Orman et al. v. Marnat Inc. et al. [Indexed as: Orman v. Marnat Inc.]
108 O.R. (3d) 81
2012 ONSC 549
Ontario Superior Court of Justice,
Perell J.
January 23, 2012
Corporations -- Remedies -- Rectification -- Applicants investing through their companies in Ponzi scheme -- Companies receiving annual payments from fraudster that were reported as income in their financial and tax statements and paying annual bonuses to applicants -- Applicants applying after discovery of fraud to rectify corporate documents to show that amounts received from fraudster were return of principal or capital rather than income -- Application dismissed -- Rectification not available as documents accurately reflected parties' intentions at time documents were prepared.
Taxation -- Income tax -- Applicants investing through their companies in Ponzi scheme -- Companies receiving annual payments from fraudster that were reported as income in their financial and tax statements and paying annual bonuses to applicants -- Applicants applying after discovery of fraud for declarations that moneys received from fraudster were not interest payments but return of capital and that moneys paid by companies to applicants were not bonuses but repayment of corporate loans -- Application granted without prejudice to how moneys were to be treated for tax purposes -- Determination of legal effect of payments being for Minister of National Revenue and Minister of Finance.
The applicants, through their companies, the respondents D Inc. and M Inc., invested money with an investment enterprise operated by W. The companies received annual payments that were reported as income in their financial and tax statements, and paid annual bonuses to the applicants. The bonuses were deducted as a business expense and loaned back to the companies, which agreed to pay interest on the loans. After W committed suicide, it was discovered that he was operating a Ponzi scheme. The applicants brought an application for an order rectifying their companies' financial statements, Canada and Ontario tax returns, and other company records to show that the amounts received from W's company were a return of principal or capital and not income. They also sought declarations to that effect and a declaration that the moneys paid to them by their companies were not bonuses but repayment of corporate loans. The federal government and the Ontario government intervened.
Held, the application should be granted in part.
The applicants were not entitled to rectification. Rectification is available when parties make a mistake in expressing their intent in the document that is designed to express their intent. It is not available to correct erroneous assumptions or beliefs as to what was intended. When the documents which the applicants now sought to have rectified were prepared, the applicants' intent was to prepare documents that showed that their companies were in receipt of investment income and that the applicants were in receipt of salary and investment income. The documents correctly expressed that intent.
The applicants were entitled to the declarations that they sought, but those declarations were made without prejudice as to how the moneys received by the [page82 ]companies from W's scheme and used by them to provide bonuses and interest income to the applicants should be treated for tax purposes. At this point, the determination of the legal effect of the payments being for the Minister of National Review and the Minister of Finance, subject to judicial review.
APPLICATION for rectification and declaration.
