2015 QCCA 837, 2015 QCCA 837

Mac's Convenience Stores Inc. c. Canada (Procureur général) 2015 QCCA 837 COURT OF APPEAL CANADA PROVINCE OF QUEBEC REGISTRY OF MONTREAL No: 500-09-022851-125 (540-17-003106-084) DATE: May 12, 2015 CORAM: THE HONOURABLE JACQUES CHAMBERLAND, J.A. LORNE GIROUX, J.A. MARK SCHRAGER, J.A. MAC’S CONVENIENCE STORES INC. APPELLANT – Plaintiff v. PROCUREUR GÉNÉRAL DU CANADA AGENCE DU REVENU DU QUÉBEC RESPONDENTS – Impleaded parties and COUCHE-TARD INC.

RESPONDENT – Defendant JUDGMENT [ 1 ] This is an appeal from the judgment of the Superior Court, District of Laval (the Honourable Madam Justice Carole Hallée), of June 19, 2012, which dismissed Appellant’s application for a declaratory judgment. [ 2 ] For the reasons of Schrager, J.A., with which Chamberland and Giroux, JJ.A., concur, THE COURT : [ 3 ] DISMISSES the appeal, with costs. JACQUES CHAMBERLAND, J.A. LORNE GIROUX, J.A. MARK SCHRAGER, J.A. Mtre Wilfrid Lefebvre, c.r. Mtre Dominic Charles Belley

Norton Rose Fulbright Canada, S.E.N.C.R.L., s.r.l.

For Appellant Mtre Pierre Zemaitis Larivière Meunier (Revenu Québec) For Agence du Revenu du Québec Mtre Grégoire Cadieux Mtre Marielle Thériault Ministère de la Justice – Canada For Le Procureur général du Canada Date of hearing: March 24, 2015 REASONS OF SCHRAGER, J.A. [ 4 ] To what extent can a taxpayer retroactively revisit the documentation giving effect to a transaction where unforeseen tax consequences have resulted? [ 5 ] That is the ultimate issue in this appeal from the judgment of the Superior Court, District of Laval (the Honourable Carole Hallée), of June 19, 2012. [ 6 ] This appeal was heard just prior to that in Attorney General of Canada v.

Le Groupe Jean Coutu (PJC) inc. and The Jean Coutu Group (PJC) USA inc. , [1] and the judgments in both cases are being rendered simultaneously. FACTS [ 7 ] Appellant is an Ontario corporation [2] whose sole shareholder was at all pertinent times Couche-tard Inc. (“CTI”) of Laval, Quebec.

Though a party in first instance, CTI has not appeared in appeal. [ 8 ] In first instance, Appellant unsuccessfully sought a declaratory judgment and the rectification of a corporate resolution declaring a dividend of 136 million dollars to reverse or correct unforeseen tax consequences resulting from the dividend. [ 9 ] On April 14, 2005, Appellant borrowed 185 million dollars from a related Delaware corporation (Sildel Corporation), which it reimbursed on April 14, 2008.

The interest paid on this loan was deducted from Appellant’s revenue for income tax purposes. [ 10 ] On April 25, 2006, Appellant participated in a number of transactions with various related entities. The series of transactions were described through an organigram annexed to the judgment in first instance. [ 11 ] Included in these transactions was a declaration of the dividend of 136 million dollars on the common shares of Appellant all of which where held by CTI.

The resolution of the Board of Directors authorizing the dividend was entered in evidence. [ 12 ] The series of transactions were meant to transfer the 136 million dollars to the shareholder (CTI) and subsequently to other entities in the group of companies particularly ACT Trust. As the companies’ tax adviser described in his testimony, the purpose was to “circulate the funds” through members of the corporate group with a view to reducing the Quebec income taxes payable by CTI and related entities to the extent of one to two million dollars.

The operation was known as the “Quebec truffle” – i.e. briefly a tax avoidance structure available at the time by which funds were channelled to a trust which received beneficial treatment under Quebec tax law in force at the time. [ 13 ] The Appellant’s tax adviser testified that the 2006 series of transactions mirrored a similar set of transactions in 2001.

