A-520-85
Consolidated-Bathurst Limited (Appellant)
(Plaintiff)
v.
The Queen (Respondent) (Defendant)
INDEXED AS: CONSOLIDATED-BATHURST LTD. V. CANADA
Court of Appeal, Urie, Stone JJ. and Cowan
D.J. — Toronto, October 28, 29; Ottawa, Novem-
ber 28, 1986.
Income tax — Income calculation — Deductions — Insur
ance scheme whereby appellant's risks insured with domestic
insurers and reinsured with offshore insurance company creat
ed by appellant, said risks being guaranteed by appellant —
Non-deductibility of insurance premiums as business expenses
where insured taxpayer, though technically insured, required
to absorb own losses — "Economic family" concept rejected
— Income Tax Act, S.C. 1970-71-72, c. 63, ss. 18(1)(e), 95 (as
am. by S.C. 1973-74, c. 14, s. 29; 1974-75-76, c. 26, s. 59),
245(1) — Income Tax Act, R.S.C. 1952, c. 148, s. 137(1).
The appellant taxpayer, a Canadian multinational pulp and
paper manufacturer, faced with the difficulty and cost of
obtaining insurance in Canada, had a "captive" offshore insur
ance company ("OI") incorporated in Bermuda. Although
other insurance transactions are involved in this case, the most
important deal with certain of the appellant's risks insured with
Canadian domestic insurers and reinsured with OI. The latter
in turn reinsured most of these risks on the open market at a
much smaller cost and further protected the domestic insurers
by indemnity agreements coupled with letters of credit backed
up by the appellant's own guarantees.
The Minister disallowed most of the "insurance expenses"
claimed as deductions for taxation years 1971 to 1975. He
further attributed to the appellant, for tax purposes, the interest
and exchange gains realized by OI from 1972 to 1975.
The Trial Judge found that the premiums paid to OI directly
or indirectly, artificially reduced the appellant's income and
were therefore not deductible pursuant to subsection 245(1) of
the Income Tax Act. These disbursements were in effect
amounts transferred to a reserve fund and, as such, not deduct
ible by virtue of paragraph 18(1)(e) of the Act. This was a
channelling of funds from the appellant to an instrumentality
over which it had complete control. And since OI depended on
the guarantees of the appellant to meet insurance claims
exceeding its capacity to pay, there was no true shifting of the
risk. The Trial Judge also found that the Minister was wrong to
attribute OI's interest and exchange gains to the appellant
because, in the absence of a specific rule to the contrary, the
normal distinctions between a parent company and its subsidi
ary should be observed.
This is an appeal and a cross-appeal from that decision.
Held, the appeal concerning the deductibility of the insur
ance premiums should be dismissed with respect to the taxation
years 1971 to 1974 but allowed with respect to 1975. The
cross-appeal concerning OI's interest and exchange gains
should be dismissed.
From 1971 to 1974, the indemnities, letters of credit and
guarantees protected the Canadian domestic insurers from
exposure to loss for risks reinsured with OI. In those years, the
appellant was in a position where it could have been required to
absorb a loss it had purported to insure. As no real protection
was purchased, the deduction of the premiums paid as business
expenses resulted in an artificial reduction of income. There
was no necessity of determining whether or not the payments
constituted a reserve within the meaning of paragraph 18(1)(e)
of the Act.
The situation in the 1975 taxation year differed from the
earlier years in that neither an indemnity nor a guarantee was
required. Payment of insurance premiums in that year did not
artificially reduce the appellant's income because there was a
real transfer of risk even if it was to a company belonging to the
same "economic family". This expression has been used to refer
to companies belonging to one group for the purpose of corpo
ration tax. American courts have held that no income tax
deductions can be claimed with respect to the transfer of risks,
by means of premium payments, to a company belonging to the
group. That concept is unacceptable as it amounts to a whole
sale disregard of separate corporate existence regardless of the
circumstances in a particular case.
CASES JUDICIALLY CONSIDERED
FOLLOWED:
Harris v. Minister of National Revenue, [1966] S.C.R.
489; Sellars v. The Queen, [1980] 1 S.C.R. 527; Clark v.
Canadian National Railway Co.; Attorney-General of
New Brunswick, intervenor (1985), 17 D.L.R. (4th) 58
(N.B.C.A.).
APPLIED:
Shulman, Isaac v. Minister of National Revenue, [1961]
Ex.C.R. 410, affirmed without reasons [1962] S.C.R. viii;
72 DTC 1166; Stubart Investments Ltd. v. The Queen,
[1984] 1 S.C.R. 536; Helvering v. Le Gierse, 312 U.S.