Cases referred to 771225 Ontario Inc. v. Bramco Holdings Co. (1995), 1995 CanLII 745 (ON CA), 21 O.R. (3d) 739, [1995] O.J. No. 157, 77 O.A.C. 75, 43 R.P.R. (2d) 70, 52 A.C.W.S. (3d) 1267 (C.A.), affg (1994), 1994 CanLII 7240 (ON SC), 17 O.R. (3d) 571, [1994] O.J. No. 329, 36 R.P.R. (2d) 295, 45 A.C.W.S. (3d) 1077 (Gen. Div.); Danso-Coffey v. Ontario (2010), 99 O.R. (3d) 401, [2010] O.J. No. 913, 2010 ONCA 171, 265 O.A.C. 345, 2010 G.T.C. 1028, 65 B.L.R. (4th) 179 (C.A.), revg 2009 CanLII 4852 (ON SC), [2009] O.J. No. 530, 55 B.L.R. (4th) 145, [2009] 3 C.T.C. 127 (S.C.J.); Juliar v. Canada (Attorney General) (2000), 2000 CanLII 16883 (ON CA), 50 O.R. (3d) 728, [2000] O.J. No. 3706, 136 O.A.C. 301, 8 B.L.R. (3d) 167, [2001] 4 C.T.C. 45, 2000 D.T.C. 6589, 100 A.C.W.S. (3d) 55 (C.A.), affg (1999), 1999 CanLII 15097 (ON SC), 46 O.R. (3d) 104, [1999] O.J. No. 3554, 103 O.T.C. 294, 49 B.L.R. (2d) 243, [2000] 2 C.T.C. 464, 99 D.T.C. 5743, 91 A.C.W.S. (3d) 392 (S.C.J.) [Leave to appeal to S.C.C. refused [2000] S.C.C.A. No. 621], consd Other cases referred to 422252 Alberta Ltd. v. Canada (Attorney General), [2003] B.C.J. No. 2081, 2003 BCSC 1362, [2004] 1 C.T.C. 73, 125 A.C.W.S. (3d) 183 (S.C.); Aim Funds Management Inc. v. Aim Trimark Corporate Class Inc., [2009] O.J. No. 4798, [2009] G.S.T.C. 170, 2010 G.T.C. 1002, 64 B.L.R. (4th) 261 (S.C.J.); Aylwards (1975) Ltd. (Re), 2001 CanLII 32734 (NL SC), [2001] N.J. No. 195, 203 Nfld. & P.E.I.R. 181, 16 B.L.R. (3d) 34, 107 A.C.W.S. (3d) 46 (S.C. (T.D.)); Bank of Montreal v. Vancouver Professional Soccer Ltd., 1987 CanLII 2588 (BC CA), [1987] B.C.J. No. 1326, 15 B.C.L.R. (2d) 34, 5 A.C.W.S. (3d) 13 (C.A.); Canada v. Johns-Manville Corp., 1985 CanLII 43 (SCC), [1985] 2 S.C.R. 46, [1985] S.C.J. No. 44, 21 D.L.R. (4th) 210, 60 N.R. 244, [1985] 2 C.T.C. 111, 85 D.T.C. 5373, 32 A.C.W.S. (2d) 282; Di Battista v. 874687 Ontario Inc. (2006), 2005 CanLII 51220 (ON SC), 80 O.R. (3d) 136, [2005] O.J. No. 5897, [2006] 5 C.T.C. 152, 146 A.C.W.S. (3d) 467 (S.C.J.); GLP NT Corp. v. Canada (Attorney General) (2003), 2003 CanLII 41554 (ON SC), 65 O.R. (3d) 840, [2003] O.J. No. 2904, [2004] 1 C.T.C. 58, 2003 D.T.C. 5654, 124 A.C.W.S. (3d) 288 (S.C.J.); GT Group Telecom Inc. (Re), 2004 CanLII 52533 (ON SC), [2004] O.J. No. 4289, 5 C.B.R. (5th) 230, 134 A.C.W.S. (3d) 540 (S.C.J.); H.F. Clarke Ltd. v. Thermidaire Corp., 1974 CanLII 30 (SCC), [1976] 1 S.C.R. 319, [1974] S.C.J. No. 151, 54 D.L.R. (3d) 385, 3 N.R. 133, 17 C.P.R. (2d) 1, revg 1973 CanLII 41 (ON CA), [1973] 2 O.R. 57, [1973] O.J. No. 1870, 33 D.L.R. (3d) 13, 9 C.P.R. (2d) 203 (C.A.); Johnson v. Canada, [2011] T.C.J. No. 432, 2011 TCC 540 (T.C.C.); Kraft Canada Inc. v. Pitsadiotis, [2009] O.J. No. 885, 73 C.C.P.B. 209, 176 A.C.W.S. (3d) 435 (S.C.J.); Performance Industries Ltd. v. Sylvan Lake Golf & Tennis Club Ltd., [2002] 1 S.C.R. 678, [2002] S.C.J. No. 20, 2002 SCC 19, 283 N.R. 233, [2002] 5 W.W.R. 193, J.E. 2002-448, 98 Alta. L.R. (3d) 1, 299 A.R. 201, 20 B.L.R. (3d) 1, 50 R.P.R. (3d) 212, 111 A.C.W.S. (3d) 733; Peter Pan Drive-In Ltd. v. Flambro Realty Ltd. (1980), 1980 CanLII 1587 (ON CA), 26 O.R. (2d) 746, [1980] O.J. No. 3491, 106 D.L.R. (3d) 576 (C.A.), affg (1978), 1978 CanLII 2160 (ON SC), 22 O.R. (2d) 291, [1978] O.J. No. 2732, 93 D.L.R. (3d) 221, [1978] 3 A.C.W.S. 435 (H.C.J.) [Leave to appeal to S.C.C. refused [1980] 1 S.C.R. xi, 32 N.R. 538]; QL Hotel Service Ltd. v. Ontario (Minister of Finance) (2008), 2008 CanLII 15226 (ON SC), 90 O.R. (3d) 760, [2008] O.J. No. 1365, 166 A.C.W.S. (3d) 1160 (S.C.J.); Razzaq Holdings Ltd. (Re), [2000] B.C.J. No. 2573, 2000 BCSC 1829, 11 B.L.R. (3d) 157, 101 A.C.W.S. (3d) 924 (S.C.); Simmonds v. Canada, 1997 CanLII 26398 (TCC), [1997] T.C.J. No. 51, [1997] 2 C.T.C. 2293 (T.C.C.); TCR Holding Corp. v. Ontario, [2010] O.J. No. 1238, 2010 ONCA 233, 69 B.L.R. (4th) 175, 261 O.A.C. 256 (C.A) [Leave to appeal to S.C.C. refused [2010] S.C.C.A. No. 206]; Wasauksing First Nation v. Wasausink Lands Inc., 2004 CanLII 15484 (ON CA), [2004] O.J. No. 810, 184 O.A.C. 84, 43 B.L.R. (3d) 244, [2004] 2 C.N.L.R. 355, 129 A.C.W.S. (3d) 2 (C.A.), affg [2002] O.J. No. 164, [2002] O.T.C. 50, [2002] 3 C.N.L.R. 287, 111 A.C.W.S. (3d) 201 (S.C.J.); Winclare Management Services Ltd. v. Canada (Attorney General), 2009 CanLII 18234 (ON SC), [2009] O.J. No. 1580, 57 B.L.R. (4th) 68, 176 A.C.W.S. (3d) 1024, [2009] 5 C.T.C. 278 (S.C.J.) [page83 ]
Statutes referred to Corporations Tax Act, R.S.O. 1990, c. C.40 [as am.] Federal Courts Act, R.S.C. 1985, c. F-7, s. 18(1)(b) Financial Administration Act, R.S.C. 1985, c. F-11, s. 23(2) Financial Administration Act, R.S.O. 1990, c. F.12, s. 5.1. Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.) [as am.], s. 152(4.2) [as am.] Retail Sales Tax Act, R.S.O. 1990, c. R.31, s. 43 [as am.]
