Consolidated-Bathurst Ltd. v. The Queen, 85 DTC 5120, [1985] 1 CTC 142 (FCTD), aff'd on different grounds, 87 DTC 5001, [1987] 1 CTC 55 (FCA)

Strayer, J.

Facts

The plaintiff commenced this action to appeal reassessments by the Minister of National Revenue with respect to the taxation years 1972 to 1975 inclusive and to appeal against the disallowance of certain expenditures during 1970 and 1971 which, while there was no tax owing in those years, would affect the amount of losses which it could carry forward into subsequent years.

During the course of the trial the Court was informed that certain issues had been resolved and counsel for both parties signed a “Partial Consent to Judgment” with respect to these matters which will be incorporated in the final judgment.

Essentially what remains in issue is the disallowance of certain “insurance expenses” as deductions from the income of the plaintiff in the taxation years 1971-1975 inclusive, together with the attribution to the plaintiff of certain “interest income” earned during that period by two companies related to the plaintiff, namely Overseas Insurance Corporation and Overseas Insurance Limited. The latter companies earned this interest on funds received directly or indirectly from the plaintiff. All together, some $5 million of putative income is at issue before me.

The plaintiff company was formed in 1967 as a result of an amalgamation of Consolidated Paper Corporation Limited and Bathurst Paper Limited. It carries on business in Canada and throughout many other countries as a manufacturer of pulp and paper and packaging. It has some twenty to thirty subsidiaries throughout the world. One of these is St Maurice Holdings Limited, a wholly owned subsidiary of the plaintiff formed for the purpose of holding shares in affiliate and subsidiary corporations outside of Canada.

According to the agreed statement of facts and the evidence, in the late sixties insurance for those in the pulp and paper industry was becoming difficult and expensive to obtain in Canada. The plaintiff had particular problems because of high loss records. But it was obliged to have insurance under trust deeds presumably relating to outstanding loans. In 1970, the plaintiff's Board of Directors after receiving advice on the matter decided to form an insurance subsidiary of its own. Without going into the details, it is apparent from the evidence that several factors influenced the Board of Directors in reaching this decision. The difficulty in, and cost of, obtaining insurance was a factor which the defendant does not dispute, although it does question the degree to which the solution adopted was necessary and effective in solving that problem. It is apparent that the idea of establishing such a subsidiary offshore was attractive, both from the standpoint of avoiding effective regulation of the insurance industry such as exists in Canada and avoiding Canadian taxes. As a result, the plaintiff incorporated in Panama a company, Overseas Insurance Corporation, in 1970, and that corporation became licensed to carry on insurance business in Bermuda. That corporation was wholly owned by St Maurice Limited, which as noted before, is in turn wholly owned by the plaintiff. In 1974 Overseas Insurance Corporation was replaced by Overseas Insurance Limited, which was incorporated that year in Bermuda. That company also was wholly owned by St Maurice Limited and all the assets of Overseas Insurance Corporation were transferred to it. I think nothing turns on the transformation of the Panamanian company into a Bermudan company and I shall refer to these two companies collectively as “OI”. The total capitalization of OI at its inception in 1970 was $120,000 consisting of 12 common shares at $10,000 per share, subscribed by St Maurice.

It appears that OI has never had any employees of its own but is managed under a contract by Insurance Managers Limited, a Bermuda corporation which is a wholly owned subsidiary of Reed, Shaw Osler Limited, Canadian insurance brokers who were largely instrumental in advising the plaintiff to establish an offshore “captive” insurer. Testimony before me by the president of Insurance Managers Limited, Mr David A Brown, indicates that with a staff of thirty-five in Hamilton, Bermuda, Insurance Managers Limited manages some fifty-five captive insurance companies which have all decided to have their head offices in Bermuda.

Given the vastness of its holdings and operations, the plaintiff has at any one time a large array of insurance policies. During the period in question, it had general policies which applied to different kinds of risks and different kinds of property and which had high deductible levels. Some of these deductibles were as high as $500,000 annual aggregate. As a result of its new insurance program adopted in 1970, the plaintiff, in addition to these policies, entered into an insurance contract with Victoria Insurance Company of Canada whereby these deductible amounts were covered by one “deductibles policy” which would insure the plaintiff against losses in amounts less than the deductibles in its general insurance policies. (I understand that the deductibles policies normally had a small deductible as well, although it is not apparent to me that this was true in the case of the policy with the Victoria Insurance.) This “deductibles” coverage was thus for the “primary” layer of risk, as contrasted to the “catastrophe” layer covered by the general policies with high deductibles. The policy with Victoria Insurance was for the last five months of 1970. Concurrently with Victoria entering into this policy, Victoria entered into an “open facultative agreement” with OI whereby Victoria reinsured with OI 92.5 per cent of the liability under the deductibles policy sold by it to the plaintiff. It also transferred to OI 92.5 per cent of the premium it had received from the plaintiff less commissions. It is not clear to me whether OI reinsured any or all of this risk, and since the plaintiffs expenditures for the 1970 taxation year are no longer in question in this action I need not consider this point further.

