Fixing Tax Mistakes: No Mulligans Allowed in BC Trust decision
Since the Supreme Court of Canada’s Fairmont decision (Canada (Attorney General) v Fairmont Hotels Inc,  2 SCR 720), taxpayers and their advisors have been seeking alternatives to rectification that will help fix errors that result in unintended tax consequences. BC Trust represents the first judgment which considered the Supreme Court’s framework (BC Trust v Canada (Attorney General), 2017 BCSC 209). Unfortunately, it looks like taxpayers will have to seek alternative remedies when fixing tax mistakes (some of which are discussed at the end of this article).
BC Trust Decision
A personal trust (the “Trust”) had been allocating 100% of its net income to another trust. The Canada Revenue Agency (“CRA”) initiated an audit of the Trust, making a designation that combined the property and income of the two trusts as one for income tax purposes pursuant to subsection 104(2) of the Income Tax Act. The CRA reassessed the Trust’s 2008, 2009 and 2010 taxation years (which were not the subject of the BC Trust case). As a result of the CRA’s audit, the trustees decided not to allocate any income to the other trust in 2012. In 2015, the CRA agreed to reverse the designation for the years under audit.
The Trust petitioned to the British Columbia Supreme Court (“BCSC”) to allow it to retroactively allocate income to the other trust for 2012. In dismissing the application, the BCSC held that rectification was not available to the Trust nor would the mistake be remedied by the “inherent jurisdiction” of the court.
Rectification is a potent remedy which grants the court the equitable power to rewrite a final agreement. Under the framework from Fairmont,taxpayers must clearly identify the precise mechanism by which they intended to minimize or avoid a particular tax, and how that mechanism was mistakenly transcribed in a document. The BCSC found that rectification was unavailable to the Trust since there was no document that mistakenly portrayed the trustee’s intention at the time the trust allocations were prepared.
How to fix tax mistakes
The BCSC commented that “nothing” prevented the Trust from amending its 2012 T3 tax return or executing a trust minute in respect of the Trust’s 2012 income allocation. It would then be up to the CRA to decide whether or not to give the allocation retroactive effect. With respect, we disagree and note that there is substantial reassessment risk under this strategy.
First, there is no legal entitlement to amend an income tax return, and the CRA does not generally accept amended returns for discretionary deductions that should have been taken at the time of filing. Second, the CRA’s administrative position is that the trustees are required to notify to the beneficiaries of the apportionment of the trust's income before the end of the trust's taxation year in writing (e.g., resolutions signed by the trustees, minutes of the trustees' meeting).
A nunc pro tunc amendment should be effective for very simple errors and does not require a rectification order. For larger errors, another alternative to rectification is to rescind an agreement (see, for example, Re Pallen Trust, 2015 BCCA 222). When rescission is granted, its effect is retroactive and the parties are returned to their original position.
Perhaps if the trustee resolutions were drafted differently, BC Trust could have avoided going to court altogether. The BC Trust and Fairmont decisions illustrate the increasing difficulty in “fixing” tax mistakes through the courts. Taxpayers looking to avoid unintended tax consequences have less room for error when seeking a remedy for when things go wrong. It may be less costly in the long-run to spend legal fees to get it right contemporaneously rather than relying on remedies such as rectification for retroactive relief.
Invitation for Discussion:
If you would like to discuss this article in greater detail, or any other business law matter, please do not hesitate to contact one of the lawyers in the Tax Law group at Shea Nerland LLP.
Note that the foregoing is for general discussion purposes only and should not be construed as legal advice to any one person or company. If the issues discussed herein affect you or your company, you are encouraged to seek proper legal advice.