531 (1941); Carnation Co. v. C.LR., 640 F. 2d 1010 (9th
Cir. 1981); Stearns-Roger Corp., Inc. v. U.S., 577 F.
Supp. 833 (D.C. Colo. 1984).
DISTINGUISHED:
Spur Oil Ltd. v. R., [1982] 2 F.C. 113 (C.A.); Covert et
al. v. Minister of Finance of Nova Scotia, [1980] 2
S.C.R. 774.
CONSIDERED:
Judgment dated August 21, 1985, High Court of the
Netherlands, Court Roll No. 22929, not reported (no
style of cause).
REFERRED TO:
Don Fell Limited v. The Queen (1981), 81 DTC 5282
(F.C.T.D.); Sigma Explorations Ltd. v. The Queen,
[1975] F.C. 624 (T.D.).
COUNSEL:
Donald G. H. Bowman, Q.C. and William I.
Innes for appellant (plaintiff).
John R. Power, Q.C., D. C. Olsen and J.
D'Auray for respondent (defendant).
SOLICITORS:
Stikeman, Elliott, Toronto, for appellant
(plaintiff).
Deputy Attorney General of Canada for
respondent (defendant).
The following are the reasons for judgment
rendered in English by
STONE J.: The principal question raised in this
appeal concerns the applicability of subsection
245(1) of the Income Tax Act, R.S.C. 1952, c. 148
as amended by S.C. 1970-71-72, c. 63, s. 1. It is
the first of its kind to come before the Court.
Background
The appellant was formed in 1967 as a result of
an amalgamation. During the years 1971 to 1975
it operated as a manufacturer of pulp and paper
and of packaging in Canada and in other coun
tries. To this end it had some twenty to thirty
subsidiaries throughout the world. The shares of
these subsidiaries were held by its wholly owned
subsidiary St. Maurice Holdings Limited ("St.
Maurice") which was formed for the purpose of
holding shares in affiliated and subsidiary corpora
tions outside of Canada.
After its formation, the appellant's insurance
requirements and those of the subsidiaries were
placed in the insurance market but a high loss
record soon made it difficult and expensive to
obtain coverage in that way. Nevertheless, insur
ance coverage was essential in order that the
appellant could satisfy conditions of trust deeds
securing corporate indebtedness. A scheme was
soon developed under which it was thought insur
ance protection could be achieved in a different
way, free of Canadian insurance industry regula
tions. The scheme took form in 1970 when Over
seas Insurance Corporation was incorporated
under the laws of Panama with a capitalization of
$120,000. It secured a license to carry on an
insurance business in Bermuda. In 1974 a second
corporation, Overseas Insurance Limited, was in
corporated under the laws of Bermuda. The assets
of the Panamanian corporation were transferred to
the Bermudian corporation which was then li
censed to carry on an insurance business in Ber-
muda. It will be convenient to refer to both corpo
rations simply as "OI". All of the directors and
officers of OI were residents of Bermuda and all of
the shares in both corporations were held by St.
Maurice. OI was managed pursuant to a contract
between St. Maurice and Insurance Managers
Limited, a Bermudian corporation owned by the
appellant's Canadian insurance brokers. Insurance
Managers Limited had a substantial staff and
managed some fifty-five insurance subsidiaries in
Bermuda.
The scheme was carried into effect during 1970
and operated throughout the 1971 to 1975 taxa
tion years. The existence of OI represented but one
of its essential elements. Other elements involved
the appellant in insuring certain risks of its own
and of its subsidiaries with Canadian domestic
insurers, the reinsuring by those insurers of all but
a small percentage of those risks with OI pursuant
to the terms of agreements known as Open Facul-
tative Agreements between that insurer and OI,
the securing by OI of stop loss and excess of loss
protection by way of reinsurance in the open
market and, finally, the protecting of the domestic
insurers by indemnity agreements coupled with
0I's bank letters of credit in favour of those
insurers secured by 01's investments and backed
up by the appellant's own guarantees. The details
of these documents and their significance for this
case will become apparent presently. The domestic
insurer was Victoria Insurance Company of
Canada in 1970, Scottish & York Insurance Co.
Limited from 1971 to 1974 inclusive and Elite
Insurance Company in 1975.
The groups of risks which the appellant sought
to insure under the scheme were of two kinds. The
first consisted of the aggregate of deductibles
found in primary insurance policies secured by the
appellant and the subsidiaries in the insurance
market. These deductibles were covered by the
primary insurers under so-called "deductibles"
policies. Almost all of these risks were reinsured by
OI which then protected itself by securing stop loss
insurance on the open reinsurance market against
claims in excess of its premium funds. The second
consisted of miscellaneous risks insured by the
appellant and the subsidiaries under "composite"
policies. A percentage of these risks was placed
with different insurance carriers and with OI.