During the years 1971 to 1974 inclusive the plaintiff obtained instead a similar deductibles policy, no 95022, from Scottish and York Insurance Co Limited, another Canadian insurance company which was associated with Victoria Insurance. Similarly Scottish and York concurrently entered into an open facultative agreement with OI and reinsured 92.5 per cent of the risk with OI, paying OI a premium equivalent to 92.5 per cent of the premium received by Scottish and York from the plaintiff, less commissions. In each of these years OI reinsured a substantial part of the risk which had been ceded to it by Scottish and York. This reinsurance was apparently in the form of “excessive loss’’ or “stop loss” insurance. It appears that the premiums paid by OI for reinsurance were only a small portion of the amounts received by it in premiums from Scottish and York. OI retained the remaining risk which it did not reinsure.

During the years of contract number 95022 with Scottish and York, the “deductibles policy”, Scottish and York required an agreement of indemnification with St Maurice, the sole shareholder of OI, to the effect that St Maurice would indemnify Scottish and York for any loss to Scottish and York resulting from the failure of OI to fulfil its obligations under the open facultative agreement. This indemnification agreement was first entered into in January, 1972. OI was also required to provide to Scottish and York a letter of credit drawn on the Bank of Montreal, and secured with time deposits of OI at the Bank of Bermuda. The plaintiff itself was also required to provide to the Bank of Montreal a guarantee of this letter of credit.

The letter of credit in favour of Scottish and York was originally in the amount of $500,000 but had been raised to $1,000,000 by the end of 1974. The agreement of indemnification provided by St Maurice, the plaintiffs wholly owned subsidiary, was for all liability, loss and expense that Scottish and York might incur by reason of the failure of OI “to perform any or all of its obligations to [Scottish and York] with respect to transactions between [Scottish and York] and St Maurice Holdings Limited and/or Consolidated-Bathurst Limited . . .”. The evidence was to the effect that Scottish and York required the agreement of indemnification because that company did not know much about OI or who it would be reinsuring with. The letter of credit was needed to enable Scottish and York to provide security deposits with the superintendent of insurance which were required because it had reinsured with an insurer (OI) unlicensed in Canada.

In 1975, the deductibles policy number 95022 with Scottish and York was replaced by a deductibles policy number 109851 with Elite Insurance Company, another Canadian insurer. Elite similarly entered into an open facultative agreement with OI and reinsured with OI 97 per cent of its liability under policy 109851. A letter of credit in the amount of $1,000,000 in favour of Elite was provided by OI, drawn on the Bank of Nova Scotia using time deposits of OI at the Bermuda National Bank as security. This letter of credit was subsequently raised to $1,500,000. Elite did not require an indemnification agreement with St Maurice nor was it necessary for the plaintiff to guarantee the letter of credit. In this case also Elite paid to OI 97 per cent of the premiums it had received from the plaintiff, minus commissions, and OI reinsured a substantial part of the risk with other reinsurance companies. Again, the amounts OI paid out in reinsurance premiums were only a small portion of the amounts received by it from Elite in premiums, and again OI retained that portion of the risk ceded by Elite that it did not reinsure.

During the period 1971-75 the plaintiff also had a series of “composite” policies covering risks or layers of risk different from the coverage in the deductibles policies. From March, 1971 to March, 1973 the composite policy was placed with a number of insurers, each company taking a certain percentage of the risk under the policy. In this case OI acted as one of the insurers, contracting directly with the plaintiff. In the first year of this policy OI contracted for 25 per cent of the risk, and in the second year 40 per cent of the risk. It received premiums directly from the plaintiff and reinsured most of the risk with Lloyds of London. In the third and fourth years of this period, the plaintiff obtained a composite policy from Lloyds for 100 per cent of the risk. Lloyds in turn reinsured a portion of the risk with OI. Again, in all these cases, the premiums paid out by OI were only a small portion of the premiums received by it directly from the plaintiff or from Lloyds.

