[1]          This is an appeal from the judgment of the Superior Court, District of Longueuil (the Honourable Mr. Justice Jean-Jude Chabot), of November 30, 2012, which granted Respondent’s, Le Groupe Jean Coutu (PJC) inc., introductory motion of suit for rectification and declaratory relief.

[2]          For the reasons of Schrager, J.A., with which Chamberland and Giroux, JJ.A., concur, THE COURT:

[3]          GRANTS the appeal;

[4]          DISMISSES Respondent’s, Le Groupe Jean Coutu (PJC) inc., motion in first instance, the whole with costs in both courts.

[5]           To what extent can a taxpayer retroactively revisit the documentation giving effect to a series of transactions where unforeseen tax consequences have resulted?

[6]           That is the ultimate issue in this appeal from the judgment of the Superior Court, District of Longueuil (the Honourable Jean-Jude Chabot), of November 30, 2012.

[7]           This appeal was heard immediately following the case of Mac’s Convenience Stores inc. v. Attorney General of Canada, Agence du Revenu du Québec and Couche-Tard inc.[1] and the judgments in both cases are being rendered simultaneously.

FACTS

[8]           Co-Respondent, Le Groupe Jean Coutu (PJC) inc. (“PJC Canada”) was incorporated under the Companies Act[2] and has its head office in Longueuil, Quebec. It is the sole shareholder of co-Respondent Jean Coutu Group (PJC) USA inc. (“PJC USA”) incorporated under the laws of the State of Delaware.

[9]           Since the acquisition of a chain of pharmacies in the United States by co-Respondent PJC USA, the value thereof appears in Canadian dollars on the financial statements of co-Respondent PJC Canada. The fluctuation and the rate of exchange between US and Canadian dollars caused corresponding fluctuations in the value of the investment as reflected on the balance sheet of PJC Canada. These fluctuations were liable to negatively influence investors and potential investors in the way they perceived the business success of that investment. Thus, in February of 2005, management of PJC Canada, after consultation with its professional advisers, put in place a series of transactions to neutralize these effects of the fluctuation of the exchange rate on the value of the US investment on PJC Canada’s balance sheet.

[10]        Respondent’s professionals had recommended two possible scenarios to effect the foregoing:

Scenario number 1:

i)             February 7, 2005, PJC Canada loans $ 120 million US to PJC USA;

ii)            February 25, 2005, PJC Canada purchases an additional 10 common shares of PJC USA for $ 70 million US;

iii)           February 25, 2005, PJC USA loans $ 70 million US to PJC Canada.

Scenario number 2:

i)             February 7, 2005, PJC Canada loans $ 120 million US to PJC USA;

ii)            February 25, 2005, PJC Canada purchases an additional 10 common shares of PJC USA for $ 70 million US;

iii)           February 25, 2005, PJC USA pays $ 70 million US of the $ 120 million US loan referred to above;

iv)           February 25, 2005, PJC USA and PJC Canada exchange loans of $ 70 million US.[3]

[11]        Regarding both scenarios, the evidence of Respondent’s management regarding the foregoing proposed transactions was that they were intended to have no adverse tax effects or in other words to be fiscally neutral.

[12]        Scenario number 1 above was chosen and put in place. The intended result was achieved; the fluctuations and the value of the US investment due to the currency exchange fluctuation were neutralized.

[13]        Unfortunately, during an audit in 2010, the Canada Revenue Agency concluded that because PJC USA was a controlled foreign affiliate of PJC Canada, the interest it earned on the $ 70 million US loan that it advanced to PJC Canada constituted income of PJC Canada for each of the years the loan was outstanding, namely 2005, 2006 and 2007. This was in virtue of Section 91(1) of the Income Tax Act.[4] The phenomenon is known as FAPI or Foreign Accrual Property Income. As a consequence of the foregoing audit, PJC Canada was assessed $ 2.2 million Canadian of unpaid income tax.

[14]        In first instance, PJC Canada sought to rectify the transaction by seeking approval to put in place Scenario number 2 above, retroactively.

[15]        PJC Canada’s position is that the transaction sought to solve a business problem. It was clearly intended that it be carried out on a tax neutral basis. The additional income assessed was an unintended consequence because the parties (or their tax advisers) erred by not foreseeing the impact of the FAPI. Thus, PJC Canada’s consent was vitiated and it has a right to set aside the documentation that was put in place so as to correct it or replace it with the documentation reflecting Scenario number 2 above.

[16]        The judge in first instance agreed. The error was not the result of negligence or lack of diligence. It was simply an oversight.