However, it appears that he forgot or failed to take proper account of a new element – i.e. the 185 million dollar loan owed by Appellant to Sildel Corporation since 2005. [ 14 ] Though the 136 million dollar dividend was without tax consequences because it was paid by a subsidiary to its parent corporation, it had the effect of reducing the undistributed surplus of Appellant. After payment of the dividend, the ratio of Appellant’s borrowed capital to its own capital (undistributed surplus) was substantially increased and, in any event, beyond a ratio of two to one as permitted by the applicable legislation.

Appellant was then on the wrong side of the “thin capitalization rules”. [3] The consequence of the foregoing was that a substantial portion of the interest paid by Appellant to Sildel Corporation on the 185 million dollar loan was no longer deductible from revenue for income tax purposes. [ 15 ] This was not intended nor even known to Appellant until 2008 when its new tax advisers noticed the problem.

Appellant’s voluntary declaration resulted in the elimination of over 22 million dollars of interest deduction and assessments for 2006, 2007 and 2008 from the federal and provincial tax authorities in the millions of dollars. [ 16 ] These assessments were contested by the appropriate filings with the taxation authorities. [ 17 ] Before the Superior Court, Appellant sought to replace the declaration of the 136 million dollar dividend by a reduction of Appellant’s stated capital and the distribution of the cash equivalent to the sole shareholder.

[ 18 ] The tax adviser testified that this would have the same effect of shifting the funds upstream in the corporate ladder but would maintain the necessary 2:1 ratio so that the thin capitalization rules would not be triggered and the interest Appellant paid to Sildel Corporation would still be deductible. The foregoing required annulling the directors’ resolution and passing a shareholders’ resolution to reduce the capital with retroactive effect.

It also involved obtaining the consent of the holder of the preferred shares (ACT Trust, also a related entity) so that the capital funds be distributed to the holder of the common shares (CTI) without any payment to the preferred shareholder. [ 19 ] Appellant relies on the authority of the judgment of the Supreme Court of Canada in matters of Services Environnementaux AES inc. ( “ AES & Riopel ” ). [4] The judgment in first instance predates the Supreme Court judgment but relied on the judgments of this Court in AES and Riopel . [5] The present appeal was suspended until the Supreme Court issued its judgment in AES & Riopel . [ 20 ] Both before the lower court and in appeal before this Court, Appellant’s position is that its intention together with CTI was to move funds (136 million dollars) from a subsidiary to a parent on a tax neutral basis which can be accomplished in the circumstances by reduction of stated capital instead of by way of dividend.

The declaration of a dividend is the result of an error by Appellant’s tax professional which gave rise to unintended tax consequences. Relying on the authority of the Supreme Court in AES & Riopel , Appellant contends that it has a right to correct this situation and to have such correction recognized judicially. [ 21 ] The Superior Court dismissed Appellant’s proceeding.

The judge applied the principles gleaned from the judgments of this Court in AES and Riopel and first analyzed whether there was disparity between the juridical act intended by the parties ( negotium ) in the series of operations effected on April 25, 2006 of which the declaration of the dividend was part and the written expression of that intent ( instrumentum ) – i.e. the directors’ resolution declaring the dividend.

The judge observed that based on the evidence, Appellant’s directors never had any specific discussion with the tax adviser concerning the consequences of the declaration of the dividend and more specifically on the consequences of the payment of the dividend on the ability to deduct interest paid to Sildel Corporation. The tax adviser conceived the plan (mainly as a copy of what had been done in 2001) and documents were prepared to reflect that plan. Thus, the judge concluded that the various operations effected in April of 2006 reflected the intention of the parties.

Accordingly, she found that contrary to what had occurred in the AES and Riopel cases, there was no divergence between the negotium and the instrumentum . In other words, the declaration of a 136 million dollar dividend by the directors of Appellant is what they intended to do as proposed by the tax adviser.

The judge further concluded that the tax consequences arose from the Sildel loan and not from the 136 million dollar dividend. [ 22 ] The judge went further to state that if there had been disparity between the negotium and the instrumentum , the proposed correction was not proper or legitimate because a dividend is declared by the directors whereas a reduction of capital is effected by shareholders’ resolution. The judge felt that Appellant was “rewriting the tax history” of the transaction which is not legitimate.

Moreover, the correcting documents proposed to the Superior Court for approval required the signature of the ACT Trust which is not a party to the legal proceedings. [ 23 ] The judge adopted the submissions of Respondent, the Attorney General of Canada, to the effect that unexpected tax consequences of a transaction do not give rise to the nullity of that transaction or make it otherwise non-binding.

