10 October 2000 External T.I. 2000-0013545 - INSURANCE BROKER'S RESERVE

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues: Availability of Reserve for unearned commissions of an Insurance Broker under subsection 32(1).

Position: General Comments.

Reasons:

XXXXXXXXXX 2000-001354
C. Savage
October 10, 2000

Dear XXXXXXXXXX:

Re: Reserve under Subsection 32(1) of the Income Tax Act (the "Act")

This is in response to your letter of March 7, 2000, wherein you requested a technical interpretation regarding the reserve that an insurance broker may claim with respect to unearned commissions under section 32 of the Act. You do not feel that the views expressed in paragraphs 5 and 6 of Interpretation Bulletin IT-321R reflect the intention of Parliament. Moreover, you feel that, if an amount is not included in income under paragraph 12(1)(a), Generally Accepted Accounting Principles (GAAP) would apply to include only the unearned portion commission in income under section 9. We apologize for the delay in responding.

Our Comments

In our opinion, Paragraphs 5 and 6 of the bulletin do reflect the intention of Parliament. A review of the history of section 32 supports this view.

In computing the income of an insurance agent or broker, subsection 32(1) of the Act provides that no amount may be deducted under paragraph 20(1)(m), but may allow a reserve.

The tax legislation was amended in 1953 to make it possible for insurance brokers to claim a special reserve. Subsequently, the appropriateness from the point of view of tax policy of maintaining the reserve provided for in section 32 was challenged. It was decided to repeal the section 32 reserve in a technical bill made public in July 1990. Shortly after that announcement, a transitional measure spread over ten years was provided for in order to lessen the considerable impact this measure could have had on some brokers. The purpose of the amendment was to correct a flaw in the Act through which the reserve for unearned commissions was applied in cases in which similar reserves were denied in other sectors of activity. The amendment ensured that tax policy on the deduction of reserves was consistent from one sector of activity to another. For most taxpayers, there is no reserve available; this is true, for example, in cases in which reserves cannot be established for contingencies and in cases in which it is only possible that fees will have to be reimbursed or a service will have to be rendered during a future taxation year in respect of a particular sale. Even when no deduction is possible under section 32 of the Act, insurance brokers, like all other taxpayers earning business income, will be able to claim a reserve by applying paragraph 20(1)(m) in respect of services to be rendered after the end of the year. Such services will not include those to be rendered only on the basis of certain contingencies (e.g., changes of address or of beneficiary, and settlements of claims), but will instead include services the broker has contracted to render at a specific time in the future.

The continuing coverage after the end of the current year of a risk described in an insurance contract is not a "service" for which a reserve would be available under paragraph 20(1)(m). In order for an amount received as an unearned commission to be included it must be an amount described in paragraph 12(1)(a) that relates to a binding obligation to provide specific types of client support services after the end of the year. Generally, amounts for services that might be required in relation to claims under the policies would not be eligible, since they normally would be contingent amounts for which a deduction would be prohibited by paragraph 18(1)(e).

Subparagraph 12(1)(a)(i) provides that any amount received by a taxpayer in the year in the course of a business that is on account of services not rendered or goods not delivered before the end of the year or that, for any other reason, may be regarded as not having been earned in the year or a previous year shall be including in computing the taxpayer's income from a business for the taxation year. This provision ensures that, for income tax purposes, certain amounts that may not otherwise be included in income under section 9, are included in income for tax purposes. If subparagraph 12(1)(a) does not apply to include an amount in income (i.e., because it is not on account of services not rendered or goods not delivered before the end of the year), the tax treatment is not necessarily determined by GAAP. You indicated that in accordance with GAAP, only the earned portion of the commission is included in income. However, for income tax purposes the whole amount is included in income. The portion of the commission included in income in accordance with GAAP is included in income for tax purposes under section 9. The portion of the commission deferred in accordance with GAAP is a reserve for tax purposes. As paragraph 18(1)(e) denies the deduction of "an amount as, or on account of, a reserve ...", the entire commission is included in income for income tax purposes.

We trust that these comments will be of assistance.

Yours truly,

for Director
Financial Industries Division
Income Tax Rulings Directorate
Policy and Legislation Branch

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