William V. Sasso and Jacqueline A. Horvat, for applicants. Lori E.J. Patyk, for Her Majesty the Queen in Right of Ontario as represented by the Minister of Finance. Marie-Therese Boris and Diana Aird, for Attorney General of Canada.
PERELL J.: --
A. Introduction
[1] Between 1998 to 2004, the applicants, Alan Orman and Gerald L. Freed, individually and through their corporations, the respondents D.S.D. Holdings Inc. and Marnat Inc., were the victims of a Ponzi scheme perpetrated by the late Howard Waxenberg, an investment advisor, and by Downing & Associates, the entity he used to defraud investors.
[2] As a result of the Ponzi scheme, Messrs. Orman and Freed, who I will sometimes refer to as the "Taxpayers", paid income tax on moneys that they reported as income, and which they now say was a return of principal or capital and not subject to income tax. Mr. Orman says that he unnecessarily paid $550,823.33 in income tax, and Mr. Freed says he unnecessarily paid $654,182.23. They also suffered capital losses on their investments.
[3] Messrs. Orman and Freed seek orders rectifying the corporate records of D.S.D. Holdings and Marnat respectively, and they seek declarations to show that (a) the moneys received from Downing & Associates were not interest payments but a return of capital; and (b) the moneys paid by D.S.D. Holdings and Marnat to Messrs. Orman and Freed were not bonuses but were repayment of corporate loans.
[4] The motion to rectify the corporate records of D.S.D. Holdings and Marnat is not resisted by these corporations but by the respondents, the Attorney General of Canada for the Minister of National Revenue and Her Majesty the Queen in Right of Ontario as represented by the Minister of Finance. [page84 ]
[5] The federal government and the Ontario government, which I will refer to collectively as the "Taxman", submit that rectification is not necessary and that, in any event, the conditions for rectification have not been satisfied. Further, the Taxman submits that granting rectification to Messrs. Orman and Freed would privilege them over other taxpayers. The Taxman submits that the application for rectification and for declarations should be dismissed.
[6] For the reasons that follow, I agree with the Taxman that Messrs. Orman and Freed are not entitled to rectification. At the time of the preparation of the documents and records they seek to have rectified, Messrs. Orman and Freed each intended that the documents express the meaning that the payments from Downing & Associates were income. There is no error in the expression of that intent in the corporate and tax documents, and, therefore, the equitable remedy of rectification is not available.
[7] I, however, disagree with the Taxman that the application for a declaration should be dismissed. In my opinion, it is appropriate to make a declaration that the moneys received by Messrs. Orman and Freed were not income but a return of principal or capital.
[8] It is important to note that this declaration is very specific and that the declaration may or may not be particularly helpful to Messrs. Orman and Freed. The declaration is without prejudice to and is not a declaration of how, as a legal question, the payments should be treated for tax purposes nor is it a determination that the Taxman should refund the $550,823.33 paid by Mr. Orman and the $654,182.23 paid by Mr. Freed.
[9] Put shortly, the court's order will not determine whether or not the Taxman must or should make tax refunds to Messrs. Orman and Freed.
[10] I add that insofar as this case may be a precedent for others in similar predicaments to Messrs. Orman and Freed, it is important to note not only the precision or narrowness of the declaration, but also that the reason that it is at all binding on the Taxman is that the Taxman intervened in this application to become a party, which may not always be the case.
B. Factual Background
[11] There is no dispute about the following facts.
[12] D.S.D. Holdings is an investment company wholly owned by Mr. Orman and his family. Marnat is an investment company wholly owned by Mr. Freed and his family.
[13] Between 1998 to 2005, D.S.D. Holdings entered into investment agreements with Downing & Associates, which was [page85 ]an investment enterprise operated or used by Howard Waxenberg, a Florida investment adviser. Messrs. Orman and Freed, who are partners in a clothing business in Windsor, Ontario, had met Mr. Waxenberg during sojourns at their winter residences in Boca Raton, Florida.
