Munich Reinsurance Company (Canada Branch) v. Minister of National Revenue, [1992] 1 CTC 2004, 91 DTC 1137

Rip, T.C.C.J.:—The issue in these appeals from income tax assessments for 1985 and 1986 is whether the appellant, Munich Reinsurance Company (Canada Branch) (“ Munich”), properly computed its income for those years in accordance with subsection 138(9) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"). [1] In determining that part of its gross investment revenue for each year, in accordance with subsection 138(9), from "property used by it in the year in, or held by it in the year in the course of” carrying on an insurance business in Canada, within the meaning of paragraph 138(12)(l) of the Act and section 2400 of the Regulations to the Act ("Regulation"), the appellant:

(a) calculated its "Canadian reserve liabilities”, as defined in subsection 2405(3) of the Regulations, by excluding certain amounts, namely the appellant's purported hail insurance reserve and deferred policy acquisition expenses in excess of 30 per cent of unearned premiums, on the basis they were not reserves or liabilities, and

(b) included a value for the year of investment property equal to the capitalized interest earned on excess income tax instalments to be refunded to the appellant; the appellant included the interest earned on the refunds of tax as investment income.

The respondent reassessed on the basis of the hail insurance reserve and deferred policy acquisition expenses ought to be excluded in the calculation of "Canadian reserve liability" and that the right to interest on refunds of tax instalments was not investment property.

Facts

All the facts alleged by the appellant were admitted by the respondent. No evidence was adduced at trial. The appellant was incorporated under the laws of Germany in 1880 and its head office is located in Munich, Germany. The appellant carries on a reinsurance business throughout the world, including a branch in Canada. In carrying on the business of reinsurance, the appellant shares with the original insurer of a property and casualty insurance policy some of the insurance policy risk for a price, usually the sharing of the insurance policy premium.

Since Munich is a non-resident insurance company carrying on business in Canada it is registered under the Foreign Insurance Companies Act ("Insurance Act”) R.S.C. 1985, c. I-13 to carry on the business of insurance in Canada. The Insurance Act regulates the appellant's business activities and solvency requirements.

Issues

In assessing, the respondent assumed that for each of the 1985 and 1986 taxation years, the appellant's hail insurance reserve for purposes of the Insurance Act was determined by the Superintendent of Insurance for Canada (“ Superintendent of Insurance”) to be $182,000 and $130,000, respectively, and that the appellant's hail insurance reserve was a reserve or liability of the appellant in the 1985 and 1986 taxation years. The respondent also assumed the appellant reported deferred policy acquisition expenses in excess of 30 per cent of the unearned premiums to the Superintendent of Insurance. The excess amounts were $63,000 in 1985 and $84,000 in 1986. [2] The appellant admitted the assumptions of the respondent were correct but claimed that in determining "Canadian reserve liabilities’, the amounts of $182,000 and $130,000 with respect to the reserve for hail insurance and the excess amounts with respect to deferred policy acquisition expenses ought to be excluded.

Counsel for the appellant informed the Court her client endeavoured to avoid paying interest to the Receiver General for Canada pursuant to subsection 161(2) of the Act, since the interest is not deductible in computing income, by overpaying the amount of tax required to be paid by instalments for the 1985 and 1986 taxation years. Thus the appellant was entitled to receive interest from the Crown pursuant to subsection 164(3). Counsel for the respondent did not disagree.

For the purposes of determining the "property used by it in the year in, or held by it in the year in the course of” carrying on an insurance business in Canada for purposes of section 2400 of the Regulations, the appellant included a value for the year of investment property equal to the capitalized interest earned on the excess payment of income tax by instalments in the amount of $508,000 for 1985 and $2,258,000 for 1986. The appellant included the interest earned on such property as investment income. The respondent was of the view that the refund was not a property acquired by the appellant for the purpose of earning gross investment revenue and therefore included the interest in business income.

Reserves

(a) Statutory Provisions

With respect to the taxation years under appeal, where a non-resident insurer carries on an insurance business in Canada and in a country other than Canada, subsection 138(9) of the Act provides there shall be included in computing its income for the particular year from carrying on that business in Canada its gross investment revenue for the year from "property used by it in the year in, or held by it in the year in the course of" carrying on the insurance business in Canada, and any additional amount required to meet a minimum return test.