Initially, 20% of these risks was insured with OI
but this was increased to 40% in the second year.
Premiums were paid directly to OI for the cover
age. Most of these risks were reinsured with under
writers at Lloyd's. The appellant placed 100% of
these risks with those underwriters in the third and
fourth years of the program and they, in turn,
reinsured most of them with OI. Again, OI pro
tected itself by securing on the open reinsurance
market excess of loss insurance against claims
exceeding its premium funds. There was evidence
that over time risks of persons other than the
appellant and the subsidiaries would be accepted
by OI, but no such risks were accepted in the years
under review.
In calculating its taxable income for its 1971 to
1975 taxation years, the appellant deducted as
business expenses the whole of the premiums paid
for this "deductibles" and "composite" protection.
The Minister disagreed and assessed the appellant
on the basis that a substantial portion should be
disallowed. Further, he assessed interest and
exchange gains realized by OI in the taxation
years 1972 to 1975 on the basis that they were to
be attributed to the appellant for tax purposes. In
the Trial Division, Strayer J. decided against the
appellant on the first point and in its favour on the
second.' This appeal is brought from that decision.
The Issues
Two issues arise for decision. First, did the
learned Trial Judge err in upholding the Minister's
assessment disallowing as business expenses por
tions of insurance premiums paid in the taxation
years 1971 to 1975? Second, did the learned Trial
Judge err in varying the Minister's assessment by
excluding therefrom the interest and exchange
gains earned by OI in the taxation years 1972 to
1975?
I turn now to deal with these issues.
Insurance Expenses
The Minister allowed as business expenses only
those portions of the amounts paid as premiums to
the domestic insurers for "deductibles" coverage
that was not reinsured with OI and premiums paid
directly by the appellant for "composite" insur
ance coverage. In the formal judgment, premiums
paid by OI for stop loss and excess of loss insur
ance together with commissions and taxes relevant
to obtaining such reinsurance were also allowed.
The remainder of the amounts paid to OI less
policy losses was disallowed. Because, in the case
of the "deductibles" policies, the domestic insurers
retained only seven and one-half percent of the
risks during the years 1971 to 1974 and but two
and one-half percent thereof in 1975, the amounts
disallowed are rather substantial.
The position of the appellant is that all of the
amounts were paid for insurance protection and as
such were properly deducted as insurance
' [1987] 1 F.C. 223; [1985] 1 CTC 142; 85 DTC 5120.
expenses. The respondent contends that the plan
represented an elaborate scheme of self-insurance
through OI which was not bona fide and that it
was in reality a reserve the deduction of which
would artificially reduce the appellant's income
contrary to subsection 245(1) and paragraph
18(1)(e) of the Act. The respondent argued that
the scheme was a sham but the learned Trial
Judge disagreed. It was also his view that the bona
fide business purpose which he found to be present
could not immunize the appellant from tax liabili
ty if the scheme otherwise attracted it. He found
at page 147 that one of the factors in the decision
to set it up was the existence of problems facing
the appellant at that time in obtaining insurance or
in obtaining it at a reasonable cost. On the other
hand, he found at page 148 that tax advantages
were also a motivation. He could not and, indeed,
did not find it necessary to say to what extent
these and other factors influenced the decision to
establish the scheme.
Paragraph 18(1)(e) and subsection 245(1) of
the Act read:
18. (1) In computing the income of a taxpayer from a
business or property no deduction shall be made in respect of
(e) an amount transferred or credited to a reserve, contingent
account or sinking fund except as expressly permitted by this
Part;
245. (1) In computing income for the purposes of this Act, no
deduction may be made in respect of a disbursement or expense
made or incurred in respect of a transaction or operation that,
if allowed, would unduly or artificially reduce the income.
In rejecting the appellant's basic position that the
amounts paid were properly deducted, the learned
Trial Judge had this to say at pages 236-237 F.C.;
149-150 CTC; 5125 DTC:
To the extent that such risks connected with the plaintiff's
property were not insured or reinsured with unrelated compa
nies, those risks remained with OI. All of OI's assets had their
ultimate source in the plaintiff. Its original capitalization of
$120,000 came from St. Maurice, the plaintiff's wholly owned
subsidiary; its revenues came directly from the plaintiff as
insurance premiums, or indirectly from the plaintiff as reinsur-
ance premiums from the plaintiff's insurers; together with such
rebates or commissions as it might earn on insuring or reinsur-
ing the plaintiff's property, and interest earned on surplus funds
having their ultimate source in the plaintiff. 01 had no other
customers among whom to spread the risk, nor any other source
of funds from which the plaintiff could be paid for losses within
the area of risk retained by OI. Therefore the "insurance
program" must be seen as a device for channelling funds from
the plaintiff to one of its own instrumentalities over which it
had complete control, and to which it would have to look to pay
losses on risks retained by OI. Any funds available in 01 would
be funds having their origin with the plaintiff. Any surplus OI
might enjoy would ultimately be under the control of the
plaintiff as the sole shareholder of the sole shareholder of OI.
