tax Act.  When they come across a taxpayer who has failed to file tax returns they normally send a request to file the missing returns.  If that request is not complied with then normally a Demand to file under subsection 150(2) is issued.  Only if the Demand is ignored will they proceed to prosecution, usually under 238(1).  When faced with clients being prosecuted with multiple years of unfiled returns our Canadian income tax litigation lawyers  are usually able to negotiate a plea bargain to plead guilty and pay the minimum penalty for just one year by bringing all years into compliance prior to the trial.

Requirement to File Income Tax Returns