OI did pay out on certain losses during this period ranging from only $26,812 in 1973 to as much as $493,306 in 1972. Nevertheless OI seems to have prospered, its current assets drawing from $1,262,109 at the end of 1971 to $3,743,125 at the end of 1975. Its cash on hand grew from $315,109 at the end of 1971 to $3,716,434 at the end of 1975.

In filing its income tax returns for the years in question, the plaintiff claimed as expenses the premiums paid with respect to insurance on its own property, including amounts paid directly or indirectly to OI with respect to insurance or reinsuranc provided by OI on the plaintiffs property. The Minister in his reassessments has taken the position that any amounts retained by OI, not expended by it in reinsurance premiums or for payment of the plaintiffs losses, are not properly deductible from the plaintiffs income. This applies both to money received from premiums paid to it for insurance or reinsurance on the plaintiffs property and interest earned on moneys held by OI. The Minister contends that the services provided by the “captive insurer”, OI, were not insurance services with respect to that portion of the risk which OI retained and did not reinsure. The Minister contends instead that this was an elaborate scheme of selfinsurance whereby the plaintiff established a fund to bear its own risks to the extent that those risks were not allocated to non-related insurers and reinsurers. The only property with respect to which OI undertook a risk was that of the plaintiff, and all of its revenues came directly or indirectly from the plaintiff. The Minister therefore contends that amounts paid by the plaintiff with respect to that portion of the risk to its property borne by OI cannot be deducted from the taxpayer’s income. He relies on paragraph 18(l)(e) of the Income Tax Act which provides as follows:

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;

Counsel for the Minister contended that what the plaintiff had done was to create a reserve fund in the hands of OI for paying for such potential losses to the plaintiffs property as were not covered by insurance with third parties. Therefore, it is contended, the money so directed to OI cannot be deducted as expenses. Further, subsection 245(1) is invoked. It provides:

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.

For its part, the plaintiff contends that all of these transactions were genuine, legal, and enforceable; that they were all normal insurance contracts; that it matters not whether the companies involved are interrelated as, in law, they are separate entities; that it cannot be assumed that OI acted as an agent of the plaintiff because it was a separate corporation; that there is no “sham” involved here; and that this insurance program was entered into by the plaintiff primarily for business purposes without taxation being a significant consideration.

Conclusions

I believe that some issues can be readily disposed of.

A great deal of time was spent at the trial in demonstrating that this “insurance program” was or was not undertaken for bona fide business purposes. It appears to me that the program was undertaken, and assumed this form, to serve several purposes, among them being bona fide business purposes. I think it was demonstrated, and I do not believe the defendant really contests the fact, that in the late 1960s the plaintiff was experiencing problems in obtaining insurance, or obtaining it at a reasonable cost. To what extent this problem was solved by the program was not clear from the evidence, but at least it did provide an important motivation for entering into the program with a “captive insurer”. Having decided that, there were reasons other than tax reasons for the resort to other jurisdictions: apparently incorporation was available more quickly in Panama, and licensing for the operation of an insurance business was a good deal less onerous in Bermuda than it was in Canada. The safeguards thought necessary in Canada for the protection of the public were apparently not thought necessary in Bermuda. The evidence certainly also indicates that there was information put before the plaintiffs Board of Directors by its advisors and officers indicating the tax advantages of having a captive insurer established in a tax haven such as Bermuda. It is impossible to say to what extent these various factors were instrumental in bringing about the decision to establish that program nor need I do so. I am now bound by the decision of the Supreme Court of Canada in Stubart Investments Limited v The Queen, [1984] CTC 294; 84 DTC 6305, since followed by the Federal Court of Appeal in The Queen v Parsons and Vivian, [1984] CTC 354; 84 DTC 6447. In the Stubart case the Supreme Court held that a transaction may not be disregarded for tax purposes solely on the basis that it was entered into by a taxpayer without an independent or bona fide business purpose. While the Court recognized that the lack of such purpose might bring a taxpayer within what is now subsection 245(1), that provision was not relied on in the Stubart case. This means, apparently, that not only is a taxpayer not precluded from arranging his affairs to minimize his tax, but the courts should normally treat as valid arrangements made by him which have no purpose except the avoidance of tax, ie no bona fide business purpose. But I take a corollary of this to be that the presence of a bona fide business purpose does not immunize the taxpayer from tax liability, if the transaction otherwise attracts tax. So I think this issue need not be considered further.

