COURT FILE NO.: 2707/16
DATE: 2024/12/02
SUPERIOR COURT OF JUSTICE - ONTARIO
RE: THOMAS J. FEENEY, 532069 ONTARIO LTD. and EARSWICK HOLDINGS LTD., Applicant
AND:
THE ATTORNEY GENERAL OF CANADA, Respondent
BEFORE: Justice M.A. Cook
COUNSEL: R. Graham Morton, Counsel for the Applicant
R. Zsigo, Counsel for the Respondent
HEARD: June 17, 2024 (with supplementary written submissions received November 27, 2024)
JUDGMENT
[1] The applicant taxpayers ask the court to exercise its equitable jurisdiction to rectify two corporate director’s resolutions by which the corporate applicants declared dividends in the common stock in June 2016. The applicants contend that the corporate director’s resolutions and the related dividends declared and paid in June 2016 do not reflect their common intention to utilize ss. 83(2) of the Income Tax Act, RSC 1985, c 1 (5th Supp), as it was then in force[^1] (the “ITA”), to flow tax-free capital dividends from Earswick Holdings Ltd. (“Earswick”) to its ultimate beneficial shareholder, Thomas J. Feeney.
[2] The respondent Attorney General of Canada (“Canada”) opposes the relief sought. Canada submits that the applicants have not demonstrated entitlement to rectification, or, in the alternative, that the court ought to exercise its discretion against granting equitable relief in light of the availability of adequate legal remedies.
Factual Background
[3] There are few facts in dispute in this application.[^2]
[4] Earswick is a private Ontario corporation that operated as a wholesale hardware distribution company in Toronto, Ontario. Earswick’s sole shareholder is 532069 Ontario Ltd. (“532”).
[5] Thomas J. Feeney is the sole shareholder, officer, and director of 532, and the sole director and officer of Earswick.
[6] In the summer of 2015, Mr. Feeney received an offer to purchase the assets of Earswick.
[7] Mr. Feeney negotiated the terms of an asset purchase agreement, by which the assets of Earswick were sold for $1,700,000. Of the purchase price, $1,483,362 was allocated to Earswick’s goodwill. The sale transaction was completed on May 9, 2016.
[8] Following completion of the sale, Mr. Feeney asked his accountant, Geoff Crewe, for an estimate of how much money would be left of the sale proceeds after tax. Mr. Crewe advised Mr. Feeney that, because goodwill was ‘eligible capital property,’ a part of the sale proceeds could be paid out to him as tax-free capital dividends.
[9] Capital dividends are special dividends that a private corporation may pay to its Canadian-resident shareholders on a tax-free basis. No part of a capital dividend is included in computing the shareholder’s income.
[10] Capital dividends are paid from a private corporation’s capital dividend account (“CDA”), a special but notional corporate tax account that keeps track of various tax-free surpluses accumulated by a Canadian private corporation over time: ITA, s. 89(1). Amounts in a corporation’s CDA commonly include:
(i.) The tax-free portion of capital gains realized by the corporation on the sale of an asset (to the extent that they exceed the non-deductible portion of the corporation’s capital losses), including goodwill; and
(ii.) Capital dividends received from another corporation.
[11] The balance of a corporation’s CDA is eligible to be paid out to qualified shareholders on a tax-free basis because accumulated capital dividends are viewed as a return of capital.
[12] For a corporation to pay a capital dividend it must declare the dividend and then make an election to designate the entire amount of the dividend to be a capital divided. The election is made by the corporation by completing and filing the required Form T2054 Election for a Capital Dividend Under Subsection 83(2) with Canada Revenue Agency.
[13] A corporation’s CDA is calculated in accordance with ss. 14, 83 and 89 of the ITA on a cumulative basis, for a particular period. Absent special circumstances not relevant to this application, the tax-free portion of capital gains realized by the corporation on the sale of eligible capital property (including goodwill) are added to the CDA on the last day of the fiscal year in which the sale is made. Practically speaking, this means that a corporation cannot normally pay capital dividends arising from the sale of eligible capital property (including goodwill) until the first day of the fiscal year following the fiscal year in which the eligible capital property was sold.