An unintended tax consequence is not an error which can be corrected in a manner which would bind the tax authorities because it cannot be said that it is an error giving rise to the juridical act or document reflecting the transaction. ANALYSIS [ 24 ] The application of the Supreme Court of Canada’s judgment in AES & Riopel is fundamental and indeed the cornerstone of this appeal.

In its factum, Appellant does not invoke any error per se in the judgment of first instance but simply states that if one accepts that Appellant’s tax adviser made a mistake then upon application of the Supreme Court judgment in AES & Riopel the judgment in first instance must be reversed. [ 25 ] A proper understanding of the judgment of the Supreme Court requires a review of the facts. AES had sought to restructure its shareholdings to accommodate the arrival of a new shareholder/investor. To this end, rollover transactions pursuant to

Section 86 of the Income Tax Act [6] and Sections 541 and 543 of the Taxation Act [7] were contemplated with a view to deferring the tax that would be payable by the existing shareholders on the gain arising from the disposition of their shares. The tax neutrality of the transaction depended on the consideration other than the shares (i.e. a promissory note) not exceeding the adjusted cost base (“ACB”) of the shares received. However, the calculation of the ACB was erroneous giving rise to a taxable capital gain.

The parties replaced the promissory note with a new note in the corrected amount in order to avoid the immediate payment of tax and to have this correction recognized by the Superior Court of Quebec in a proceeding seeking rectification and declaratory relief. They also created the necessary class of shares to give effect to the restructuring. [ 26 ] In Riopel , a couple sought to restructure the shareholdings in a family enterprise, the assets of which had been sold. The only asset left in the company was the cash proceeds arising from the asset sale.

The tax professionals recommended a corporate restructuring with a view to distributing funds as a capital dividend as foreseen by

Section 83 of the Income Tax Act [8] in order to defer tax. The restructuring recommended was to occur on a tax neutral basis but unfortunately due to a series of errors by the professionals in executing the transaction, one of the shareholders was deemed to have been paid a taxable dividend and was assessed accordingly by the tax authorities.

The parties sought rectification by changing the order of the transactions as well as the attributes of the classes of shares of a new amalgated corporation and the price of newly issued shares the whole so that the transaction be carried out as originally intended. [ 27 ] Writing for the Court, LeBel J. emphasized that in Quebec civil law the essence of a contract is in a meeting of the minds of the parties (Art. 1385 C .C.Q. ) so that there is a distinction to be drawn, as did this Court, between the agreement that the parties intended ( negotium ) and the declaration (oral or written) of that intended agreement ( instrumentum ).

Error which vitiates consent may be the cause a contract’s nullity. An error in the nature of disparity between what was agreed and what was written does not vitiate the parties’ consent. The latter type of “error” was in issue in both AES and Riopel . In any event, the parties are free to acknowledge a common error and to agree to correct it subject to any rights acquired by third parties.

[ 28 ] In Riopel , because of the error of the tax advisers, the desired effect of the tax planning agreement to defer income tax by following procedures provided in the tax legislation did not succeed. The professionals failed to implement the agreement correctly. After receipt of tax assessments alerting the parties to the error, the parties agreed to the necessary corrections. [ 29 ] In AES , the error in implementing the tax planning agreement was an incorrect calculation of the ACB of certain shares.

Though the error could have served as a basis to annul the contract between the parties, they chose to correct the error by amending the documents and the tax forms to reflect the proper figures. [ 30 ] LeBel J. examined whether the tax authorities had acquired rights to have the existing, erroneous instruments continue to apply and he said the following: [45] For such a conclusion to be reached, it would have to be found that, once the respondents completed their operations, the revenue agencies became special assignees that were entitled to collect part of the economic proceeds of the transactions, and that they could rely forever on the parties’ declared will.

I do not dispute the fact that the tax collection procedures, remedies and types of security established by law to facilitate the recovery of tax debts give the agencies rights in the proceeds of a variety of juridical operations. For example, they may become assignees of a series of claims or holders of rights in a trust in respect of certain property affected by transactions. Under the civil law itself, the agencies can also prove that simulation existed and demonstrate the true nature of transactions they allege to be shams.

