London Life Insurance Co. v. The Queen, 87 DTC 5312, [1987] 2 CTC 90 (FCTD), aff'd 90 DTC 6001 (FCA)

Martin, J.:—The plaintiff, London Life Insurance Company, appeals the defendant's reassessment of July 28, 1980 in respect of its 1976 taxation year under which the defendant assessed the plaintiff for additional tax on the basis that the plaintiff was not carrying on an insurance business outside of Canada, and reduced expenses deductible in computing the amount on which tax payable under Part XII of the Income Tax Act is applicable by treating revenue received from the plaintiff's subsidiary, Lonlife Data Services Limited ("L.D.S."), as a reduction of expenses rather than as income received.

At issue in respect of the first part of the plaintiff's appeal is whether, during 1976, the plaintiff was carrying on the life insurance business in Bermuda. The issues in respect of the second part of the plaintiff's appeal are, unfortunately, not as clear and have given rise to the delay in filing my decision. I will deal with the Bermuda issue first and the L.D.S. issue in the latter portion of these reasons for my decision.

The plaintiff is a major Canadian life insurance company which, until 1976, had carried on the life insurance business exclusively in Canada. Although it had given consideration to extending its business outside of Canada as early as 1973 it took no steps to do so until 1976. What prompted the company to extend its business at that time was what counsel for both parties have referred to as a tax loophole which allowed more favourable tax treatment to a life insurance company which carried on its business outside of Canada than to a company which carried on its life insurance business exclusively within Canada.

In order to ensure that it would be treated as favourably as its competitors, which carried on their life insurance business both within and outside of Canada, the plaintiff decided to extend its operations to Bermuda.

There is no doubt that the decision to do so was tax motivated but for the purposes of the issue in this matter the motivation is irrelevant. Even if it were relevant to the initial decision that motivation was removed, at least in the opinion of the president and other senior officers of the company, when, on May 26, 1976, which was prior to the time the plaintiff completed its arrangements for its Bermuda operations, the Canadian government publicly gave notice of its intention to amend the Income Tax Act to remove the tax benefits which prompted the plaintiff to extend its operations outside of Canada.

Had the plaintiff been solely tax driven I am satisfied that it would have discontinued its plans to establish itself in Bermuda when it satisfied itself that there would be no, or minimal, tax benefits to be derived from doing so. It did not, however, abandon its plans for once it had decided to enter the Bermuda market, for whatever reason, it implemented that plan in a thoroughly businesslike and well considered manner.

It is not necessary to detail step by step every activity which the plaintiff took to establish its Bermuda operation. Instead, I think a short list of its activities should be sufficient. In this respect during 1976 the plaintiff caused the following steps to be taken:

(a) It obtained several opinions from its solicitors with respect to all aspects of Bermuda law which would be relevant to its proposed operations.

(b) It sent one of its senior personnel to Bermuda to study the potential of Bermuda as a market for life insurance and to identify a suitable firm to represent it.

(c) On May 11, 1976, after Mr. Alex Jeffery, the then president of the plaintiff, personally assured Harnett & Richardson Limited of Bermuda that the plaintiff had a long-term interest in Bermuda it appointed that firm as its Bermuda agent and authorized it to apply for a Bermuda licence to allow the plaintiff to carry on the life insurance business in that country which licence was obtained on June 24,1976.

(d) In early June of 1976 it sent its solicitor to Bermuda for meetings with bankers, lawyers and the plaintiff's agent for the purpose of further assessing the particular requirements of doing business in Bermuda.

(e) It had the heads of its various departments prepare written submissions on any changes in the plaintiff's procedures which would be necessary as a result of its entry into the Bermuda market and held many meetings of its senior executive personnel to plan and execute the proposed venture.

(f) It prepared special insurance policy and application forms for the several types of insurance intended for the Bermuda market which, among other things, provided that Bermuda law would apply and that payment would be made in Bermuda currency.

(g) It brought Mr. Simon Evrett, the Director of Harnett & Richardson Limited's insurance operation, to London, Ontario, for a week of meetings and indoctrination.

(h) It set up a system of contracts for premium billings and collections for the Bermuda market.

(i) Through Harnett & Richardson Limited it solicited many Bermuda residents to take policies with it and provided rate quotations to potential policy holders.

(j) It opened bank accounts in Bermuda into which it deposited $100,000.

