Bonavista Cold Storage Company Limited v. Minister of National Revenue, [1983] CTC 2093, 83 DTC 89

Guy Tremblay:—This case was heard on November 3 and 4, 1981, at the City of Halifax, Nova Scotia.

1. The Point at Issue

The point at issue is whether the appellant is correct, in the computation of its income for the years 1973 and 1974, in:

(a) deducting all the insurance premiums of $81,779 in 1973 and $381,240 in 1974 paid for marine risks of its vessels. Those premiums were paid to its subsidiary, Humber Insurance Company Limited (“Humber”), incorporated in Bermuda; and

(b) not including in its net income the interest income ($4,162 in 1973 and $12,796 in 1974) of the said insurance company.

The respondent’s contention is that a part of the premiums cannot be deducted ($24,557 in 1973 and $123,025 in 1974) and the net interest income of Humber must be included in the appellant’s income.

2. The Burden of Proof

2.01 The burden is on the appellant to show that the respondent’s assessments are incorrect. This burden of proof results particularly from several judicial decisions, including the judgment delivered by the Supreme Court of Canada in Johnston v MNR, [1948] CTC 195; 3 DTC 1182.

2.02 In the same judgment, the Court decided that the assumed facts on which the respondent based the assessment or reassessment are also deemed to be correct. In the present case the assumed facts are described in the reply to notice of appeal as follows:

8. In reassessing the Appellant in respect of its 1973 and 1974 taxation years, the Respondent proceeded on the basis that:

(a) Humber, at all relevant times, did not provide bona fide insurance protection to the Appellant and was not in the insurance business;

(b) the Appellant did not in fact or in law make or incur any disbursement or expense which would be deductible in the computation of its income while it transferred its funds to Humber;

(c) Humber had no permanent employees and was, at all relevant times, merely acting as the Appellant’s agent to act as a depositary for funds set aside in Bermuda by the Appellant;

(d) to the extent that the funds transferred by the Appellant to Humber were used for “re-insurance” and stop-loss protection, such amounts were treated as deductible expenses. The said expenses were in the following amounts:

	Taxation year
	1973	1974
Commission	4,089	15,780
Re-insurance	53,133	242,435
	57,222	258,215

(e) the deductions from income sought to be made by the Appellant in respect of the transfer of funds to Humber where such funds were not used for re-insurance or stop-loss protection purposes if allowed, would unduly or artificially reduce the Plaintiff's income for income tax purposes. The said deductions are in the following amounts:

	Taxation year
	1973	1974
Amounts paid to Humber as “premiums” under in-
Surance contracts (see paragraph 6)	$81,779	$381,240
Less: amounts paid for “re-insurance” or stop-loss protec
tion (see paragraph 7(d))	57,222	258,215
	$24,557	$123,025

9. In reassessing, the Respondent further proceeded on the basis that the interest income purportedly earned by Humber was in fact and in law income earned by the Appellant. The following amounts were therefore to be included in the Appellant’s income:

Taxation year	Amount
1973	$ 4,162
1974	$12,796

3. The Facts

3.01 The appellant company was incorporated in about 1940. It carries on a fish processing business through its head office in the Province of Newfoundland and in the course of doing so owns several fishing vessels.

3.02 The first witness of the appellant was Mr David Lunnen. He testified during chief examination that:

(a) Originally and during the years involved, the company was directly controlled by the Russell Family (some seventy percent (70%)) (SN I, page 13).

(b) From 1968 to early 1975, he was the controller of the appellant and as such was its primary representative and spokesman. He was indeed re- sponsible “for the accounting functions and financial reporting, financial planning” (SN I, page 13).

(c) The placement of insurance on the company’s vessels fell within his jurisdiction (SN I, page 13). He was never a shareholder or principal, but a senior employee.

(d) The company in 1973 and 1974 had between 11 and 14 fishing vessels called trawlers (about 150 feet long and 400 to 500 tonnage) (SN I, page 16). The company also owned 4 or 5 small boats (40 to 60 feet long) called “Longliners”. They were used seasonally and only in shore (SN I, page 18). All the vessels had a value of about $13,000,000. This was confirmed during cross-examination.

(e) In the early 1970s the cost of insuring marine risks for the vessels had become very expensive. The rates were growing; inflation, the state of competition or lack of competition in the market, the cost of repairing vessels, loss experience, etc. The vessels were used for fishing off the coast of Newfoundland and on the Grand Banks twelve months a year in many areas. In fact, some vessels went down in the last couple of years with serious losses. Icebergs also infested the waters. In those circumstances, there were serious risks involved in operating the vessels. However, the fact was that the loss experience had been considerably lower than the premiums that they were paying. The insurers, in order to maintain the premium cost at an acceptable level, would have been obliged to increase substantially the “deductible”.