In addition, tax legislation may recharacterize contractual or economic transactions for its own purposes by overriding the legal categories established by the common law and the civil law. With the exception of such situations, however, tax law applies to transactions governed by, and the nature and legal consequences of which are determined by reference to, the common law or the civil law. [45] Pour juger en ce sens, il faudrait décider que, dès la conclusion des opérations des intimés, les Agences sont devenues des ayants droit particuliers — qui auraient obtenu le droit de percevoir une

partie du produit économique des transactions — et qu’elles pouvaient se fonder définitivement sur la volonté déclarée des parties. Je ne conteste pas que les procédures de perception des impôts, les voies de recours et les sûretés diverses établies par la loi pour faciliter le recouvrement des créances fiscales accordent à ces organismes des droits dans le produit d’opérations juridiques variées. Par exemple, le fisc peut devenir cessionnaire d’un ensemble de créances ou titulaire de droits fiduciaires sur certains biens visés par des transactions.

En droit civil proprement dit, le fisc peut aussi établir qu’il y a eu simulation et démontrer la nature réelle de transactions qu’il prétend être factices. De plus, les lois fiscales peuvent, pour leurs propres fins, requalifier des opérations contractuelles ou économiques en mettant de côté les catégories juridiques établies par la common law et le droit civil.

Sous réserve de telles situations, toutefois, le droit fiscal vise des opérations régies par la common law ou le droit civil, dont les règles en déterminent la nature et les conséquences juridiques. [ 31 ] LeBel J. then added: [46] (…) This Court must decide whether the parties’ juridical acts, which led to the notices of assessment, are consistent with their true common intention and whether the tax authorities are entitled to have an erroneous declaration of intention continue to apply. (…) [46] […] Notre Cour doit décider si les actes juridiques accomplis par les parties et qui sont à l’origine des avis de cotisation correspondent à l’intention réelle commune des parties et si le fisc a droit au maintien d’une déclaration de volonté erronée. […] [ 32 ] LeBel J. observed that the parties had the power to correct the documents without the intervention of the Court, [9] although the Courts could intervene to declare the amendments legitimate and necessary by way of the motion for rectification.

He saw no reason to intervene in the conclusion of this Court that it was possible to remedy the errors based on the parties’ common intention.

In so approving the manner of proceeding, LeBel J. stated that: [52] (…) In the civil law, the tax authorities do not have an acquired right to benefit from an error made by the parties to a contract after the parties have corrected the error by mutual consent. (Emphasis added) [52] […] En droit civil, le fisc ne possède pas de droit acquis au bénéfice d’une erreur que les parties à un contrat auraient commise, puis corrigée de consentement mutuel. [ 33 ] He continued as follows:

[ 33 ] He continued as follows: [54] (…) Taxpayers should not view this recognition of the primacy of the parties’ internal will — or common intention — as an invitation to engage in bold tax planning on the assumption that it will always be possible for them to redo their contracts retroactively should that planning fail.

A taxpayer’s intention to reduce his or her tax liability would not on its own constitute the object of an obligation within the meaning of art. 1373 C .C.Q. , since it would not be sufficiently determinate or determinable. (…) [54] […] En effet, les contribuables ne devraient pas interpréter cette reconnaissance de la primauté de la volonté interne — ou intention commune — des parties comme une invitation à se lancer dans des planifications fiscales audacieuses, en se disant qu’il leur sera toujours possible de refaire leurs contrats rétroactivement en cas d’échec de ces planifications.

L’intention d’un contribuable de réduire ses obligations fiscales ne saurait à elle seule constituer l’objet de l’obligation au sens de l’ art. 1373 C.c.Q. , compte tenu de son caractère insuffisamment déterminé ou déterminable […]. [ 34 ] Accordingly, in my view, the judgment of the Supreme Court in AES & Riopel is authority for the proposition that as between related parties, who choose to effect a legitimate [10] corporate transaction for the purpose of avoiding, deferring or minimizing tax and who commit an error in giving effect to such transaction (for example, by miscalculating the ACB, by the timing of certain corporate steps or the attributions of a new class of shares) may correct that error to achieve the tax consequence originally and specifically intended and agreed upon. [ 35 ] However, LeBel J. did not set aside all the previous case law in tax matters, to the effect that the parties cannot rewrite history and change their transactions because of unintended tax consequences.