(k) In late December 1976 Mr. John Fowler, a marketing executive with the plaintiff, was sent to Bermuda to conclude the formal agency agreement with Harnett & Richardson Limited atwhich time the first two policies which had been issued for Bermuda residents were given to the agent for delivery to the policy holders.

Both in Her pleadings and in Her counsel's argument the defendant submits that Harnett & Richardson Limited's authority to act on behalf of the plaintiff was so limited that the plaintiff cannot be considered to be carrying on business in Bermuda through its agent.

Specifically the defendant says that the agent was only authorized, under the agency agreement of December 30, 1976, to solicit applications for insurance policies to be issued by the plaintiff, to receive premiums therefore, and to draw cheques on the plaintiff's current bank account to make payments for Commissions, Stamp Tax and such other liabilities as the plaintiff would from time to time designate.

The defendant, in paragraph 3 of the statement of defence, refers to the several limitations placed upon the agent's authority by the agency agreement as follows:

(1) could not bind the Plaintiff in any way,

(2) could not interpret a contract of insurance so as to bind the Plaintiff,

(3) could not make, alter or discharge a contract,

(4) could not extend the time for payment of any premium;

(5) could not waive any forfeiture or grant any permit;

(6) could not incur any liability on behalf of the Plaintiff;

(7) could not make or allow the delivery of any policy not issued under a binding receipt, unless the applicant was at the time in good health and the first premium had been paid;

(8) could not collect a premium on any policy or a payment on any policy loan except as he might be authorized under this Agreement;

(9) could not give a receipt for any premium or payment except upon the printed form of receipt furnished by the Plaintiff for that purpose;

(10) could not vary any of the conditions contained in any printed form or receipt;

(11) could not institute or defend legal proceedings for any cause in connection with the transaction of the Plaintiff's business;

(12) could not publish any advertisement relating in any way to the business of the Plaintiff until a copy of same had been submitted to and approved by the Plaintiff.

In paragraph 6 of the statement of defence the defendant says that any business which the plaintiff may have carried on by insuring lives in Bermuda was carried on in Canada in that:

(a) any and all applications for the insurance of lives in Bermuda were required to be submitted, and they were in fact submitted, to the Plaintiff in Canada,

(b) all decisions required to be made by the Plaintiff regarding the acceptance or rejection of applications for the insurance of lives in Bermuda were required to be made, and they were in fact made, by the Plaintiff in Canada,

(c) any and all contracts of insuring lives in Bermuda were in fact and law required to be made, and they were in fact made, in Canada,

(d) any and all insurance policies which the Plaintiff issued on lives in Bermuda were prepared and issued by the Plaintiff in Canada,

(e) any and all claims against or arising out of any life insurance policies on lives in Bermuda were required to be processed, and they were in fact processed, by the Plaintiff in Canada, and

(f) any and all business decisions or transactions collateral to the entering into contracts of insurance on lives in Bermuda were required to be made or directed, and they were in fact made or directed by or on behalf of the Plaintiff in Canada.

Furthermore the defendant claims, in paragraph 7 of the statement of defence, that in the 1976 taxation year the plaintiff's agent solicited no applications for insurance policies to be issued by the plaintiff on lives in Bermuda and that the two policies which were issued on residents of Bermuda resulted from their applications which they submitted to the plaintiff in Canada and which the plaintiff accepted in Canada.

In his argument counsel for the defendant submitted that the only test to determine where a business is being carried on is the one stated in F.L. Smidth and Company v. F. Greenwood, [1921] 3 K.B. 583. The test set out in that case is that the place where a business is carried on is wherever the operations take place from which the profits in substance arise. Counsel went on to identify the activities which in his view were in substance responsible for the profits from the Bermudian policies as being:

(a) the underwriting activities which took place exclusively in Canada, i.e. the activity of the plaintiff leading up to a decision whether or not to underwrite the risk that has been offered;

(b) of lesser importance, but nevertheless highly relevant, the financial control activities, such as the preparation of premium notices, the determination of premiums payable, and the authorization of the payment of claims which all took place entirely in Canada.

Counsel also argued, on the authority of Grainger & Son v. William Lane Gough, [1896] A.C. 325, 3 T.C. 462 (H.L.) that the mere solicitation of insurance applications by the plaintiff's agent in Bermuda is not sufficient to permit the conclusion that the plaintiff was carrying on business there.

