Canassurance, Compagnie d'Assurance-Vie Inc. v. The Queen, 94 DTC 6186, [1994] 2 CTC 37 (FCA)

Marceau, J.A. (Desjardins and Létourneau, JJ.A., concurring):— This appeal is from a judgment of the Trial Division ([1991] 2 C.T.C. 214, 91 D.T.C. 5535), rendered pursuant to the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"). The central question presented by it, stated in the abstract, is whether during the 1983, 1984 and 1985 taxation years the appellant could in calculating its taxable income deduct certain amounts paid by it as interest. It is the provisions of subparagraph 20(1)(c)(i) of the Act which are in question, and I set them out forthwith:

20(1) Notwithstanding paragraphs 18(1)(a), (b) and (h), in computing a taxpayer's income for a taxation year from a business or property, there may be deducted such of the following amounts as are wholly applicable to that source or such part of the following amounts as may reasonably be regarded as applicable thereto:

(c) an amount paid in the year or payable in respect of the year (depending upon the method regularly followed by the taxpayer in computing his income), pursuant to a legal obligation to pay interest on

(i) borrowed money used for the purpose of earning income from a business or property (other than borrowed money used to acquire property the income from which would be exempt or to acquire a life insurance policy). . . .

If there is any problem presented by the application of these relatively straightforward provisions in the case at bar it is due to the very special nature of the appellant’s personality, its relations with the legal person to which the "interest" payments were made and the exceptional circumstances in which the transactions involved took place. Here, then, are the facts.

The appellant was incorporated as an insurance company known as "The Quebec Mutual Life Assurance Company" in 1959 by a special statute of the Quebec National Assembly. This Act (An Act to incorporate the Quebec Mutual Life Assurance Company), which became c. 183 of the 1958-59 Quebec statutes, provided inter alia that the appellant would be a corporation without share capital acting exclusively in the interests of its members (section 2); that its members would be limited to the owners of its paid-up insurance contracts (sections 4 and 7); that its net profits could only be distributed to those of its members recognized as owning a paid-up insurance contract (section 11); that it would be subject to the provisions of the Quebec Insurance Act and to those of Part II of the Quebec Companies Act, in so far as they were not inconsistent (section 13). The appellant kept its mutual company status until 1986, when the Quebec National Assembly adopted a new special Act (An Act respecting the Quebec Mutual Life Assurance Company) providing that in future the Quebec Mutual Life Assurance Co. would cease to be a mutual company and would be a company with share capital and would henceforth be known under the corporate name of, in English, “Blue Cross Life of Quebec Inc." (S.Q. 1986, c. 134). In the following year the appellant adopted the name it now has, "Canassurance, Compagnie d’assurance-vie inc."

The appellant was created at the instance of the Quebec Hospital Service Association ("the association”). The association has been in operation since 1942 (also under a special Act, An Act to incorporate the Quebec Hospital Service Association, S.Q. 1942, c. 102) as a mutual aid society in the medical and hospital care field and its directors had represented that a complementary mutual life insurance association was desirable. The initial 1959 legislation creating the appellant, as well as that of 1986 which transformed its status, dealt fully in their introductory paragraphs with this close relationship between the appellant and the association, and the two legal entities, thought from a legal standpoint completely separate, have always functioned jointly: they still share their premises at this time and have elected the same person as president.

The 1959 Act gave special recognition to this link between the appellant and the association in two of its provisions, sections 16 and 17, which as they are at the root of the dispute must be reproduced in full:

16. The company shall at all times possess a reserve fund of at least $200,000, which reserve fund may be subscribed by Quebec Hospital Service Association, which, notwithstanding any other law or statute to the contrary, is hereby authorized to subscribe said reserve fund.

The company may pay on such subscription or any balance thereof interest at a rate not exceeding five per centum per annum.

The company may at any time, if, in the opinion of its directors, its financial situation permits and with the approval of the superintendent of insurance, reimburse the whole or any part of the aforesaid subscription.

17. Notwithstanding any provision of this Act or other law to the contrary, until the reserve fund subscribed by Quebec Hospital Service Association has been fully reimbursed,

(a) each of the individuals named in section 1 hereof shall be deemed to be a member of the company;

(b) each of the governors of the said association for the time being in office shall be qualified to be a director of the company; and

(c) a majority of the directors of the company shall at all times be the nominees of said association and the by-laws of the company shall contain provisions to ensure the attainment of that result.

