Due in particular to the outcome of some recent court cases, many have feared that formal applications to rectify plans would receive a favorable hearing only in the event of obvious clerical errors in the documentation. However a recent court case in the Supreme Court of British Columbia demonstrated that rectification is possible in circumstances where a definite agreement has gone awry in its implementation.
In Crean v. Canada, 2019 BCSC 146, two brothers each owned 50% of a holding company which in turn owned a couple of family businesses. One of the brothers wanted to retire from the family business and sell his interest to his other brother. They entered into an agreement in principle such that the buyer would purchase all of the seller’s interest for an agreed amount and the transaction would be structured, to the extent possible so the seller would receive capital gains treatment for tax purposes.
After entering into the agreement, the brothers sought tax advice. The tax advisor advised the brothers to create a new company to purchase the shares instead of the buyer selling directly to the seller. Thru a series of transactions (rollovers and purchases), the buyer became the sole shareholder of the new company and the new company became the sole shareholder of the holding company, and the seller got the agreed proceeds from sale.
Unfortunately, these transactions triggered specific anti-avoidance provisions in the Income Tax Act involving surplus stripping between related parties and turned a major portion of proceeds from sale into dividends instead of capital gains.
The brothers went to the Court to seek rectification. They argued that they were seeking to correct a mistake. Their agreement in principle specifically expressed the wish for the selling brother to get capital gains treatment on the sale and the transactions entered into failed to accurately represent their true agreement. The Crown argued that the brothers were merely seeking a second chance, with the benefit of hindsight, at re-drafting the agreements so it did not produce the tax consequences noted above.
The Court granted rectification because in large part, the rectification was being sought to correct the agreement to reflect their true intent, which included a specific written intent for the seller to pay capital gain taxes (and not avoid it). By the way, the brothers alerted the Canada Revenue Agency of the error as soon as they become aware of it, which supported their contention that they were trying to execute their plan according to the agreement in principle.