Counsel for the plaintiff argued that, notwithstanding the written agreement between the plaintiff and its agent, the agent could and did bind the plaintiff to the terms of interim insurance coverage, that the agent could and did complete the contracts of insurance by delivering the policies to the applicants, and that thereby the contracts were made, he argues, is an important if not a determining factor in resolving the question of whether the plaintiff was carrying on its business in Bermuda (Firestone Tyre and Rubber Co., Ltd. v. Lewellin, [1957] 1 All E.R. 561; 37 T.C. 111 (H.L.)).

In this respect there was some confusing evidence about the interim insurance coverage, i.e. the coverage which the policy holder has between the time he makes his application for coverage and the time the contract of insurance is completed by delivery to him of the policy by the agent, providing that the applicant has tendered with the application the amount of the first premium.

On the authority of Zurich Life Insurance Company of Canada v. Barbara Wallace Davies, [1981] 2 S.C.R. 670, and Matchett et al. v. London Life Insurance Co. (1986), 14 C.C.L.I. 89 (Sask. C.A.), I am satisfied that it was within the authority of the plaintiff's agents to bind the plaintiff to this coverage and that that contract, like the contract represented by the policy itself, was completed in Bermuda. However I share the view of counsel for the defendant that the bare completion of those contracts by the formality of accepting an application in the one case and the delivery of a policy in the other case is by itself of little assistance in determining whether the plaintiff was carrying on business in Bermuda.

Counsel for the plaintiff also advances the argument that I should have regard to section 253 of the Income Tax Act and subsection 2(1) of the Canadian and British Insurance Companies Act R.S.C. 1952, c. 31 in deter mining whether the activities of the plaintiff through its agent in Bermuda constituted the carrying on of its business there.

Section 253 is a deeming provision of the Income Tax Act which provides that a non-resident of Canada who solicits orders or offers anything for sale in Canada will be deemed to have been carrying on business in Canada. Counsel submits if that is the test which Canada applies to determine whether a non-resident is carrying on business in Canada it would be an appropriate test for me to apply in order to determine whether a Canadian resident is carrying on business in Bermuda.

Presumably by way of buttressing this argument, as well as his argument with respect to the completion of the insurance contracts in Bermuda, the plaintiff tendered the expert evidence of Smedly, Q.C. [sic] of Bermuda who said that for the purposes of Bermuda statutory law the activities of the plaintiff through its agent would be considered to be carrying on the insurance business in Bermuda.

He also cites subsection 2(1) of the Canadian and British Insurance Companies Act, R.S.C. 1952, c. 31 which defines the business of insurance as, among other acts, any act of inducement to enter a contract of insurance and submits that this definition should be applied to the concept of carrying on an insurance business in a country other than Canada as provided for in subsection 138(9) of the Income Tax Act.

If one were to apply these statutory provisions to the plaintiff's activities in Bermuda in 1976 it would be clear, because the agent solicited insurance applications and induced persons to enter into contracts of insurance in Bermuda, that the plaintiff did, within the meaning of those statutory provisions as well as within the meaning of the relevant provisions of Bermuda's legislation, carry on the insurance business in Bermuda.

Once again I find these statutory provisions, by themselves, of little assistance in determining the issue in this matter. I note that section 253 of the Income Tax Act is a deeming provision and commences with the phrase: "Extended meaning of carrying on business”. That indicates to me that it extends beyond the normal or generally accepted meaning of the expression.

I note also that the definition in the Bermudian legislation would characterize as carrying on the insurance business in Bermuda, a non-resident who merely advertised in Bermuda insurance for sale in Canada which, in my view, clearly extends beyond any generally accepted meaning of the term.

The Canadian statutory provisions define what will constitute the carrying on of business and the carrying on of an insurance business in Canada for the purpose of that particular Canadian legislation. The provisions do not purport to define what will constitute the carrying on of a business or an insurance business outside of Canada by a Canadian resident. Nor does the Bermudian legislation purport to determine, for the purposes of the Canadian Income Tax Act, what will constitute the prosecution of the insurance business in Bermuda.

Dubé, J. put in perspective the matter of the place where the contracts are made and the place where the operations take place from which the profits arise in Cutlers Guild Limited v. The Queen, [1981] C.T.C. 115 at 117; 81 D.T.C. 5093 at 5095 where he observed:

Whether or not a taxpayer is carrying on a business in another country is a question of fact to be determined in each case. Courts have ruled that the place where sales, or contracts of sale, are effected is of substantial importance. However, the place of sale may not be the determining factor if there are other circumstances present that outweigh its importance. Firestone Tyre and Rubber Co. Ltd. v. Lewellin (1957), 37 T.C. 111.