Any losses which 01 did not have assets to cover would have to
be borne by the plaintiff. The net result is similar to the
establishment of a reserve fund by any institution or corpora
tion from which it would plan to pay for uninsured losses to its
property.
Nor was it established by the evidence that this was only an
incidental consequence of an arrangement required by the
plaintiff for obtaining insurance from third parties. For exam
ple, the evidence indicates that the premiums paid to Scottish
and York, the Canadian insurer, were the same as it would
have charged to any insured whether or not the insured had a
captive insurance company to act as reinsurer. By the same
token this suggests that there was no market advantage in
having a captive reinsurer. Similarly, although it was said that
one of the reasons for establishing a captive insurer was to
obtain access to reinsurance markets not available otherwise
than to a captive insurance company, in fact the evidence
indicates that the reinsurance obtained was available to any
insurance company whether a captive or not. Therefore the use
of the captive insurance company in part to cover risks not
otherwise reinsured was not merely incidental to an arrange
ment for obtaining from third parties reinsurance not otherwise
available.
Therefore I conclude that the so-called "premiums" paid by
the plaintiff in respect of risks for which its instrumentality, OI,
assumed the responsibility, were disbursements which would
artificially reduce the income of the plaintiff and are therefore
not deductible from its income, pursuant to subsection 245(1).
In fact such disbursements were in effect amounts transferred
to a reserve fund and are therefore not deductible by virtue of
paragraph 18(1)(e) of the Income Tax Act.
The learned Trial Judge relied on cases dealing
with the meaning of artificiality in the context of
the predecessor of subsection 245(1) including a
decision of the Exchequer Court of Canada in
Shulman, Isaac v. Minister of National Revenue,
[1961] Ex.C.R. 410 (affirmed without reasons by
the Supreme Court of Canada, [1962] S.C.R.
viii; 72 DTC 1166), where Ritchie D.J. said at
page 425:
In the context found here, "artificially" means "unnatural",—
"opposed to natural" or "not in accordance with normality".
I construe subsection (1) as though it read:
In computing income for the purpose of this Act no
deduction that if allowed would unduly or artificially reduce
the income may be made in respect of a disbursement or
expense made or incurred in respect of a transaction or
operation.
In considering the application of section 137(1) to any
deduction from income, however, regard must be had to the
nature of the transaction in respect of which the deduction has
been made. Any artificiality arising in the course of a transac
tion may taint an expenditure relating to it and preclude the
expenditure from being deductible in computing taxable
income.
The decisions of the Trial Division in Don Fell
Limited v. The Queen (1981), 81 DTC 5282 and
Sigma Explorations Ltd. v. The Queen, [1975]
F.C. 624 were also relied upon. He was neither
persuaded by the appellant's arguments based
upon the parties to undoubtedly binding and
enforceable legal transactions being separate legal
entities nor by the lack of a principal/agent rela
tionship between the appellant and OI. It was his
view, at page 149, that "it is permissible to pierce
the corporate veil on occasion". In that connection
he referred to the majority decision of the
Supreme Court of Canada in Covert et al. v.
Minister of Finance of Nova Scotia, [1980] 2
S.C.R. 774 where, at page 796, the Court felt
compelled to "examine the realities of the situa
tion" and concluded that a subsidiary company
"was bound hand and foot to the parent company
and had to do whatever its parent said". That case
was exceptional on its facts. Nevertheless, the
learned Trial Judge at page 149 inferred that OI
had to do whatever St. Maurice and the appellant
said. In my view, evidence supporting this infer
ence is somewhat scant. The respondent relies on a
general investment guideline directed to OI by the
appellant but, taken alone, I would regard it as
nothing more than the legitimate interest of an
ultimate investor in the financial success of its
affiliate.
In attacking the decision under appeal the
appellant repeats submissions made at trial, all of
which were directed toward showing that the oper
ation of the scheme had not "artificially" reduced
income in any of the years in question but rather
that it was a legitimate program which was
designed to secure the appellant's insurance
requirements. Accordingly, it argues that no por
tion of the premiums should have been disallowed
as business expenses even though tax savings had
resulted. The respondent likens the scheme to a
train operating on a single track between two fixed
points. Each year as annual coverage expired and
new coverage was required the scheme took over
and, like the train, was set upon a preordained
course. The appellant, it is said, had locked itself
into a program that amounted in reality to a
reserve for payment of future losses. The indemni
ties, letters of credit and guarantees could only
mean that the appellant and St. Maurice had
obliged themselves to make good any short-fall
between insurance claims presented and funds
available in OI to meet them. The fact that the
scheme had been dressed up in the guise of an
insurance program, argues the respondent, did not
make it such.