[14] Downing & Associates sent investors like Messrs. Orman and Freed account statements along with cheques that were represented to be interest income on the investments less a management fee. The statements indicated a return of between 18 per cent to 20 per cent per annum.
[15] As set out in the chart below, between 1998 and 2005, D.S.D. Holdings made investments with Downing & Associates, and it received payments that were reported as income in its financial and tax statements. Each year, D.S.D. Holdings paid bonuses to Mr. Orman, which were deducted as a business expense. The bonuses were loaned back to D.S.D. Holdings, and it agreed to pay interest on the loans, as set out in following chart.
[QL:GRAPHIC NAME="108OR3d081-1.jpg"/]
[16] In 1998 and 1999, Mr. Freed entered into investment agreements with Downing & Associates, which investments were transferred to Marnat in 1999, after which it was Marnat that made investments, until the Ponzi scheme was discovered in 2005. In 1998 and 1999, Mr. Freed received $52,842.52 from Downing & Associates that he reported in his income tax returns as taxable income.
[17] As set out in the chart below, between 1999 and 2005, Marnat made investments with Downing & Associates, and it received payments that were reported as income in its financial and tax statements. Each year, Marnat paid bonuses to Mr. Freed, which were deducted as a business expense. The bonuses were loaned back to Marnat, and it agreed to pay interest on the loans, as set out in the following chart. [page86 ]
[QL:GRAPHIC NAME="108OR3d081-2.jpg"/]
[18] In 2005, Mr. Waxenberg committed suicide, and it was subsequently discovered that Downing & Associates was operating a Ponzi scheme.
[19] The U.S. Securities and Exchange Commission charged Downing & Associates and Waxenberg's estate with violations of U.S. securities laws. The receiver appointed by the United States District Court reported that Mr. Waxenberg had defrauded about 200 investors, who had invested about $141 million.
[20] The receiver reported and it is uncontested that Downing & Associates did minimal trading, made marginal or negative returns and falsely reported earnings that were actually a return of the investors' principal.
[21] At the time of Mr. Waxenberg's death, D.S.D. Holding's investment with Downing & Associates was US$2,400,000. The return on this investment in moneys received from Downing & Associates by D.S.D. Holdings (it is a matter of debate whether as a matter of tax law the return was principal or a return of income) was US$1,686,696.
[22] At the time of Mr. Waxenberg's death, Marnat's investment with Downing & Associates was US$2,250,000. The return on this investment in moneys received from Downing & Associates by Mr. Freed and Marnat (it is a matter of debate whether as a matter of tax law the return was principal or a return of income) was US$1,683,148.40.
[23] The receiver recovered approximately $10 million for investors, being a 27.45 per cent recovery. Mr. Freed received $18,852.09. Marnat received $159,751.17 and D.S.D. Holdings received $201,279.43. Thus, Mr. Orman lost approximately US$512,000 in capital and also paid approximately $551,000 in income taxes on Ponzi fund moneys. Mr. Freed lost approximately US$388,000 in capital and also paid approximately $654,000 in income taxes on Ponzi fund moneys. [page87 ]
C. Procedural Background
[24] On December 15, 2006, Messrs. Orman and Freed commenced an application against D.S.D. Holdings and Marnat. In their notice of application, they seek the following order:
(a) rectifying Marnat Inc.'s financial statements, Canada tax returns and Ontario tax returns and other corporate records, reports and filings in each of the years 1998 to 2004 to record that the amounts received from Downing Associates Technical Analysis ("Downing") particularized in the affidavit of Gerald Freed filed in support of this application, are treated and accounted for as a return of the principal amount invested and not as income and a declaration accordingly;
(b) rectifying Marnat Inc.'s financial statements, Canada tax returns and Ontario tax returns and other corporate records, reports and filings so that the payment to Gerald Freed of the bonus and interest authorized in each of the years 1998 to 2004 inclusive, set out in paragraphs 14 and 16 of his affidavit, is treated and accounted for as payments on account of Marnat Inc.'s indebtedness to him and on account of capital and a declaration accordingly;
(c) rectifying D.S.D. Holding Inc.'s financial statements, Canada tax returns and Ontario tax returns and other corporate records, reports and filings in respect of each of the years 1998 to 2004 to record that the amounts received from Downing particularized in the affidavit of Alan Orman are treated and accounted for as a return of the principal amount invested and not as income and a declaration accordingly;
(d) rectifying D.S.D. Holding Inc.'s financial statements, Canada tax returns and Ontario tax returns and other corporate records, reports and filings so that the payment to Alan Orman of the bonus and interest authorized in each of the years 1998 to 2004 inclusive, set out in paragraphs 10 and 12 of his affidavit, be treated and accounted for as payments on account of D.S.D. Holding Inc.'s indebtedness to him and on account of capital and a declaration accordingly.
[25] After the application had been commenced, Messrs. Orman and Freed wrote Canada Revenue and the Ontario Ministry of Finance to advise that the business income reported by D.S.D. Holdings and Marnat was not income but was a return of capital invested.