It also appears to be a part of the Minister’s assumptions that these arrangements were a sham and that therefore 01 must be regarded as the agent of the plaintiff with respect to collecting and holding a reserve fund and earning interest thereon. The standard definition of a “sham”, confirmed again by the Supreme Court of Canada in the Stubart case (supra) at 313 [6320] is that stated by Lord Diplock in Snook v London & West Riding Investments, Ltd, [1967] 1 All ER 518 at 528 where he said that a sham consists of acts

. . . which are intended by them to give to third parties or to the courts the appearance of creating between the parties legal rights and obligations different from the actual legal rights and obligations (if any) which the parties intend to create.

I do not think that the arrangements entered into by the plaintiff and its subsidiaries can be regarded as a sham. The legal relationships as between the various companies and with outside insurers were all apparently legally binding contracts giving rise to enforceable obligations. There was no back-dating, etc as is typical of a sham.

This leaves the question, however, as to whether the arrangements should be seen as “artificially” reducing the plaintiffs income because any payments by it to OI in respect of risks assumed by OI on the plaintiffs property are amounts transferred to a reserve and thus expenses which are not deductible from the plaintiffs income by virtue of subsection 245(1) and paragraph 18(l)(e).

As I understand the Stubart case, it does not address the issue of what would be an artificial reduction of income as contemplated in subsection 245(1) or its predecessor. Estey, J at 311 [6319] noted that the Crown had not invoked section 137, the predecessor to subsection 245(1). He noted at 314-315 [6323-24] that the lack of a bona fide business purpose might, depending on all the circumstances, make section 137 applicable. I do not understand this to mean, however, that the presence of a bona fide business purpose necessarily makes section 137 or its successor inapplicable. That is, the absence of a bona fide business purpose is not a condition precedent to the application of subsection 245(1) if artificiality is otherwise established, and the Supreme Court has not defined artificiality as it was not in issue in the Stubart case. In the present case, unlike the Stubart case, the Minister is specifically relying on subsection 245(1) on the basis that the payments in issue would artificially reduce the plaintiffs income.

Other cases have assisted in defining artificiality. In Don Fell Limited et al v The Queen, [1981] CTC 363; 81 DTC 5282 (FCTD), Cattanach, J said at 375 [5291] that subsection 245(1) is directed “not only to sham transactions but to something less as well . . .”. At 375 [5292] he adopted a definition of “artificially” as meaning “not in accordance with normality”. He quoted with approval Collier, J in Sigma Explorations Ltd v The Queen, [1975] FC 624 at 632; [1975] CTC 215 at 221; 75 DTC 5121 where the latter said that a judge must determine objectively whether section 137 (now section 245) applies, having regard not only to the taxpayer’s evidence but also to all the surrounding facts. A similar definition of “artificially” was adopted by the Exchequer Court in Shulman v MNR, [1961] Ex CR 410 at 425; [1961] CTC 385 at 399; 61 DTC 1213.

It therefore seems to me that I must look at these “insurance” arrangements of the plaintiff to see whether they accord with normal concepts of insurance or whether the moneys paid to 01 directly or indirectly by the plaintiff, purportedly as premiums, should be non-deductible as artificially reducing its income.

Counsel for the plaintiff stressed that, in law, companies are separate entities from their shareholders and that they are not automatically the agents of their shareholders. He stressed that all of the transactions in question were in proper legal form and established legally enforceable rights and obligations. I accept those propositions but I do not think that they are determinative of the matter. In tax cases it is permissible to pierce the corporate veil on occasion. As the majority in the Supreme Court of Canada held in Frank M Covert, QC et al v Minister of Finance of Nova Scotia et al, [1980] 2 SCR 774 at 796; [1980] CTC 437 at 449; 81 DTC 5344:

This is eminently a case in which the Court should examine the realities of the situation and conclude that the subsidiary company was bound hand and foot to the parent company and had to do whatever its parent said. It was a mere conduit pipe linking the parent company to the estate.

It was not contested in the present case that there were no officers or employees of the plaintiff on the Board of OI. But the latter company was a wholly owned subsidiary of St Maurice, which was in turn a wholly owned subsidiary of the plaintiff, and it is hardly credible that the plaintiff would have tolerated important decisions being taken by the Board of OI which were other than in accord with the plaintiffs insurance program. One can only infer that 01 “had to do whatever its parent said”, as the Supreme Court put it in the Covert case, and that that parent (St Maurice) had to do what its parent (Consolidated-Bathurst) said. There was certainly nothing in the evidence to suggest that OI had ever diverged from the implementation of the plaintiffs plan for risk management.