The term property used by it in the year in, or held by it in the year in the course of" is defined in paragraph 138(12)(l) to mean property determined in accordance with section 2400 of the Regulations.

In determining gross investment revenue, the non-resident insurer must first determine the value of its “Canadian investment fund”. The "Canadian investment fund” essentially represents the value of properties used by the non-resident insurer in the year in the course of carrying on its insurance businesses in Canada. "Canadian investment fund” is defined in subsection 2405(3) of the Regulations and reads, in part, as follows:

"Canadian investment fund”, as at the end of a taxation year, in respect of

(b) a non-resident insurer, means the amount, if any, by which the aggregate of amounts each of which is

(iv) a liability (other than a debt referred to in paragraph (h) of the definition “valuation” in this subsection) or a reserve (other than the insurer's investment valuation reserve), as determined for the purposes of the relevant authority at the end of the year, that was incurred or provided for in the course of carrying on the insurer's property and casualty insurance business in Canada,

Regulation 2405(3) also defines "Canadian reserve liabilities":

"Canadian reserve liabilities" of an insurer, as at the end of a taxation year, means the aggregate amount of the insurer's liabilities and reserves (other than liabilities and reserves in respect of amounts payable out of segregated funds) in respect of its insurance policies in Canada, as determined for the purposes of the relevant authority at the end of the year;

The "relevant authority” is the Superintendent of Insurance.

The Insurance Act requires a non-resident insurance company carrying on business in Canada to maintain a minimum value of assets in Canada in respect of each class of business for which it is registered. Subsection 14(1) of the Insurance Act states that the non-resident insurer shall:

. . .maintain assets in Canada the total value of which, when determined on the same basis as is prescribed under this Act for the purposes of the annual statement of its Canadian business [3] or on the basis of the market values of those assets, whichever basis produces the greater total value, is at least equal to the aggregate of the following amounts

(a) . . .

(b) an amount equal to 1.15 times the amount of the unearned premiums in respect of the policies of the company in Canada, other than the policies referred to in paragraph (a);

(c) an amount equal to 1.15 times the amount of the provision for claims

incurred but unpaid, other than claims referred to in paragraph (a);

(d) an amount equal to the total of the other liabilities of the company in Canada relating to all classes of insurance business in Canada other than life insurance; and

Section 19 of the Insurance Act requires that:

[w]here a company transacts the business of hail insurance in Canada, the aggregate of the amounts referred to in subsection 14(1) shall be increased by an amount equal to fifty per cent of the total premiums received by the company in respect of its business of hail insurance in Canada during the preceding calendar year.

Subsection 62(1) of the Insurance Act provides that:

[a] company shall, in respect of its policies in Canada in force, and in respect of claims under accident and sickness policies in Canada payable in instalments, include in the liabilities shown in its annual statement of Canadian business reserves not less than the following:

(a) . . .

(b) a reserve equal to the unearned premiums less a deduction with respect to acquisition expenses of such an amount as may be determined in accordance with the regulations.

For the purposes of paragraph 62(1)(b) [formerly paragraph 47(1)(b)] of the Insurance Act, Regulation SOR/78-18, dated December 29, 1977 states the amount of the deduction that may be made with respect to acquisition expenses shall be the least of the following:

(a) the actual acquisition expenses incurred;

(b) the proportion of the unearned premiums that may reasonably be considered not to be required for the payment of claims and expenses other than acquisition expenses; and

(c) 30 per cent of the unearned premiums.

(b) Appellant's Submissions

Counsel for the appellant submitted that the definition of "Canadian reserve liabilities” is narrower than the type of liability or reserve that is included in the computation of "Canadian investment fund” since the former definition includes only those reserves and liabilities in respect of insurance policies in Canada, rather than all those incurred or provided for in the course of carrying on the property and casualty insurance business in Canada.

The deferral of a portion of the insurance premiums permitted by paragraph 62(1)(b) of the Insurance Act, as specified by Regulation SOR/78-18, is based on the claims or loss ratio and expenses, counsel stated. However, if the adjusted deferral is more than 30 per cent of the unearned premium reserve, in the case at bar, $63,000 and $84,000 in 1985 and 1986, respectively, the difference is to be set up as a statutory reserve". This reserve ("deferred policy acquisition expenses”), she argued, is related to the insurer's cost of carrying on its business rather than in respect of any particular insurance policy or particular line of business.

