The B.C. Supreme Court recently concluded that failing to complete a transaction in the most tax efficient manner is not a “corporate mistake” that can be remedied under the Business Corporations Act[1] (the “Act”).
In Greither Estate v. Canada (Attorney General), 2017 BCSC 994, Justice Mayer dismissed a petition seeking to remedy an alleged corporate mistake where the form of a share sale transaction had unanticipated adverse tax consequences.
Otto and Karoline Greither were residents of Germany who jointly owned a B.C. company. They sought tax advice with respect to their Canadian holdings, and were advised in February 2013 to sell their shares to a related company for preferred shares in that related company[2].
However, Karoline died in May 2013. On her death, she was deemed to have disposed of her share of the company, which had a fair market value of $1,951,458 and was taxable Canadian property. Capital gains taxes of about $500,000 were paid and her estate inherited the share.
In February 2015, the Greithers’ tax lawyer proposed that Karoline’s estate sell the share to the related company for its fair market value less $1, plus one preferred share, believing the estate would not be required to pay tax on the sale as it would not have a gain. The estate followed this advice, and the related company purchased the share by way of a promissory note in the amount of $1,951,457 and a preferred share worth $1.
Karoline’s estate then applied to Canada Revenue Agency for a clearance certificate[3]. The CRA refused to issue the certificate and proposed to assess the estate for tax on the basis that it was deemed to have received a dividend from the related company under s. 212.1 of the Income Tax Act.
Karoline’s estate filed a petition[4] to rectify the share sale documents such that the estate received a promissory note in the amount of $1 and a preferred share worth $1,951,457, which would not attract tax under s. 212.1 of the Income Tax Act. The estate argued:
- if the documents were not rectified, it may be liable to pay an additional $335,000, on top of the almost $500,000 that it had already paid in capital gains tax (akin to double taxation); and
- the intention behind the structure of the sale was tax efficiency. The tax lawyer’s evidence was that he had not considered s. 212.1 in giving his 2015 opinion. Had he done so, he would have advised the estate to take his 2013 advice, which would not have drawn the same tax consequences.
The Court dismissed the petition because the transaction did not fall within the definition of “corporate mistake”. Although s. 229(2) allows the Court discretion to alleviate the consequences of a corporate mistake, there must first be an omission, defect, error or irregularity in the conduct of a company’s affairs that has led to one of the “mistakes” listed in s. 229(1):
(a) a breach of the Act or regulations;
(b) a default in compliance with the company’s constating documents;
(c) the proceedings at a meeting of the shareholders or directors have been rendered ineffective; or
(d) a consent resolution has been rendered ineffective.
The “mistake” of not completing the transaction in the most tax effective manner was not captured by any of these subsections. Karoline’s estate “did what it planned to do” and the transaction “simply did not have the desired tax effect”: para. 38.[5] In the result, the petition was dismissed.
Justice Mayer’s decision highlights the importance of reviewing all possible adverse tax consequences in administering an estate. In this case, the form of transaction in the circumstances resulted in additional taxes, penalties, and interest of some $335,000, on top of the significant capital gains taxes that had already been paid.
If you have questions about estate planning or administration, please feel free to contact one of the lawyers in our Wills, Estates + Trusts Practice Group.
[1] S.B.C. 2002, c. 57.
[2] This would avoid taxation on a deemed dividend, pursuant to s. 212.1 of the Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.), which deals with non-arm’s length share sales by non-residents.
[3] A clearance certificate is required when non-residents sell taxable Canadian property.
[4] The petition relied on s. 229 of the Act, which permits the court to modify the consequences of a “corporate mistake” in certain circumstances.
[5] Further, although the estate had only applied under the Act, equitable rectification would not have been available either. Even though the transaction led to undesirable or otherwise unexpected tax consequences, the sale documents were completed as intended and, as noted in Canada (Attorney General) v. Fairmont Hotels Inc., 2016 SCC 56, rectification cannot be used for retroactive tax planning.
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