Executive Summary: Key Legal and Evidentiary Issues

• Rectification was sought to amend a director’s resolution after an accountant’s error led to the payment of capital dividends in excess of the Capital Dividend Account (CDA), resulting in significant tax liability.

• The dispute focused on whether the director’s resolution accurately recorded the parties’ agreement or merely reflected the accountant’s mistaken calculation.

• The court applied Supreme Court of Canada precedents, which restrict rectification to errors in recording agreements, not to mistakes in professional advice or judgment.

• The responsibilities and reliance of corporate directors on professional advice in tax matters were examined.

• The court considered the application of equitable remedies in the context of unintended tax consequences under the Income Tax Act.

• The application was dismissed, with no costs or monetary awards granted, in favor of the Attorney General of Canada.

Facts of the case

Keystone Enterprises Real Estate Ltd. [Keystone] was incorporated under The Business Corporations Act, 2021, SS 2021, c 6. Its current directors, officers, and shareholders are Kevin Gerry and Dolores Gerry. Don K. McMillan, CPA, CA Prof. Corp. [Accountant], has been the accountant for Keystone since 2007. On May 29, 2023, the Accountant advised Mr. Gerry, on behalf of Keystone, that there was an available balance of $721,465 in Keystone’s Capital Dividend Account (CDA). He advised that this balance could be paid to Keystone’s shareholders as a non-taxable dividend. Mr. Gerry, who is also Mrs. Gerry’s enduring power of attorney, agreed to be paid out the balance of Keystone’s CDA, provided the Accountant could confirm the payment was tax-free. The Accountant prepared the August 10, 2023 director’s resolution, which stated that effective August 10, 2023, the corporation would pay capital dividends in the amount of $721,465 from the CDA to the shareholders, Kevin Gerry and Dolores Gerry, in proportion to their shareholder percentage ownership. After the director’s resolution was executed, Keystone filed Form T2054, “Election for a Capital Dividend Under Subsection 83(2)” of the Income Tax Act, electing to treat the dividend as a capital dividend. Capital dividends of $721,465 were paid to Keystone’s shareholders.

On June 7, 2024, the Canada Revenue Agency [CRA] advised that Keystone’s CDA balance was $184,464, not $721,465. This resulted in an excess election of $537,001. The CRA advised that Keystone had the option of being taxed at 60 percent under Part III of the Income Tax Act or treating the amount as taxable dividends to the shareholders under s. 184(3) of the Income Tax Act. On October 29, 2024, the CRA issued a notice of assessment to Keystone, taxing the amount at 60 percent. The Accountant acknowledged he made an error in calculating the CDA balance, as he had not properly entered a capital dividend payment previously made to a former shareholder, Mr. Gerry’s father, Raymond Gerry, who passed away in 2014.

Policy terms and legal framework

The case involved the application of the Income Tax Act, RSC 1985, c 1 (5th Supp), specifically the provisions regarding capital dividends and the Capital Dividend Account (CDA). Under the Act, capital dividends are tax-free only up to the balance of the CDA, and any amount exceeding the balance is not tax-free and is subject to a 60 percent tax under Part III unless the shareholder and corporation jointly elect to treat the excess as a regular dividend taxable to the shareholder (see ss. 83(2) and 89(1) of the Income Tax Act). The court referenced leading Supreme Court of Canada cases, including Canada (Attorney General) v Fairmont Hotels Inc., Jean Coutu Group (PJC) Inc. v Canada (Attorney General), and Canada (Attorney General) v Collins Family Trust, which confirm that rectification is limited to cases where the written instrument does not accurately record the parties’ agreement and is not available to correct errors in professional advice or to avoid unintended tax consequences.

Arguments and analysis

The applicants argued that their intention was to pay only the tax-free amount available in the CDA and that the director’s resolution should be rectified to reflect this intention. They submitted that the error was in the Accountant’s calculation, not in the agreement itself. The Attorney General of Canada, as respondent, argued that the director’s resolution accurately reflected the agreement as made, based on the Accountant’s advice, and that rectification should not be used to avoid tax liability resulting from an error in professional advice. The court found that the director’s resolution correctly recorded the agreement reached by the parties, which was based on the Accountant’s advice regarding the CDA balance. The error was not in the transcription of the agreement but in the underlying calculation. The court emphasized that rectification is not available to correct mistakes in professional advice or to avoid adverse tax consequences that arise from the ordinary operation of tax statutes.

Ruling and outcome

The court dismissed the application for rectification, holding that the applicants must bear the tax consequences of the transaction as executed. The successful party is the Attorney General of Canada. The court stated: “While I have determined in favour of the respondent, I make no order as to costs.” No costs or monetary awards were granted or ordered. The applicants remain liable for the tax assessed by the CRA, and there is no amount awarded in their favor.