[26] The Taxman disagreed and did not issue any reassessments. The Taxman's position is that in a Ponzi scheme, the investors do not receive a return of capital, but rather investors receive funds from the contribution of new investors into the Ponzi scheme, which is a source of income for tax purposes.
[27] To date, Messrs. Orman and Freed have not sought judicial review of the Minister of National Revenue's decision not to reassess the income tax liability, and the matter is currently before the minister on a "Second Level Review", which is a reconsideration of the decision not to reassess. [page88 ]
[28] To date, Messrs. Orman and Freed have also not sought judicial review of the Ontario Minister of Finance's decision not to reassess.
[29] In February 2007, on consent and because the relief claimed in the application might affect the tax assessments of Messrs. Orman and Freed, D.S.D. Holdings and Marnat under the Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.), as amended, and the Corporations Tax Act, R.S.O. 1990, c. C.40, the federal and provincial governments were added as respondents.
[30] After being added as parties, the Taxman moved for an order striking the application on the grounds that the Superior Court did not have jurisdiction to grant the rectification orders being sought by Messrs. Orman and Freed. Justice Desotti, however, dismissed the motion by order dated October 20, 2009.
D. Discussion and Analysis
[31] As a general proposition, the Taxman submits that taxpayers, like Messrs. Orman and Freed, are free to restate or rectify their income tax returns and corporate financial statements, and they do not need a court order to do so. The Taxman submits that taxpayers can rectify their documents without a court order and then re-apply under the tax legislation for a re-assessment. In the circumstances of this case, if this is correct, it means that Messrs. Orman and Freed's request for a re-assessment may eventually be a matter of judicial review to determine whether the Taxman's treatment of their tax liability should be changed.
[32] Visualize, if the Taxpayers challenge the decision of the Minister of Revenue under s. 152(4.2) of the Income Tax Act not to reassess for a statute-barred request for a reassessment, then the decision is subject to judicial review exclusively in the Federal Court pursuant to s. 18(1)(b) of the Federal Courts Act, R.S.C. 1985, c. F-7. Taxpayers may also request a remission order under the Financial Administration Act, R.S.C. 1985, c. F-11, s. 23(2). If the Taxpayers challenge the decision of Ontario Minister of Finance's decision, under the Corporate Tax Act, there is an appeal to the Superior Court. Also, the Minister of Finance has discretion to accept a portion of tax assessed where it would be inequitable to collect the full amount, which exercise of discretion is subject to judicial review. Taxpayers may also request a remission order under the Financial Administration Act, R.S.O. 1990, c. F.12, s. 5.1.
[33] In other words, the Taxman submits that the Superior Court should defer or not interfere with a matter that is within the designated jurisdiction of a minister or another court. The Taxman submits that the court should not order rectification or [page89 ]make a declaratory order that would interfere with the jurisdiction of a specialized tribunal or another court: GLP NT Corp. v. Canada (Attorney General) (2003), 2003 CanLII 41554 (ON SC), 65 O.R. (3d) 840, [2003] O.J. No. 2904 (S.C.J.), at paras. 20-22; 422252 Alberta Ltd. v. Canada (Attorney General), [2003] B.C.J. No. 2081, 2003 BCSC 1362 (S.C.).
[34] In my opinion, the Taxman's submission fails for three reasons. First, as a general proposition, independent of the affect, if any, of this court's order on a taxpayer's liability, there may be reasons for this court to order rectification or to make declarations for taxpayers. In the case at bar, it just happens that Messrs. Orman and Freed and their corporations agree that the financial statements and other documents should be rectified, but this will not always be the case, and the court should not defer the appropriate exercise of its own jurisdiction when there is a genuine reason to exercise it. Further, an administrator, a tribunal or another court may not have the jurisdiction to order rectification of the documents that would affect tax liability, and the court may be the only recourse for a taxpayer. For example, it was conceded during argument that the Tax Court would not have jurisdiction to order rectification of the corporate documents.
[35] Juliar v. Canada (Attorney General) (2000), 2000 CanLII 16883 (ON CA), 50 O.R. (3d) 728, [2000] O.J. No. 3706 (C.A.), affg (1999), 1999 CanLII 15097 (ON SC), 46 O.R. (3d) 104, [1999] O.J. No. 3554 (S.C.J.), leave to appeal to S.C.C. refused [2000] S.C.C.A. No. 621 is authority that a court should not defer from making rectification orders because the order might affect the Taxman's imposition of tax. See, also, Aim Funds Management Inc. v. Aim Trimark Corporate Class Inc., [2009] O.J. No. 4798, [2009] 9 G.S.T.C. 170 (S.C.J.).
[36] Second, in the case at bar, although the court's order may be relevant to the exercise of the minister's discretion to re-assess and to the determinations of other administrative or judicial proceedings, the order will not interfere with the jurisdiction of the other administrator or tribunal to make determinations within their jurisdiction. This court will make a declaration about a state of facts but not make a declaration of the legal outcome of that state of facts.
