This British Columbia Surpreme Court (BCSC) decision is an important addition to this jurisprudence. In this case, the petitioners successfully obtained an order for rectification to correct, for a second time, trust deed provisions that gave rise to the application of the reversionary provisions in subsection 75(2) of the Income Tax Act (the Act).
In her analysis, Justice Jacqueline Dorgan provided valuable guidance as to the circumstances in which rectification should be available in the context of a series of tax-motivated transactions. In so doing, she attempted to reconcile apparently inconsistent court decisions by clarifying that where the parties’ tax-avoidance intentions from the inception of the transaction are clear, whether stated explicitly in the agreements or inferred, rectification may be available. She also confirmed that the balance of probabilities is the standard of proof required when making a request for rectification.
Mr. McPeake, together with two business partners, operated a software company. In anticipation of an eventual sale, the corporation entered into a series of tax planning transactions in 1996 and 1997 in which they established a family trust to purchase a portion of the shares in the software company. This new structure would allow each beneficiary to use the capital gains exemption to reduce any capital gain realized on the eventual sale of the shares.
In 1999, the business was sold for approximately $4 million, and the beneficiaries of the McPeake family trust received a portion of the proceeds from the sale.
In 2003, the Canada Revenue Agency (CRA) issued reassessments to the trust and Mr. McPeake for the 1997 to 2001 taxation years on the basis that subsection 75(2), the so-called “revocable trust” rule, applied.
This rule applies when a person transfers property to a trust in the following circumstances:
- The property can revert to the transferor;
- The property can pass to persons determined by the transferor; or
- The property cannot be disposed of without the transferor’s consent or direction.
If one of these conditions is met, income and capital gains or losses from the property are attributed to the transferor.
In this case, the trust deed provided that property that Mr. McPeake had contributed to the trust could revert to him, so subsection 75(2) clearly applied. However, an unopposed order for rectification to the trust deed to delete the offending clause was granted in May 2009. This was intended to remedy the problem, but unfortunately it did not end there.
Later in 2009, the CRA reassessed Mr McPeake and the trust again on the basis that the trust deed contained two more clauses that caused subsection 75(2) to apply. First, trust property could pass to persons determined by Mr. McPeake. Second, it could not be disposed of without Mr. McPeake’s consent.
The trustees made a second request for rectification on the basis that the intention of the trust was improperly expressed due to errors made by their previous advisors, whom the trustees were also suing in a separate action in Ontario. The CRA opposed the second request for rectification.
Supreme Court Decision
The BCSC granted the application. Based on the affidavit evidence presented to her, Justice Dorgan concluded the trust deed did not reflect the petitioners’ true intentions in forming the trust. She found that there was a “common specific intention” that existed before the deed's formation “to avoid tax payable on capital gains from the sale of the shares by maximizing tax exemptions that could be multiplied across the trust’s many beneficiaries.” (paragraph 43)
Reconciling existing case law
To highlight the importance of demonstrating a sufficiently specific intention in a rectification request, Justice Dorgan relied on two divergent Ontario Court of Appeal (OCA) decisions: Bramco SC and 771225 Ontario Inc. v Bramco Holdings Co. ((1995), 21 O.R. (3d) 739 (C.A.)) and Juliar. In both cases, rectification was requested in respect of tax-motivated transactions; however, the evidence provided to support the petitioners’ intentions had fundamental differences.
In Bramco, the petitioner sought a rectification order to avoid land transfer tax triggered by an income tax avoidance scheme. The petitioner’s intent to minimize income tax was clear by the way she structured her affairs. However, the court found that the resulting land transfer tax liability had not been contemplated in the original tax strategy. Consequently, the rectification order was intended to correct an error in the planning strategy rather than to align the documents with the initial intentions of the petitioner at the outset of the transaction. The request for rectification was denied.
Conversely, in Juliar, the petitioner’s intention — to postpone triggering capital gains on a transfer of shares — was much clearer, and the court found sufficient evidence to support the petitioner’s intention to effect the transfer on a tax-deferred basis. The court rectified the written agreement to conform to the parties’ intentions. The OCA noted that, in this case, although the parties’ intentions were not explicitly documented at the outset of the transaction, the intention could be inferred from the evidence.
Justice Dorgan found no inconsistency between these two cases, noting that “their histories follow the same understanding of the law of rectification, in particular with respect to finding a sufficiently specific intention.” (paragraph 22)
In both cases, the parties sought a change that would result in tax avoidance.
Burden of Proof
There has been some confusion over the standard of proof required in a request for rectification in various cases over the years. Justice Dorgan confirmed that the standard of proof in civil cases is the balance of probabilities, rejecting the view that an order for rectification is subject to a more “convincing standard” by referring to the following statement by Justice Marshall Rothstein of the Supreme Court of Canada in F.H. v McDougall (2008 SCC 53):
In the result, I would reaffirm that in civil cases there is only one standard of proof and that is proof on a balance of probabilities. In all civil cases, the trial judge must scrutinize the relevant evidence with care to determine whether it is more likely than not that an alleged event occurred. (paragraph 49).
This clarification is welcome news for taxpayers. Petitioners should not have to provide evidence meeting a higher standard of proof, thereby increasing the chance for a successful outcome when the conditions for rectification are satisfied.
As mentioned, this decision is significant because it clarifies that proper evidence of a common intention to avoid tax may be sufficient grounds for a court to grant rectification. Given the BCSC’s reasoning in this case, and the OCA’s in the Bramco and Juliar decisions, this cannot be a vague intention, but must be specific as to the type of tax the taxpayer intends to avoid and their plan to avoid it.
In this case, the court found that the evidence submitted sufficiently showed a common specific intention — both before and after the deed’s formation — to avoid tax payable on capital gains. Similar to Juliar, the tax advantage achieved was not incidental to the formation of the trust, but the very reason for its formation.
This decision also confirms that the standard of proof in rectification cases is the balance of probabilities, rejecting the view that an order for rectification is subject to a more “convincing standard.”
Because rectification is an equitable remedy, the court also had to consider the inequities Mr. McPeake would face if the court were not to rectify the trust. The fact that Mr. McPeake would suffer the tax liabilities of ownership of the trust’s property without having any of its benefits was an additional factor in favour of rectification.
It is clear from this decision and those that preceded it that rectification is not granted lightly. Care must be taken when structuring transactions to ensure that the professional advice is reliable, the parties’ intentions are clearly identified and the underlying agreements accurately document the transaction.
The legal costs associated with obtaining a rectification order can be significant. It is far better to “get it right the first time”.