[14] Earswick and 532 share a fiscal year end of December 31.
[15] Using the transaction figures provided to him by Mr. Feeney, Mr. Crewe prepared a handwritten note setting out the rough cash flows arising from the sale of the Earswick assets. At the bottom of Mr. Crewe’s handwritten note is a chart showing anticipated payments of $740,000 first from Earswick to 532, and then from 532 to ‘Tom’ (being Mr. Feeney). To the right of the chart is the date “June 17”.
[16] Mr. Feeney approved of Mr. Crewe’s distribution plan.
[17] Mr. Crewe’s formal calculations arrived at a capital dividend figure of $741,680.00, being the 50% non-taxable portion of the proceeds of sale of Earswick’s goodwill.
[18] On May 30, 2016, Mr. Crewe sent Mr. Feeney a letter enclosing the Director’s Resolution, Form T2054 Election for a Capital Dividend Under Subsection 83(2) and supporting documentation for each of Earswick and 532. The letter provided Mr. Feeney with the following directions:
(i.) Mr. Feeney should sign the Directors’ Resolution and Form T2054 Election for a Capital Dividend Under Subsection 83(2) for each of Earswick and 532, and remit them to Canada Revenue Agency;
(ii.) On June 15, 2016 (and not before), Earswick should issue a cheque to 532 for $741,680;
(iii.) On June 20, 2016 (and not before), 532 should issue a cheque to Mr. Feeney in the amount of $741,680.
[19] The Earswick Director’s Resolution dated May 27, 2016, prepared by Mr. Crewe, read as follows:
Declaration of Capital Dividend
WHEREAS under subsection 83(2) of the Income Tax Act (Canada) the Corporation may elect, in prescribed manner and in prescribed form, in respect of the full amount of a dividend so that the said dividend shall be deemed to be a capital dividend:
BE IT RESOLVED THAT
A dividend aggregating $741,680 on the issued and outstanding common shares in the Capital of the Corporation is hereby declared payable on June 15, 2016 to the shareholder of record at the close of business on that day;
The Corporation is authorized to make an election under subsection 83(2) of the Income tax Act (Canada) in respect of the full amount of the said dividend;
Any director or officer of the Corporation is hereby authorized and directed to do all things as in his opinion may be necessary for desirable in connection with the foregoing, including the execution of the prescribed form of election on behalf of the Corporation and filing of same within the applicable time period.
[20] The Director’s Resolution for 532 was identical to the Earswick Director’s Resolution, except that the 532 dividend was declared and made payable on June 20, 2016.
[21] Mr. Feeney signed the Director’s Resolutions and Form T2054 Election for a Capital Dividend Under Subsection 83(2) for each of Earswick and 532 and sent them to Canada Revenue Agency.
[22] On June 15, 2016, Earswick paid a dividend to 532 in the amount of $741,860.
[23] On June 24, 2016, 532 paid its sole shareholder, Mr. Feeney, a dividend in the amount of $741,860.
[24] Canada Revenue Agency determined that the dividends paid by Earswick to 532 and from 532 to Mr. Feeney were not tax-free capital dividends because neither Earswick nor 532 had any amount available in its CDA when the dividends were declared in June 2016. This is because the tax-free proceeds of sale of Earswick’s goodwill had not been added to Earswick’s CDA when the dividends were declared, and they would not be available until after Earswick’s December 31, 2016 year end. Canada Revenue Agency took the position that the dividends were excess capital dividends subject to Part III tax in the amount of $445,008.
[25] Mr. Crewe candidly admits that, when he prepared the Director’s Resolutions and Form T2054 Election for a Capital Dividend Under Subsection 83(2) for Earswick and 532, he mistakenly believed that Earswick could pay out a capital dividend any time following the completion of the asset sale on May 9, 2016.