(f) Before 1973, the insurance was placed through a local company called Job Brothers Limited, as the appellant’s exclusive insurance brokers. At the end of 1972, after receiving tenders from various insurers, Reed, Shaw, Osler Limited was chosen to cover the vessels.

(g) The appellant company had an excellent insurance record from the years 1968 to 1972:,

59. Q Do you recall how your actual loss experience was in those years, that is, immediately preceding 19. . .

A We had an excellent insurance record. Usually, the insurance companies will go by your last five or eight years record for losses when they look at you as a company. During my period, we had very little in the way of losses. There had been a couple of losses back . . . a great number of years ago, but nothing in recent years. (SN I, page 27)

(h) Despite an excellent record, premiums were getting too high:

60. Q Well, in the light of your loss experience did you feel that your premiums were getting too high or were just right, or . . .

A We thought, quite frankly, as we discussed with our brokers many times, why are we being penalized with our excellent records, why are we being penalized with higher rates on a yearly basis. Why couldn’t we get some recognition for the fact, and we were told, yes, we were getting recognition as much as could be given, but the coverage had to be placed on international markets and on that market we are only a pebble on the beach as opposed to some of the major companies. (SN I, pages 27 and 28).

(i) He tried to find a way to keep insurance costs down; he planned to get into the insurance business:

63. Q Well, if you were concerned about continuing increases in premium rates even after Reed, Shaw became your brokers, did you do anything about it?

A Well, I was looking around for ways and means of trying to keep insurance costs down. We looked at several options. We looked at an actual insurance set-up in Canada. A Dominion Charter, whereby we would set up our own insurance company and actively get involved in the insurance business. I did look at that, and did some study, and actually had some correspondence, at the time, with the Superintendent of Insurance.

64. Q This would be the Superintendent m Ottawa?

A Yes. But, the Dominion thing would require substantial deposits and this type thing which I’m just taking from memory, now, and I really don’t know too much about, but at the time it turned us off because of the dollar valuation and because we would have to become a Dominion company, as opposed to a local Newfoundland company. So, we turned off. ..

65. Q Did Reed Shaw help you in your inquiries?

A Oh, yes, we had correspondence back and forth as to . . . I wouldn't be a bit surprised if they may have been the one to have suggested the possibility. They were being paid to advise us and they gave us whatever advice they could.

66. Q Now, assuming that the obstacles that you mentioned had not arisen, that is the high cost and inconvenience of establishing a Federal insurance company, what function would it have performed if you had been able to go through with it’

A Well, had we done that, we actually planned to get into the insurance business, per se, to take the risk of our own company, as such, ah, being our own fishing trawlers, our own buildings and equipment, and also to start taking risks of other companies, and possibly joining forces with any number of companies if they had similar risks. So, it would benefit the group of companies as a whole. This was the idea. (SN I, pages 29 and 30)

(j) He thought this operation would be profitable:

67. Q The question was did you feel that such an operation . . . an insurance operation would be profitable?

A We thought that it would be. However, we would have to qualify that, but I would have to qualify it by the fact that I wasn’t an insurance person, as such, but presumably the insurance companies stay in business and the only way they stay in business is if they are profitable. So, using that analogy somewhere down the road, presumably, they would have been profitable. (SN I, page 31)

(k) He studied the possibility of setting up an insurance company in Bermuda:

68. Q Having rejected, is as I believe you testified. Having rejected this particular option what did you do next?

A Well, basically, I looked around for some means of, again, getting reduced premiums. This was the purpose. At some point down the road to keep .. . either to level off or to reduce or to find some way of reducing our insurance costs. So, at that point I discussed with our Brokers was there any area, within their knowledge, any tool that I could use whatsoever to approach from that point in mind, and they at that point suggested that there was a possibility of an insurance company to be set up in Bermuda. (SN I, pages 31 and 32)

(l) He made an investigation:

69. Q Did you investigate this suggestion?

A I did. Yes.

70. Q What steps did you take?

A In actual fact, I had further discussions . . . I didn’t truly understand the principle and can’t say that I do at the moment as to how they work these things, but I discussed it . . . I had great confidence in the Broker, in Jim Horrick and Peter Shelton, and they explained the thing to me. It looked good. I went before our Directors and said let me have a look at this further, and they said go ahead, have a look. I did visit Bermuda and talked to the various people, and I said that I’m not satisfied, at this stage, with the thing. I want to know all aspects of it. I said that I want to get professional opinion here, and so we did have a professional opinion from chartered accountants.

