Fairmont Hotels Inc. et al. v. Attorney General of Canada

[Indexed as: Fairmont Hotels Inc. v. Canada (Attorney General)]

Ontario Reports

Ontario Superior Court of Justice,

Newbould J.

December 18, 2014

123 O.R. (3d) 241 | 2014 ONSC 7302

Case Summary

Remedies — Rectification — Applicants intending internal unilateral share redemption to be on tax-free basis — Share redemption triggering foreign exchange gain as result of mistake in documentation — Applicants applying successfully to rectify documentation — Common intent on exact method of achieving tax avoidance objective at time of transaction not required — Common intention that transaction be on tax-free basis sufficient — Applicants not engaging in retroactive tax planning.

The applicants brought an application to rectify documentation relating to an internal unilateral share redemption, claiming that what occurred was intended to be on a tax-free basis but that because of a mistake, the share redemption triggered a foreign exchange gain that resulted in a tax assessment by the Canadian Revenue Agency. The respondent argued that rectification should not be granted because there was no specific intent on the part of the applicants to do what they now wished to do and that what was being sought was impermissible retroactive tax planning.

Held, the application should be allowed.

The exact method to achieve a common intention to avoid tax is not required to be decided at the time of the transaction. A common intention that the transaction be on a tax-free basis is sufficient. It was always the common intention of the applicants that the share redemption be on a tax-free basis. This was not a case of retroactive tax planning.

Juliar v. Canada (Attorney General) (2000), 2000 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 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.), apld

Performance Industries Ltd. v. Sylvan Lake Golf and Tennis Club Ltd., [2002] 1 S.C.R. 678, [2002] S.C.J. No. 20, 2002 SCC 19, 209 D.L.R. (4th) 318, 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, consd

Other cases referred to

Amcor Packaging Canada, Inc. (Re), [2012] O.J. No. 5148, 2012 ONSC 6168, 1 C.C.P.B. (2d) 179, 223 A.C.W.S. (3d) 524 (S.C.J.); Council of the Wasauksing First Nation v. Wasausink Lands Inc., 2004 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.); Graymar Equipment (2008) Inc. v. Canada (Attorney General), [2014] A.J. No. 300, 2014 ABQB 154, 2014 D.T.C. 5051, 97 Alta. L.R. (5th) 288, [2014] 8 W.W.R. 524, 24 B.L.R. (5th) 193, 239 A.C.W.S. (3d) 81; H. (F.) v. McDougall, [2008] 3 S.C.R. 41, [2008] S.C.J. No. 54, 2008 SCC 53, 61 C.R. (6th) 1, 61 C.P.C. (6th) 1, 297 D.L.R. (4th) 193, 83 B.C.L.R. (4th) 1, [2008] 11 W.W.R. 414, 260 B.C.A.C. 74, EYB 2008-148155, J.E. 2008-1864, 60 C.C.L.T. (3d) 1, 380 N.R. 82, EYB 2008-148155, 169 A.C.W.S. (3d) 346; [page242] Kanji v. Canada (Attorney General) (2013), 114 O.R. (3d) 781, [2013] O.J. No. 504, 2013 ONSC 781, [2013] 3 C.T.C. 141, 2013 D.T.C. 5058, 225 A.C.W.S. (3d) 992 (S.C.J.); 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.); McLean v. McLean (2013), 118 O.R. (3d) 216, [2013] O.J. No. 5956, 2013 ONCA 788, 313 O.A.C. 364, 370 D.L.R. (4th) 167, 39 R.P.R. (5th) 181, 235 A.C.W.S. (3d) 415

Statutes referred to

Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.), ss. 40(3.6), 85 [as am.]

Authorities referred to

Spry, I.C.F., The Principles of Equitable Remedies, 6th ed. (Pyrmont, NSW: LBC Information Services, 2001)

APPLICATION for rectification.

Chia-yi Chua and Brandon Siegal, for applicants.

Dianna Aird and Donna A. Dorosh, for respondent.