To the extent that such risks connected with the plaintiffs property were not insured or reinsured with unrelated companies, those risks remained with OI. All of OI’s assets had their ultimate source in the plaintiff. Its original capitalization of $120,000 came from St Maurice, the plaintiffs wholly owned subsidiary; its revenues came directly from the plaintiff as insurance premiums, or indirectly from the plaintiff as reinsurance premiums from the plaintiffs insurers; together with such rebates or commissions as it might earn on insuring or reinsuring the plaintiffs 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 OI. 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 OI. 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(l)(e) of the Income Tax Act.

In coming to this conclusion I am also influenced by some decisions of the United States courts which, although not dealing with the same statutory framework, are useful in representing a realistic analysis of relationships allegedly involving insurance. In Helvering v Le Gierse (1941), 312 US 531 the Supreme Court of the United States had before it an insurance contract and an annuity contract entered into by the deceased dated one month prior to her death at the age of 80. The amounts paid by her under these contracts in premiums exceeded the amount payable under the insurance policy which was for the benefit of her daughter. The Court held that in calculating the value of the deceased’s estate the amount payable under the insurance contract had to be included because it was not truly insurance. At page 539 the Court said “historically and commonly insurance involves risk-shifting and risk-distributing”. In that case there was simply no risk: during her lifetime the premium paid by the deceased would provide more than enough interest to pay the annuity as long as it was required; and upon her death the amounts paid by her for the life insurance premium and the annuity contract would more than cover the amount payable under the life insurance policy. In the present case, with respect to losses not insured with third parties, the plaintiff was obliged to look to its own instrumentality, OI, 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.

More directly relevant is the case of Carnation Company v Commissioner of Internal Revenue (1981), 640 F 2d 1010, a decision of the US Court of Appeals, 9th Circuit, in which certiorari was later denied by the Supreme Court at (1981), 454 US 965. The facts were remarkably similar to the present case. The Carnation company incorporated Three Flowers Assurance Co, Ltd, a wholly owned Bermuda subsidiary. Carnation then purchased a blanket insurance policy from American Home Assurance Company. At the same time Three Flowers, the captive insurer, contracted to reinsure 90 per cent of American Home’s liability under Carnation’s policy. American Home paid to Three Flowers 90 per cent of the premium received from Carnation, less commission. It was part of this arrangement that Carnation, at the insistence of American Home, agreed to capitalize Three Flowers up to $3,000,000. Carnation deducted as a business expense the entire premium paid to American Home. The Internal Revenue Service decided that the 90 per cent premium ceded to Three Flowers was not deductible by Carnation as a business expense. It treated it as a capital contribution by Carnation to its subsidiary. This ruling was upheld by the Tax Court and by the US Court of Appeals, and the US Supreme Court denied certiorari. The Court of Appeal relied inter alia on the Helvering case and found that similarly here there was no risk-shifting or risk-distribution. While some emphasis was put on the obligation assumed by Carnation to capitalize Three Flowers up to $3,000,000, that does not alter the principle which is equally applicable in the present case: the principle being that there was no risk shifted to anyone other than an instrumentality of the “insured” and that any gain or loss experienced by the “insurer” would be that of the “insured”. It is of course also true in the present case that the plaintiff through its wholly owned subsidiary St Maurice undertook to indemnify Scottish and York, during the years that that company was the plaintiffs insurer, for any losses which Scottish & York might suffer as a result of OI’s failure to perform its obligations as a reinsurer. Also, the plaintiff itself guaranteed the letter of credit, first for $500,000, and later for $1,000,000, provided by OI to Scottish and York. These arrangements reinforce the conclusion that the ultimate risk remained with the plaintiff and puts its case on all fours with that of Carnation during the years when the indemnity agreement and the guarantee by the plaintiff existed. But I do not consider the indemnity and the guarantee to be essential to a finding that at no time during the years in question was the risk shifted way from the plaintiff or its instrumentalities.

Both the Helvering and the Carnation case were followed in Stearns-Roger Corp, Inc v United States (1984), 577 F Supp 833 (USD Ct). In that case the captive insurance subsidiary, Glendale Insurance Company, was a US subsidiary to which the US parent company paid premiums directly. These premiums which were deducted by Stearns-Roger as business expenses were disallowed by the Internal Revenue Service. The District Court upheld the position taken by the Internal Revenue Service. It cited with approval the statement to the effect that the essence of insurance is a transfer of risk to an individual or a corporation that is in the business of assuming the risk of others. It went on to say, at page 838,

Here Glendale Insurance Company is not in the business of insuring “others.” Its only business is to insure its parent corporation which wholly owns it and ultimately bears any losses or enjoys any profits its produces. Both profits and losses stay within the Stearns-Roger “economic family.” In substance the arrangement shifts no more risk from Stearns-Roger than if it had self-insured.