Thus, appellant's counsel concluded, in computing its “Canadian reserve liabilities", the appellant, as a non-resident insurer, is not required to include deferred policy acquisition expenses of $63,000 and $84,000 in its 1985 and 1986 taxation years, respectively, since these expenses related to its Canadian insurance business as a whole. She acknowledged that the amounts of $63,000 and $84,000 were included in the reserves reported to the Superintendent of Insurance as required by subsection 62(1) of the Insurance Act for each respective year, but these reserves and liabilities were those of its Canadian business; she submitted these excess amounts are not required to be included as a reserve or liability of a non-resident insurer for purposes of "Canadian reserve liabilities’ defined by the Regulations. It is only those liabilities and reserves required to be reported to the Superintendent of Insurance with respect to the insurance policies themselves that are to be included in computing 'Canadian reserve liabilities”.

Under section 19 of the Insurance Act, a company carrying on the business of hail insurance is required to increase its normal reserve by 50 per cent of the total premiums received by the company in respect of its business of hail insurance in Canada during the preceding calendar year. Counsel for the appellant also argued that the appellant is not required to include hail insurance reserves of $182,000 and $130,000 in its 1985 and 1986 taxation years, respectively, in determining “ Canadian reserve liabilities” since they too were not liabilities or reserves in respect of any particular insurance policy or policies but rather related to the particular type of business carried on by the appellant. Counsel also argued that the reserve required by section 19 of the Insurance Act is determined by reference to premiums received in a previous taxation year.

The liabilities or reserves required for the purpose of the Canadian investment fund” are those required to be determined and reported to the Superintendent of Insurance; in counsel's view these liabilities and reserves include the "Canadian reserve liabilities" plus other reserves such as deferred policy acquisition expenses and hail insurance reserves. She submitted the deferred policy acquisition expenses and hail insurance reserves are separate statutory reserves over and above reserves required with respect to the policies themselves. These additional reserves, she said, relate to the solvency requirements under the Insurance Act, that is, to ensure the entire business is solvent and not the policies themselves,

(c) Respondent's Submissions

The term Canadian reserve liabilities’ means liabilities and reserves", in respect of insurance policies . . . as determined for the purposes of the relevant authority. . .”. The deferred policy acquisition expenses and the hail reserves, respondent's counsel submitted, were in fact determined by the appellant for the purposes of the relevant authority and are therefore to be included in "Canadian reserve liabilities’. She acknowledged the definitions “Canadian reserve liabilities’ and the liability or reserve included in the computation of "Canadian investment fund” are dissimilar but in her view "this is a distinction without a difference".

(d) Analysis

The first issue before me is whether or not the deferred policy acquisition expenses and the hail insurance reserves were reserves in respect of the appellant's insurance policies in Canada and therefore are to be included in its "Canadian reserve liabilities".

The issue boils down to whether the definition of "Canadian reserve liabilities" includes only reserves directly related to the insurer's Canadian policies of insurance or if the definition may include reserves indirectly related to policies; or, as appellant's counsel put it, only those reserves traceable to specific policies. Clearly, some link must be established between the reserves for deferred policy acquisition expenses and hail insurance on one hand and the appellant's insurance policies on the other hand, for these reserves to be included in the definition of "Canadian reserve liabilities".

As stated previously no evidence was called by either party. I do not have before me any evidence that business of the appellant consisted of anything other than the business of reinsurance.

The Insurance Act defines “ business of insurance” to mean:

. . . the making of any contract of insurance, and includes any act or acts of inducement to enter into a contract of insurance, and any act or acts relating to the performance thereof or the rendering of any service in connection therewith;

The provision of paragraph 138(12)(I) of the Act and Regulation 2400 must be interpreted in the context of the business of insurance carried on by the appellant, as defined by the Insurance Act. [4] The appellant, then, is registered to carry on business in insurance policies within Canada, and, I must assume, does in fact carry on such business.

