Friday, July 01, 2022

Collins Family Trust

 In a decision released June 17, 2022, Canada (Attorney General) v. Collins Family Trust, a majority of the Supreme Court of Canada held that taxpayers could not rely on equitable recission of transactions to avoid unintended tax consequences. The decision involved two different, but similar transactions. I will refer to just one of them, the Colins Family Trust.

After receiving professional tax and legal advice, Todd Collins, the principal of a company called Rite-Way Metals Ltd. (the “operating company”) undertook some transactions in order to move assets out of the operating company and into a trust in order to protect the assets from future creditors of the operating company. Based on his advice, the was structured in a way that would not (or so they thought) trigger any tax.

It is not really necessary to understand the mechanics of the tax planning to follow the principles in this case, but I will do my best to set them out in a general way. Mr. Collins incorporated a holding company and created the Collins Family Trust. The holding company bought shares in the operating company, which it then sold to the Trust in exchange for a promissory note. The operating company then declared dividends on the shares held in the Trust, and these were used to repay the promissory note. The tax planning hinged on an attribution rule in the Income Tax Act, which attributes income earned in a trust to a person, including a company, that has contributed property to the trust in certain circumstances. The idea was that the dividends paid to the trust would be attributed to the holding company, which in turn could claim a deduction of the income as inter-corporate dividends.

This planning was consistent with Canada Revenue Agency’s own interpretation of the attribution rule, s. 75(2), at the time these transactions were carried out. The Canada Revenue Agency’s position had been that the attribution rule applied to a sale of property to a trust, as well as a gift of property to a trust. However, in another decision made after these transactions, Sommerer v. The Queen, 2011 TCC 212, 2011 D.T.C. 1162, aff’d 2012 FCA 207, [2014] 1 F.C.R. 379, the Tax Court of Canada held that the attribution rule did not apply to a sale of property, as opposed to a gift. The court held that the attribution rule only applied to the settlor of the trust.

As a result, Canada Revenue Agency reassessed the Trust’s income tax return on the basis that the income was taxed in the trust, which could not take advantage of the deduction available to the holding company.

The trustee of the Trust applied to the Supreme Court of British Columbia to rescind the transactions on the basis that they were made on a mistake of the tax law. The Supreme Court of British Columbia held that the Trust was able to rescind the transactions (2019 BCSC 1030), and the Court of Appeal agreed (2020 BCCA 196). The Attorney General of Canada appealed to the Supreme Court of Canada.

Justice Brown for the majority held that rescission was not available in these circumstances. In doing so, he applied two previous decisions in which the Supreme Court of Canada held that the taxpayers involved were not permitted to rectify documents to avoid the unexpected tax consequences of the transactions,  (Attorney General) v. Fairmont Hotels Inc., 2016 SCC 56 (S.C.C.) and Jean Coutu Group (PJC) Inc. v. Canada(Attorney General), 2016 SCC 55 (S.C.C.) (I wrote a post about Fairmont here.)

Rectification and rescission are related, but distinct, concepts. A court may rectify an agreement where the parties have reached an agreement, but in error the document does not reflect the agreement. It may also be applied to wills and trusts, if the documents to not reflect the will-maker or settlors intentions. Rescission, on the other hand, allows the court to undue the transaction if it is based on a mistake of fact or law that underpins the transaction. Rectification involves modifying documents, while rescission sets them aside.

Both rectification and rescissions are based on equitable principles. As set out by Justice Brown for the majority at paragraph 11:

Generally speaking, a court of equity may grant relief where it would be unconscionable or unfair to allow the common law to operate in favour of the party seeking enforcement of the transaction. But there is nothing unconscionable or unfair in the ordinary operation of tax statutes to transactions freely agreed upon.

The reasoning is that taxpayers are permitted to structures their affairs in a manner that reduces the tax they might otherwise have had to pay under a different structure, but conversely, if they choose to structure their affairs in a manner that results in increased taxation, it is not unfair or unconscionable to hold them to arrangements that they had freely entered into.

Justice Brown summarized the principles applicable to both rectification and rescission in the tax context as follows:

[16]                         From Fairmont Hotels and Jean Coutu, taken together, I draw the following interrelated principles relevant to deciding this appeal:

(a)      Tax consequences do not flow from contracting parties’ motivations or objectives. Rather, they flow from the freely chosen legal relationships, as established by their transactions (Jean Coutu, at para. 41; Fairmont Hotels, at para. 24).

(b)      While a taxpayer should not be denied a sought‑after fiscal objective which they should achieve on the ordinary operation of a tax statute, this proposition also cuts the other way: taxpayers should not be judicially accorded a benefit denied by that same ordinary statutory operation, based solely on what they would have done had they known better (Fairmont Hotels, at para. 23, citing Shell Canada, at para. 45; Jean Coutu, at para. 41).

(c)      The proper inquiry is no more into the “windfall” for the public treasury when a taxpayer loses a benefit than it is into the “windfall” for a taxpayer when it secures a benefit. The inquiry, rather, is into what the taxpayer agreed to do (Fairmont Hotels, at para. 24).

(d)      A court may not modify an instrument merely because a party discovered that its operation generates an adverse and unplanned tax liability (Fairmont Hotels, at para. 3; Jean Coutu, at para. 41).

In these circumstances, where the tax consequences were “a direct result of the ordinary operation of the [Income Tax] Act respecting transactions freely undertaken…,” equitable rescission is not available.

Justice Côté dissented. The tax planning was based on a widely held understanding among tax advisors, and was shared by the Canada Revenue Agency. The planning was not based on ignorance or a “misprediction.” It was not aggressive tax planning. Canada Revenue Agency exercised a discretion to reassess the Trust at the same time it was appealing the Sommerer decision arguing that attribution rule did apply. It was unfair for Canada Revenue Agency to reassess the return in these circumstances, and rescission should be available.

It will not be much consolation to the trustee and beneficiaries of the Collins Family Trust, but I prefer the dissent. 

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