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:
Whether or not the amounts recorded in the Head Office Account of a non-resident insurer are included in the capital of the corporation for purposes of Part I.3 tax.
Position:
The total amount of the Head Office Account should be included in the capital for purposes of Part I.3 tax under 181.3(3)(d)(ii) except amounts already included under 181.3(3)(d)(i).
Reasons:
Head Office Account is equivalent to shareholders' equity and retained earnings.
June 28, 1999
TORONTO EAST TSO HEADQUARTERS
Michèle Trotier
Attention: Duncan McKay (613) 957-8953
Insurance Specialist
982458
Head Office Account of Non-Resident Insurers and Part 1.3 Tax
This is in reply to your memorandum dated September 4, 1998 wherein you requested that we reconsider our previous opinion dated September 30, 1997 from our Directorate to the XXXXXXXXXX Tax Services Office (Document number 970321) on the above topic in light of subsequent submissions from each of XXXXXXXXXX We had been asked by XXXXXXXXXX to delay our review until they forwarded to us a further submission which was received May 14, 1999.
In our earlier opinion we indicated that the Head Office Account of a non-resident insurer “represents the amount of capital retained in Canada relating to the Canadian branch”, and that “It is equivalent to the shareholders’ equity and retained earnings of a Canadian insurer. It includes many elements such as infusions of capital, trading transactions, adjustments (increase or decrease) of reserves, accumulated earnings, etc.” Consequently, we were of the opinion that the “total amount of the Head Office Account as of year end should be included under subparagraph 181.3(3)(d)(ii) of the Income Tax Act (“Act”) as “any other surpluses...” except amounts already included under subparagraph 181.3(3)(d)(i) of the Act.” We also noted that any other administrative questions relating to the inclusion or exclusion of amounts in certain circumstances should be resolved by Audit Directorate.
We have reviewed all the submissions referred to above. However, it continues to be our view that the Head Office Account is essentially equivalent to shareholders’ equity and retained earnings and therefore should be included in capital under subparagraph 181.3(3)(d)(ii) of the Act to the extent not otherwise included under subparagraph 181.3(3)(d)(i) of the Act. It has been suggested that certain items may be reflected in the Head Office Account that do not represent capital or surplus and to the extent these are identified by the taxpayer they would not be included in capital under subparagraph 181.3(3)(d)(ii) of the Act.
While not determinative in and of itself we would note that in a previous advance income tax ruling to a non-resident life insurer, it had been set out as a fact that the non-resident insurer’s Head Office Account reported to the Office of the Superintendent of Financial Institutions Canada (“OSFI”) represented the amount of capital retained in Canada relating to the Canadian branch. This description was not disputed by the non-resident life insurer.
Part 1.3 tax was introduced by the Department of Finance, as stated in the 1989 Technical Notes, to ensure that all large corporations pay federal taxes and thus contribute to deficit reduction...” The Technical Notes also indicated that “For all non-resident insurance companies, financial capital employed in Canada will be determined with respect to the capital used in the firm’s Canadian business.” Where non-resident insurers are maintaining capital in Canada and it is related to the Canadian insurance branch business then this capital should be subject to Part 1.3 tax in Canada. In our view this would be the case even where the income from the assets supporting the capital may not be subject to tax under Part I.
As noted in our previous opinion the word “surplus” is not defined in section 181 of the Act. However, the definition of “surplus” in Black’s Law Dictionary (Sixth Edition), for instance, states that surplus is “the remainder of a thing”. It also states that “Ordinarily, surplus means residue or excess of assets after liabilities... A general term in corporate accounting that usually refers to either the excess of assets over liabilities or that amount further reduced by the stated capital represented by issued shares.” In our view, the Head Office Account can represent such “surplus” of the non-resident insurer relating to its Canadian insurance business.
We note that in their April 17, 1998 submission the XXXXXXXXXX has indicated on page 1 that “ ...XXXXXXXXXX ". It is also stated that “ XXXXXXXXXX ... ” The XXXXXXXXXX then states on page 3 of this submission that “ XXXXXXXXXX ... ” Similar statements were made by the XXXXXXXXXX in their March 31, 1998 submission. We note that the XXXXXXXXXX has also referred to the so-called “excess assets” in their submission. The XXXXXXXXXX in their May 12, 1998 submission indicated on page 4 that “XXXXXXXXXX". In our opinion for such statements to be made is an indication that the so-called “excess assets” can be identified by the non-resident insurers. However, where the non-resident insurer is able to substantiate that these “excess assets” do not support and therefore do not relate to its insurance business carried on in Canada, consequently, the offsetting credit recorded in the head office account would not be included pursuant to subparagraph 181.3(3)(d)(ii) of the Act. The XXXXXXXXXX had provided us in their May 14, 1999 submission with an example of a head office account and an analysis detailing the current year’s net income and various adjusting journal entries. We were advised by the XXXXXXXXXX that they are not able to provide us with details with respect to the opening balance in the head office account which represents the majority of the balance in this account.
