Unintended Tax Liability? Supreme Court Of Canada Says No Take-Backs

• Published date: 24 June 2022
• Subject Matter: Litigation, Mediation & Arbitration, Tax, Trials & Appeals & Compensation, Income Tax, Tax Authorities
• Law Firm: Clark Wilson LLP
• Author: Mr Ryan Lincoln

The Supreme Court of Canada ("SCC") in Canada (Attorney General) v. Collins Family Trust, 2022 SCC 26 ("Collins Family Trust") recently set out that a series of transactions cannot be undone using "rescission" in order to avoid an unexpected tax liability, even if the taxpayer relied on public statements made by Canada Revenue Agency ('CRA') as to the correct interpretation of the law at the time the transaction was entered into.

Rescission is the retroactive cancellation of an agreement with the goal of returning each party to the position they would have been in if the agreement had never been made. Rectification on the other hand involves the cancellation of an existing agreement together with the formulation of a new agreement, both with retroactive effect, to correctly reflect the original intentions of the parties.

Previous SCC cases (Attorney General) v. Fairmont Hotels Inc., 2016 SCC 56, ("Fairmont") and Jean Coutu Group (PJC) Inc. v. Canada (Attorney General), 2016 SCC 55, ("Jean Coutu") found that rectification generally could not be used to avoid an unexpected tax liability. However, it was unclear if Fairmont and Jean Coutu also limited the use of rescission in similar circumstances. The SCC in Collins Family Trust has now confirmed that rescission is not an available option when dealing with an unforeseen tax liability.

Key takeaways of the SCC's decision are:

• Rescission cannot be used to avoid unintended or unanticipated tax consequences.
• Both rescission and rectification may be granted where the law would otherwise give an unfair or unconscionable result. However there is nothing unconscionable or unfair in the application of the Income Tax Act (Canada) (the "ITA") to transactions freely entered into by a taxpayer. This includes cases where CRA originally applied one interpretation of the law, but later retroactively applied another (correct) interpretation of the law, with the latter application resulting in adverse tax consequences to the taxpayer.
• The principles stated in the SCC decisions in Fairmont Hotels and Jean Coutu are to be applied broadly to rectification, rescission and other similar remedies. These principles include "that tax consequences flow from legal relationships, that taxpayers' liabilities should be governed by the ordinary operation of tax statutes and on what the taxpayer agreed to do, and that legal instruments cannot be modified merely because they generated an adverse tax liability" (Collins Family Trust at...