It seems to me that the applicability of subsec
tion 245(1) must be examined from two distinct
points of view: first, in the circumstances of the
1971 to 1974 period with its indemnities, letters of
credit and guarantees and, then, in the absence
any such indemnity or guarantee in the 1975
taxation year. Those elements were not incorpo
rated in the original scheme though they seemed to
have been contemplated. They were introduced
during the 1972 taxation year. The effect of the
indemnities was to protect both Victoria Insurance
Company of Canada and Scottish & York Insur
ance Co. Limited from exposure to loss for any
coverage ceded by either of them to OI pursuant to
the Open Facultative Agreement. By their terms
St. Maurice bound itself both to Victoria Insur
ance Company of Canada and to its sister com
pany, Scottish & York Insurance Co. Limited, as
an "eligible person" therein defined, as follows:
In consideration of the benefits to ST. MAURICE HOLDINGS
LIMITED from operations of its wholly owned subsidiary OVER
SEAS INSURANCE CORPORATION, "OVERSEAS", ST. MAURICE
HOLDINGS LIMITED shall indemnify and hold harmless any
eligible party, as hereinafter defined, against all current liabili
ty, loss and expense, including but not limited to reasonable
attorneys' fees, that such eligible party may incur by reason of
the failure of OVERSEAS to perform any or all of its obligations
to such eligible party with respect to transactions between such
eligible party and ST. MAURICE HOLDINGS LIMITED and/or
CONSOLIDATED-BATHURST LIMITED, or any of their subsidiary
companies, or in defending or prosecuting any suit, action or
other proceeding brought in connection therewith or in obtain
ing or attempting to obtain a release from liability in respect
thereof.
ST. MAURICE HOLDINGS LIMITED covenants that it will reim
burse such eligible party on demand for, or pay over to such
eligible party, all sums of money which such eligible party shall
pay or become legally liable to pay by reason of any of the
foregoing, and will make such payment to such eligible party as
soon as such eligible party shall become liable therefor, whether
or not such eligible party shall have paid out such sums or any
part thereof.
The obligation of ST. MAURICE HOLDINGS LIMITED to indem
nify any such "eligible party" hereunder shall continue for as
long as any obligation is outstanding from OVERSEAS to such
"eligible party".
Then, from time to time throughout the 1971-
1974 years OI arranged bank letters of credit in
favour of Victoria Insurance Company of Canada
and Scottish & York Insurance Co. Limited
against which either company could on demand
draw up to specified limits on terms similar if not
completely identical to the following which
appeared in the 1972 letter of credit:
The amount so drawn is to be payable upon presentation of a
certificate by Scottish & York Insurance Co. Ltd. and/or
Victoria Insurance Co. of Canada, stating that Overseas Insur
ance Corporation is in default of its current obligations towards
Scottish & York Insurance Co. Ltd. and/or Victoria Insurance
Co. of Canada, written demand for which was mailed to
Overseas Insurance Corporation with copy to St. Maurice
Holdings Ltd. not less than 30 days prior to presentation of this
certificate.
These instruments were each secured by 01's time
deposits in Bermuda. The evidence was that they
were required by Scottish & York Insurance Co.
Limited and Victoria Insurance Company of
Canada because OI was not a Canadian licensed
insurer as required by the Superintendent of Insur
ance. Finally, the appellant furnished the bank
with its own guarantees as further security for the
letters of credit. These guarantees each read in
part:
IN CONSIDERATION of the (Bank) dealing with Overseas Insur
ance Corporation herein referred to as the Customer, the
undersigned hereby guarantee(s) payment to said Bank of all
present and future debts and liabilities direct or indirect or
otherwise, now or at any time and from time to time hereafter
due or owing to said Bank from or by the Customer, arising
from a demand having been made under Letter of Credit ....
When, in 1975, the Elite Insurance Company
entered the picture as the domestic insurer neither
an indemnity nor a guarantee supporting the letter
of credit was required. Again, that letter of credit
was provided directly by 01.
I am in respectful agreement with the conclu
sion of the learned Trial Judge insofar as it con
cerns the taxation years 1971 to 1974 inclusive.
The effect in those years of the appellant's guaran
tees, it seems to me, was to place the appellant in a
position where it could have been required to
absorb a loss it had purported to insure. OI was
then in its infancy and its capitalization was rela
tively small. True, it had reinsurance protection
for its premium accounts and neither expected to
be nor in fact was called upon to make good under
its guarantees. I do not see that that matters at all.