[17]        Relying on the decision of this Court in AES,[5] the judge sought to give effect to Respondents’ intention to put in place Scenario number 2 above which he saw as a series of juridical acts which would allow Respondents to achieve their intended purpose without adverse tax consequences. The judge stated that correcting the unforeseen tax consequence did not amount to “rewriting tax history”. He found an analogy with the factual situation in Riopel[6] where new articles of amalgamation to provide the appropriate class of shares to give effect to the parties intention were approved by this Court in a rectification proceeding.

[18]        The Attorney General of Canada appeals before us alleging that Respondents are indeed attempting to rewrite the tax history of the transaction. What the parties intended (i.e. to ease the effect of the currency fluctuation on the foreign investment on the Canadian parent’s balance sheet) was indeed effected. That is what the parties intended (negotium) and that is what the documentation (instrumentum) succeeded in achieving. Now, because of the unintended FAPI consequence, Respondent PJC Canada seeks to create retroactively an expense so as to reduce the interest income of a foreign affiliate (PJC USA) to zero. The Attorney General of Canada adds that rectification cannot be granted so as to give effect to a general intent to avoid or minimize tax. This is the essence of the judgment of the Supreme Court of Canada in the matters of AES and Riopel[7] decided after the judgment of the lower court herein. The present appeal was suspended awaiting the Supreme Court of Canada’s judgment, which is the center of gravity of the positions of the parties and in which each of them finds support.

ANALYSIS

[19]       A proper understanding of the judgment of the Supreme Court requires a review of the facts. AES had sought to restructure its shareholdings to accommodate the arrival of a new shareholder/investor. To this end, rollover transactions pursuant to Section 86 of the Income Tax Act[8] and Sections 541 and 543 of the Taxation Act[9] were contemplated with a view to deferring the tax that would be payable by the existing shareholders on the gain arising from the disposition of their shares. The tax neutrality of the transaction depended on the consideration other than the shares (i.e. a promissory note) not exceeding the adjusted cost base (“ACB”) of the shares received. However, the calculation of the ACB was erroneous giving rise to a taxable capital gain. The parties replaced the promissory note with a new note in the corrected amount in order to avoid the immediate payment of tax and to have this correction recognized by the Superior Court of Quebec in a proceeding seeking rectification and declaratory relief. They also created the necessary class of shares to give effect to the restructuring.

[20]       In Riopel, a couple sought to restructure the shareholdings in a family enterprise, the assets of which had been sold. The only asset left in the company was the cash proceeds arising from the asset sale. The tax professionals recommended a corporate restructuring with a view to distributing funds as a capital dividend as foreseen by Section 83 of the Income Tax Act[10] in order to defer tax. The restructuring recommended was to occur on a tax neutral basis but unfortunately due to a series of errors by the professionals in executing the transaction, one of the shareholders was deemed to have been paid a taxable dividend and was assessed accordingly by the tax authorities. The parties sought rectification by changing the order of the transactions as well as the attributes of the classes of shares of a new amalgated corporation and the price of newly issued shares the whole so that the transaction be carried out as originally intended.

[21]       Writing for the Court, LeBel J. emphasized that in Quebec civil law the essence of a contract is in a meeting of the minds of the parties (Art. 1385 C.C.Q.) so that there is a distinction to be drawn, as did this Court, between the agreement that the parties intended (negotium) and the declaration (oral or written) of that intended agreement (instrumentum). Error which vitiates consent may be the cause a contract’s nullity. An error in the nature of disparity between what was agreed and what was written does not vitiate the parties’ consent. The latter type of “error” was in issue in both AES and Riopel. In any event, the parties are free to acknowledge a common error and to agree to correct it subject to any rights acquired by third parties.

[22]       In Riopel, because of the error of the tax advisers, the desired effect of the tax planning agreement to defer income tax by following procedures provided in the tax legislation did not succeed. The professionals failed to implement the agreement correctly. After receipt of tax assessments alerting the parties to the error, the parties agreed to the necessary corrections.

[23]       In AES, the error in implementing the tax planning agreement was an incorrect calculation of the ACB of certain shares. Though the error could have served as a basis to annul the contract between the parties, they chose to correct the error by amending the documents and the tax forms to reflect the proper figures.