As previously stated "Canadian reserve liabilities” are the insurer's liabilities and reserves. . . in respect of its insurance policies in Canada. . .”: Regulation 2405(3). The phrase "in respect of" was considered by the Supreme Court of Canada in Nowegijick v. The Queen, [1983] C.T.C. 20, 83 D.T.C. 5041. At page 20 (D.T.C. 5045) Dickson, J. (as he then was) explained that:

The words "in respect of are, in my opinion, words of the widest possible scope. They import such meanings as in” relation to”, "with reference to" or “in connection with”. The phrase “in respect of" is probably the widest of any expression intended to convey some connection between two related subject matters.

Deferred Policy Acquisition Expenses

Deferred policy acquisition expenses must be deferred expenses related to, or connected to, the acquisition of insurance policies. They are also expenses related to the collection of premiums on the policies. Such expenses are expenses of the insurer in carrying on its business in Canada. The business of the insurer, in general, is to make insurance policies, to induce people to purchase a policy, and to perform on the policies or render service on the policies. All expenses incurred, or provided for, to do or perform these activities relate to insurance policies but are incurred, or provided for, in the course of carrying on the insurer's insurance business in this country. There is no evidence before me that any liability or reserve, as determined for the purposes of the Superintendent of Insurance, incurred or provided for in the course of carrying on the appellant's property and casualty insurance business in Canada was not a liability or reserve as determined for purposes of the Superintendent of Insurance in respect of its insurance policies in Canada. I cannot find any substantial difference between the liabilities and reserves to be included in “Canadian investment fund” and those included in "Canadian reserve liabilities”.

I see nothing in the definition "Canadian reserve liabilities’ that compels me to find that the “.. .insurer's liabilities and reserves in respect of its insurance policies. . .” means the insurer's liabilities and reserves in respect of any particular insurance policy or policies. I am not of the view any tracing is required. The principles with respect to deduction of interest on borrowed money enunciated by the Supreme Court of Canada in The Queen v. Bronfman Trust, [1987] 1 C.T.C. 117, 87 D.T.C. 5059 are not, in my view, relevant to the appeal at bar.

Having regard to the business carried on by a non-resident insurer, that is, the business of insurance, the definition of “Canadian reserve liabilities” is broad enough to include the liabilities and reserves reported to the relevant authority under the relevant provisions of the Insurance Act which have a connection, directly or indirectly, with the insurer's insurance policies in Canada.

Hail Insurance Reserve

Pursuant to section 19 of the Insurance Act, a non-resident insurer is to increase its regular reserve by 50 per cent of the total premiums it received in respect of its hail insurance business in Canada during the preceding year. This hail insurance reserve is dependent on premiums received by the insurer “ respect of its business of hail insurance”. Premiums are received by the insurer in consideration of it issuing insurance policies; that is the insurer's business. The reserve therefore is related to the appellant's insurance policies in Canada. A connection also exists between the hail insurance reserve itself and the value of the property required to be held by the non-resident insurer in Canada, in carrying on its hail insurance business in Canada. The increased value of the assets required to be held in Canada by the non-resident insurer pursuant to section 19 of the Insurance Act is dependent on premiums received by the insurer on the hail insurance policies it has written.

The hail insurance reserve was provided for in the course of carrying on the insurer's property and casualty business in Canada but, as with the deferred policy acquisition expenses, the reserve also is a reserve in respect of the insurer's insurance policies in Canada for purposes of determining the appellant's Canadian reserve liabilities".

Interest on Refunds

(a) Appellant's Position

The appellant contends the interest on the refund due on the excess amounts of tax paid by instalments is investment income, and its value, as capitalized, is investment property for the purpose of determining the "property used by it in the year in, or held by it in the year in the course of" carrying on a non-resident insurer's insurance business in Canada in accordance with paragraph 138(12)(l) of the Act and section 2400 of the Regulations.

In the appellant's view the right to a refund of tax is a debt due from Her Majesty and is property for the purpose of the Act: subsection 248(1). All amounts received or receivable in the year, otherwise than or on account of capital, are included in "gross revenue" of a taxpayer: subsection 248(1). Interest paid on the debt is gross investment revenue, as defined by subparagraph 138(12) (e)(i). [5]

Subsection 138(9) describes the amounts a non-resident insurer is to include in computing its income for the year from carrying on its insurance

business in Canada: gross investment revenue from property used by it in the year in, or held by it in the year in the course of" carrying on an insurance business in Canada, as well as such additional amounts prescribed in Regulation 2400. Subsection 138(12)(i) defines "property used by it in the year in, or held by it in the year in the course of” carrying on an insurance business to mean, appellant's counsel stated, property designated or required to be designated by the insurer in accordance with Regulation 2400. Included in the designated item is the "value for the year" of investment property: Regulation 2400(1)(c).

