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.
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
countries.
To
this
end
it
had
some
20
to
30
subsidiaries
throughout
the
world.
The
shares
of
these
subsidiaries
were
held
by
its
wholly
owned
subsidiary
St.
Maurice
Holding
Limited
("St.
Maurice”)
which
was
formed
for
the
purpose
of
holding
shares
in
affiliated
and
subsidiary
corporations
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,
insurance
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
insurance
protection
could
be
achieved
in
a
different
way,
free
of
Canadian
insurance
industry
regulations.
The
scheme
took
form
in
1970
when
Overseas
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
incorporated
under
the
laws
of
Bermuda.
The
assets
of
the
Panamanian
corporation
were
transferred
to
the
Bermudian
corporation
which
was
then
licensed
to
carry
on
an
insurance
business
in
Bermuda.
It
will
be
convenient
to
refer
to
both
corporations
simply
as
"Ol".
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
55
insurance
subsidiaries
in
Bermuda.
The
scheme
was
carried
into
effect
during
1970
and
operated
throughout
the
1971
to
1975
taxation
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
Facultative
Agreements
between
that
insurer
and
Ol,
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
Ol's
bank
letters
of
credit
in
favour
of
those
insurers
secured
by
Ol'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
Ol.
Initially,
20
per
cent
of
these
risks
was
insured
with
OI
but
this
was
increased
to
40
per
cent
in
the
second
year.
Premiums
were
paid
directly
to
OI
for
the
coverage.
Most
of
these
risks
were
reinsured
with
underwriters
at
Lloyd’s.
The
appellant
placed
100
per
cent
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
protected
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
Ol,
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
portions
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"
insurance
coverage.
In
the
formal
judgment,
premiums
paid
by
OI
for
stop
loss
and
excess
of
loss
insurance
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
per
cent
of
the
risks
during
the
years
1971
to
1974
and
but
two
and
one-half
per
cent
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
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
liability
if
the
scheme
otherwise
attracted
it.
He
found
at
page
147
(D.T.C.
5123)
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
(5123)
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
149-50
(D.T.C.
5125):
To
the
extent
that
such
risks
connected
with
the
plaintiff's
property
were
not
insured
or
reinsured
with
unrelated
companies,
those
risks
remained
with
OI.
All
of
Ol'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
reinsurance
premiums
from
the
plaintiff’s
insurers;
together
with
such
rebates
or
commissions
as
it
might
earn
on
insuring
or
reinsuring
the
plaintiff's
property,
and
interest
earned
on
surplus
funds
having
their
ultimate
source
in
the
plaintiff.
OI
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
Ol.
Any
funds
available
in
OI
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
Ol.
Any
losses
which
OI
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
corporation
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
example,
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
arrangement
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
v.
M.N.R.,
[1961]
Ex.
C.R.
410;
[1961]
C.T.C.
385
(affirmed
without
reasons
by
the
Supreme
Court
of
Canada,
72
D.T.C.
1166),
where
Ritchie,
D.J.
said
at
page
425
(C.T.C.
399-
400):
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
transaction
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
et
al.
v.
The
Queen,
[1981]
C.T.C.
363;
81
D.T.C.
5282
and
Sigma
Explorations
Ltd.
v.
The
Queen,
[1975]
F.C.
624;
[1975]
C.T.C.
215
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
relationship
between
the
appellant
and
OI.
It
was
his
view,
at
page
149
(D.T.C.
5124),
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
the
Province
of
Nova
Scotia
et
al.,
[1980]
2
S.C.R.
774;
[1980]
C.T.C.
437
where
at
page
796
(C.T.C.
449)
the
Court
felt
compelled
to
"examine
the
realities
of
the
situation”
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
(D.T.C.
5124)
inferred
that
OI
had
to
do
whatever
St.
Maurice
and
the
appellant
said.
In
my
view,
evidence
supporting
this
inference
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
operation
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
portion
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
indemnities,
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
Ol
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
subsection
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
incorporated
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
Insurance
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
Insurance
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
OVERSEAS
INSURANCE
CORPORATION,
"OVERSEAS
,
ST.
MAURICE
HOLDINGS
LIMITED
shall
indemnify
and
hold
harmless
any
eligible
party,
as
hereinafter
defined,
against
all
current
liability,
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
obtaining
or
attempting
to
obtain
a
release
from
liability
in
respect
thereof.
ST.
MAURICE
HOLDINGS
LIMITED
covenants
that
it
will
reimburse
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
indemnify
any
such
“eligible
party”
hereunder
shall
constitute
for
as
long
as
any
obligation
is
outstanding
from
OVERSEAS
to
such
“eligible
party
.