Those principles continue to apply. [ 36 ] Even though the tax authorities have no acquired rights in civil law, LeBel J., in my view, does not sanction a general license to travel back through time with the benefit of hindsight to reverse or correct unintended tax consequences of commercial dealings.

LeBel J. merely approved the parties restoring their agreement to what it should have been in circumstances where there was no mistake in the transaction itself but rather a mistake in the way the transaction had been expressed in writing. [ 37 ] Tax liability is based on what happened and not on what a party in retrospect would have rather done : [11] The incidence of taxation depends on the manner in which a taxpayer arranges his affairs.

Just as he may arrange them to attract as little taxation as possible, so he may unfortunately arrange them in such a manner as to attract more than is necessary. [12] [ 38 ] Correcting a transaction is not the same as changing it: [66] (…) rectification is granted to restore a transaction to its original purpose , and not to avoid an unintended effect . A transaction which does not succeed in achieving its goal of avoiding tax is not the same thing as a transaction whose goal is other than tax avoidance but which unexpectedly results in a tax disadvantage.

While, therefore, rectification is available in order to avoid a tax disadvantage which the parties had originally transacted to avoid, it is not available to avoid an unintended tax disadvantage which the parties had not anticipated at the time of transacting. [13] [ 39 ] AES & Riopel clearly examined the first type of transaction whose legitimate goal of avoiding tax was not achieved.

The courts approved a correction to allow the parties to avoid a tax consequence that they had originally transacted to avoid. [ 40 ] The Supreme Court of Canada has made it clear in a taxpayer’s favour that: Unless the ( Income Tax) Act provides otherwise, a taxpayer is entitled to be taxed based on what it actually did, not based on what it could have done, and certainly not based on what a less sophisticated taxpayer might have done. [14] [ 41 ] The corollary of the foregoing premise, in my view, is that a taxpayer is obliged to pay tax arising from the transaction it effected and not the transaction that it would have preferred to have effected given the benefit of hindsight regarding unintended tax consequences.

Taxpayers must live with the consequences of the contract they chose to put in place. [15] [ 42 ] In this case, Appellant sought to effect not a transaction by way of corporate restructuring or otherwise, specifically seeking the deferral or other avoidance of tax on the retained earnings of 136 million dollars. Appellant sought to channel those funds to its parent corporation for the latter’s use and in turn to be channelled through other related entities to a trust where a lower rate of tax would be applicable.

The transaction was not a rollover (as in AES ) or other restructuring transaction specifically designed to defer or minimize Appellant’s tax burden or that of its shareholders (as in Riopel ) following the distribution of the 136 million dollars. [16] I would not go so far as to limit the possibility of rectification to correct mechanical or technical errors in transactions specifically foreseen by the tax legislation (as in AES and Riopel ). However to be legitimate, the object sought by the rectification cannot be a mere general intention to reduce tax liability.

As Justice LeBel stated, mere tax avoidance cannot be the object of an obligation as it is not sufficiently determinate or determined within the meaning of

Article 1378 C .C.Q. Otherwise stated, a transaction cannot be rectified merely to avoid the unintended tax. [ 43 ] In the present case, because of an oversight, there was an unexpected tax consequence regarding the deductibility of interest payments on the loan from a related foreign corporation because of the thin capitalization rules. This was a matter different from the

declaration of the dividend. The payment of the 136 million dollar dividend to CTI was intended and was effected. There was no tax consequence on the dividend to Appellant’s parent, CTI. Everything was carried out as intended. Reduction of capital was not intended. The unintended consequence of the dividend, by ricochet, resulted from the thin capitalization rules and was not part and parcel of the transaction.

Seen in this manner, the decision of the Supreme Court of Canada in AES & Riopel is not a licence to recast the documentation to effect the transfer of the 136 million dollars so as to avoid triggering the thin capitalization rules. There was no common intention of the parties regarding these rules as they were never contemplated and so cannot be the object of a meeting of the minds to which a court can give effect. [ 44 ] In view of the above, I agree with the conclusion arrived at by the judge in first instance.

I see no error in the result of her judgment dismissing Appellant’s application and I would accordingly propose that the appeal be dismissed, with costs. MARK SCHRAGER, J.A. [15] BNC, supra , note 12 . [16] As an example see Felix & Norton International inc. et Canada (Procureur général) , 2009 QCCS 919 .