[1] NEWBOULD J.: — The applicants ("Fairmont") apply on the equitable grounds of rectification to change documentation relating to an internal unilateral share redemption. They say that what occurred was intended to be on a tax-free basis but that because of a mistake, the share redemption triggered a foreign exchange gain that resulted in a tax assessment by CRA after an audit of the applicants' tax returns. The respondent ("AGC") says that rectification should not be granted because there was no specific intent on the part of the applicants to do what they now wish to do and that what is sought is impermissible retroactive tax planning.

[2] The events have their genesis in 2002 and 2003, when Fairmont Hotels Inc. ("FHI") became involved in the financing for the Legacy Hotels REIT ("Legacy") purchase of two hotels in Washington and Seattle.

[3] Fairmont carries on an extensive hotel management business throughout the world in respect of properties owned by the Fairmont group of corporations and third parties.

[4] Legacy was a Canadian real estate investment trust, in which FHI had an interest, whose units were traded on the TSX. Legacy was created in 1997 to purchase 11 Canadian city-centre hotels owned by the Fairmont group of companies. FHI continued to manage the 11 city-centre hotels and, when Legacy acquired other hotels over time, Fairmont sought to obtain the management contracts for those hotels.

[5] In 2002 and 2003, FHI and its affiliates entered into reciprocal loan transactions to provide financing to Legacy, which was acquiring two hotels in Washington and Seattle. FHI did this because it provided certain Canadian and U.S. tax benefits to Legacy. Instead of financing the purchase of the hotels directly, Legacy routed the financing money through Fairmont corporations. Fairmont participated in the financing in order to obtain the management contracts for the hotels. The financing was in U.S. dollars, which meant a potential foreign exchange tax exposure to Fairmont.

[6] For the purposes of the loan transactions, two Fairmont subsidiaries, FHIW Investments Canada Inc. ("FHIW Canada") and FHIS Hotel Investments Canada Inc. ("FHIS Canada"), were established. The result of the arrangement was that the reciprocal loans were neutral for accounting purposes, and Fairmont's foreign exchange exposure on the financing was fully hedged as each of FHI, FHIW Canada and FHIS Canada had a U.S. dollar denominated asset and a U.S. dollar denominated liability of equal value.

[7] The diagram below summarizes the transactions for the US$67.6 million Washington hotel loan:

[8] The same structure was used for a US$19 million loan for the Seattle hotel, FHIS Canada and FHIS U.S. being used rather than FHIW Canada and FHIW U.S. The AGC does not dispute that the financing was set up to fully hedge Fairmont's foreign exchange exposure and that Fairmont and Legacy's tax and financial advisors spent at least a year planning the structures to ensure they were set up in a way that would achieve the parties' business and tax objectives.

[9] In 2006, Fairmont was purchased by Kingdom Hotels International and Colony Capital LLC and its shares ceased to be publicly traded. FHI and its advisors recognized that if nothing was done, the acquisition of control would frustrate the intention that no entity would realize a net foreign exchange gain or loss in connection with the reciprocal loan arrangements. In particular, the acquisition of control would cause FHI to realize a deemed foreign exchange loss on the preferred shares it held in FHIW Canada and FHIS Canada, FHIW Canada to realize a deemed foreign exchange loss on the preferred shares it held in FHIW U.S. and FHIS Canada to realize a deemed foreign exchange loss on the preferred shares held by it in FHIS U.S., but such acquisition of control would not cause these entities to realize the matching foreign exchange gains.

[10] Initially, Fairmont's tax advisors proposed a plan which would have allowed for each of FHI, FHIW Canada and FHIS Canada's foreign exchange exposures to continue to be fully hedged for economic and tax purposes, and would also have allowed for FHIW Canada and FHIS Canada to later redeem their shares without realizing taxable foreign exchange gains. It is not necessary to describe the structure. It was contained in a memorandum dated March 3, 2006.

[11] However, the purchaser's tax advisors were concerned that s. 40(3.6) of the Income Tax Act might apply to any redemption of shares so as to deem the foreign exchange losses arising on a redemption of shares to be nil for tax purposes. That would create a tax issue as the corresponding foreign exchange gain would not be deemed to be realized and thus there would be a tax problem of what counsel for the respondent described as a "pregnant gain" that would have to be dealt with.