Sections 16 and 17 are at the root of the dispute for the simple reason that what they contemplated as a possibility is precisely what happened: for several years the appellant had recourse to repeated subscriptions of the association to keep its reserve fund up, and those subscriptions, which were made by instalments in 1960 to 1973, reached the total amount of $11,248,981. The issue turns on the amounts paid by the appellant to the association as interest on the "subscriptions" paid. This point requires clarification.

In 1961, and in each of the following three years, the appellant paid interest to the association on its “subscriptions”. Written agreements were concluded each year determining the applicable rate. From 1965 to 1973, due to its financial difficulties and with the consent of the association, the appellant made no undertaking to pay interest and did not pay any. In 1979 the appellant resumed its interest payments and continued them until 1987 (on a sporadic but constant basis, since for example the interest for 1984 and 1985 was paid as a lump sum in 1986), and in 1987 it was able to remit to the association the entire cumulative amount of its subscriptions. No written agreement similar to those of the earlier years was made in 1979 when the payments resumed, nor in subsequent years, out formal resolutions of the appellant’s board of directors were adopted each year determining the amount payable and the date of the payments.

As indicated above, this Court is concerned with the 1983, 1984 and 1985 taxation years. For each of those years the appellant claimed a $560,000 deduction in calculating its taxable income, being the amount of interest it had paid to the association. The Minister disallowed the deduction on the ground that subparagraph 20(1 )(c)(i) of the Act, on which it relied, did not permit this deduction and each time issued a notice of reassessment which was objected to by the appellant. When the case came before the Trial Division it found in the Minister’s favour. The appellant then appealed the decision.

It is clear from reading subparagraph 20(1)(c)(i) of the Act that an interest deduction is subject to three conditions: (1) that the interest was paid to discharge a legal obligation to pay interest on the money borrowed; (2) that the money borrowed was used to produce income from a business or property; (3) that the money borrowed was not used to acquire property having a tax-free income. There can of course be no doubt that these conditions are peremptory and, in The Queen v. MerBan Capital Corp., [1989] 2 C.T.C. 246, 89 D.T.C. 5404, this Court could not do otherwise than recognize this. It is the first of the three conditions which the trial judge considered was not met. After noting that analysis of tax matters should not be limited to the form of a transaction but should consider the intention of the parties and look at the substance and true nature of the transaction, he said the following in the key paragraphs of his reasons for judgment at pages 220-21 (D.T.C. 5539-40):

The facts in the case at bar are similar to those in Société d'Assurance des Caisses Populaires v. M.N.R., [1967] Tax A.B.C. 632, 67 D.T.C. 455. It therefore seems worth reproducing the conclusions of the Tax Appeal Board which reflect the principles applicable to the matter, at pages 649-50 (D.T.C. 465):

The so-called cash advances did not create any legal obligation to pay interest because, pursuant to the Acts of incorporation, they were payable only after authorization was obtained from the Superintendent of Insurance and after a resolution was adopted to that effect. Moreover, interest payments were in direct proportion to the appellant’s profits and were solely dependent on them. . . . All these elements show, without the shadow of a doubt, that the relationship of the Caisses Populaires, in respect of the appellant, was that of shareholders rather than that of lenders.

In this case there was no obligation to pay interest and the contributions might not be considered a loan used for purposes of earning income but rather a locked-up fund, or an obligatory capital stock according to the Acts, and an indispensable element of assets or of goodwill.

Applying the rules taken from the case law, I come to the conclusion that the amounts in question were not paid pursuant to a legal obligation to pay interest on the borrowed money. The amounts paid by the plaintiff are not really in the nature of interest paid under an obligation within the meaning of the Act.

In the case at bar, under its enabling Act, the plaintiff had to maintain sufficient reserves to meet the claims of insured parties. the association was authorized to subscribe to the company’s reserve fund. The latter is not required to repay the said subscriptions, as repayment of “the whole or any part" depends on its financial position and the approval of the Superintendent of Insurance. The company has discretion as to whether or not it pays interest at a rate not exceeding five per cent per annum. There is thus no legal obligation to repay the subscriptions or to pay interest. The 1960 resolution authorizing the company to sign an agreement with the association regarding the payment of interest on the subscriptions to the reserve fund and the subsequent agreement of the same year between those two parties has not changed the true substance and nature of the transactions in question. The 1986 resolutions did not have the effect of creating a legal obligation to pay interest on the money borrowed, as required under the provisions of subparagraph 20(1)(c)(i) of the Income Tax Act.

With respect, I must beg leave to dispute the approach taken by the trial judge.

