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.