[26] Mr. Crewe says that he recognized his error in July 2016 while reading a technical tax publication. Mr. Crewe wrote a letter dated July 8, 2016 to Canada Revenue Agency asking to “withdraw/rescind/cancel” the Form T2054 Election for a Capital Dividend Under Subsection 83(2) because the CDA balances in Earswick and 532 did not permit them to pay capital dividends on a tax-free basis. Mr. Crewe’s letter dated July 8, 2016 reads, in part:
The dividends were intended to be paid on June 15, 2016 and June 20, 2016 for Earswick and 532, respectively. It has come to my attention since then that the companies’ Capital Dividend Account balances on June 16 and June 20 were in fact $0 and not $741,680 since the Capital Dividend Account remains $0 until the end of the fiscal year in which the sale of goodwill took place. For both companies, the fiscal year is December 31, 2016. The intention is that the companies take advantage of the opportunity to pay out tax-free dividends and, to do so, will have to wait until January 1, 2017 or later, at which time there will be a balance in their respective CDAs. Accordingly, I respectfully request that the recent submissions (copies attached) be withdrawn and that you not process them.
[27] The applicants seek rectification of the Director’s Resolutions and related dividends to correct what they say is a case of “right amount, wrong date.” In particular, they seek:
(i.) An order rectifying the Earswick Directors’ Resolution dated May 27, 2016 and related dividend declared on its common shares in the amount of $741,680 and made payable on June 15, 2016, such that the dividend be declared by Earswick and made payable on January 1, 2017 nunc pro tunc;
(ii.) An order rectifying the 532 Director’s Resolution dated May 27, 2016 and related divided declared on its common shares in the amount of $741,680 and made payable on June 20, 2016, such that the dividend be declared by 532 and made payable on January 1, 2017 nunc pro tunc;
Analysis
Equitable Remedy of Rectification
[28] Rectification is an equitable remedy that permits the correction of instruments that, by mistake, do not accurately reflect the intention of the parties to the instrument. The Supreme Court of Canada described the remedy of rectification in Canada (Attorney General) v. Fairmont Hotels Inc., [2016] 2 S.C.R. 720, [2016] S.C.J. No. 56, 2016 SCC 56 (“Fairmont”) at para. 12 as follows:
[12] If by mistake a legal instrument does not accord with the true agreement it was intended to record—because a term has been omitted, an unwanted term included, or a term incorrectly expresses the parties’ agreement—a court may exercise its equitable jurisdiction to rectify the instrument so as to make it accord with the parties’ true agreement. Alternatively put, rectification allows a court to achieve correspondence between the parties’ agreement and the substance of a legal instrument intended to record that agreement, when there is a discrepancy between the two. Its purpose is to give effect to the parties’ true intentions, rather than to an erroneous transcription of those true intentions.
[29] In Fairmont, the Supreme Court of Canada affirmed that, where the error of the instrument results from a common mistake, rectification of an agreement is available upon the court being satisfied on a balance of probabilities that:
(1) The parties had reached a prior agreement whose terms are definite and ascertainable;
(2) The agreement was still effective when the instrument was executed;
(3) The instrument fails to record accurately that prior agreement; and
(4) If rectified as proposed, the instrument would carry out the agreement.
[30] In cases of unilateral mistake, the test in Fairmont requires the applicant to further satisfy “demanding preconditions” that:
(5) the party resisting rectification knew or ought to have known about the mistake; and
(6) permitting that party to take advantage of the mistake would amount to 'fraud or the equivalent of fraud.’
See Fairmont, para. 14-15, 38.
