A mistaken impression on the part of a Fairmont Hotel Inc. executive in 2007 will see a large tax payment to the Canada Revenue Agency, the result of a recent judgment by the Supreme Court of Canada that will influence future rectification cases.
In Canada (Attorney General) v. Fairmont Hotels Inc., the majority of the Supreme Court found that two Ontario courts had erred in holding that the respondent’s intention of tax neutrality could support a grant of rectification.
“A common continuing intention does not suffice,” Justice Russell Brown wrote for the majority. “It is limited to cases where a written instrument has incorrectly recorded the parties’ antecedent agreement. In other words, rectification is not available where the basis for seeking it is that one or both of the parties wish to amend not the instrument recording their agreement, but the agreement itself.”
Fairmont Hotels Inc. had been involved in financing the purchase of two U.S. hotels, in U.S. currency, by Legacy Hotels REIT, in which Fairmont held a minority interest; the hotels were accordingly purchased in 2003. The financing arrangement was intended to operate on a tax-neutral basis. But when Fairmont was later acquired, in 2006, that intention was frustrated, as the acquisition would cause Fairmont and its subsidiaries to realize a deemed foreign exchange loss.
Legacy Hotels later asked Fairmont to terminate their financing agreement in order to allow for the sale of the two hotels it had purchased. Fairmont subsequently redeemed its shares in its subsidiaries, which resulted in an unanticipated tax liability that Fairmont then sought to avoid by rectification of the directors’ resolutions. (Fairmont’s vice president of tax had been under the mistaken assumption that the subsidiaries’ foreign exchange tax neutrality had been secured, and so had instructed the directors of Fairmont’s subsidiaries to pass resolutions that would unwind the reciprocal loan structure with a share redemption.)
At issue for the majority was that “Fairmont has not demonstrated how its intention, held in common and on a continuing basis with its subsidiaries, was to be achieved in definite and ascertainable terms while unwinding the financing arrangement,” Justice Brown wrote. “Fairmont refers to a plan to protect its subsidiaries from foreign exchange tax liability, but that plan was not only imprecise. It really was not a plan at all, being at best an inchoate wish to protect the subsidiaries, by unspecified means.”
In dissenting reasons, Justice Rosalie Abella, also writing for Justice Suzanne Côté, found that a “common, continuing, definite and ascertainable intention to pursue a transaction in a tax-neutral manner has usually satisfied the threshold for granting rectification.
“Allowing the tax authorities, a third party, to profit from legitimate tax planning errors, when its own rights have not been prejudiced in any way, amounts to unjust enrichment,” Justice Abella wrote.
The majority of the court took a restrictive approach to rectification in reaching its conclusion, Scott Rollwagen, the research partner at Lenczner Slaght in Toronto, told Legal Feeds. (A companion decision, Jean Coutu Group (PJC) Inc v Canada (Attorney General), considered the corresponding principles under Quebec law, and took the same approach.)
“A tax-efficient result will often form the motivation for entering into an agreement, but the question of intention is much more specific than that,” Rollwagen says of the court’s decision. “The only common intention that will support rectification is proof that the parties actually had a prior intention of entering into a transaction having a definable structure.
“Intention is the thing that you actually want to do,” he says. “The motive is why you want to accomplish it. You can get rectification when you can clearly show that there was an intention that the written agreement doesn’t effect. . . . What was really a problem in Fairmont was not the intention but the motive.”
Fairmont executed some directors’ resolutions to redeem some shares, which wasn’t what they would have done if they knew what the tax consequence would be, he says. “The motive was to avoid tax, but [Fairmont] mistakenly formed the wrong intention in effecting that motive.” The result of the Fairmont Hotels decision is “that you can’t rectify for motive.”
One implication of the decision will be increased transaction costs for corporations, Rollwagen predicts, to “make sure they get it right.” Mistakes such as occurred in Fairmont often occur when dealing with real-time commercial decisions. “Some things may need to be slowed down.