Rectification, again

The Niagara region seems to be doing its part to contribute to the law of rectification in the tax context. Juliar v. Canada (Attorney General), 1999 CanLII 15097 (ON S.C.) originated in the peninsula. Now comes QL Hotel Service Limited v. Ontario (Finance), 2008 CanLII 15226 (ON S.C.). In the latter case, one corporation incorporated another and then transferred intangible property to the other for one common share and tangible property for one million Class A Special Shares. The transferor then sold the shares of the transferee to an arm’s length purchaser.Ontario took the position that the transfer of tangible property did not meet the requirements for the exemption from provincial PST provided by subsection 13(3) of R.R.O. 1990, Reg. 1013, which provided that, at the time of the transfer, the transferee had to have been a wholly-owned subsidiary of the transferor to take advantage of the exemption. Ontario took the position that the sale of tangible property occurred at the same time as the issue of shares from the transferee to the transferor. As a result, Ontario claimed, the transferee was a wholly-owned subsidiary only after the sale was complete. The sale of the tangible property, then, was subject to PST.

Mr. Justice Turnbull disagreed. He held that, on the whole, the legal documents seemed to provide that the issue of the one Common Share occurred immediately before the issue of the Class A Special Shares (the consideration for the tangible property). As a result, at the time of the sale of the tangible property, the transferee corporation was a wholly-owned subsidiary of the transferor.

The taxpayer’s counsel also requested rectification in respect of the transaction. The Court was asked to divide the resolution issuing the Common Share and the Class A Special Shares into two, with the issue of the Common Share occurring in the first resolution. The Court agreed that it had no power to grant rectification under the Retail Sales Tax Act, in the context of an appeal under that statute. The taxpayer’s counsel, however, had wisely thought to bring a separate application under the Courts of Justice Act seeking the remedy. The Court found that the parties, based on professional tax advice, had clearly intended to avoid paying PST twice in respect of the same assets. As a result, the Court granted rectification, just in case it was wrong on the question whether the transferee was a wholly-owned subsidiary of the transferor at the time of the sale of the tangible assets.

QL Hotel emphasizes the importance of paying attention to the wording in legal documents when the documents are supposed to give effect to a particular intention for tax purposes. If the timing of the transactions is important, then the documents should explicitly state the time at which they are supposed to have effect. If the parties intend a particular tax effect by signing documents, then the documents should document that intention. It appears that some of the wording in the relevant legal agreement in QL Hotel was unhelpful on both these counts. The judge accepted that the “the agreement was largely a standard form agreement and not dissimilar to many used in other non-arm’s length transactions” (¶50). The taxpayer won this point in court, but it would be better to avoid having to go to court at all!