We refer to both schedules reported for purposes of OSFI in the annual returns prepared by non-resident life and non-life insurers. These are found on page 83.050 of the OSFI 55 (1997 Revision) prepared by non-resident life insurers and on page 20.45 of the P&C2 prepared by non-resident property and casualty insurers. These schedules are headed Head Office Account and reconcile the balance at the beginning of the year to the balance at the end of the year of this account. It identifies the net income for the year; transfers from (to) Head Office for both life and property and casualty non-resident insurers and also identifies with respect to property and casualty non-resident insurers decreases and increases in reserves required by OSFI.
Our understanding, based on telephone discussions with officials of OSFI is that, contrary to what has been represented by both the XXXXXXXXXX and XXXXXXXXXX , the Head Office Account is not simply viewed as a “balancing account” by OSFI.
We note, for example, that on page IV-4 of the P&C2 Annual Return Instructions (1996) OSFI states that “The Annual Return (P&C2) of a foreign company should reflect only the company’s Canadian business.” It does go on to indicate that “For example, suppose that a European company, registered in Canada on a branch basis, transacts some business in the United States, using the facilities of the Canadian branch to do so. Although the Canadian branch may have been involved in managing and developing of this business, it should not be shown in the Canadian annual return. If the business generated a profit and if the profit was retained in Canada, it should be seen, for accounting purposes, as having flowed to the Head Office of the company and from there, having been transferred to the Canadian branch and reported in the Canadian Annual Return on Page 20.45, Head Office Account”.
The legislator did specifically refer to “any other surpluses” in subparagraph 181.3(3)(d)(ii) of the Act where they relate to the Canadian insurance business of the non-resident insurer and this in addition to the amounts which are included pursuant to subparagraph 181.3(3)(d)(i) of the Act. It is left up to the non-resident insurer to substantiate that the amounts reflected in the Head Office Account do not relate to its insurance businesses carried on in Canada and that they relate to its insurance businesses outside of Canada.
As noted it is our view that a resident multinational insurer has to include for purposes of Part 1.3 tax all of its capital as determined pursuant to subsection 181.3(3) of the Act regardless of the fact that some of the assets supporting this surplus may not have been subject to tax under Part I because of the application of subsection 138(9) of the Act. However, it would be entitled to a proration of its capital based on the canadian reserve liabilities over its total reserve liabilities. We would view this as being equivalent to the situation of Canadian insurers who do not pay out dividends but decide to retain the capital within their company notwithstanding that such capital may be in excess of what is necessary to support the Canadian insurance operations.
XXXXXXXXXX in their submission raised the fact that a non-resident insurer is subject to Part XIV of the Act if it elects pursuant to subsection 219(4) of the Act. They are of the view that Part I.3 tax is unfair when it is imposed in addition to the branch tax. Both the XXXXXXXXXX and the XXXXXXXXXX in their submissions have indicated that to use the Head Office Account to determine Part I.3 tax of the Canadian branch of a non-resident insurer is inconsistent with the scheme of Parts I, XIII and XIV of the Act. When the non-resident insurer elects pursuant to subsection 219(4) of the Act to pay the branch tax the Canadian Investment Fund as defined in subsection 2405(3) of the Income Tax Regulations would be reduced for purposes of computing Part I tax. If the non-resident insurer does elect to pay the branch tax and therefore repatriates assets from the Head Office Account to the Head Office, there would also be a lesser amount left in the Head Office Account. In addition we note that pursuant to subclause 181.3(3)(d)(i)(A)(II) of the Act the legislator has provided an adjustment with respect to an amount on which the non-resident insurer was required to pay Part XIV branch tax thereby reducing the amount otherwise required to be included in the capital of the non-resident insurer pursuant to subparagraph 181.3(3)(d)(i) of the Act.
We also note that the XXXXXXXXXX commented that our Department had not mentioned Head Office Account in our Draft Bulletin on Part 1.3 Tax. We would like to emphasize that the Draft Bulletin on Part 1.3 Tax focuses primarily on corporations that are resident in Canada which are not financial institutions.
In conclusion we are still of the view that the total amount of the Head Office Account should be included in computing the capital of the non-resident insurer as “surplus” pursuant to subparagraph 181.3(3)(d)(ii) of the Act to the extent that it relates to the insurance businesses carried on in Canada by the non-resident insurer and to the extent that it was not otherwise included pursuant to subparagraph 181.3(3)(d)(i) of the Act.
We trust that the above will be of assistance. If you need further information or would like to discuss the above please do not hesitate to contact F. Lee Workman (957-3497) or Michèle Trotier (957-3494).
F. Lee Workman
Manager
Financial Institutions Section
Financial Industries Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch
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