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 a captive “insurer” would artificially reduce the income of the “insured”.

In the Stubart case, Estey, J said at 315 [6322]

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 wtihin “the object and spirit’’ of the taxing provisions.

Parliament having specifically precluded in paragraph 18( l)(e) of the Income Tax Act the deduction from income of amounts transferred to a reserve fund, I cannot think it was Parliament’s intention that such a proscription should be capable of avoidance if the taxpayer can assemble a sufficient array — one not normally available to individuals or small businessmen — of advisers and offshore management firms to create what, if in legal form is an insurance scheme, is in reality a reserve fund for repair or replacement of uninsured property.

Some references were made by counsel for the plaintiff to section 138 of the Income Tax Act where there is a declaration as to certain corporations being deemed to have been carrying on an insurance business. I do not understand counsel to be arguing that this section applies to OI, presumably because OI is not a taxable corporation operating in Canada. Therefore I need not decide specifically whether section 138 is inconsistent with the foregoing. In my view, however, what I have said above would equally apply to a captive Canadian insurance corporation and in my view paragraph 138(l)(a) would not apply to such a corporation because it speaks of a corporation which undertakes “to insure other persons against loss . . .” For the reasons which I have already given, I do not think the kind of captive insurance arrangement in the present case is truly insurance.

It was also contended that under the “foreign accrual property income” rules adopted in 1972 and put into effect in 1976, the income of such offshore captive insurers is deemed to be the income of the Canadian parent. It is therefore implied that the law was otherwise prior to 1976 during the taxation years here in question. As I understand it the “FAPI” rules do not apply to the situation with which I am dealing, namely the deductibility of “premiums” from the parent’s income. Even if they did, however, this does not necessarily mean that such amounts were exempt from Canadian taxation if in the particular circumstances they were deductions not permissible under paragraph 18(l)(a) or subsection 245(1) of the Act.

In reassessing the plaintiffs income, the Minister, while disallowing the deductions for “premiums” paid indirectly or directly to OI by the plaintiff with respect to risks retained by OI, allowed to be subtracted from the amounts disallowed by the amounts actually paid out by OI with respect to losses to the plaintiffs property. The net effect was to reduce the plaintiffs income by that amount. I confirm that that also was a correct reassessment.

The Minister also attributed to the plaintiff amounts earned by OI in interest and through changes in the exchange rate with respect to the funds in the possession of OI. While these funds had their origin in the plaintiff, directly or indi rectly, in my view any income or capital gains arising from the holding of those funds by OI are not attributable to the plaintiff. I see no reason why the normal laws of property should not apply here in the attribution of taxation, and these funds and any other income it earned were the property of OI which was a legal entity separate from its parent, St Maurice, and St Maurice’s parent, the plaintiff company. It is one thing to say, as I have done, that for a parent company to provide funds for a wholly owned subsidiary of its wholly owned subsidiary and then look to those funds for replacement of uninsured losses is not risk-shifting and therefore is not insurance. But it is quite another thing to say that the income of a subsidiary is the income of the parent in the absence of a specific rule so providing (as is now the case with the FAPI rules in respect of offshore subsidiaries). Subsection 245(1) does not apply to the interest or exchange income of OI and in the absence of a sham, which I have found not to exist here, the normal distinctions between a parent and its subsidiaries should be observed: see, e.g., Fraser Companies Limited v The Queen, [1981] CTC 61; 81 DTC 5051 (FCTD); The Queen v Redpath Industries Ltd et al, [1984] CTC 483; 84 DTC 6349 (Que SC); The Queen v Parsons and Vivian, (FCA), supra. I therefore find that in this respect the reassessment by the Minister is in error so that there should be a reassessment which does not attribute such revenues to the plaintiff.

The Minister’s reassessments for the 1972 to 1975 taxation years are therefore referred back to the Minister for reconsideration on the above bases and on the bases set out in the “partial consent to judgment” filed at the trial on January 25, 1985 by counsel for both parties. Given the complexity of the matter, I am requesting that counsel for the defendant draft an appropriate judgment to implement these reasons and, if possible, move for judgment under Rule 324 or otherwise under Rule 319.

The defendant being principally successful is entitled to its costs.