[37] Third, the submission fails because the Taxman joined these proceedings, and as a party to the application, the Taxman is now bound by the outcome (which will be declaratory relief but not rectification). In my opinion, if, as the Taxman submits, the Taxpayers should have exercised self-help and rectified their own documents and then resorted to the administrative and judicial proceedings designed to determine tax liability, then it is [page90 ]equally true that the Taxman should not have become a party to these proceedings. Rather, the Taxman should have confined its involvement to the administrative tax assessment or re-assessment procedures, in which case it could have argued that it was not bound at all by the Superior Court's termination. The Taxman, however, participated and it will be bound by the declaration, although not in a way that interferes with the jurisdiction of another administrator or tribunal.
[38] Thus, I conclude that the court should decide and not defer deciding Messrs. Orman and Freed's request for rectification and declaratory relief.
[39] Turning to the merits of the claim for rectification, in my opinion, equity's remedy of rescission of documents is not available in the circumstances of this case.
[40] Rectification is available when parties -- and often the reference is to contracting parties -- make a mistake in expressing their intent in the document that expresses their intent.
[41] In addition to contracts, courts have ordered rectification of
-- articles of amalgamation: TCR Holding Corp. v. Ontario, [2010] O.J. No. 1238, 2010 ONCA 233 (C.A.), leave to appeal to S.C.C. refused [2010] S.C.C.A. No. 206; Aylwards (1975) Ltd. (Re), 2001 CanLII 32734 (NL SC), [2001] N.J. No. 195, 16 B.L.R. (3d) 34 (S.C. (T.D.));
-- articles of amendment: Di Battista v. 874687 Ontario Inc. (2006), 2005 CanLII 51220 (ON SC), 80 O.R. (3d) 136, [2005] O.J. No. 5897 (S.C.J.);
-- an arrangement under the Companies' Creditors Arrangement Act: GT Group Telecom Inc. (Re), 2004 CanLII 52533 (ON SC), [2004] O.J. No. 4289, 5 C.B.R. (5th) 230 (S.C.J.);
-- corporate resolutions: Winclare Management Services Ltd. v. Canada (Attorney General), 2009 CanLII 18234 (ON SC), [2009] O.J. No. 1580, 57 B.L.R. (4th) 68 (S.C.J.); QL Hotel Service Ltd. v. Ontario (Minister of Finance) (2008), 2008 CanLII 15226 (ON SC), 90 O.R. (3d) 760, [2008] O.J. No. 1365 (S.C.J.);
-- share transfers: Razzaq Holdings Ltd. (Re), [2000] B.C.J. No. 2573, 2000 BCSC 1829;
-- a retirement plan under a collective agreement: Kraft Canada Inc. v. Pitsadiotis, [2009] O.R. No. 885, 73 C.C.P.B. 209 (S.C.J.).
[42] Rectification is concerned with mistakes in recording the parties' intent or purpose in their writing. It is not concerned [page91 ]about mistakes in the underlying purpose. Rectification is designed to ensure that the parties' documents express the parties' purpose at the time the document was finalized. See H.F. Clarke Ltd. v. Thermidaire Corp., 1973 CanLII 41 (ON CA), [1973] 2 O.R. 57, [1973] O.J. No. 1870 (C.A.), at para. 25, revd on other grounds 1974 CanLII 30 (SCC), [1976] 1 S.C.R. 319, [1974] S.C.J. No. 151; Wasauksing First Nation v. Wasausink Lands Inc., 2004 CanLII 15484 (ON CA), [2004] O.J. No. 810, 184 O.A.C. 84 (C.A.), at paras. 76-81, affg [2002] O.J. No. 164, [2002] 3 C.N.L.R. 287 (S.C.J.); Juliar v. Canada (Attorney General), supra.
[43] To obtain an order rectifying a document, usually a contract, the applicant must prove (1) a common intention held by the parties before the making of the document alleged to be incorrect; (2) the common intention remained unchanged at the date that the document was finalized; and (3) the document, by mistake, does not conform to the parties' prior common intention: Peter Pan Drive-In Ltd. v. Flambro Realty Ltd. (1978), 1978 CanLII 2160 (ON SC), 22 O.R. (2d) 291, [1978] O.J. No. 2732 (H.C.J.), at para. 13, affd (1980), 1980 CanLII 1587 (ON CA), 26 O.R. (2d) 746, [1980] O.J. No. 3491 (C.A.), leave to appeal to S.C.C. refused, [1980] 1 S.C.R. xi, 32 N.R. 538.
[44] The court has an equitable jurisdiction to rectify documents that do not reflect the intentions of the parties where it can be said that the parties shared a common and continuing intention up to the time of the finalization of the documents: Bank of Montreal v. Vancouver Professional Soccer Ltd., 1987 CanLII 2588 (BC CA), [1987] B.C.J. No. 1326, 15 B.C.L.R. (2d) 34 (C.A.); Razzaq Holdings Ltd. (Re), supra.
