On December 9, 2016, the Supreme Court of Canada rendered its judgment in Jean Coutu Group (PJC) Inc. v Attorney General of Canada (2016 SCC 55) along with its companion case Canada (Attorney General) v Fairmont Hotels Inc. (2016 SCC 56).
Our post on the Court's decision in Fairmont Hotels is available here.
In Jean Coutu, a 7-2 decision, the Supreme Court specified and enhanced the civil law test applicable to rectification of a written instrument where the taxpayer has suffered an unintended and adverse tax result. The Court had previously addressed this test in Quebec (Agence du revenu) v Services Environnementaux AES Inc. (2013 SCC 65).
The Supreme Court confirmed that a general intention of tax neutrality does not permit the modification instruments in accordance with the Civil Code of Quebec.
In Jean-Coutu, the taxpayer brought a motion for rectification in the Superior Court of Quebec in order to modify certain documents for transactions that were undertaken to neutralize the effect of the fluctuations in foreign exchange rates. The transactions had achieved this goal, but such transactions had the unexpected and adverse effect of creating foreign accrual property income for one of the companies in the corporate group.
The taxpayer argued that the constant and clear intention of the parties to address the exchange rate fluctuation without generating adverse tax consequences was not reflected in the transaction documents.
The Quebec Superior Court allowed the taxpayer's motion on the basis that the evidence showed there was discrepancy between the clear intention of the parties and the tax consequence of the transaction as executed.
The Quebec Court of Appeal allowed the Crown's appeal and stated that the taxpayer's general intent that its transactions be completed in a tax-neutral manner was insufficient to support a motion for rectification.
On appeal, the Supreme Court defined the issue as follows:
[14] This appeal raises the following key issue: Where parties agree to undertake one or several transactions with a general intention that tax consequences thereof be neutral, but where unintended and unforeseen tax consequences result, does art. 1425 C.C.Q. allow the written documents recording and implementing their agreement to be amended with retroactive effect to make them consistent with that intention of tax neutrality?
In its analysis, the Court applied and confirmed the guidelines it developed in Services Environnementaux AES Inc.
Pursuant to an exhaustive review of the provisions of the Civil Code of Quebec applicable to contracts, the Supreme Court reaffirmed that under the Quebec civil law the agrement or contract lies in the common intention of the parties. A contract is created by "an agreement of wills by which one or several persons obligate themselves to one or several other persons to perform a prestation" (see Article 1378 of the C.C.Q.), which prestation must be "possible and determinate or determinable" (see Article 1378 of the C.C.Q.), and must have a cause (see Article 1410 of the C.C.Q.) and an object (see Article 1412 of the C.C.Q.).
For the majority, Justice Wagner stated that, in light of these provisions of the Civil Code of Quebec, a court may not use the remedy offered by article 1425 C.C.Q. to modify a transactional scheme because it generated unforeseen adverse tax consequences. The Court stated:
[23] A taxpayer's general intention of tax neutrality cannot form the object of a contract within the meaning of art. 1412 C.C.Q., because it is insufficiently precise. It entails no sufficiently precise agreed-on juridical operation. Nor can such a general intention in itself relate to prestations that are determinate or determinable within the meaning of art. 1373 C.C.Q. It says nothing about what one party is bound to do or not to do for the benefit of the other. Therefore, a general intention of tax neutrality, in the absence of a precise juridical operation and a determinate or determinable prestation or prestations, cannot give rise to a common intention that would form part of the original agreement (negotium) and serve as a basis for modifying the written documents expressing that agreement (instrumentum). As a result, art. 1425 C.C.Q. cannot be relied on to give effect to a general intention of tax neutrality where the writings recording the contracting parties' common intention produce unintended and unforeseen tax consequences.
And specifying the applicable test developed in Services Environnementaux AES Inc., the Court stated:
[24] In my opinion, when unintended tax consequences result from a contract whose desired consequences, whether in whole or in part, are tax avoidance, deferral or minimization, amendments to the expression of the agreement in accordance with art. 1425 C.C.Q. can be available only under two conditions. First, if the unintended tax consequences were originally and specifically sought to be avoided, through sufficiently precise obligations which objects, the prestation to execute, are determinate or determinable; and second, when the obligations, if properly expressed and the corresponding prestations, if properly executed, would have succeeded in doing so. This is because contractual interpretation focuses on what the contracting parties actually agreed to do, not on what their motivations were in entering into an agreement or the consequences they intended it to have.
Furthermore, the Court distinguished Jean Coutu from Services Environnementaux AES Inc.:
[31] In contrast, in the appeal here, the parties to the contract did not originally and specifically agree upon a juridical operation for the purpose of turning their general intention to neutralize tax consequences into a series of specific obligations and prestations. This general intention of the parties was not sufficiently precise to establish the details of a contemplated operation [...] The determinate scenario agreed on by PJC Canada and PJC USA was drawn up properly, but because it was drawn up properly, it produced unintended and unforeseen tax consequences.
The Court dismissed the taxpayer's appeal and affirmed the decision of the Quebec Court of Appeal.
In dissent, Justice Côté stated that the convergence of principles between the common law and the civil law as expressed by the majority in Jean Coutu was inconsistent with the contract law applicable in Quebec:
[91] [...] I agree with my colleague that convergence between Quebec civil law and the common law of the other provinces is desirable from a tax policy perspective (para. 52). Indeed, in this Court, the parties agreed that the common law and the civil law are functionally similar with respect to the availability of rectification. But retreating from the interpretation of art. 1425 C.C.Q. adopted in AES in order to achieve harmony with this Court's contraction of equitable discretion in Fairmont is inconsistent with the law of contract in Quebec.. [...] Given that contracts can be expressed orally without recourse to written instruments, AES left open the possibility of rectifying errors in oral expression (paras. 28 and 32). This is consistent with the civil law principle, inherent in arts. 1378 and 1425 C.C.Q., that a contract is based on the common intention of the parties, not on the expression of that intention.
[92] The majority's reasons in Fairmont are irreconcilable with these articles of the Code. Rectification in Canadian common law jurisdictions in now "limited to cases where the agreement between the parties was not correctly recorded in the instrument that became the final expression of their agreement" (Fairmont, at para. 3). There appears to be no scope for rectifying oral agreements. With respect, to the extent that my colleague in this case would import this limitation into the civil law, the "convergence" between the two legal systems is, in my opinion, far from "natural" (majority reasons, at para. 52).
The decision rendered by the Supreme Court in Jean Coutu is of significant importance as it restricts the circumstances in which taxpayers may rely on Article 1425 of the Civil Code to rectify transaction documents in tax cases.
Quebec tax professionals should carefully consider the additional guidelines provided in Jean Coutu in assessing whether or not a motion for rectification is available to correct mistakes resulting in unintended and unforeseen adverse tax consequences.
For more information, visit our Canadian Tax Litigation blog at www.canadiantaxlitigation.com
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