Regulation 2405(3) defines "investment property" of an insurer as nonsegregated property that is property acquired by the insurer for the purpose of earning gross investment revenue.

In attempting to comply with the Act and to ensure that there was no underpayment of tax so as to avoid the uneven treatment of interest (that is, the treatment of interest charged as not being deductible but interest earned as being included in computing income), counsel stated, the appellant overpaid the taxes owing. As a result, the appellant became entitled to receive both a refund of the overpayment and interest thereon at the prescribed rate: section 164.

Counsel referred to Dominion Natural Gas Ltd. v. M.N.R., [1941] S.C.R. 19, [1940-41] C.T.C. 155, 1 D.T.C. 499-133; Mahaffy v. M.N.R., [1945] C.T.C. 408, 2 D.T.C. 755 (Ex. Ct.); aff’d [1946] S.C.R. 450, [1946] C.T.C. 135 for the principle that"for the purpose of earning the income” means" in the process of earning the income”. She also submitted that in relation to expenditures, the phrase "for the purpose” has been defined as “ with the object and interest, that they should earn the particular gross income for the period in question”. (Riedle Brewery Ltd. v. M.N.R., [1939] S.C.R. 253, [1938-9] C.T.C. 312, 1 D.T.C. 499-29 (S.C.C.).)

Counsel for the appellant argued that if the overpayment had been refunded immediately when the debt was created, the appellant would have used it in the same way as it used all of its normal cash flow: to deposit it in a bank in Canada, in Canadian dollars, which deposit itself would constitute investment property. Ultimately the deposit would be used to acquire other investment property or otherwise in the Canadian branch.

Thus, she submitted, the amounts of interest earned by the appellant in the 1985 and 1986 taxation years on the overpayments of tax were properly given a "value for the year" of $508,000 and $2,258,000, respectively, as "investment property" for purposes of Regulation 2400(1). The effect of the reassessment, she concluded, was that the interest would be required to be included in computing the appellant's income without having the benefit of including the value for the year of the investment property to cover its liabilities and reserves, thereby requiring the appellant to add other investment property to provide such coverage.

(b) Respondent's Position

In the respondent's view "investment property" of an insurer is essentially property acquired by the insurer for the purpose of earning gross investment income. When a taxpayer, during the course of a year, makes payments of instalments of tax, respondent's counsel submitted, the taxpayer is making an expenditure. No asset is being acquired. Further, she argued, the right to receive any refund is determined only on the issuance of an assessment; the taxpayer receives a refund only if the respondent does not apply the refund to another liability or to current instalments. This, counsel submitted, is not a liability contemplated by Regulation 2400; the overpayment was not incurred for the purpose of earning income but for the fear of incurring a larger tax liability. The right to receive a tax refund is not property acquired in the course of carrying on an insurance business in Canada.

(c) Analysis

The definition of "gross investment revenue” does not look to the source of interest; the definition includes all interest. It would appear, therefore, that interest received on overpayment of tax would be included in gross investment revenue.

Subsection 138(9) provides that in computing its income for a taxation year a non-resident insurer is to include in his income for the year that part of gross investment revenue for the year that is gross investment revenue from "property used by it in the year in, or held by it in the year in the course of” carrying on business in Canada, as defined in paragraph 138(12)(l) and determined by Regulation 2400. To fall within the definition of Regulation 2400(1)(a) to (e), certain property of the non-resident insurer must be designated or required to be designated as "property used by it in the year in, or held by it in the year in the course of”, carrying on an insurance business. As appellants counsel stated, included in the designated items is the value for the year of investment property.

For the appellant to succeed in this part of the appeals it must demonstrate that it acquired a property when it made the excess tax payments and the purpose of making the overpayments was to earn gross investment revenue.