[45] The traditional rule was to permit rectification only for mutual mistake, but rectification is now available for unilateral mistake provided certain demanding preconditions are met: Performance Industries Ltd. v. Sylvan Lake Golf & Tennis Club Ltd., [2002] 1 S.C.R. 678, [2002] S.C.J. No. 20, 2002 SCC 19, at para. 31.
[46] In Wasauksing First Nation v. Wasausink Lands Inc., supra, at paras. 77 and 81, the Court of Appeal stated:
[A]n applicant seeking rectification of a written agreement must demonstrate, on "convincing proof", that the parties had a common intention, antecedent to the formal document in question and evidenced by some outward expression of accord, that continued unchanged until the time that the formal document was executed by the parties and that the formal document mistakenly did not conform to the prior common intention. . . . . .
Rectification is not used to vary the intentions of the parties, or to speculate on the substance of those intentions; rather it is designed to correct a mistake in carrying out the settled intentions of the parties as established by the evidence. As well, and importantly, rectification is not available to correct erroneous assumptions or beliefs as to what was intended[.][page92 ]
[47] At the time when Messrs. Orman and Freed were preparing or having prepared the documents that they now seek to rectify, their intent was to prepare or have documents prepared to express that their corporations were in receipt of investment income and that Messrs. Orman and Freed were in receipt of salary and investment income. At the time when the documents were finalized, the documents correctly expressed Messrs. Orman and Freed's intent. Rectification is not available to correct what is a mistake in the underlying purpose that was accurately expressed in the parties' documents. Rectification is not available to correct erroneous assumptions or beliefs as to what was intended.
[48] In the case at bar, I regard Juliar v. Canada (Attorney General), supra; 771225 Ontario Inc. v. Bramco Holdings Co. (1994), 1994 CanLII 7240 (ON SC), 17 O.R. (3d) 571, [1994] O.J. No. 329 (Gen. Div.), affd (1995), 1995 CanLII 745 (ON CA), 21 O.R. (3d) 739, [1995] O.J. No. 157 (C.A.); and other cases about rectification where rectification is sought in order to avoid or reduce the imposition of tax are helpful only insofar as they illustrate the general principles about rectification and equitable relief because Messrs. Orman and Freed were never engaged in arranging their affairs to obtain a more favourable tax treatment. Rather, their intent at the time the documents were prepared was to pay tax, because they perhaps mistakenly thought that they were obliged to do so. By seeking rectification, they are not seeking to be taxed in a more favourable manner; they are seeking rectification because they now believe that it was a mistake to believe that they were obliged to pay tax.
[49] 771225 Ontario Inc. v. Bramco Holdings Co. is a useful case for demonstrating the general principle that rectification is not available to correct a document because of a mistake in forming a party's or the parties' intentions, but rather it is available to correct a mistake in implementing the party's or the parties' intentions. In this case, Audrey Ho transferred property to 6840002 Ontario Ltd. This was a mistake because the grantee was a non-resident corporation and liable for a higher rate of land transfer tax. The court held that it could not order rectification to "re-do" the transaction. Ms. Ho never had an intention other than to transfer to 6840002 Ontario Ltd., and thus the documents correctly expressed her intent and there was no basis for rectification.
[50] In Juliar v. Canada (Attorney General), supra, a majority of the Court of Appeal distinguished 771225 Ontario Inc. v. Bramco Holdings Co. In Juliar, the applicants transferred shares into a holding company in a manner that had adverse tax consequences. The choice of a conveyance mechanism was a [page93 ]mistake because the applicants always intended a transaction designed to avoid the adverse tax consequences. Thus, the documents used by the parties did not correctly express their pre-existing and continuing intention, and rectification was appropriate to align the expression of the intent with the pre-existing intent. See, also, QL Hotel Service Ltd. v. Ontario (Minister of Finance), supra.
[51] Messrs. Orman and Freed rely on the Court of Appeal's decision in Danso-Coffey v. Ontario (2010), 99 O.R. (3d) 401, [2010] O.J. No. 913, 2010 ONCA 171 (C.A.) in support of their claims for relief, and the case supports their claim for a declaration but not their claim for rectification.
[52] The Court of Appeal's reasoning in Danso-Coffey is intricate, and the judgment requires a close and careful reading. The facts were that without her consent, Ms. Danso-Coffey was made a director of her brother's corporation, which went bankrupt. Under s. 43 of the Retail Sales Act, R.S.O. 1990, c. R.31, the directors of a bankrupt corporation are liable to pay unremitted retail sales tax, and as a director, Ms. Danso-Coffey became liable to remit $64,020.78. Because of bad advice, she did not challenge the assessment under the Act, but instead she sued the Ontario government to obtain a cancellation of the tax liability. The judge at first instance [2009 CanLII 4852 (ON SC), [2009] O.J. No. 530, 55 B.L.R. (4th) 145 (S.C.J.)] declared that she was never a director and, accordingly, that she was not liable for the unremitted retail sales tax. The judge at first instance also held that the assessment was unlawful because she was not a director.