71. Q In Bermuda?

A No. The chartered accountants were in Canada, and we had professional opinions from a firm of lawyers specializing in tax matters and such, incorporations and this type thing.

. .. Because, as I say, I had no knowledge of either income tax or insurance, or I should say very limited knowledge, and I wanted to be certain as to what we were getting into, and we received the professional opinion, as are in your file, and based on that, and on the advice of our Brokers, I approached our Directors and said that I would recommend that we take this route. I see the possibil- ity somewhere down the road that it will benefit our Company and they said, go ahead. So, I did. (SN I, pages 32 and 33)

(m) It was decided to incorporate an insurance company in Bermuda:

72. Q Alright, when you say you went ahead, you gave instructions to certain people in Bermuda?

A Yes. Through Jim Horrick, and Reed, Shaw, Osler, I was told that they had a management company in Bermuda that specialized in this type of work. They were well aware of the fact that I knew nothing about insurance, and didn't profess to. So, all the way through I was guided by their advice, and they said the . . . we were aware. I’m under oath here, so, we were aware of tax implications. I’m a Chartered Accountant, so I would assume that I would have some knowledge of income tax. So, I was aware of income tax, but based on the best professional advice that I could get, the thing looked like it was a going proposition. So, based on that, we went ahead.

73. Q Alright, then, did you engage assistance in Bermuda to issue this . . .

A We did. Insurance Managers Limited, in actual fact, had the full package so that they would provide legal services, corporate services, accounting services, professional services in the insurance angle, for which they would be remunerated in the form of fees.

74. Q And, the Insurance Managers Limited is situated where?

A They’re situated in Bermuda.

75. Q And, there is in evidence that a company by the name of Humber Insurance was incorporated .. .

A It was incorporated under the laws of Bermuda. (SN I, pages 33 and 34)

(n) Humber Insurance Company was incorporated in 1973. Forty-eight percent (48%) of the shares were held by Bonavista Fish Meals and Oils Limited (a wholly-owned subsidiary of the appellant) and 47% by the members of the Russell family. The witness himself had 5% (SN I, page 35).

(o) He did not hold his shares “in trust” for anybody else. He paid for his own shares with his own money. He paid $6,000 (5% of $120,000 of the issued shares) (SN I, pages 36 and 37).

(p) The directors of Humber were John Ellison (lawyer), Sandy McPhed- ran (Manager of a bank) and James Mylrea (Manager or Vice-president of the Insurance Managers Limited).

(q) The officers of the said company were Sandy McPhedran, President; James Mylrea, Vice-President; Donald Robertson, Secretary (“some sort of corporate secretary”) and David Brown, Treasurer (accountant for Insurance Managers Limited) (SN I, pages 41 and 42).

(r) His intention was to keep Humber going for a long period of time:

87. Q Did you intend to keep Humber going for a short period of time, a long period or indefinitely, or what was your intention at the time?

A At the time we set up it was a long range thing for me. I was looking down the road from five to ten years and presumably, had I still been with the company the Company may still have been operating as an insurance company. I can’t really say that for a certainty. But, my view was not one or two years. It goes down the road several years. (SN I, page 38)

(s) If his loss experience had continued favourably, there would have been an accumulation of funds in Humber based on the amount of profit that the company was making in Bermuda (SN I, page 39). However, he also said that in 1973 and 1974: “I don’t believe there were any real loss records during the period that Humber Insurance actually held the insurance” (SN I, page 43). With the profit, the intention was to operate Humber with clients other than the appellant (SN I, page 39). The profits really made in 1973 and 1974 stayed in Bermuda, and were invested in funds:

. . . the Managers decided what were the best funds to invest them in. (SN I, page 43)

No dividends were paid to shareholders because “it was not our intent to take any profits” in the first years, only in the future:

. . . we would have accumulated enough funds to get into other ventures and also to possibly pass the funds in the way of reduced premiums to our Company in Newfoundland. (SN I, page 44).

(t) Humber had engaged Insurance Managers Limited to provide the necessary management services (Exhibit A-1):

A Well, they provided the whole service in Bermuda. I had no input whatsoever into the operation of the Company. I knew nothing about insurance, and even less about Bermuda. Having only been there, at that time, only once. And, they completely provided all services from the start of the incorporation of the Company, of Legal Services right through to the quarter financial statements. I had no day by day or month by month input at all. (SN I, page 40)

Moreover, he said that nobody in the appellant’s organization (the Russell family and himself) gave directions or advice to Humber. He went once after the incorporation, when Humber “was starting to get into operation”. He went “. . . to see what the operation was, to meet the people, that I presumably would be running the affairs . . . (of Humber)” (SN I, page 46). That was in early 1973. He spent two days there and never went back afterwards. He never had contact (telephone, letter or telex) with them. The only contact was with Jim Horrick, the broker in Montreal. He also said that he received quarterly financial statements.