[31] The purpose of rectification is to restore the parties to their original bargain, not to rectify a belatedly recognized error of judgment by one party or the other, nor stand in substitute for due diligence: Performance Industries Ltd. v. Sylvan Lake Golf & Tennis Club Ltd., 2002 SCC 19, [2002] 1 S.C.R. 678 (“Performance Industries”), para. 31. For this reason, “mere unilateral mistake alone is not sufficient to support rectification”: Performance Industries, para. 38. It is not, as Justice Brown noted in Fairmont, at para. 39, “equity’s version of a mulligan”.
[32] Even where the parties seeking rectification can satisfy the Fairmont test, the remedy remains in the discretion of the court. Relief may be denied where, for example, there is an adequate legal remedy available to the parties, or where the conduct of the party seeking relief is such that fairness does not demand intervention: Performance Industries, para. 66; Canson Enterprises Ltd. v. Boughton & Co., 1991 CanLII 52 (SCC), [1991] 3 S.C.R. 534, at p. 589; Canada Life Insurance Company of Canada v. Canada (Attorney General), 2018 ONCA 562 (“Canada Life”), para. 92.
Application to the Case at Bar
[33] For the reasons below, I find that this is not an appropriate case for rectification.
[34] The applicants are not entitled to rectification under the Fairmont test. The applicants have failed to prove, on cogent and compelling evidence, an antecedent plan to defer Earswick’s payment of the corporate dividends until after the end of the corporate fiscal year rather than in June 2016 as recorded in the Director’s Resolutions.
[35] If I am wrong, and the applicants satisfy the Fairmont test, I would nevertheless decline to exercise my equitable jurisdiction to grant relief in the circumstances of this case due to the lack of diligence on the part of the applicants and because there are adequate legal remedies available to them.
[36] The first element of the Fairmont analysis requires the court to determine the nature and particularity of the terms which the taxpayer intended to record in the instrument sought to be rectified: Fairmont, para. 1. Recently, in 2484234 Ontario Inc. v. Hanley Park Developments Inc., 2020 ONCA 273 (“Hanley Park”), Justice Zarnett, writing for the court, expanded on the inquiry at the first stage of the Fairmont analysis at para. 41:
An important question in any claim for rectification is a central question in this one: did the parties have an agreement that preceded the document sought to be rectified…, and if so, what were the terms of that prior agreement and what did they mean? It is only by answering this question that one can address whether the appellant is seeking to correct an error in the recording of the parties' true agreement, or is seeking to insert something that was never the subject of a prior agreement.
[37] The applicants assert that they had a definite, ascertainable, and continuing plan to utilize capital dividends declared under ss. 83(2) of the ITA to achieve the specific fiscal objective of maximizing the available after tax-proceeds of sale in Mr. Feeney’s hands.
[38] I do not agree. While the applicants had a general plan to make use of ss. 83(2) of the ITA to declare capital dividends and maximize after-tax proceeds in Mr. Feeney’s hands, the evidence is that the applicants always intended to declare the dividends in June 2016. Mr. Crewe believed that the tax-free proceeds of sale of Earswick’s goodwill were added to the CDA immediately after the asset sale closed on May 9, 2016. Mr. Crewe’s handwritten planning notes, which formed the basis for Mr. Feeney’s instructions, show the distributions on “June 17”. Mr. Crewe advised Canada Revenue Agency in his correspondence dated July 8, 2016 that the applicants intended to pay the dividends on June 15 and June 20.
[39] Mr. Feeney’s subjective intention to receive tax-free capital dividends in the amount of $741,680 is immaterial to interpreting the antecedent agreement: Hanley Park, paras. 53-54; Reddick v. Robinson, 2024 ONCA 116 at para. 17.
[40] I find that the parties’ agreement to declare dividends in June is accurately reflected in the Director’s Resolutions and Form T2054 Election for a Capital Dividend Under Subsection 83(2). Accordingly, there Director’s Resolutions signed by Mr. Feeney are consistent with the antecedent agreement, and there is no error to rectify.
