Equity Cannot Relieve Tax Mistakes
The Supreme Court of Canada (“SCC”) bifurcated 8-1 in Canada (Attorney General) v Collins Family Trust, 2022 SCC 26 (“Collins”) with Brown J writing for the majority and Côté J dissenting. The SCC majority allowed the Crown’s appeal from the British Columbia Court of Appeal (“BCCA”) concerning the tax planning and the Income Tax Act, RSC 1985, c 1 (5th Supp) (“ITA”).
The majority opined that equity may intervene to preclude common law from unconscionable or unfair conduct; however, equity should avoid overreaching. This principle is of special consideration in the case at bar as taxpayers freely choose to enter into tax transactions. Equity should not prevent a transaction from running its course simply due to the unexpected outcome of adverse tax liability.
It seems that the majority closed the door of deploying equitable relief in cases where agreements or transactions fall short of unconscionability or unfairness. Mere adverse tax liability is insufficient to trigger the application of rescission.
The events began in 2008 when Todd Collins (principal of Rite-Way Metals Ltd) and Floyd Cochran (principal of Harvard Industries Ltd) both retained the same accounting firm as their tax advisor. Collins and Cochran asked the firm to advise on plans to shield corporate assets from creditors without incurring tax liability.
Both plans built upon attribution rules in section 75(2) and the inter-corporate dividend deduction in section 112(1) of the ITA. Essentially, the central issue revolved around the transfer of $510,000 from Rite-Way Metals Ltd to the Collins family trust and the transfer of $2,085,000 from Harvard Industries Ltd to the Cochran family trust without any tax liability.
First, the plans involve the incorporation of a holding company to buy shares in an operating corporation. After this incorporation, a family trust would be created with the holding company as a beneficiary (Collins, para 2). Then, funds would be loaned to the family trust to subsequently purchase shares in the operating company. The operating company will pay dividends to the trusts—ultimately attributed back to the holding company (the beneficiary) under section 75(2) of the ITA (Collins, para 2). The operating company would then claim a deduction vis-à-vis the dividends pursuant to section 112(1) (Collins, para 2).
Should equity intervene to change the tax liability of agreed-upon transactions? The SCC does not think so.
The majority underscored that retroactive tax planning should not be allowed as taxation should be based on what taxpayers initially agreed upon (Canada (Attorney General) v Fairmont Hotels Inc, 2016 SCC 56 (“Fairmont”) at para 3). Equity intervenes to ensure ethical, conscionable and fair relief. Courts of equity can and perhaps should apply equity to prevent common law from wielding too harsh a hand. Yet, in this matter, “there is nothing unconscionable or unfair in the ordinary operation of tax statutes to transactions freely agreed upon” (Collins, para 11, emphasis added).
Yes, taxpayers are permitted to arrange affairs to minimize taxes payable according to the Duke of Westminster principle. Courts, however, should not take this too far. The judiciary cannot simply “recharacterize a taxpayer’s bona fide legal relationship” (Shell Canada Ltd v Canada,  3 SCR 622, paras 39-40). A retrospective re-characterization by a court would effectively usurp the role of Parliament by creating new policy or legislation. Courts simply need to identify what taxpayers specifically agreed upon in the transactions. The “intended or unintended effects of those arrangements” are distractions from the central legal issue (Fairmont, para 24). The SCC has reaffirmed this fundamental principle of tax from Fairmont in Jean Coutu Group (PJC) Inc v Canada (Attorney General),  2 SCR 670 by emphasizing that tax consequences flow from legal relationships or transactions intended by taxpayers (para 41). Examining retroactive tax liability, the judiciary seeks to avoid the “rewriting of history” to focus on what taxpayers initially agreed upon (Fairmont, para 75).
Côté J diverged from the majority to explain that rescission is an available remedy to the parties in this instance since they entered into agreements upon mistaken assumptions. Rescission is an equitable right for parties to retroactively cancel, annul or set aside a contract if parties made serious mistakes rendering the contract unconscionable or unfair. This remedy, according to Côté J, does not become unavailable even if tax liability exists.
Côté J, referencing Professor Paul Davies and Professor Simon Douglas, stated that the rescission of transactions may be granted in rare cases as a “last resort” where taxpayers will be seriously prejudiced by unfairness or injustice were the transactions to proceed forward (Collins, para 58). The existence or absence of tax liability should not trigger the application of rescission. Rescission, according to the minority, may be granted in cases involving serious erroneous assumptions about certain transactions.
In this case, the majority focused on preventing taxpayers from deploying equitable relief as a method to diminish adverse tax liability. The majority implies that taxpayers should be careful, prudent and diligent in structuring transactions: equity should not be used too leniently. The dissent, on the other hand, emphasized that equitable relief should generally be available even if cases involve taxes because transactions may be premised on unfair or erroneous mistakes.
The Canadian tax system prides itself on certainty—individuals can expect uniform administration of the same tax laws. Equitable relief, if used loosely, undermines structural integrity of the tax system by encouraging retroactive tax planning. Equitable rescission may camouflage retroactive tax planning. The majority, in denying this relief, underscores the value of ensuring the uniform application of the ITA. Equity should not function as a resort for taxpayers “to undo or alter or in any way modify a concluded transaction” (Collins, para 22).
Collins has the effect of curtailing the availability of equitable remedies in tax planning. Taxpayers wishing to call upon equity are now warned to tread cautiously and provide compelling evidence of serious mistakes before they can seek equitable remedies. The SCC expressly rejects “Option B” and asks taxpayers to be thorough and careful when entering into transactions. Taxpayers must recognize that both adverse and beneficial consequences may flow from tax planning.