Rectification is About Intention - Not Interpretation

The Ontario Superior Court of Justice recently granted rectification in a case in which the CRA and the taxpayer differed in their interpretation and effect of a particular document. In Kaleidescape Canada Inc et al v Computershare Trust Company of Canada et al, 2014 ONSC 4983, the Court was asked to determine whether the parties intended that Kaleidescape Canada Inc. remain a Canadian-controlled private company (CCPC) for the purposes of obtaining certain scientific research and development tax credits under the Income Tax Act (Canada).

Facts

Kaleidescape Canada Inc. (KCI) is a research and development company located in Ontario. KCI was structured as a deadlock corporation so that it would not be controlled by a non-resident and therefore would qualify as a CCPC.

From its incorporation in 2001 to 2006, KCI was accepted as a CCPC by CRA and benefitted from SR&ED credits. KCI's shareholdings were restructured, and by 2008, were owned by Kaleidescape Inc. (KI), an American company, and Kaleidescape Canada Employment Trust (the Trust).

It was believed at the time of the restructuring that replacing the previous Canadian resident individual shareholder with the Trust would allow KCI to maintain its CCPC status and continue to take advantage of the SR&ED credits. A Restated and Amended Trust Deed (the Deed) was entered into with KCI as the Settlor and Computershare Trust Company of Canada as the sole trustee. Pursuant to the Deed, the Trust and the Trustee were intended to be residents of Canada.

However, KI and the Trustee held equal voting rights, and a unanimous shareholders agreement relieved KCI's directors of their powers and conferred those powers on the shareholders. There was no provision to resolve a deadlock, and neither the shareholders nor directors had the right to make unilateral decisions.

CRA took the position that KCI was not a CCPC for the 2008 and 2009 tax years, arguing that the effect the Deed was to give a non-resident authority to direct the Trustee how to vote its shares of KCI, such that a non-resident controlled KCI.

Decision

KCI argued that its common and continuing intention at all times was to structure and operate in a manner that would establish and preserve its CCPC status. The CRA argued that the Applicants could not prove common intention, did not admit that a mistake had been made, and could not show the precise form of a corrected document that would express their prior intention.

The Court reiterated that rectification is an equitable remedy that permits the retroactive correction of written instruments that do not accurately express the parties' original agreement. The onus is on the applicant to satisfy the Court that rectification would simply align the documentation to the true intentions of the parties. The Court further noted that rectification can be granted where parties had an agreement to achieve a specific tax outcome but failed to implement their plan properly. It must be established that the original purpose of the transaction was to avoid taxation in a particular way, not simply avoid an unexpected tax disadvantage.

The Court found that the intention of the parties throughout was to ensure that KCI “ as a research and development company “ qualified for CCPC status and the available research tax credits. As a result, the wording used in the Trust Deed was a mistake and there was no intention to give KI de jure control over KCI. The Court granted rectification.

The Take Away

This case is another reminder that proof of a common intention at the time the original agreement is made is the key to a successful application for rectification. The parties must show that, in entering into a particular agreement or transaction, they had the intention to achieve a certain result under the ITA. Rectification will not be granted in cases where a disadvantageous tax result occurred, but there was not prior intention to avoid that result. Rectification can only be used to properly record the agreement between the parties and not as a tool for retroactive tax planning.

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