Another test emanating from the jurisprudence is "Where do the operations take place from which the profits arise?” Soliciting orders in one country may only be ancillary to the exercise of a trade in another country. F. L. Smidth & Co. v. F. Greenwood (1922), 8 T.C. 193. Certain authorities establish that activities and operations other than contracts for sale constitute the carrying on of a business, especially where these respective activities and operations produce or earn income. While income may be realized through sales, it may not arise entirely from that one activity or operation. Estey, J. in Wm. Wrigley Company Limited v. Provincial Treasurer of Manitoba, [1947] C.T.C. 304; confirmed by the Privy Council, [1949] C.T.C. 377. Purchasing of merchandise in one country (i.e. Japan) with the view of trading in it elsewhere (Canada) does not, of course, constitute an exercise of the trade in the former country. Grainger & Son v. William Lane Gough, [1896] A.C. 325 (House of Lords).

Counsel for the defendant relied heavily on F.L.Smidth and Company v. F. Greenwood, [1921] 3 K.B. 583, referring to it as "perhaps the most important case". He emphasized the following passage from the decision of Atkin, L.J. at page 593:

The contracts in this case were made abroad. But I am not prepared to hold that this test is decisive. I can imagine cases where the contract of resale is made abroad, and yet the manufacture of the goods, some negotiation of the terms, and complete execution of the contract take place here under such circumstances that the trade was in truth exercised here. I think that the question is, Where do the operations take place from which the profits in substance arise?

In that case, as well as in Grainger & Son v. William Lane Gough, [1896] A.C. 325 (H.L.), the court was required to determine the meaning of an expression used in the taxing legislation of the United Kingdom which expression is not the same as that used in subsection 138(9) of the Canadian Income Tax Act. The test or question stated by Atkin, L.J. is thus applicable to the interpretation of the relevant tax legislation of the United Kingdom which is quite different from the Canadian legislation.

Atkin, L.J. was not addressing the issue of whether the taxpayer was carrying on business in a country (which is the expression in subsection 138(9) of the Income Tax Act) but the narrower question of whether the profits sought to be taxed arose out of the trade which was exercised in the country, and it was for that reason that the carrying on of a business or the exercise of a trade was necessarily related to the place where the profits arise. This seems clear from his observations at page 593 immediately before the passage cited by counsel for the defendant.

The question is whether the profits brought into charge are “profits arising or accruing” to the respondents "from any trade . . . exercised within the United Kingdom" within the meaning of Sch. D. of the Income Tax Act, 1853. The question is not whether the respondents carry on business in this country. It is whether they exercise a trade in this country so that profits accrue to them from the trade so exercised.

From that I conclude that the "profits" test relied upon by counsel for the defendant is not as determinative of the issue in this matter as he would urge it to be, and that the concept of a person carrying on a business in a country is somewhat broader than the more restrictive interpretation of the United Kingdom legislation contained in the two cases to which I have referred.

Although I have indicated that the place where the contracts are made, the place where the profits arise, and the legislative definitions are of little assistance or are not determinative of the issue before me, I do not discount them entirely. I simply mean to say that no single one of those arguments in itself persuades me I should thereby conclude that the plaintiff was carrying on business in Bermuda in 1976. Because, however, I have concluded that the operations which the plaintiff conducts through its agent in Bermuda fall within the parameters of all three methods suggested to me for determining the question in issue, and because of the nature of the insurance business I have concluded that the plaintiff did carry on its business in Bermuda in its 1976 taxation year.

In so far as the place where the contracts are made dictates that as the place where the business is carried on, the plaintiff makes its contracts of insurance on lives of Bermudian policy holders in Bermuda. I am satisfied that the interim insurance coverage is effected in Bermuda by the completion in Bermuda of the requisite formalities. Similarly I am satisfied that the contract of insurance represented by the written policy is completed in Bermuda by the delivery in Bermuda to the applicant of the policy itself.

Although counsel for the defendant brushed this aside as a mere formality, and I tend to agree with him, I cannot agree with his suggestion that the agent's duty to assure himself that there had been no perceivable change in the applicant's insurable status before he concluded the contract by delivering the policy is a mere formality without substance.

The policies themselves provide that the contract will not come into effect until they are delivered to the insured. The delivery and final, even though cursory, assessment of the continued insurability of the proposed policy holder is an important condition precedent to the completion of the contract. It is also a procedure or action which is vital to the protection of the business interest of the plaintiff and one which is perfomred by the plaintiff's agent in Bermuda.

