Supreme Court decision puts chill on use of accepted tax structures

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There is constant tension within society between those with greater wealth and those with less. Is the wealth you create primarily for your benefit, and the benefit of your family and chosen philanthropies? Or is it primarily a pool of funds to satisfy the government’s ever expanding spending desires, or its political goals of flattening income and asset disparities (and weakening non-state centres of power)?

The battle of ideas is waged on various fronts, but the changing political winds are made manifest in the tax system. Increased rates, new types of taxes and constant substantive and procedural changes in tax law are tightening the noose. Consider the recent (June 17, 2022) Supreme Court of Canada decision Canada (Attorney General) v Collins Family Trust (Collins), 2022 SCC 26.

Facts of the case

In Collins, a taxpayer obtained tax advice on how to obtain greater creditor proofing without increasing tax liability. The plan details aren’t important. What is important is that the procedure was common, most tax advisors understood it to be compliant with the law, and the Canada Revenue Agency’s published guidance confirmed that the procedure would not trigger additional tax. Several years after the Collins family implemented the plan, the Tax Court of Canada held in Sommerer v The Queen (2011 TCC 212, affirmed 2012 FCA 207) (with a different, unrelated taxpayer but a similar plan) that contrary to the CRA’s published positions, tax was payable. The CRA then audited and reassessed other taxpayers – including Collins – and retroactively disallowed certain attributions and imposed tax on the trust.

Equitable rescission is a fancy legal term that gives us a potential remedy to “rescind” (i.e., unwind) an unfair transaction. We can ask the court to undo a transaction (a contract, a gift, etc.) where it would be very unfair (‘inequitable”) to require the party to be bound. The Collins Family Trust applied to the court for equitable rescission – it asked the court to unwind the original transactions because they were entered into on the basis of a reasonable, but very wrong, understanding of the expected tax consequences. Collins won at trial, and at the BC Court of Appeal (in part because that court had recently granted recission in a substantially identical case, Re Pallen Trust, 2014 BCSC 305, affirmed 2015 BCCA 222).

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The Supreme Court overruled. It said equitable rescission isn’t available when the misunderstanding relates to tax consequences. So, if a car vendor innocently but mistakenly tells you a vehicle is a 2022 model but it is really a 2020 model, you might get recission. But if CRA gives you guidance that a particular structure will legally minimize or defer your taxes, and several years later a court says CRA “guidance” was too nice to taxpayers, and is wrong, you can’t get recission.

“Taxpayers should be taxed based on what they actually agreed to do and did, and not on what they could have done or later wished they had done.” The Supreme Court analogized this to retroactive tax planning.

The result is that most Canadian taxpayers are now deprived of a valuable remedy against severe tax resulting from misunderstanding our very complex and hard to understand Income Tax Act. Quebec taxpayers will still have this remedy, because its Civil Code permits a court to unwind a contract that is entered into in error, even if the error was a misunderstanding of the tax consequences of the deal.

Implications

Prior to this decision, most tax practitioners would have told you that if you structured a transaction in a certain way (thinking it was a legitimate tax planning path) there was a potential remedy that you, as a taxpayer, could use to retroactively fix mistakes in papering the transaction, if those mistakes accidentally resulted in you having to pay higher taxes than you would have, had you followed another available transaction structure. This advice probably remains for purely clerical errors (such as a typo in a date or a number or a name). However, post-Collins, if the error is your reliance on the advice of your tax advisor’s incorrect understanding of the law, and more generally a reliance on the widely held interpretation by tax experts of a vague law, then – even if that interpretation was shared by CRA – taxpayers (outside of Quebec) are dead in the water.

A few other implications: Tax advisors (lawyers and accountants) will be called on more often, and will now need to give more conservative advice. Transactions will take a little more time to close. Taxpayers will likely become more conservative. Ironically, this may mean assets remain locked up for longer, deferring dispositions that will yield taxable gains or revenue to the government.

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While the published guidance of CRA can no longer be comfortably relied on in many situations, key players in significant transactions may wish to avail themselves of CRA advance rulings to obtain greater certainty. These are highly fact specific, have little or no precedential value, and will considerably delay the closing of any particular transaction.

David Latner is a partner at Toronto-based Advocan Law LLP, a boutique law firm focused on assisting family offices and technology companies.