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The Supreme Court of Canada Rules in Favor of Taxpayers Regarding Retroactive Rectification of Documents and their Enforceability Against Tax Authorities

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Tax Bulletin

On November 28, 2013, in the Services environnementaux AES Inc. case, the Supreme Court of Canada ("SCC") has confirmed a decision of the Québec Court of Appeal ("QCA") which retroactively rectified documents that did not reflect the parties' intent and made them enforceable against tax authorities[1].

As part of a reorganization of their business, Services environnementaux AES Inc. ("AES") and Centre technologique AES Inc. ("Centre technologique") had entered into an agreement using statutory provisions allowing rollovers so as to obtain a tax deferral.  However, the adjusted cost base of the transferred shares was mistakenly overstated and the Agence du revenu du Québec ("ARQ") assessed AES regarding the capital gain arising from such overstatement.  In order to remedy this situation, AES and Centre technologique filed with the Québec Superior Court ("QSC") a motion for rectification of documents and declaratory judgment to enable them to modify the documents relating to the transaction. 

The QSC allowed such modification and declared that same had retroactive effect and was enforceable against third parties and in particular the tax authorities[2]. The QCA affirmed the QSC's judgment and ruled that the courts have the power under Québec civil law to rectify documents in order to give effect to the parties' true common intention, and there is no need to import the common law doctrine of rectification into Québec's law obligations[3].

On appeal to the SCC, the two main issues were (1) whether the proceedings instituted by AES were consistent with Québec's rules of civil procedure and (2) whether AES could be permitted under Québec civil law to rectify written agreements and documents[4].

The ARQ argued that there was nothing in the Québec Code of Civil Procedure ("CPP") that authorized the courts to consider the type of motion AES had made and that the CPP did not authorize a court to rectify or amend a contract. The ARQ argued that the basis of any such power must be found in the substantive law and that article 1425 of the Civil Code of Québec ("CCQ") did not apply in this case since the errors relied upon by AES were not clerical errors. According to the ARQ and the Attorney General of Canada ("AGC"), the QCA had given too broad a scope to the power to interpret contracts provided for in art. 1425 CCQ[5].

The SCC rejected the position of the ARQ and the AGC.  After reviewing some concepts of the Québec civil law of contracts, the SCC held that the determination of the common intention of the parties to a contract represents a true exercise of interpretation under article 1425 CCQ. If there is a discrepancy between the common intention of the parties and their stated intention in the contract, a judge may take such discrepancy into account in giving effect to the contract, provided that the request is legitimate and that the proposed modification does not affect third parties' rights.  Here, the parties only sought to make the documents consistent with the scenario involving no tax consequence that had been originally designed, and not to rewrite the transaction's tax consequences.  No prejudice was caused to the tax authorities because the tax legislation provided for such scenario where the transaction would have no tax consequence and such would have been the case if the parties had proceeded in a manner consistent with their intention.  The tax authorities had no vested right in the adverse tax consequences arising from the defective documents.

The SCC ruled that it was open to the courts to intervene to find that the amendments made by the parties to the contracts and documents at issue were legitimate and necessary and that their intervention was justified by the substantive civil law and was not precluded by Québec's rules of civil procedure[6]. However, the recognition by the SCC of retroactive rectification of documents in Québec civil law is accompanied by certain reservations.  The SCC warns that taxpayers should not view that recognition as an invitation to engage in bold tax planning on the assumption that it will always be possible to redo the contracts retroactively. Art. 1425 CCQ could not be relied upon if the common intention of the parties is not sufficiently determinate or determinable[7].

This decision constitutes an important development in Canada's and Québec's case law on retroactive rectification of documents that do not reflect the parties' intent and their enforceability against the tax authorities and when the parties agree that their documents do not reflect their intent, should in most instances allow rectification of their documents in order to remedy adverse tax consequences.

[1]  Agence du revenu du Québec v. Services environnementaux AES Inc., 2013 SCC 65. Note that the Services environnementaux AES Inc. decision also covers the appeal in the Riopel case and that the SCC came to a similar conclusion. Our comments will focus on the Services environnementaux AES Inc. appeal.

[2]  Services environnementaux AES inc. v. Agence des douanes et du revenu du Canada, 2009 QCCS 790.

[3]  Québec (Sous-ministre du Revenu) v. Services environnementaux AES inc., 2011 QCCA 394.

[4]  Services environnementaux AES Inc., supra note 1, at paragraph 25.

[5]  Ibid., at paragraphs 22 and 23.

[6]  Ibid., at paragraph 51.

[7]  Ibid., at paragraph 54.

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