I have already suggested that the "profits" test may have its limitations because of the requirement under the United Kingdom legislation that there be profits in the United Kingdom from the exercise of the trade. It is not unusual that a new business will have no profits for a substantial period of time but it will nevertheless be carrying on business. However it is not necessary, or even possible, for me to determine whether the plaintiff derived a profit from its 1976 operations in Bermuda. By any standard the direct and allocable costs attributable to the Bermuda operation for 1976 would have resulted in a loss. The question, if I were to apply the "profits" test, would be whether those operations which the plaintiff carried on through its agent in Bermuda during 1976 were the beginning of a proposed or systematic type of operation out of which the plaintiff could reasonably expect to derive a profit. In my view they were.

An insurance company carries on its business by underwriting risks, collecting premiums, investing the funds represented by the premiums, paying losses, fixing rates, advertising and in a host of other ways but, as counsel for the plaintiff says, without the huge force of insurance agents there would be no business and no profits. The insurance salesman, agent, underwriter or broker and the activities which he carries on are not, like the wine makers' and manufacturers’ representatives, merely to accept or even solicit orders, which has been found to be ancillary to the main business of buying, storing, selling or manufacturing the product. The insurance agent represents the insurance company and on its behalf carries on a major and essential portion of the insurance company's business operations.

Counsel for the defendant characterizes the insurance agent as a person who simply takes orders for a policy and submits the premium to the company. If that were the case there would have been little need for the elaborate preparations which the plaintiff made prior to embarking upon its Bermuda venture. The insurance company's sales force not only solicits insurance and collects the premiums, but the agents promote the various policies available, make various proposals to prospective policy holders, complete the applications, arrange for the medical examinations, bind the company to interim insurance coverage, complete the contract of insurance by delivering the policy and deliver the cheque in payment of a claim.

The agent also has, in Bermuda, the responsibility of assessing the "persistency rating" of a policy holder i.e. the likelihood of the applicant continuing with the payment of the premiums. The profits of the plaintiff and the renewal commissions of the agent are dependent on the accuracy of the agent's assessment in this respect. The agent also has the responsibility, already referred to, prior to completing the contract of insurance by delivery of the policy, to assure himself that there has been no material change in the risk during the interval between taking the application and the delivery of the policy. A further and important part of the agent's activities on behalf of the company is to service the policy and deal directly with the policy holder on any problems which arise.

It was by these activities or operations which the plaintiff carried on through its agent in Bermuda that the plaintiff expected to derive a profit, not in 1976, but as the business which it started in 1976 grew. By that test the plaintiff was, in my view, carrying on business in Bermuda.

The fact that the plaintiff issued only two policies in Bermuda in 1976, and then only at the end of December, is of little consequence. The plaintiff put in motion its plan to operate in Bermuda in May and thereafter did all things necessary to implement that plan. Its intention to carry on its business in Bermuda was evident well before December 1976. It had, as early as August of 1976, embarked upon its business by having its agent solicit insurance contracts from Bermudian residents with the intention that the venture would continue indefinitely. The operations of 1976 were but the beginning of a systematic or habitual series of activities which were intended to and did continue with a view to producing a profit.

While I have previously noted that I do not accept the argument of counsel for the plaintiff that the meaning assigned to the business of insurance in the several pieces of legislation to which he referred me should be applied to determine whether the plaintiff was carrying on business in Bermuda, I do note that throughout the various definitions there is the common thread that the inducement of persons to enter into contracts of insurance is considered to be the business of insurance.

Whatever reservations I may have with respect to applying legislative definitions to an activity which must be determined on the facts, it appears to me that the inducement of persons to enter into contracts of insurance fairly describes the business of an insurance company, or at least a vital portion of that business. In my view it can be fairly said that the business of an insurance company is selling insurance. It is, of course, other things as well, but it is certainly that, and it carries on that portion of its business through its sales agents. In this matter the plaintiff, through its agent in Bermuda, induces residents of Bermuda to enter into contracts of insurance in Bermuda. Accordingly if I were to apply the “legislative” test suggested by counsel for the plaintiff I would also find that the plaintiff was carrying on business in Bermuda.

Thus, although no one of the several tests to which counsel have referred me is determinative, the cumulative effect of applying them all has been. The contracts of insurance issued in 1976 were made in Bermuda, a vital part of the company's business, its sales operations, was conducted in Bermuda through its agent, and the inducements to have residents of Bermuda enter into life insurance contracts clearly fell within the common, and also legislatively defined, meaning of carrying on the insurance business. Those circumstances, combined with the other activities carried on by the plaintiff's agent in Bermuda, to which I have already made reference, have satisfied me that in 1976 the plaintiff did carry on its business in Bermuda.

