SUPERIOR COURT OF JUSTICE - ONTARIO

COURT FILE NO.: CV-13-490446

DATE: 20140905

RE: Kaleidescape Inc., Kaleidescape Canada Inc. and The Kaleidescape Canada Employee Trust, Applicants

AND:

Computershare Trust Company of Canada and the Minister of National Revenue, Respondents

BEFORE: Carole J. Brown J.

COUNSEL: Douglas Langley, for the Applicants

Darren Prevost, for the Respondents

HEARD: June 11, 2014

ENDORSEMENT

[1] The applicant, Kaleidescape Canada Inc. ("K-Can"), seeks rectification of the Restated and Amended Deed of Trust dated September 22, 2008 to delete one paragraph therefrom in order not to be subject to income tax which would otherwise be imposed.

[2] K-Can is a research and development company incorporated pursuant to the laws of Ontario, with head offices in Waterloo. As an R & D company it seeks to be eligible to claim the highest level of Scientific Research and Experimental Development Income Tax Credits ("SR&ED") as a Canadian Controlled Private Corporation ("CCPC") pursuant to the Income Tax Act (Canada), and Ontario innovation tax credits under the Ontario Corporations Tax Act. Both credits are administered by the CRA.

[3] It had, from its incorporation in 2001 to 2006, been accepted as a CCPC by CRA and had benefited from the SR & ED credits.

[4] Prior to 2006, the shares of K-Can were owned by Daniel Collens, a Canadian citizen resident in Ontario and by Kaleidescape Inc. ("K-US"), a Delaware company having head offices in California. The shares in K-Can were held as follows: 100 Class A non-voting common shares and 100 Class B voting common shares owned by K-US and 100 Class B voting shares owned by Mr. Collens. When Mr. Collens announced his intention to leave K-Can in 2006, K-Can decided to create the Kaleidescape Canada Employment Trust ("Trust") to replace Mr. Collens as a shareholder.

[5] The legal advice from the legal advisor to K-Can was that the Trust would be beneficial to K-Can and its status as a CCPC and to its ability to take continued advantage of the SR&ED credits.

[6] The principal legal advisor to K-Can provided his advice as to creating the new Employee Trust so as to preserve K-Can's status as a CCPC. The Settlor of the Trust and the original Trustees were Stephen Watson, a resident of Ontario, who, at all relevant times, was the Chief Technology Officer and Corporate Secretary of K-Can and, who became the second director of K-Can after Mr. Collens left the company, and Michael Malcolm, an American citizen, resident in Colorado, who was one of the two directors of K-Can. A third Trustee could be added provided that the third Trustee was a Corporation resident in Canada and licensed to provide trust services and to act as a Trustee under the laws of Ontario. In 2006, when the Employee Trust was being created, K-Can had been negotiating with Scotia Bank to become the third institutional Trustee. However, those discussions did not bear fruit.

[7] Pursuant to the relevant legislation, a CCPC is a private Canadian corporation that is not controlled by a non-resident or by a public corporation, or by a combination of the two. K-Can was set up as a deadlock corporation, such that it would not be controlled by a non-resident and therefore would qualify as a CCPC.

[8] At the time of the re-organization, a new class of shares, Class C special voting shares were created and 100 shares were issued to the Trust such that the Trust became a shareholder of K-Can. The 100 Class B voting shares which were owned by Mr. Collens were repurchased by K-Can. As a result, the 100 Class B voting shares owned by K-US and the 100 Class C special voting shares owned by the Trust created equal voting rights between K-US and the Trust.

[9] At the time of the reorganization, a shareholders’ agreement dated January 1, 2007 was entered into signed by K-Can, K-US and the Trust, which stated, inter alia, that the Board of Directors would consist of two directors, one of whom was to be a resident in Canada. The unanimous shareholder agreement relieved the directors of K-Can of their powers as directors of K-Can and conferred those powers on the shareholders of K-Can. There was no provision to resolve a deadlock and neither of the shareholders nor directors had the right to make unilateral decisions, all of which were intended to ensure that K-Can would qualify as a CCPC. According to the evidence of the applicants, the intention, throughout, was to ensure that the Corporation remained a deadlock corporation and that there was never any control by a non-resident.