[41] In arriving at this conclusion, I have carefully considered the clear statements of the Supreme Court in Fairmont that taxpayers should be taxed based on what they actually agreed to do and did, and not what they could have done or later wish they had done: Fairmont, para. 23-24. I have also carefully considered the direction of the Court of Appeal in Canada Life at para. 69:
Retroactive tax planning is not limited to attempts to secure a more favourable tax consequence than one had originally hoped to generate. It includes attempts to change one’s affairs so that tax consequences that were intended, but were prevented by a mistake, can be achieved.
[42] The applicants rely on Pyxis Real Estate v Attorney General of Canada, 2024 ONSC 2039, in which Koehnen J. granted rectification. The tax plan in Pyxis involved paying tax-free capital dividends up the corporate chain from “Old Pyxis” to Edgefund Equities to Edgecombe to 2523183 to David Jubb. When the plan was initiated, Old Pyxis had a capital dividend account of approximately $45 million. It declared a valid, tax-free capital dividend of $1.4 million. However, unbeknownst to the accountant, Edgecombe had a capital dividend account deficit. When Edgecombe received its tax-free capital dividend of $1.4 million, its CDA balance was reduced by the existing deficit. When Edgecombe paid the planned capital dividend of $1.4 million up the corporate chain, to 2523183, CRA determined that Edgecombe’s dividend payment exceeded its CDA and assessed Part III tax. The taxpayer sought rectification of the director’s resolutions to gross up the dividend payment by the amount to Edgecombe’s deficit.
[43] CRA opposed rectification on the basis that terms of the accountant’s written memorandum did not contain any mistake about the amount of the dividend payment. CRA took the position that rectification was not available to correct the accountant’s mistaken assumption about Edgecombe’s CDA balance prior to the transactions. The accountant did not verify Edgecombe’s CDA balance despite being specifically directed to do so.
[44] Koehnen J. granted rectification, finding that the accountant’s written memorandum set out definite and ascertainable terms of an agreement to pay tax-free capital dividends through the corporate chain. Old Pyxis had $45 million available in its CDA when the transactions were initiated, and it was immaterial to Old Pyxis whether it declared $1.4 million or a grossed up number to address the deficit in Edgecombe’s CDA.
[45] Pyxis is distinguishable on its facts. I infer from Koehnen J.’s reasons that he did not consider the deficit in Edgecombe’s CDA to be a material term of the planned transactions. In contrast, I have found the timing of Earswick’s initial dividend payment to be a material and settled term of the antecedent plan, and that the Director’s Resolution accurately records the prior agreement to pay dividends in June 2016.
[46] In conclusion, I find that the applicants are seeking an impermissible form of retroactive tax planning to achieve the tax outcomes that they intended but were prevented by Mr. Crewe’s error in judgment. The applicants have not satisfied the first element of the Fairmont test and the application must be dismissed.
Discretionary Considerations
[47] If I am wrong, and the applicants meet the Fairmont test applicable to cases of unilateral mistake, I would exercise my discretion against granting rectification due to the applicant’s lack of due diligence and because there are adequate legal remedies available.
Lack of Due Diligence
[48] Rectification is not an appropriate substitute for due diligence at the time a document is signed: Fairmont at para. 13.
[49] I recognize that due diligence on the part of a plaintiff is not a condition precedent to rectification, and a party’s negligence is never an absolute bar to equitable relief. Most cases of rectification involve a degree of carelessness on the part of the petitioner party: Performance Industries, para. 61. However, the conduct of the applicant is relevant to the exercise of the court’s discretion in equity: Performance Industries, para. 36, 66.
[50] Mr. Crewe has candidly accepted responsibility for his failure to review the requirements of ss. 83(2) of the ITA before advising his clients. Mr. Crewe recognized his error after reviewing a technical tax bulletin a few weeks after the Director’s Resolutions were signed. Had Mr. Crewe done his reading before advising his client and preparing the Director’s Resolutions, the mistake would likely have been avoided. Mr. Crewe made no inquiry of Canada Revenue Agency to confirm the balance of Earswick’s CDA before preparing the Director’s Resolutions and related elections.
