Harvest Operations Corp v. A.G. (Canada), 2015 DTC 5067 [at at 5904], 2015 ABQB 327

A debtor transferred assets to an affiliated creditor in order to repay debt of approximately $170 million owing by it. However, the conveyance only included partnership interests worth $158 million and did not include the balance of the debtor's assets of $12 million (the "Other Assets"). CRA assessed on the basis that the debt forgiveness rules applied to the debtor in the amount of $12 million as its debt had been settled in full on the repayment of an inadequate amount.

Dario J declined to issue a rectification order to have the assets transferred retroactively. After finding that rectification would be inappropriate in any event (see summary under General Concepts - Rectification), Dario J stated (at para. 93):

The Applicant had been relying on the non-transfer of the Other Assets to seek a tax benefit, and now seeks the transfer of such assets to obtain a different one. Rectification is a discretionary equitable remedy… . "He who seeks equity must do equity"…[B]y taking advantage of the capital cost allowance of the Other Assets, instead of immediately seeking a rectification order, I find [the debtor] undertook a course of conduct akin to acquiescence, precluding the remedy it now seeks.

The Bump Mistake

A predecessor in interest of the applicant ("Viking") entered a multi-step acquisition and restructuring transaction to acquire an arm's length corporation ("Krang"). The plan was originally for a sibling unit trust of the taxpayer ("VHT") to lend $35 million to the taxpayer's subsidiary ("082"), which would then acquire all the shares of Krang for $171 million, with 082 and Krang then amalgamating to form "Krang #2".

On the day of closing, a Krang creditor unexpectedly required Krang to repay its revolving credit facilities rather than consenting to the transaction. Consequently, VHT lent the $35 million directly to Krang, thereby reducing the purchase price paid by 082 for the Krang shares by $35 million. This had the effect of reducing the s. 88(1)(d) "bump" of the cost to Krang #2 of partnership interests previously held by Krang by the same amount, thereby resulting in a taxable capital gain on a subsequent transfer of those interests described below.

The taxpayer applied to have the transaction rectified to reflect that the loan was made to 082 instead of Krang, and that those funds were used to subscribe for additional shares of Krang.

Dario J dismissed the taxpayer's application, stating (at paras. 77, 81 and 82):

[T]his is not a case of the parties "wrote it down wrong", but rather the parties got it wrong.

… To the extent we are talking only about the increased bump room due to the Krang Debt, the evidence does not establish that the inability to benefit from this tax treatment would have terminated the acquisition, or that the common intent of the parties that drove them to the formation of the transaction was frustrated.

… The intent to complete a transaction in the most tax efficient manner possible is not sufficiently specific. The Applicant must establish how the parties had intended on achieving this tax objective… .

Cases, such as Fairmont, where courts granted "rectification where there was no ‘particular way' the parties had intended to achieve the tax objective… run contrary to the express views of the Supreme Court of Canada as set out in Performance Industries and others…" (paras. 46, 49).

Here, the taxpayer's tax advisor had listed a number of possible options to deal with the last-minute hurdles in a tax-efficient manner - none of them were taken, and furthermore none of them matched the order being sought.

The Other Assets Mistake

A subsequent leg of the series involved transferring Krang's assets (now Krang #2's assets) to VHT in purported full repayment of debt owing, with VHT then transferring the same assets to a subsidiary partnership ("Olaf"), also as a purported full debt repayment. Approximately $12 million of the $170 million in assets of Krang #2 were not transferred, with the result that both debts had been settled without full repayment, so that the debt forgiveness rules applied to both Krang #2 and VHT.

After concluding that rectification was not available in any event, Dario J stated (at para. 92):

In the present case, where these assets were unknown or forgotten, not specifically referred to in the Step Memorandum, remained (and presumably, with respect to prepaid expenses and depreciable assets, used) in the Krang #2 entity, and subsequently recorded in Krang #2's tax filings (including recording a capital cost allowance on the assets), the Applicant has not met the requisite burden of proof to establish intent.

A last-minute requirement of a Target lender for its loan to be repaid on closing resulted in the purchase price being reduced by $35M and that amount being lent by an affiliate of the Buyer to the Target to fund the loan repayment. That was a mistake. The $35M purchase price reduction reduced the s. 88(1)(d) bump for partnership interests held by Target when it was amalgamated with Buyer to form Amalco, so that a capital gain was realized when the partnership interests were then transferred to repay debt owing by Amalco to the affiliate.

The potential bump problem was identified on the closing date, but the solution (involving the affiliate loan proceeds being lent instead to the Buyer and then applied to subscribe for Target shares so as to fund the third-party loan) was not identified until later. Dario J found that this precluded rectification.

See summary under General Concepts – Rectification.