[10] On October 1, 2007, Computershare Trust Company of Canada became the third institutional Trustee. Computershare wished to use its own form of Trust Agreement which included paragraph 5.8, as follows: “When this Declaration of Trust expressly provides a right to any person to direct the Trustee to consent to act or take action or refrain from acting, the Trustee shall be required, and hereby agrees to, comply with such directions to the extent permitted by law”.

[11] Generally, corporate Trustees will not act unless directed and typically require written instructions from the Settlor. As K-Can's legal counsel was concerned that paragraph 5.8 was vague and uncertain, he and Thomas Geisler, the CFO of K-US added a new paragraph 5.9, as follows:

Where the Deed of Trust requires or authorizes the Settlor to give directions to the Trustee, the Trustee shall accept only a direction in writing from the CEO or President of the Settlor.

[12] In 2008, Stephen Watson resigned his position as one of the two original Trustees of the Trust and Michael Malcolm was also removed and released as an original Trustee, leaving Computershare as the sole corporate Trustee. The Trust instrument was amended thereafter.

[13] The Restated and Amended Deed of Trust dated September 22, 2008 was entered into with K-Can as Settlor and Computershare as the sole Trustee of the Employee Trust. The Deed states at section 3.3 that it is intended that the Trust be a resident of Ontario and a Canadian taxpayer pursuant to the Income Tax Act. Section 7.5 further stipulates that the Trustee shall at all times be a resident of Canada for purposes of the Income Tax Act. A Deed of Amendment and Appointment of New Trustee was also executed on the same date. This document acknowledged that the Restated and Amended Trust Deed would be "incorporating incidental administrative changes to conform the settlement with the standard form of Trust used by the New Trustee…"

[14] Thereafter, K-Can received notices from the CRA advising that K-Can did not qualify as a CCPC for the taxation years ending December 31, 2008 and December 31, 2009. Large portions of the companies SR&ED credits and OITC credits were also refused for those years. CRA bases its reassessments in part on the wording of section 5.2 and 5.9 of the Restated and Amended Deed of Trust which provide as follows:

5.2…Upon the direction of the Settlor, the Trustee shall… exercise any voting rights…

5.9 Where this Deed of Trust requires or authorizes the Settlor to give directions to the Trustee, the Trustee shall accept only a direction in writing from the CEO or President of the Settlor.

[15] CRA had concluded that the combined effect of those two provisions was to give Michael Malcolm, a non-resident, authority to direct Computershare how to vote the Class C shares of K-Can, such that K-US had de jure control over K-Can and the definition of the CCPC was not met.

[16] In order to address the problem, K-Can and Computershare entered into a Deed dated December 23, 2010, and signed on January 13, 2011, which changed the wording of section 5.9. The Deed of Rectification states, in part, as follows:

RECITALS:

Whereas this Deed is supplemental to the Restated and Amended Deed of Trust made between Kaleidescape Canada Inc. as Settlor, and Computershare Trust Company of Canada as Trustee;…

AND WHEREAS as a result of restating and amending the settlement, incidental and administrative changes were incorporated into the settlement to conform it to the standard form of Trust used by the Trustee;

AND WHEREAS paragraph 5.9 was incorporated into the settlement as follows:

"Where this Deed of Trust requires or authorizes the Settlor to give directions to the Trustee, the Trustee shall accept only a direction in writing from the CEO or President of the Settlor";

AND WHEREAS paragraph 5.9 of the Deed may be misinterpreted as that the CEO or the President of the Settlor has the power to change and or control the Board of Directors of the Settlor;

AND WHEREAS it was the intention of both the Settlor and Trustee and continues to be their intention that the sole purpose of paragraph 5.9 is to provide certainty on how the Settlor will give direction to the Trustee;