[51] Mr. Feeney takes no responsibility at all. Mr. Feeney was the sole director and officer of Earswick and 532. He took no steps to understand how capital dividends worked, despite his responsibilities of office and his substantial personal interest in the transactions. While I appreciate that Mr. Feeney was relying on his accountant’s professional advice, Mr. Feeney apparently failed to review the Form T2054 Election for a Capital Dividend Under Subsection 83(2) before signing them for each of Earswick and 532. The Form T2054 Election read, in part:
A disposition (includes sale) of eligible capital property (ECP) may result in an addition to your CDA. If there is an addition to the CDA, it will occur on the earliest day as follows:
a) If you are eligible and have made an election under subsection 14(1.01) or 14(1.02) the addition will occur on the date you made the 14(1.01) or 14(1.02) election
b) In all other cases, the addition will occur on the last date of your tax year. (emphasis added)
[52] The evidence is that neither Mr. Feeney nor Mr. Crewe exercised even the most basic diligence in planning or implementing what ought to have been a straight-forward tax election. The resulting tax liability is a result of the want of care of Mr. Crewe, and of Mr. Feeney acting in his capacity as director of the corporate applicants. Nothing in the circumstances of this case evokes unconscionability or the kind of unfairness that invites equity to intervene.
Adequate Remedies in Law
[53] In any event, I would decline to exercise my discretion to grant equitable relief because there are adequate legal remedies available to the applicants to address the unexpected tax consequences of the dividend payments. In particular:
(i.) Subsection 184(3) of the ITA permits corporate applicants to elect to treat the excess dividend amount as a regular taxable dividend;
(ii.) The applicants may file a notice of objection to appeal the tax reassessments;
(iii.) Under s. 23 of the Financial Administration Act, the applicants may apply to the minister for a remission of tax; and
(iv.) The applicants have a potential legal action against their professional advisor, Mr. Crewe. As noted by the Supreme Court of Canada in Jean Coutu Group (PJC) Inc. v. Canada (Attorney General), 2016 SCC 55, [2016] 2 SCR 670, at para. 43:
I recognize that “[i]ncome tax law is notoriously complex and many taxpayers rely on tax advisors to help them comply”: Guindon v. Canada, 2015 SCC 41, [2015] 3 S.C.R. 3, at para. 1. But when taxpayers agree to certain transactions and later claim that their advisors made mistakes by failing to properly advise them that the transactions they agreed to would produce unintended tax consequences, the appropriate avenue to recoup their ensuing losses is not through the retroactive amendment of their agreement. Rather, if the mistakes are of such a nature as to warrant it, taxpayers can bring a claim against their advisors, who generally have professional liability insurance, and try to prove that claim in the courts.
Conclusion
[54] The application is dismissed.
[55] The parties are urged to resolve the matter of costs. If they are unable to do so, the respondent shall provide its costs submissions, not exceeding five pages exclusive of its bill of costs and caselaw, by not later than January 5, 2025. The applicant shall provide its costs submissions, also not to exceed five pages exclusive of its bill of costs and caselaw, by not later than January 15, 2025. There shall be no reply costs submissions without leave of the court in advance.
[56] I would like to thank counsel for their helpful written and oral submissions in this matter.
Date: December 2, 2024 Justice M.A. Cook
[^1]: All references herein to the Income Tax Act refer to the legislation as it was in force between August 1, 2015 and June 21, 2016: see Income Tax Act, RSC 1985, c 1 (5th Supp), https://canlii.ca/t/52lhj retrieved on 2024-10-25.
[^2]: In support of their application, the applicants have filed affidavits of Thomas J. Feeney dated November 9, 2016 and March 7, 2023, and affidavits of Geoff Crewe dated November 9, 2016 and March 21, 2023. Canada did not file any evidence in response to the application and it did not cross examine Mr. Feeney or Mr. Crewe.