Mac's Convenience Stores Inc. v. A.G. of Canada, 2015 QCCA 837

The appellant, which was a wholly-owned Ontario subsidiary of a Quebec corporation ("CTI"), paid a $136 million dividend to CTI in connection with a "Quebec shuffle" transaction. The tax advisor did not focus on the resulting reduction in the appellant's retained earnings which, under the s. 18(4) thin cap rule, caused a substantial portion of the interest on a $185 million loan owing to a related non-resident corporation to become non-deductible.

In finding that the appellant could not retroactively rectify the dividend so as to be a stated capital distribution instead, and after noting (at para. 34) that AES and Riopel dealt with related parties committing an error in giving effect to a "legitimate corporate transaction for the purpose of avoiding, deferring or minimizing tax" and correcting "that error to achieve the tax consequences originally and specifically intended and agreed upon," Schrager JA stated (at para. 43):

The payment of the 136 million dollar dividend to CTI was intended and was effected. … Reduction of capital was not intended. The unintended consequences of the dividend, by ricochet, resulted from the thin capitalization rules and was not part and parcel of the transaction. … There was no common intention of the parties regarding these rules as they were never contemplated and so cannot be the object of a meeting of the minds to which a court can give effect.

The taxpayer did not realize at the time that paying a substantial dividend to its Canadian parent (which reduced its retained earnings) would cause the thin capitalization rules to apply to interest on a loan from a related non-resident corporation. Schrager JA found that rectification was not available to convert the dividend into a stated capital distribution. See summary under General Concepts – Rectification.