Taxes are inevitable. In business transactions, strategic decisions are made to reduce or eliminate the amount of taxes paid. Whether your business is making a purchase, refinancing or allocating funds, the terms of any agreement between parties to such a transaction may affect the amount of tax that must be paid. Mistakes or misunderstandings can result in tax implications greater than the parties had contemplated.
In law, contracts can be “rectified” by our courts if the written agreement does not reflect what was actually intended to be contained in the contract. Over the last few years, Canadian courts have trended towards being flexible where parties intended to achieve a particular tax result, but the desired tax result did not occur. In these cases, an Order from the Court would often grant rectification and allow the parties to re-characterize the contractual relationship.
However, the Supreme Court of Canada recently constrained the ability of courts to grant rectification for tax purposes. In Attorney General (Canada) v. Fairmont Hotels Inc., the Supreme Court of Canada ruled on when parties will be granted rectification. No longer will the parties’ intentions to avoid or minimize tax be sufficient to obtain rectification. Rectification will only be available if there is a mistake in the contract, such as a typo, but errors in the actual intended agreement will not be eligible.
Although the Fairmont decision does not eliminate the Court’s discretion to grant rectification, it does narrow the availability of rectification. This decision underscores the importance of careful legal drafting. The manner in which the contract is drafted must clearly demonstrate the parties’ intentions. This decision highlights the importance of tax planning in your business, and may result in more legal actions commenced against advisors, such as accountants and lawyers, when a court declines to rectify problems in a contract that could have been avoided with proper consideration and drafting.
Whether your business is looking ahead to a transaction and you are concerned about potential tax implications, or your business is in the unfortunate situation where you have suffered an unintended adverse consequence, significant legal questions arise regarding appropriate strategies to pursue and how to allocate responsibility. In either case, you would be well served seeking quality legal advice.