Accordingly I direct that the 1976 reassessment be referred back to the Minister for reassessment of tax under Part I in accordance with the method contemplated by subsection 138(9) of the Act and Part XXIV of the Regulations as they read in respect of the 1976 taxation year.

The second part of the plaintiff's appeal is in respect of both its 1975 and 1976 taxation years and relates to the reductions in expenses claimed by the plaintiff by reason of the fact that the Minister treated or characterized certain amounts received by the plaintiff from its subsidiary, Lonlife Data Services Limited ("L.D.S."), as a reduction of expenses rather than as income received.

It is this portion of the plaintiff's appeal which, as I have already noted, has given rise to the delay in filing my decision. Even though counsel took the most elaborate and detailed efforts to guide me through the evidence I was not able, by the end of the trial, to crystallize in my own mind any succinct exposition of the issues to be addressed. I am not sure that my painstaking and lengthy efforts to resolve this difficulty since the trial have been successful.

The plaintiff uses computer equipment in carrying on its insurance business. Because the equipment must have the capacity to handle the peak demand loads of the plaintiff's business there exists extra capacity when the plaintiff’s requirements are at less than peak or maximum.

Realizing this, the plaintiff wanted to turn that excess capacity to account. The natural method of doing this would be to sell or lease the excess capacity to others for a fee. However the plaintiff's business is subject to the provisions of the Canadian and British Insurance Companies Act, R.S.C. 1952, c. 31 which counsel for the parties to this action inform me prohibits the plaintiff from selling that capacity to the public at large.

The plaintiff, however, is not prohibited from providing that excess capacity to a subsidiary which in turn may sell it to the public. Accordingly, with the apparent approval of the Superintendent of Insurance, the plaintiff incorporated a wholly owned subsidiary, L.D.C., which acquired that excess capacity, or portion of it, and with it provided computer services to the public.

L.D.S. paid the plaintiff for this capacity an annual amount calculated as a percentage of certain actual and fictional expenses incurred by the plaintiff in the operation of the computer. By the direction of the Superintendent of Insurance the plaintiff, in this arrangement with L.D.S., was not permitted to make a profit or suffer a loss as determined by the methods of accounting prescribed for life insurance companies.

I should note here that because the accounting methods prescribed by the plaintiff as an insurance company are not precisely the same as those which determine the plaintiff's liability for income tax, it does not follow from the Superintendent's directives that there could not be a taxable income or a loss resulting from the arrangement into which the plaintiff entered with L.D.S. Nor, as I understand the evidence, does it follow that the plaintiff's unconsolidated corporate financial statements would necessarily show a "no profit/no loss" arrangement.

For its 1975 and 1976 taxation years, the plaintiff carried on this arrangement with its subsidiary and, for the purposes of its insurance accounting requirements, made neither a profit nor sustained a loss. In its annual statements for those years, which it was required to submit to the Superintendent of Insurance, the revenues and expenses associated with the intercompany computer business were shown as net amounts which sometimes offset one another in individual categories of each and the net totals of each category of which offset each other completely. This was as required and to the satisfaction of the Superintendent of Insurance.

In filing its income tax returns for the same years, however, the plaintiff did not report the revenues and expenses in the same manner as it did for the Superintendent of Insurance. Indeed it reported all of the funds received from L.D.S. as income and all of the expenses, which it considered as deductible expenses, as expenses.

This had the result of increasing the plaintiff's income as well as its expenses. It also gave rise to the result which formed the basis for the defendant reassessing the plaintiff for those two years. The reassessment was for additional tax in each year under Part XII of the Income Tax Act by reason of the defendant reducing the expenses deductible in computing the amounts on which the Part XII tax was applicable.

Part XII of the Act, now repealed, contained special provisions for the taxation of investment income of a life insurer arising in the course of its Canadian life insurance business. Subsection 209(2) also provided for the deduction of expenses incurred in carrying on its life insurance business. Fifty per cent of any expense so incurred was allowed as a deduction and the resultant taxable income was taxed at the rate of 15 per cent. By adding 50 per cent of the gross expenses associated with its income from L.D.S. to 50% of each of the other expenses incurred in carrying on its life insurance business, the plaintiff reduced its taxable income from its life insurance business by an equivalent amount and its tax by 15 per cent of that amount.