AND WHEREAS since the Trust was established, neither the CEO nor the President of the Settlor has given any direction to the Trustee;

AND WHEREAS the Trustee acknowledges that the Settlor has advised it of the misinterpretation and the Trustee and the Settlor have agreed that the Deed requires rectification to reflect their true intention as restating the Trust on September 22, 2008;

NOW THEREFORE THIS DEED WITNESSES THAT

1. Paragraph 5.9 of the Deed is hereby written correctly to provide as follows:

Where the Deed of Trust requires or authorizes the Settlor to give directions to the Trustee, the Trustee shall accept only a direction in writing in the form of a certified copy of a resolution from the Board of Directors of the Settlor".

[17] The document provides that it is effective from September 22, 2008 subject to the approval of the Ontario Superior Court of Justice or, if such approval is not obtained, the effective date of the amendment is to be January 1, 2011.

[18] It is the position of K-Can that they had no intention of removing K-Can’s status as a CCPC, but only attempted to give certainty to the provision for directions to the institutional Trustee. It is their position that the Board, a deadlock body, would decide what the message was and the said message would be communicated by the President or CEO to the Trustee. It is their position that the President or CEO were not authorized to make a decision, but only the Board. In the Deed of Rectification, "from the CEO or the President of the Settlor" is replaced by the Board of Directors, who would make the decision which is communicated by certified resolution to the Trustee.

The Law and Analysis

[19] Rectification is an equitable remedy that, in certain circumstances, permits the retroactive correction of written instruments that do not accurately express the content of the parties' agreement.

[20] In order to obtain rectification, an applicant must satisfy three criteria, set forth by the Supreme Court of Canada as follows:

1. the existence and content of the prior agreement;

2. an error in the written instruments such that the instrument is not consistent with the prior agreement; and

3. a proposed correction that shows the precise form in which the written document can be made to express the prior agreement.

Performance Industries Ltd v Sylvan Lake Golf and Tennis Club Ltd, 2002 SCC 19

[21] Rectification does not change an intended legal relationship or the essence of an agreement between contracting parties, but rather changes an instrument's mistaken expression of that intention. It restores parties to their original bargain. It is not intended to rectify a belatedly recognized error of judgment on the part of the parties. The onus is on the applicant to satisfy the court that rectification would simply align the documentation to the true intentions of the parties which are obstructed due to mistake in the documentation.

[22] Pursuant to the jurisprudence, rectification can be applied where parties had an agreement to achieve a specific tax outcome but failed to implement their plan properly. To the extent that the written agreement or instrument does not carry out the clear intention to produce a particular tax result, and where that particular result was a primary objective of the transaction, this Court has the discretion to rectify that instrument. In cases where the document is sought to be rectified to avoid taxation, it must be established that the original purpose of the transaction was to avoid taxation in a particular way, not simply to avoid an unexpected tax disadvantage.

[23] The applicant argues that prior to the creation of the Restated and Amended Trust Deed, there were no provisions such as paragraph 5.2, 5.8 and 5.9 of the Restated and Amended Trust Deed, as the Trustees were two individuals. They argue that there is no evidence of an attempt to bestow on K-US de jure control of K-Can and that the provisions were drafted in such a way that the proper intention of the parties, namely that K-Can would continue to benefit from the R&D tax credits as a CCPC were, through mistake, not realized. The applicant argues that the only intention of the parties is to preserve the right to apply for research tax credits, which was an intended and fundamental aspect of the transaction from the beginning. They argue that this is not an example of retroactive tax planning.

[24] The Minister of National Revenue (“MNR”) argues that when reasonably sophisticated business people reduce their oral arguments to written form, which are prepared and reviewed by lawyers, and changes made, and the documents are then executed, there is usually little scope for rectification: Performance Industries Ltd v Sylvan Lake Golf and Tennis Club Ltd, supra; Shafron v KRG Insurance Brokers (Western) Inc., 2009 SCC 6.