[24]       LeBel J. examined whether the tax authorities had acquired rights to have the existing, erroneous instruments continue to apply and he said the following:

[25]       LeBel J. then added:

[26]       LeBel J. observed that the parties had the power to correct the documents without the intervention of the Court,[11] although the courts could intervene to declare the amendments legitimate and necessary by way of the motion for rectification. He saw no reason to intervene in the conclusion of this Court that it was possible to remedy the errors based on the parties’ common intention. In so approving the manner of proceeding, LeBel J. stated that:

[27]       He continued as follows:

[28]       Accordingly, in my view, the judgment of the Supreme Court in AES & Riopel is authority for the proposition that as between related parties, who choose to effect a legitimate[12] corporate transaction for the purpose of avoiding, deferring or minimizing tax and who commit an error in giving effect to such transaction (for example, by miscalculating the ACB, by the timing of certain corporate steps or the attributions of a new class of shares) may correct that error to achieve the tax consequence originally and specifically intended and agreed upon.

[29]       However, LeBel J. did not set aside all the previous case law in tax matters, to the effect that the parties cannot rewrite history and change their transactions because of unintended tax consequences. Those principles continue to apply.

[30]       Even though the tax authorities have no acquired rights in civil law, LeBel J., in my view, does not sanction a general license to travel back through time with the benefit of hindsight to reverse or correct unintended tax consequences of commercial dealings. LeBel J. merely approved the parties restoring their agreement to what it should have been in circumstances where there was no mistake in the transaction itself but rather a mistake in the way the transaction had been expressed in writing.

[31]       Tax liability is based on what happened and not on what a party in retrospect would have rather done:[13]

The incidence of taxation depends on the manner in which a taxpayer arranges his affairs. Just as he may arrange them to attract as little taxation as possible, so he may unfortunately arrange them in such a manner as to attract more than is necessary.[14]

[32]       Correcting a transaction is not the same as changing it:

[66]      (…) rectification is granted to restore a transaction to its original purpose, and not to avoid an unintended effect. A transaction which does not succeed in achieving its goal of avoiding tax is not the same thing as a transaction whose goal is other than tax avoidance but which unexpectedly results in a tax disadvantage. While, therefore, rectification is available in order to avoid a tax disadvantage which the parties had originally transacted to avoid, it is not available to avoid an unintended tax disadvantage which the parties had not anticipated at the time of transacting.[15]

[33]       AES & Riopel clearly examined the first type of transaction whose legitimate goal of avoiding tax was not achieved. The courts approved a correction to allow the parties to avoid a tax consequence that they had originally transacted to avoid.

[34]       The Supreme Court of Canada has made it clear in a taxpayer’s favour that:

Unless the (Income Tax) Act provides otherwise, a taxpayer is entitled to be taxed based on what it actually did, not based on what it could have done, and certainly not based on what a less sophisticated taxpayer might have done.[16]

[35]       The corollary of the foregoing premise, in my view, is that a taxpayer is obliged to pay tax arising from the transaction it effected and not the transaction that it would have preferred to have effected given the benefit of hindsight regarding unintended tax consequences. Taxpayers must live with the consequences of the contract they chose to put in place.[17]

[36]       In the present case, the commercial transaction was not a restructuring transaction seeking to defer or avoid tax as foreseen by the income tax legislation (as was the case in AES & Riopel) but rather a series of offsetting loans meant to neutralize the effect on the balance sheet of the variation in the value of PJC Canada’s American investment. The variations corresponded to fluctuations in the rate of exchange between Canadian and US dollars.

[37]       The observation of the judge of first instance that the parties were not seeking to rewrite the tax history of the transaction constitutes, in my respectful opinion, a manifest error. Clearly, this is precisely what the parties were seeking to do. The rectification sought is to approve the implementation of Scenario number 2 described above, presented by the tax professionals and discarded. The parties intended to put Scenario number 1 in place. They did so and achieved their intended purpose of neutralizing the effect of the exchange fluctuations.

[38]       Neither scenario was a transaction which had the specific and legitimate intent of restructuring the affairs of Respondents so as to avoid tax by deferral or otherwise as was the case in the matters of AES and Riopel. I would not go so far as to limit the possibility of rectification to correct mechanical or technical errors in transactions specifically foreseen by the tax legislation. However, to be legitimate the object sought cannot be a mere general intention to reduce tax liability by modifying or replacing a transaction. The general intent of the Respondents that their transaction be “tax neutral” is not sufficiently determinate, in the words of Justice LeBel, to serve as the basis of a modified agreement which a court should recognize with retroactive effect to cancel unintended tax consequences. I repeat that the parties already achieved their purpose with the Scenario number 1 transaction. They did what they meant to do. They are taxed on that basis even though they did not foresee the tax consequences.

[39]       In view of the foregoing, I conclude that the judgment of first instance contains an error of mixed fact and law which is palpable and overriding. I would propose then that this Court intervene, grant the appeal and reverse the judgment in first instance so as to dismiss Respondent’s motion in first instance, the whole with costs in both courts.