The defendant disallowed the deductions associated with the income received by the plaintiff from L.D.S. on the grounds that:

(a) the amounts shown as income by the plaintiff from L.D.S. were not income of the plaintiff but were operating expenses incurred by the plaintiff on behalf of L.D.S. for which the plaintiff was reimbursed; and

(b) even if the amounts received by the plaintiff from L.D.S. were income from the sale of excess computer capacity the amounts were income of the plaintiff from a business other than the plaintiff's life insurance business and the amounts shown as expenses, 50 per cent of the total of which are claimed as deductions, are not deductible under the provisions of subsection 209(2) because they were incurred for the purpose of earning income from the sale of excess computer capacity and not for the purpose of carrying on the life insurance business.

As counsel for the defendant put the issue to me in argument: . . . these expenses in question

(1) were not expenses of the plaintiff but, in fact and law, expenses of Lonlife Data Services Limited;

(2) even if these expenses were expenses of the plaintiff rather than Lonlife Data Services Limited, they were nevertheless not incurred for the purpose of carrying on a life insurance business but were, rather, incurred for the purpose of providing computer services.

To resolve those issues I must, as I understand them, answer the following questions.

1. Was the amount received by the plaintiff from L.D.S. as payment for the plaintiff's excess computer capacity properly characterized as income of the plaintiff?

2. If the amount was income earned by the plaintiff and for which it incurred expenses, were the expenses incurred by the plaintiff on its own behalf or by the plaintiff on behalf of L.D.S. and for which the plaintiff was reimbursed?

3. If the expenses were incurred by the plaintiff on its own behalf, were they incurred for the purpose of carrying on the life insurance business and therefore deductible under subsection 209(2) of the Act?

The defendant submits that the amounts characterized by the plaintiff as income from L.D.S. cannot be characterized as such because the arrangement was made on a no profit/no loss basis. Counsel for the defendant cites Dickson, J. (as he then was) in William Moldowan v. The Queen, [1978] 1 S.C.R. 480 at 485; [1977] C.T.C. 310 at 313 for the proposition that there can be no income without a profit or a reasonable expectation of profit. Counsel then submits that because of the no profit/no loss arrangement between the plaintiff and L.D.S. there could be no profit or reasonable expectation of profit and thus no income in the hands of the plaintiff resulting from that arrangement.

The error in this submission is that the no profit/no loss arrangement between the plaintiff and L.D.S. was with reference to the manner in which the plaintiff was obliged to keep its accounts for the Superintendent of Insurance under the provisions of the Canadian and British Insurance Companies Act. It was within the confines of those provisions that the plaintiff could not show a profit or a loss. Under those provisions, for example, the plaintiff properly allocated to the defendant as an expense a portion of the rent which the Superintendent of Insurance required the plaintiff to charge itself for premises which were in fact owned by the plaintiff. As this was not an expense of the plaintiff in providing the computer services to L.D.S. it represented at least the possibility or reasonable expectation of a profit to the plaintiff to that extent. In the same way portions of other expenses incurred by the plaintiff in providing services to L.D.S. which would have been incurred in any event, such as equipment rentals and salaries, were reduced by allocating a portion of them to L.D.S. The reduction of the plaintiff's overall costs thus also represented additional income or profit in the hands of the plaintiff in a business sense if not in the accounting methods prescribed by the Superintendent of Insurance.

In my view the plaintiff, in a business sense, had a reasonable expectation of making a profit from the arrangement and, for the purposes of the Income Tax Act, properly characterized the revenue from L.D.S. as income from a business.

The defendant also submits that even if the amount received by the plaintiff from L.D.S. is income in respect of which it incurred expenses, the expenses were incurred, not by the plaintiff on its own behalf, but by the plaintiff on behalf of L.D.S. Counsel for the defendant likens this arrangement to an agency relationship where the plaintiff is the agent and L.D.S. is the principal which had simply reimbursed the plaintiff for expenses or outlays which the plaintiff made on its behalf.