It is clear that the link existing between the appellant and the association, close though it was in practice, and the conditions to which their business relations were subject, while of a special nature, were not a bar to the relations of lender to borrower arising between them. They were two separate entities, and the appellant's enabling legislation indeed provided for this. That being the case, can these periodic payments of money made by the association to the appellant, all subject to reimbursement, be regarded in law otherwise than as so manÿdoans? I do not think so. It appears to me that the association could not act in any other capacity than that of a lender. There was no question of its making gifts, since an obligation to repay was assumed; nor of course could it simply be making a deposit, since the purpose was to finance the appellant; it could not be becoming a member of the appellant in any capacity, since only owners of insurance policies could be members; it could not share in possible profits made by the appellant, since only members were entitled to do so; and it could not merge in any way with the appellent, since by their respective enabling statutes, the two entities had to remain completely separate. The payment of interest is not in the nature of a loan contract. It is the transfer of ownership of the thing to which the contract applies and the obligation to repay it which are the essence of the contract, and the transfer of ownership and obligation to repay are unquestionably present here, though the performance of the latter is subject to the ability to pay. In my opinion, the fact that these periodic payments of money by the association to the appellant were called “subscriptions” — the word used by the legislature in section 16, which in any case is a neutral term as such, as Casey, J. noted in his reasons in Richelieu Royal v. Duclos, [1950] K.B. 714, at pages 717-18 — or were called “advances”, does not affect the matter. It is clear that the contracts pursuant to which these periodic payments were made were unusual. They were not loans ure and simple, but I do not see how the relationships which they created, if we look at the essence of those relationships, can legally be described as anything but relationships between a lender and borrower.

I do not have to rule on the validity of the finding by the Tax Appeal Board in Société d'Assurance des Caisses Populaires v. M.N.R., [1967] Tax A.B.C. 632, 67 D.T.C. 455, to which the judge referred; but in any case I see essential differences between the facts that were before the board in that case and those now before this Court. In that case the Caisses populaires were the only ones able to finance the subsidiary Société; they became shareholders in the Société merely because they made advances with the right to participate in the distribution of assets in the event of dissolution, and could furthermore refuse any repayment in order to preserve their status as members. The association here, on the contrary, is a legal entity completely separate from the appellant which did not as a result of its advances become either a shareholder or member of the appellant, could not refuse the repayments and in the event of dissolution would simply have ranked with the other creditors. Moreover, in that case the Caisses and the Société d'assurance had clearly never by their actions done anything to suggest that lender-borrower relations existed between them; the parties here, on the contrary, have from the outset clearly recognized that one was a debtor and the other a creditor. While in that case the Tax Appeal Board could conclude from the facts and the context it had to consider that "the relationship of the Caisses Populaires, in respect of the appellant, was that of shareholders rather than that of lenders” (at page 640 (D.T.C. 465) of the judgment), no such conclusion can in my opinion be drawn here; and it is the legislature itself which, in the preamble to the 1986 Act, unambiguously indicates this in two introductory paragraphs which read:

Whereas, due to its financial position, the Quebec Mutual Life Assurance Company has been unable for several years to pay to the Quebec Hospital Service Association any interest on the money advanced by the latter;

Whereas the current financial position of the Quebec Mutual Life Assurance Company is such that the company is now in a position to reimburse, as permitted under chapter 183 of the statutes of 1958-59, the amount due to the Quebec Hospital Service Association. . . .

It is true that the recognition of a lender-borrower relationship is not conclusive. The wording of subparagraph 20(1 )(c)(i) and the clear primary purpose of the first condition for the exemption to apply, namely preventing a taxpayer placing part of his income beyond the reach of the Revenue Department by directly or indirectly making a gratuitous disposition of it, indicates that even in the case of a loan of money the condition may not be met. If the lender has expressly or tacitly, but irrevocably, agreed that interest would not be payable on his loan a payment of interest by the borrower would, it seems to me, be gratuitous and would not benefit from the exemption in subparagraph 20(1 )(c)(i). However, in my opinion it is clear that is not the case here. From the very beginning the parties indicated as clearly as possible that they expected interest to be paid. The waiver that followed, made because of the appellant's financial problems, was not in any way irrevocable, and the resumption of payments in 1979 until the capital was paid off was made on the basis of an agreement which, though not written as in the earlier years, is just as certain and valid as the initial agreements and cannot be seen as having been made gratuitously by the appellant.

I accordingly consider that the payments of interest made by the appellant to the association in 1979 and subsequent years meet the conditions for an exemption under subparagraph 20(1)(c)(i) of the Act. This is why I would allow the appeal, reverse the trial judgment and ask the Minister of National Revenue to issue reassessments.

Appeal allowed.