The effect of the guarantee arrangements was that
in the event something unforeseen had occurred
such as would have prevented OI from meeting
claims presented by the domestic insurers pursuant
to the Open Facultative Agreement, the appellant
itself would have had to absorb any resulting loss
otherwise covered by the terms of its insurance
contracts. According to the evidence, guarantees of
this kind had some prevalence in the industry as
between insurer and reinsurer but not as between
insured and reinsurer. It only stands to reason. I
should have thought that an insurer's request for
such a guarantee might, in ordinary circum
stances, quite properly be met with incredulity
and, I suspect, with a firm and swift rejection by
his insured. Similarly, even though no guarantee
was given in respect of the "composite" policies,
the appellant would also have had to absorb any
loss thereunder for coverage retained by OI
because OI might not have had sufficient funds
available. In respect of risks retained by OI, I do
not see how the arrangement which operated
throughout the 1971 to 1974 taxation years can be
viewed as providing bona fide insurance protection
under which risk shifted and was distributed so as
to render eligible for deduction as business
expenses amounts paid by the appellant as premi
ums thereunder. As no such protection was pur-
chased in those years, the deduction of such
amounts resulted in an artificial reduction of the
appellant's income.
The respondent urges that these payments con
stituted a "reserve", within paragraph 18(1)(e) of
the Act and the learned Trial Judge agreed. There
seems to me, however, no necessity of characteriz
ing the payments in that or any other particular
way. It is sufficient to say that they cannot be
regarded as insurance premiums deductible
against income. This follows because in the cir
cumstances they were abnormal payments whose
deduction would "artificially" reduce income
within the test of artificiality set forth in the
Shulman case. A contract of insurance is a con
tract to indemnify an insured for losses incurred to
the full extent provided in the contract according
to its terms and conditions. In my view, an
arrangement or condition whereby an insured may
be required to absorb any portion of the loss for
which indemnity is so provided does not result in
bona fide insurance protection. Monies paid as
premiums therefor may not be deducted from
income as business expenses. 2
I have not overlooked additional arguments put
forward by the appellant although I cannot accept
them. Reliance is placed on the decision of this
Court in Spur Oil Ltd. v. R., [1982] 2 F.C. 113
and particularly at page 125 concerning the treat
ment accorded the word "artificial" found in sub
section 137 (1) of the Income Tax Act as it then
stood [R.S.C. 1952, c. 148]. That case did not
involve an insurance scheme. Additionally, while
binding and enforceable legal obligations were
incurred, the transaction did not, as here, relieve
2 See Harris v. Minister of National Revenue, [1966] S.C.R.
489 per Cartwright J., at p. 505. Although it was not necessary
for the Court to deal with subsection 137(1) of the Income Tax
Act [R.S.C. 1952, c. 148] I think I must accept the case as
binding guidance in view of the fact that the point "was fully
argued" (Sellars v. The Queen, [1980] 1 S.C.R. 527; and see
Clark v. Canadian National Railway Co.; Attorney-General of
New Burnswick, intervenor (1985), 17 D.L.R. (4th) 58
(N.B.C.A.), per La Forest J.A., at p. 66).
the performance of a fundamental obligation had
the need to do so arisen. Further, the appellant
argues that the "foreign accrual property income"
rules in section 95 of the Act as amended in 1972
[S.C. 1970-71-72, c. 63] and effective in 1976 [as
am. by S.C. 1973-74, c. 14, s. 29; 1974-75-76, c.
26, s. 59] and subsequent years, must be taken as
expressing parliamentary intention that amounts
paid as premiums in the years under review are not
to be regarded as contravening subsection 245(1).
Under those rules, it was said, the income of an
offshore captive insurer is deemed to be the
income of its Canadian parent. I do not gain
assistance from this argument for it seems to me
that whether the scheme is proscribed by subsec
tion 245(1) must depend on the interpretation to
be given its language regardless of the presence in
some of those years of newly adopted rules await
ing legal effect.
But what of the 1975 taxation year? Should the
result be any different? The situation differed
from the earlier years in that neither an indemnity
nor a guarantee was required. By 1975 OI had
been in operation for some years and had built up
substantial assets. The evidence rather suggests
that the strength of its financial position in that
year made it unnecessary to require either a guar
antee or an indemnity. Indeed, in its Memoran
dum of Fact and Law the respondent appears to
say as much by stating that "by 1975 sufficient
funds had been transferred either directly or in
directly by the appellant to OI ... that no indem
nification was required". Moreover, OI had devel
oped its own investments and continued to protect
its premium funds against reinsurance claims
under stop loss or excess of loss reinsurance in the
open market.