[12] Fairmont and the purchasers agreed on a modified plan that is described in a March 23, 2006 memorandum. This modified plan caused FHI to realize its accrued foreign exchange gains and losses and, going forward, enabled FHI's foreign exchange exposure to be hedged. However, the modified plan did not address the foreign exchange exposure of FHIW Canada and FHIS Canada. The foreign exchange losses deemed to be realized by FHIW Canada and FHIS Canada on the acquisition of control could not be carried forward. Thus the foreign exchange exposure of FHIW Canada and FHIS Canada was no longer hedged and Fairmont knew that.

[13] Mr. Badour of Fairmont acknowledged on his cross-examination that they knew at the time of the change of control that the issue had to be addressed at some point so as not to incur a taxable foreign exchange gain. In his words, they were kicking the can down the road to be dealt with on another day when some other event intervened. He said that they knew that they were going to have to find a means of ensuring that the structure remained tax and accounting neutral going forward. He said there was no specific plan as to how they would do that.

[14] The next time they considered the issue was in 2007, when Legacy approached Fairmont on September 10, 2007 to terminate the reciprocal loan arrangements on an urgent basis so as to allow for the sale of the Washington Hotel and the Seattle Hotel. Legacy's chief financial officer requested that Fairmont approve Legacy's proposed unwind steps that same day. At that time, the Fairmont management team was particularly busy, completing multiple transactions with an aggregate value of almost a billion dollars.

[15] In his haste to unwind the reciprocal loan arrangements, Fairmont's vice-president and treasurer advised by e-mail of September 11, 2007 of his preference for the Fairmont companies to redeem their preference shares. Fairmont's vice-president of tax Joseph Zahary was not alert to the fact that the proposed redemptions would trigger taxable foreign exchange gains, as he mistakenly believed that the original plan had been implemented in 2006. Under the original plan, the redemption of shares of FHIW Canada and FHIS Canada would have not resulted in any taxable foreign exchange gains. Mr. Zahary states in his affidavit, on which he was not cross-examined, that because of the extreme time constraints with only a few days until the closing of the acquisition of Legacy on September 18, 2007 and several other significant transactions ongoing at the same time, he did not have the opportunity to review the last-minute unwind proposal in great detail or engage external tax advisors to review it. As a result of his mistaken belief that the original 2006 plan had been implemented, he agreed with the suggestion that FHIW Canada and FHIS Canada redeem the preference shares held by FHI. On September 14, 2007, the directors of FHIW Canada and FHIS Canada passed resolutions to implement the share redemptions.

[16] Mr. Zahary was responsible for reporting the 2007 transactions in filing the tax returns for each of FHIW Canada and FHIS Canada for their taxation years ended on December 31, 2007. In each case, the unwind transactions were reported as if the original 2006 plan had been implemented such that at the time of the acquisition of control in 2006, the accrued foreign exchange losses were offset by accrued foreign exchange gains and were fully hedged going forward for tax purposes. This filing is confirmatory of the mistaken belief of Mr. Zahary that the original plan in 2006 was carried out. There is no suggestion otherwise.

[17] The mistake was learned after CRA undertook to audit the 2007 tax returns of FHIW Canada and FHIS Canada and asked questions of Fairmont about the returns. In the course of preparing responses to the CRA query sheets, FHI, FHIW Canada and FHIS Canada discovered that when planning the 2007 transactions, they failed to take into account the fact that the 2006 acquisition of control had caused FHIW Canada and FHIS Canada to realize accrued foreign exchange losses for tax purposes but not the matching accrued foreign exchange gains. FHI, FHIW Canada and FHIS Canada mistakenly believed that FHIW Canada and FHIS Canada's foreign exchange exposure was fully hedged for tax purposes.

[18] Mr. Zahary stated in his affidavit that had he realized in September 2007 that the original 2006 plan had not in fact been implemented, he would not have agreed with the redemption of preferred shares to effect the unwind because it did not fulfil Fairmont's intention that existed since 2002 not to have any net foreign exchange gains or losses as a result of the reciprocal loan arrangements with Legacy.