Then,
from
time
to
time
throughout
the
1971-1974
years
Ol
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
Insurance
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
Ol'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
Insurance.
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
Insurance
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
Ol.
I
am
in
respectful
agreement
with
the
conclusion
of
the
learned
trial
judge
in
so
far
as
it
concerns
the
taxation
years
1971
to
1974
inclusive.
The
effect
in
those
years
of
the
appellant’s
guarantees,
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
relatively
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
circumstances,
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
premiums
thereunder.
As
no
such
protection
was
purchased
in
those
years,
the
deduction
of
such
amounts
resulted
in
an
artificial
reduction
of
the
appellant's
income.
The
respondent
urges
that
these
payments
constituted
a
“reserve"
within
paragraph
18(1)(e)
of
the
Act
and
the
learned
trial
judge
agreed.
There
seems
to
me,
however,
no
necessity
of
characterizing
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
circumstances
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
contract
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.
Moneys
paid
as
premiums
therefor
may
not
be
deducted
from
income
as
business
expenses.*
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.
The
Queen,
[1982]
2
F.C.
113;
[1981]
C.T.C.
336
and
particularly
at
page
125
(C.T.C.
343)
concerning
the
treatment
accorded
the
word
“artificial"
found
in
subsection
137(1)
of
the
Income
Tax
Act
as
it
then
stood.
That
case
did
not
involve
an
insurance
scheme.
Additionally,
while
binding
and
enforceable
legal
obligations
were
incurred,
the
transaction
did
not,
as
here,
relieve
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
and
effective
in
1976
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
subsection
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
awaiting
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
Ol
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
guarantee
or
an
indemnity.
Indeed,
in
its
memorandum
of
fact
and
law
the
respondent
appears
to
say
as
much
by
stating
that
“by
1975
sufficient
funds
had
been
transferred
either
directly
or
indirectly
by
the
appellant
to
OI
.
..
that
no
indemnification
was
required".
Moreover,
OI
had
developed
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
(D.T.C.
5126),
did
not
consider
the
presence
of
the
indemnities
and
guarantees
“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
destination
was
a
captive
insurance
subsidiary
(Carnation
Company
v.
Commissioner
of
Internal
Revenue,
640
F.
2d
1010
(9th
Cir.
1981)
and
Stearns-Roger
Corp.,
Inc.
v.
United
States,
577
F.
Supp.
833
(D.
Colo.
1984)).
In
examining
these
cases
I
must
not
forget
what
was
said
by
Estey,
J.
in
Stubart
Investments
Limited
v.
The
Queen,
[1984]
1
S.C.R.
536
at
555;
[1984]
C.T.C.
294
at
304
to
the
effect
that
the
Internal
Revenue
Code
and
its
predecessors
“did
not
include
an
anti-tax
avoidance
provision
in
the
nature
of
section
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
deduction
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
concluded
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
"economic
family’.
In
coming
to
his
conclusion,
the
learned
trial
judge
made
the
following
observations
at
page
150
(D.T.C.
5125):
In
the
present
case,
with
respect
to
losses
not
insured
with
third
parties,
the
plaintiff
was
obliged
to
look
to
its
own
instrumentality,
Ol,
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
151-52
(D.T.C.
5126):
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
familial
metaphors,
I
can
conclude
that
such
does
not
involve
a
true
shifting
of
the
risk
and
therefore
the
payment
of
"premiums”
to
such
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
Ol's
capitalization
nor
a
guarantee
was
sought
or
given.
Moreover,
the
concept
of
"economic
family”
has
been
neither
authoritatively
established
nor
universally
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
concern
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
translation
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
corporation
tax,
no
attention
should
be
paid
to
the
transfer
of
risks
to
a
company
belonging
to
the
group
by
means
of
premium
payment,
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
preceding
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
appellant.
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
created
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
"deductibles”
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
likelihood
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
subsection
137(1).*
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
attribution
rather
than
expense
deduction.
Nevertheless,
at
page
579
(C.T.C.
316),
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
circumstances
of
the
case”.
The
learned
trial
judge
found
such
a
purpose
to
be
present
in
this
case.
Earlier,
at
page
576
(C.T.C.
315),
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
interference
with
the
granting
and
withdrawal,
according
to
the
economic
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,
letters
of
credit
and
guarantees
already
was
required
lest
the
scheme
abort.
That
neither
an
indemnity
nor
a
guarantee
was
required
in
1975
rather
testifies
to
Ol’s
financial
strength
and
independence
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
dismissed
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
reassessment
on
the
basis
that
the
premium
expenses
claimed
as
deductions
in
that
year
did
not
artificially
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.
Appeal
allowed
in
part.