Once again I do not agree. The fact is that practically all of the expenses which went to make up the annual charge to L.D.S. would have been incurred by the plaintiff without the existence of its arrangement with L.D.S. They were therefore, in my view, incurred by the plaintiff in its own right and not on behalf of L.D.S. There is no suggestion in the evidence that the salaries of the plaintiff's staff would have been reduced or that the number of employees of the plaintiff would have been reduced if the plaintiff had not entered into the arrangement with L.D.S. Similarly the computer equipment would have required the same amount to maintain and repair it and would have depreciated to the same extent. What was charged by the plaintiff to L.D.S. for the provision of the excess computer capacity was an annual fee calculated in accordance with the guidelines of the Superintendent of Insurance and by reference to percentages of certain costs of the plaintiff allowed as costs under the provisions of the Canadian and British Insurance Companies Act. The expenses were incurred by the plaintiff in its own right and not on behalf of L.D.S. Indeed the rent and depreciation amounts which were allocated and made up some $60,000 of the 1976 charge to L.D.S. were not incurred by the plaintiff at all and therefore could not possibly be considered as reimbursed expenses because there was no outlay by the plaintiff and therefore nothing to be reimbursed.

I come now to the third and, to me, the most troublesome question which is, assuming the income is income of the plaintiff and the expenses are expenses of the plaintiff properly incurred in rendering the computer service to L.D.S., were the expenses incurred for the purpose of carrying on the plaintiff’s life insurance business and therefore deductible under subsection 209(2) of the Act?

Counsel for the defendant submits that in order for the expenses relating to the L.D.S. arrangement to be deductible under Part XII of the Act they must have been incurred by the plaintiff for the purpose of carrying on its life insurance business. Because these expenses were incurred for the purpose of providing a computer service to L.D.S. and not for the purpose of carrying on the plaintiff's life insurance business, according to counsel for the defendant, they are not deductible within the meaning of subsection 209(2) of the Act.

Counsel for the plaintiff argues that the expenses were incurred to carry on the plaintiff's life insurance business. The expenses are associated with the operation of the plaintiff's computer, the operation of which is a part of the operation of its life insurance business. He argues, and I agree, that the plaintiff had to have the extra capacity to service its peak demands and that the expenses claimed would have been incurred whether or not there had been any arrangements with L.D.S.

Counsel referred me to Joyal, J.'s decision in The Excelsior Life Insurance Company v. The Queen, [1985] 1 C.T.C. 213; 85 D.T.C. 5164 which he sug- gested clearly established that the expenses may be taken into account. If I understand the effect of that decision counsel is correct in his assertion that the disputed expenses should be allowed.

In that case an expense was incurred by the taxpayer a portion of which was attributable to its life insurance business and a portion of which was not. The Minister disallowed the latter portion. Joyal, J. allowed the taxpayer's appeal against that decision saying, in effect, that expenses allowed under Part I of the Act are also allowed under Part XII whether or not they are attributable to the taxpayer's life insurance business. In this case the evidence is that the plaintiff completed its Part I tax return using gross income and gross expenses. Mr. James Macdonald, the plaintiff's comptroller in 1975 and 1976 and now its Director of Taxation and Cash Management, described how this was done.

I think what you've outlined follows essentially how we had filed our tax return for Part I; in other words, we had grossed up the Lonlife expenses and we had grossed up depreciation and grossed up the rent, as has been done there. So, for Part 1, we felt that it was the correct way to handle it — the expenses should be grossed up and the other items shown as miscellaneous income so they came into the tax calculation.

To the best of my knowledge, there was no adjustment made as to how we did the Part I calculation. It was when we came to doing the Part XII in determining the 50% administrative expenses that they indicated that we could not treat the Lonlife payment to us, the charge to Lonlife, as miscellaneous income; we had to use it as a net of expense.

We understand there's an inconsistency there between how we're treated under Part XII and how we're treated under Part I. To do Part I properly, you have to gross it up and take off the gross depreciation and take out the gross rental in order to come up with the proper figures.

Thus the expenses, the subject of this action, were allowed under Part I but, by requiring the plaintiff to file net figures for income and expenses under Part XII, they were effectively disallowed. Assuming that I have interpreted Joyal, J.'s decision properly, this the defendant is not entitled to do and this is the conclusion that I have reached.

Accordingly, the plaintiff's appeal on this issue will be allowed and the assessments of tax for the plaintiff's 1975 and 1976 taxation years, for the purposes of Part XII of the Act, are referred back to the Minister for reassessment on the basis that amounts received by the plaintiff from L.D.S. did not reduce expenses incurred by the plaintiff deductible under Part XII of the Act.

Counsel for the plaintiff is asked to submit a draft judgment for signature, in accordance with these reasons, pursuant to paragraph 2(b) of rule 337 of the Federal Court Rules and approved as to form by counsel for the defendant.

The plaintiff shall have its costs.

Appeal allowed.