Subsection 164(1) provides a mechanism for the Minister to refund an overpayment of tax. The Minister may refund an overpayment of tax for the year when mailing the notice of assessment for the year or later, and shall make the refund subsequent to the mailing of the notice on application by a taxpayer within a time period. Thus by filing a tax return within a specified period, the taxpayer acquires an enforceable right against the Minister for any amount of money he has overpaid in tax. While this right is undoubtedly property, it is important to note that the right to a refund does not arise at the time an overpayment of any tax instalment is made but it arises on the day a return is filed. [6] As section 164 makes clear, a refund is not due and payable until a return is filed. The opening words of subsection 164(1) read:

If the return of a taxpayer's income for a taxation year has been made within 3 years from the end of the year. . .

Thus, at the time of any overpayment of tax the appellant had not acquired any property which was the right to receive interest as the overpayment of tax. Indeed, the overpayments were made in a taxation year prior to the year the right to a refund was acquired. Since no property can be said to have been acquired in the taxation year an overpayment of tax was made, no such property was acquired to earn income in that period. In the case at bar, there is no evidence of the dates the appellant obtained the right to receive interest on the refunds.

The admitted purpose of overpaying the tax on instalments was to avoid potential underpayments which would result in interest having to be paid from the date of the underpayment without the right to deduct the interest in computing income for the year. The purpose, then, as both parties acknowledge, was not to earn gross investment income but to prevent an underpayment of tax.

Even if the appellant could demonstrate that it overpaid taxes only for the purpose of generating interest on the refund, I would be inclined to find that it still did not make the payment for the purpose of earning interest, or gross investment income.

Subsection 164(3), as it applied prior to January 1, 1987, provided:

(3) Where under this section an amount paid on account of a taxpayer's tax under this Part for a taxation year is refunded or repaid, or applied to another liability, the Minister shall pay or apply interest thereon at the prescribed rate for the period beginning on the day that is the latest of the following days:

(a) . . .

(b) where the taxpayer is a corporation, the day that is 120 days after the end of the year,

(c) the day on which the taxpayer's return of income under this Part for the year was filed under section 150, unless the return was filed on or before the day on or before which it was required to be filed, or would have been required to be filed if tax under this Part were payable by him for the year,

(d) in the case of a refund of an overpayment of tax, the day the overpayment arose, . . .

and ending on the day the amount is refunded, repaid or applied, unless the amount of the interest so calculated is less than $1, in which event no interest shall be paid or applied under this subsection.

Interest on the overpayments does not begin to run until the latest of the dates set out in subsection 164(3). Interest on a tax refund is not paid with respect to the period prior to the date the return was filed. It is not inconceivable that if a return is filed early and processed quickly, no interest will be payable on any overpayment of tax.

When a person lends money to another person for interest the interest earned on the loan is income from property. And it may well be that any interest earned by a taxpayer on overpayment of tax is income from property as well, for in truth, the overpayment is a loan to the government. However, the appellant goes further. Its position is that the interest earned on the overpayment of tax is itself an asset that can be sold. For example, as I understand it, a money-lender may capitalize interest due on a loan to obtain value of the interest and dispose of his interest property for such value. The capitalized value is what the appellant refers to as being the “value for the year" of the interest, that is, the "property used by it in the year in, or held by it in the year in the course of" carrying on an insurance business in Canada.

I have several problems in accepting the appellant's submissions. At the time any overpayment of tax is made, no refund is yet due and payable and no interest has yet commenced to run. The taxpayer making an overpayment of tax cannot know, at the time of payment, when the excess amount will be refunded. Therefore, the taxpayer does not know when interest will start to run, the rate of interest on the refund, or when it will receive its refund. Also, for reasons previously stated, it is possible no interest will ever be paid on the overpayment. For these reasons alone, I cannot contemplate how a person is in a position at the time the overpayment of tax is made, or even during the financial period in which an overpayment of tax is made, to capitalize the value of the interest. Value is the worth in money of a property. The underlying assumption in property having a value is that the property may be sold on the market for that value. The appellant has failed to convince me that anyone would acquire the appellant's contingent right to interest on the tax refund, taking into account, amongst other things, interest may never be paid. What the appellant has obviously done is retrospectively capitalize the interest based on the interest it actually received. It has attempted to value the interest payments received but has confused the value of a proprietary right to a refund, a dollar amount, with the value of the future payment of interest which accrued on that refund.

The appeals are therefore dismissed.

Appeals dismissed.