[25] It is the position of MNR that the applicants do not satisfy the requirements of rectification, as set forth by the Supreme Court of Canada, supra, as they cannot prove a common intention, do not admit to a mistake in their instrument and the precise form of the rectified instrument will serve no practical purpose. MNR takes the position that there is no evidence that the applicant even considered the effect of the voting control of the Class C shares on the CCPC status prior to signing the Amended Deed, nor was there any consideration as to whether K-Can would continue to be a CCPC, nor any consideration given that K-Can was indirectly controlled by non-residents. The respondent argues that the applicant cannot demonstrate the common intention to structure the Amended Deed in such a way that would qualify K-Can as a CCPC in order to access the more generous SR&ED credits. They argue that the record only shows that the applicants were concerned with amending the Trust instrument to satisfy Computershare’s concerns about voting the shares, and nothing about tax avoidance or SR&ED credits. Further, the respondent argues that the evidence demonstrates the common intention to have Malcolm, the non-resident, instruct the Trustee as to how to vote the Class C shares. They argue that there is no or insufficient evidence that the common intention of the parties was to arrange the Class C voting shares in order to qualify K-Can as a CCPC. They argue that the CCPC status did not become an issue until after the CRA audit and that the applicants simply seek to use rectification to avoid an unintended tax consequence realized after the fact, not to restore the original purpose of the transaction.

[26] Further, MNR argues that the applicants do not admit a mistake which requires correction, but rather seem to suggest in the affidavits that there was a mistake made by the CRA in interpreting the document. They argue that the applicants do not seem concerned about the actual wording of the Amended Deed but rather are concerned with the interpretation of that wording given by CRA. They argue that the remedy for their concerns is to proceed before the Tax Court of Canada to argue that K-Can is, in fact, eligible for the more generous SR&ED credits. While the applicants do not use the word mistake, but rather term the wording inadvertent in its results, there is nothing to indicate that they did not believe they would retain the same status as before. The applicants, or their legal counsel, erred in terms of the wording used.

[27] The respondent argues that the applicants must also show the precise form in which the written document can be made to express the prior intention of the parties, which the applicants failed to do. The respondent argues that even if this Court were to grant the rectification order sought, the order would not fix the asserted tax problem. If the intention was that K-Can was to be a CCPC, the direction of the Board of Directors of K-Can cannot be controlled, either de jure or de facto by non-residents. Even if rectification were granted, K-Can would still be de jure controlled by non-residents based on the amendment sought. The Trustees would still be obligated to take instructions from the Board of Directors of K-Can. Due to the unanimous shareholder agreement, the Board of Directors of K-Can does not have the right to instruct the Trustees. Rather, that authority is delegated to the shareholders of K-Can, namely K-US and the Trust. As K-US is a non-resident, and as the Trustee is unwilling to vote without instructions, rectifying the amended Deed would result in a non-resident, K-US, controlling the Class C shares of K-Can. Thus, the respondent argues, K-Can would still fail to satisfy the requirements of the CCPC.

[28] As regards common intention, I am of the view that based on an entire reading of the record and history of the applicants, the intention throughout was to ensure that K-Can, as an R&D body, with no other functions than research and development, qualified for CCPC status and for the tax credits available.

[29] As regards mistake, I am satisfied that the wording chosen was chosen by mistake and not to intentionally give K-US de jure control over K-Can.

[30] As regards the proposed correction, this must be read within the entire context of the documents. I find that the Deed of Rectification, as proposed, does correct the mistake from the original wording in section 5.9 of the Restated and Amended Deed of Trust. The Deed makes it clear that the decision-making body is the Board of Directors and that the Trustee is to accept only a direction in writing in the form of a certified copy of a resolution from that Board. Accordingly, I grant the rectification sought by the applicants.

Costs

[31] I would urge the parties to agree upon costs, failing which I would invite the parties to provide any costs submissions in writing, to be limited to three pages, including the costs outline. The submissions may be forwarded to my attention, through Judges’ Administration at 361 University Avenue, within thirty days of the release of this Endorsement.

Carole J. Brown J.

Date: September 5, 2014