Position of the Parties

[19] The applicants now apply to rectify the 2007 resolutions of FHIW Canada and FHIS Canada under which the preference shares in those corporations owned by FHI were redeemed. They wish to remove the redemption of those shares from the resolution and instead resolve to make loans by FHIW Canada and FHIS Canada to FHI in the same amount that had been paid to FHI for redemption of the preference shares. In short, to change the share redemption to a loan because a loan will not trigger a taxable foreign exchange gain.

[20] The applicants say that their intent from 2002 was consistently to have the loan transactions and their unwinding done on a tax neutral basis. They say that the mere fact that in 2006 after control of FHI changed due to it being purchased they had not considered the exact way in which they would solve the tax neutrality problem does not preclude rectification.

[21] The AGC takes the position that a loan to FHI as now planned was not part of the plan in 2006 or even 2007, and that it only came into play after the CRA audit disclosed the problem. The AGC says that replacing the share redemptions with loans is retroactive tax planning. Rectification is a remedy that corrects a written instrument when it does not accurately reflect what the parties intended to record. The mistake is not that the Fairmont's directors' resolutions inaccurately recorded what Fairmont intended. Fairmont's mistake was that it failed to develop a plan to avoid capital gains until after the shares had already been redeemed. Rectification should not be used to sanction a new plan that Fairmont wishes it had implemented in 2007.

Analysis

[22] The equitable remedy of rectification is available to relieve against mistake in a document. The basis for this remedy is the protection of an applicant, so that he or she is not prejudiced by the existence of a document, reliance upon which would, without rectification, be unconscionable. See Spry, The Principles of Equitable Remedies, 6th ed. (Pyrmont, NSW: LBC Information Services, 2001), at p. 607.

[23] In Council of the Wasauksing First Nation v. Wasausink Lands Inc., 2004 15484 (ON CA), Laskin J.A. summarized the principles as follows [at para. 81]:

As relevant to the appellants' rectification claim, the following principles concerning equitable rectification emerge from the foregoing authorities. Rectification is available in the exercise of the court's discretion. Such discretion is not to be exercised lightly but, rather, only where it is demonstrated that, by mistake, a written document or instrument does not accord with or accurately reflect the agreement or arrangements intended by the parties. 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; the remedy seeks to effect the actual intentions of the parties which, by mistake, were not accurately recorded.

[24] Performance Industries Ltd. v. Sylvan Lake Golf and Tennis Club Ltd., 2002 SCC 19 involved rectification of an agreement made between parties at arm's-length in which there was a unilateral mistake by one party to the knowledge of the other in that the written signed agreement did not record what had earlier been orally agreed. It does not strictly deal with a non-arm's-length situation in which there was no oral agreement. However, Binnie J. made a statement regarding the law of rectification relied on by the AGC [at para. 31]:

The court's task in a rectification case is corrective, not speculative. It is to restore the parties to their original bargain, not to rectify a belatedly recognized error of judgment by one party or the other.

[Citations omitted]

[25] A number of cases have considered how to apply rectification principles to situations where the document was not the result of arm's-length bargaining but involved the reorganization of the affairs of a person or business. See, e.g., Juliar v. Canada (Attorney General) (2000), 2000 16883 (ON CA); Amcor Packaging Canada, Inc. (Re), 2012 ONSC 6168; Kanji v. Canada (Attorney General) (2013), 2013 ONSC 781; Kraft Canada Inc. v. Pitsadiotis, [2009] O.J. No. 885, 73 C.C.P.B. 209 (S.C.J.).

[26] In Kanji, Justice D. Brown articulated a test as follows [at para. 20]:

First, in such situations, as a practical matter the requirements of prior agreement and error tend to be articulated in the following way: the applicant must show that (i) a common, specific intention existed amongst the creators of the instrument effecting the transaction to accomplish a particular result and (ii) a mistake caused the instrument not to comport with the common intention of the parties.

[27] As for the standard of proof, in Performance Industries the Supreme Court of Canada said that the hurdles must be established by proof which is "convincing". However, the Supreme Court of Canada in H. (F.) v. McDougall, 2008 SCC 53 made clear that in civil cases only one standard of proof exists at common law, that standard being on a balance of probabilities. That standard applies to rectification cases. See McLean v. McLean (2013), 2013 ONCA 788, at paras. 41‑42.