The learned Trial Judge, at page 151, did not
consider the presence of the indemnities and guar
antees "essential to a finding that at no time
during the years in question was the risk shifted
away from the plaintiff or its instrumentalities". In
so concluding he was influenced by decisions of
courts in the United States dealing with the nature
of insurance in the context of a taxing statute
(Helvering v. Le Gierse, 312 U.S. 531 (1941)) and
particularly with the deductibility from income of
amounts paid as premiums whose ultimate destina
tion was a captive insurance subsidiary (Carnation
Co. v. C.I.R., 640 F. 2d 1010 (9th Cir. 1981) and
Stearns-Roger Corp., Inc. v. U.S., 577 F. Supp.
833 (D.C. Colo. 1984)). In examining these cases I
must not forget what was said by Estey J. in
Stubart Investments Ltd. v. The Queen, [1984] 1
S.C.R. 536, at page 555, to the effect that the
Internal Revenue Code and its predecessors "did
not include an anti-tax avoidance provision in the
nature of s. 137".
According to these decisions, insurance involves
risk shifting and risk distributing. I agree. That
view was central to the Carnation and Stearns-
Roger decisions and was the view taken by the
Supreme Court of the United States in the Le
Gierse case. The Carnation case involved a deduc
tion of premium paid by the parent to a domestic
insurer, the ceding of most of the cover to an
offshore captive and payment of a correspondingly
high percentage of the premium. The United
States Court of Appeals for the 9th Circuit con
cluded that as there had been no shifting and
distributing of risk no insurance resulted and,
accordingly, that the amount paid as premium
could not be deducted from income pursuant to the
Internal Revenue Code. In the Stearns-Roger case
the parent paid an amount as premium to its U.S.
captive insurance company but its deduction from
income was disallowed on the basis that the parent
and the subsidiary belonged to the same "econom-
ic family". In coming to his conclusion, the learned
Trial Judge made the following observations at
pages 238 F.C.; 150 CTC; 5125 DTC:
In the present case, with respect to losses not insured with third
parties, the plaintiff was obliged to look to its own instrumen
tality, 01, for any funds it might require to replace the losses on
such property. If the money were not there—money which
incidentally had come from the plaintiff directly or indirectly—
then the plaintiff would not be recompensed for its loss, at least
unless it provided the funds to this subsidiary of its subsidiary
with which to reimburse itself. Therefore, the risk had not been
shifted or distributed.
and he added at pages 240 F.C.; 151-152 CTC;
5126 DTC:
While in Canadian jurisprudence we have not apparently
embraced the term "economic family" it appears to me we
should reach the same conclusion, that in a case such as the
present one the risk has not been shifted to anyone other than
an instrumentality of the insured, an instrumentality which
draws all of its assets directly or indirectly from the insured and
whose only source of more funds for paying insurance losses,
should its assets not be sufficient, would be the insured itself.
Without resorting to familiary metaphors, I can conclude that
such does not involve a true shifting of the risk and therefore
the payment of "premiums" to such a captive "insurer" would
artificially reduce the income of the "insured".
I should note here that unlike the case at bar
neither of these U.S. cases involved reinsurance of
any part of the risks beyond the captive itself.
Besides, in the Carnation case the requirement of
the domestic insurer that the parent subscribe to
additional capital was seen by the Court at page
1013 as "key" to the arrangement by which the
parent could insure its risks. That factor is entirely
missing in the present case for the taxation year
1975 for in that year neither an increase in OI's
capitalization nor a guarantee was sought or given.
Moreover, the concept of "economic family" has
been neither authoritatively established nor univer
sally accepted. In this Court for the first time the
appellant relies on a decision of the High Court of
the Netherlands rendered August 21, 1985 (Court
Roll No. 22929). The parties are not identified by
name. As I understand, a domestic business con
cern placed its insurance requirements and those
of its other companies with an offshore subsidiary
incorporated under the laws of the Netherlands
Antilles. It was assessed to tax liability on the
basis that risks were not covered by insurance and
that no business relationship existed between the
parent and the offshore subsidiary. The Court
disagreed, saying at page 26 of the certified trans
lation handed to this Court:
For the rest, the argument is based on the view that with
companies belonging to one group for the purpose of corpora
tion tax, no attention should be paid to the transfer of risks to a
company belonging to the group by means of premium pay
ment, since in this case, these risks remain inside the concern.
This view is not correct. If and in so far as in a group
relationship a premium is charged for the transferred risk,
based on normal business practice—and therefore is not
influenced by the relationship itself within that concern—,
allowance should be made for the premium payment when
corporation tax is levied.