[53] In a judgment written by Justice Weiler, the Court of Appeal held that the judge at first instance was correct in declaring that Ms. Danso-Coffey was not a director but incorrect in concluding that the assessment was unlawful.
[54] Justice Weiler held that the minister's assessment was lawful and that Ms. Danso-Coffey could have raised the issue that she was never a director as a defence to the assessment. Further, Justice Weiler held that assuming that the Superior Court had a general jurisdiction to grant declaratory relief, the application judge erred in declaring that Ms. Danso-Coffey was not liable for retail sales tax.
[55] Since Ms. Danso-Coffey could have raised a defence under the assessment procedure of the Retail Sales Tax Act, there was no jurisprudential reason for the Superior Court to exercise its jurisdiction to make a declaration. Justice Weiler concluded that the legislature intended that disputes about the validity of an assessment of tax were to be resolved within the procedures of the Act. [page94 ]
[56] In the result, the Court of Appeal allowed the minister's appeal, but Justice Weiler noted that this outcome did not mean that the declaration that Ms. Danso-Coffey had never been a director had no legal effect. Since the factual basis on which the assessment was made did not exist, Ms. Danso-Coffey could ask the minister to reassess the imposition of liability for tax based on the true state of facts.
[57] Applying the analytical approach of Danso-Coffey v. Ontario to the circumstances of the case at bar, the uncontested evidence establishes as a fact that the payments received from Downing & Associates were not investment income. It is uncontested that Downing & Associates was not using the moneys it received to make investments and earn income, but it was operating a Ponzi scheme and using the investors' own money or the money of other investors to make payments purporting, but not being in truth, a return on the investors' investments.
[58] This factual determination is binding on the Taxman and the Taxpayers who are parties to this proceeding. However, this factual determination is not a legal determination of the legal propriety of the Taxman's treatment of this factual truth.
[59] The question of law as to whether a payment or a receipt is on account of income or of capital is a determination to be determined under the procedures of the Income Tax Act and the Corporate Tax Act. See Canada v. Johns-Manville Corp., 1985 CanLII 43 (SCC), [1985] 2 S.C.R. 46, [1985] S.C.J. No. 44; 422252 Alberta Ltd. v. Canada (Attorney General), supra.
[60] This subtle distinction between influencing an administrator's decision in law and making the legal decision for the administrator was recognized in Danso-Coffey v. Ontario and explains why Justice Weiler's judgment is so careful and intricate. In that case, it was appropriate for the judge at first instance to declare that Ms. Danso-Coffey was not a director, but it was wrong for him to declare that she was not liable as a director to remit retail sales tax.
[61] Similarly, in the case at bar, it would be wrong of me to declare how for tax purposes the moneys received by D.S.D. Holdings and Marnat as investment income but now know in truth to be something other than genuine investment income should be treated for tax purposes. At this juncture, the determination of the legal effect of the nature of the payments received by D.S.D. Holdings and Marnat is for the Minister of National Revenue and the Minister of Finance, subject to judicial review in the Federal Court with respect to the Income Tax Act or this court with respect to corporate tax under the Corporate Tax Act. [page95 ]
[62] Therefore, I do not have to agree or disagree with Simmonds v. Canada, 1997 CanLII 26398 (TCC), [1997] T.C.J. No. 51, [1997] 2 C.T.C. 2293 (T.C.C.), where the Tax Court held that money from a Ponzi scheme is a source of income for tax purposes or with Johnson v. Canada, [2011] T.C.J. No. 432, 2011 TCC 540 (T.C.C.), where the opposite decision was reached.
[63] I also do not have to address the Taxman's argument that treating Messrs. Orman and Freed's monthly payments from the Ponzi scheme as a return of capital would be unfair to other investors who lose money on their investments for other reasons and this unfairness was a reason for the court not to grant any relief but to dismiss the application. However, I did address this argument during oral argument and expressed the view that I did not see any unfairness because the Ponzi scheme investors are not similarly situated to other investors because there is a difference between investors whose investment losses are a result of fraud and investors whose losses are a result of a failure in performance of the investment. For whatever it is worth, I have not changed my opinion.
E. Conclusion
[64] For the above reasons, I dismiss the request for rectification.
[65] For the above reasons, without prejudice to how as a matter of law the moneys received by D.S.D. Holdings and Marnat from Downing & Associations and used by those corporations to provide bonuses and interest income to Messrs. Orman and Freed is treated for tax purposes, I declare the moneys are not income, but rather a return of principal or capital to D.S.D. Holdings and Marnat.
[66] I regard success on this application as being equally divided, and my inclination is not to make an order as to costs. However, the parties may disagree and, therefore, if any party seeks costs, they may do so within 20 days of the release of these reasons for decision to be followed by reply submissions within a further 20 days.
[67] I would like to thank counsel for their interesting and helpful arguments.
Application granted in part.