[28] The AGC says that there is no contemporaneous documentation at the relevant times establishing a plan to use a loan to solve any tax issue relating to foreign exchange losses or gains and that such lack of documentation should weigh heavily against Fairmont. I understand this concern but would note that even in Performance Industries, in which Binnie J. said the evidence had to be convincing, he did say that documentation was not always necessary, particularly when the parole evidence was corroborated by the conduct of the parties [at para. 43]:

It was formerly held that it was not sufficient if the evidence merely comes from the party seeking rectification. In Ship M. F. Whalen, supra, Duff J. (as he then was) said, at p. 127, "[s]uch parol evidence must be adequately supported by documentary evidence and by considerations arising from the conduct of the parties". Modern practice has moved away from insistence on documentary corroboration (Waddams, supra, at para. 337; Fridman, supra, at p. 879). In some situations, documentary corroboration is simply not available, but if the parol evidence is corroborated by the conduct of the parties or other proof, rectification may, in the discretion of the court, be available.

[29] There is evidence that because of concerns regarding potential tax on redemption of the preferred shares of FHIW Canada and FHIS Canada, it was recognized in 2006 that the shares should not be redeemed.

[30] Ms. Carrie Smit, the head of the tax group at Goodmans LLP, was a tax lawyer working for Colony when it acquired Fairmont in 2006. She wrote in an e‑mail of November 30, 2012 describing the discussions and planning at the time.

[31] Ms. Smit was not cross‑examined on her affidavit. She did produce a contemporaneous note of hers in 2006 referring to the concern that s. 40(3.6) of the ITA might apply and the statement: “But we don't ever have to redeem the shares.”

[32] I think a fair conclusion from the evidence, and I so find, is that there was a continuing intention on the part of Fairmont from the time of the 2002 loan arrangements with Legacy that the loan arrangements would be carried out with a view to being tax and accounting neutral and a continuing intention from the time of the 2006 transaction that the preference shares of FHIW Canada and FHIS Canada would not be redeemed.

[33] I also think a fair conclusion from the evidence is that when the 2006 transaction was undertaken, Fairmont intended that at some point in the future they would have to deal with the unhedged position of FHIW Canada and FHIS Canada in a way that would be tax and accounting neutral although they had no specific plan as to how they would do that.

[34] In these circumstances, Fairmont relies on Juliar v. Canada (Attorney General) (1999), 1999 15097 (ON SC).

[35] In Juliar, a holding company owned all the shares of a family convenience store business. The parties intended the transaction to occur on a basis which would not attract immediate income tax liability.

[36] Due to a mistaken assumption as to the tax cost base of the shares, the structure used triggered unexpected tax liability.

[37] Fairmont relies on this case as authority for the proposition that the exact method to achieve a common intention to avoid tax is not required to be decided at the time of the transaction.

[38] The decision of the trial judge was upheld in the Court of Appeal.

[39] Thus, while the parties had no expectation as to exactly how to accomplish their tax objective, it was held that the intention to achieve the transfer of shares on a tax‑free basis was sufficient to permit rectification.

[40] The AGC criticizes Juliar and points to Graymar Equipment (2008) Inc. v. Canada (Attorney General), 2014 ABQB 154.

[41] Whatever the views expressed in that decision, I am bound by the appellate authority in Juliar.

[42] In this case, the intention of Fairmont from 2002 was to carry out the reciprocal loan arrangements on a tax and accounting neutral basis so that any foreign exchange gain would be offset by a corresponding foreign exchange loss.

[43] I do not see this as a case in which tax planning has been done on a retroactive basis after a CRA audit. The redemption of the preference shares was mistakenly chosen as the means to accomplish the unwind.

[44] In the circumstances, denial of the application would result in a tax burden which Fairmont sought to avoid from the inception of the loan arrangements and but for an unfortunate mistake would have been avoided.

[45] I allow the rectification claim of the applicants to rectify the corporate resolutions in the form set out in Schedules A and B to the notice of application.

[46] In accordance with the agreement of the parties as to quantum, the applicants are entitled to costs of $30,000, all inclusive, to be paid within 30 days.

Application allowed.

End of Document