While care must be taken in the treatment to be
given this case decided under foreign laws with
which we are not familiar, it may be seen as
rejecting the "economic family" concept. As I see
it, adoption of that concept would amount to a
wholesale disregard of separate corporate existence
regardless of the circumstances in a particular
case. I find that to be unacceptable.
In the present case, whether risk shifted and was
distributed is a question of law. I am unable to say
that in the 1975 taxation year risk did not shift
and was not distributed. Unlike in the four preced
ing years, the domestic insurer as the fronting
company could not look to the insured to absorb
losses covered by the scheme in the event OI
defaulted. True, that insurer held a letter of credit
from OI but it was not guaranteed by the appel
lant. This may suggest that OI occupied a far
more mature and solid financial position in 1975
than may have been the case in the preceding
years. As was noted by the learned Trial Judge,
the appellant's holdings were vast. In my view, the
arm's length insurance transactions in 1975 creat
ed binding and enforceable legal obligations.
Moreover, a shifting and distributing of risk
occurred for the following additional reasons.
First, the coverage arranged in that year was
extremely large e.g. in the case of the "deduct-
ibles" alone, the limit of coverage was $750,000
per loss, accident or disaster. Second, the risks
were numerous and were of a similar kind. Third,
there is nothing in the record suggesting the likeli
hood that OI would have been faced at the same
time with paying similar losses incurred by more
than one of the insured entities, for it appears the
risks were not interdependent.
The predecessor of subsection 245(1) was sub
section 137(1). 3 It was the subject of certain
observations by a majority of the Supreme Court
of Canada in the Stubart case some of which are
relied upon by the respondent. No issue actually
arose in that case as to the application of that
subsection; it was concerned with income attribu
tion rather than expense deduction. Nevertheless,
at page 579, Estey J. set out as the first of several
guidelines to the interpretation of the Act that the
absence of a bona fide business purpose for a given
transaction may render applicable the general tax
avoidance provisions (then subsection 137(1), now
subsection 245(1)) "depending upon all the cir
cumstances of the case". The learned Trial Judge
found such a purpose to be present in this case.
Earlier, at page 576, Estey J. laid down what I
understand to be a general approach to be taken to
interpreting the Act in the context of a scheme
which must be determined as falling on one side or
other of the tax line. He said:
It seems more appropriate to turn to an interpretation test
which would provide a means of applying the Act so as to affect
only the conduct of a taxpayer which has the designed effect of
defeating the expressed intention of Parliament. In short, the
tax statute, by this interpretative technique, is extended to
reach conduct of the taxpayer which clearly falls within "the
object and spirit" of the taxing provisions. Such an approach
would promote rather than interfere with the administration of
the Income Tax Act, supra, in both its aspects without interfer
ence with the granting and withdrawal, according to the eco
nomic climate, of tax incentives. The desired objective is a
simple rule which will provide uniformity of application of the
Act across the community, and at the same time, reduce the
attraction of elaborate and intricate tax avoidance plans, and
reduce the rewards to those best able to afford the services of
the tax technicians.
I am unable to say that any such conduct was
present in the 1975 taxation year. The complexion
of OI had changed considerably from the earlier
years when doubt as to its ability to pay claims
was such that the elaborate set of indemnities,
3 137. (1) In computing income for the purposes of this Act,
no deduction may be made in respect of a disbursement or
expense made or incurred in respect of a transaction or opera
tion that, if allowed, would unduly or artificially reduce the
income.
letters of credit and guarantees already mentioned
was required lest the scheme abort. That neither
an indemnity nor a guarantee was required in 1975
rather testifies to OI's financial strength and in
dependence as an insurer in that year. As I have
stated, there was in that year a genuine transfer of
risk and distribution thereof among the insurers
and reinsurers. Accordingly, in my view, expenses
laid out in that year as insurance premiums did not
work an artificial reduction of the appellant's
income contrary to subsection 245(1).
Income Attribution
I am persuaded that the learned Trial Judge did
not err in referring the matter back to the Minister
for reassessment on the basis that the interest and
exchange gains earned by OI in the taxation years
1972 to 1975 inclusive could not be attributed to
the appellant. The cross-appeal should be dis
missed for the reasons given below.
Disposition
I would dismiss the appeal with respect to the
taxation years 1971 to 1974 but would allow it
with respect to the taxation year 1975 and would
refer the matter back to the Minister for reassess
ment on the basis that the premium expenses
claimed as deductions in that year did not artifi
cially reduce the income of the appellant contrary
to subsection 245(1). I would dismiss the cross-
appeal with costs. As success in the main appeal
has been divided, I do not think it is a case for
costs to either party.
URIE J.: I concur.
COWAN D.J.: I concur.
You are being directed to the most recent version of the statute which may not be the version considered at the time of the judgment.