(u) After this arrangement (Exhibit A-1) was set up, the appellant gave to Reed, Shaw, Osler Limited the authority to negotiate with Humber:

A Well, we gave Reed, Shaw, Osler, as our Insurance Brokers, the authority to negotiate with Humber Insurance to place our insurance, the best way and the best coverage that they could obtain for us. We relied on them, as professionals, as we did before and presumably have been doing since, to give us their best advice to get up the lowest premiums that they could and we accepted what they recommended, so, we accepted the premiums, and .. . that were charged by Humber Insurance to Bonavista Cold Storage, as being legitimate, reasonable premiums that would have been paid by any company in the industry at the time. (SN I, page 42)

(v) Humber had its own bank account and its own stationery. It had its own financial statements prepared by its own auditors. It also had its own lawyers. The paid up capital of one hundred and twenty thousand dollars ($120,000) was actually paid (SN I, page 47).

(w) He left the appellant company after the Lake Group Limited had acquired the ownership. It was at that time that the arrangement ceased with Humber.

129. Q Alright. Now, at some point the arrangement with Humber ceased? Can

you explain when and why, from your point of view?

A Well, the actual arrangements ceased some time after I was left . . . I left the Company, but what was happening that each year there was an ongoing instruction to reach Osler to go around the world and find the lowest rates that they could, for Bonavista Cold Storage, with Humber Insurance also in mind. In other words, Humber bid on the insurance the same as any other company did and to provide the company with the lowest insurance rates that they could. It was my understanding, although I was not personally involved in that, at some point it came to pass that they could get cheaper coverage elsewhere than by the route of Humber Insurance and the insurance company was changed. I, personally, had no input into that. (SN I, pages 48 and 49)

He added that Lake Group Limited also acquired the shares of Humber. He sold his own shares with a gain. They were sold at book value.

(x) According to the witness, tax implications were really of no importance:

I wanted to be aware of the tax implication, but in my own mind they were of really no importance whatsoever. The purpose was a legitimate business insurance deal, with somewhere down the road our Company would benefit. You have to pay the piper when it comes to taxes anyway, now or some time in the future. So, that was not a major consideration. It had to be considered by the fact that we did all that was possible legally, and that was checked out, and we had professional recommendations as to each step that we took. (SN I, page 51).

3.03 During cross-examination, Mr Lunnen testified that:

(a) The insurance policy (JP72/M/100) covering, among others, the appellant’s vessels (Exhibit R-10) was issued for the period commencing September 4, 1972, and ending September 4, 1973. It appears from this document that 8 of the 13 vessels had a deductible of $21,250 (the others $15,000 and $12,500), and that the full premium paid for the vessels was $300,975 (SN I, page 60, Q 174), detailed as $272,600 per haul and machinery (SN I, page 61, Q 177) plus $28,375 for increased value (SN I, page 62, Q 180). The value of the insured vessels was $11,680,000. This was the situation before the incorporation of Humber.

(b) The underwriters were Lloyd’s of London to the extent of 75%, and 5 other insurance companies for 25%. The premium was paid by instalments. Ten endorsements have amended the original policy. They are dated from October 18, 1972, to July 8, 1974. In the sixth endorsement dated November 29, 1973, one may read:

Conditions'.

It is understood and agreed that this Appendix is written as a reinsurance of the Humber Insurance Company and is to pay all claims as adjusted on behalf of the Reinsured in accordance with the terms and conditions of the Humber Insurance Company Policy. It is understood and agreed that said policy is in accordance with the terms and conditions of the policy to which this endorsement is attached.

These Insurers are only to be liable hereunder for any loss on any vessel insured on this policy when the total amount of loss payable on the original policy for 100% interest on any vessel exceeds $50,000 over all insured interests and/or liabilities.

The total premium of $259,942.50 was paid to the underwriters (SN I, pages 65 and 66; Q 192 to Q 194).

(c) He received a letter dated September 7, 1972 (Exhibit R-8) from Mr Dean, Vice-President of Reed, Shaw, Osler Limited, showing the competition on a tax comparison between the conventional insurance method and the captive insurance method. The result for the appellant company iS:

Convention method: $165,000 net profit after tax cost;

Captive method: $118,595 net profit after tax cost.

The figures are detailed as follows:

(A) Conventional Method

Hull and Machinery insurances subject $15,000 deductible (say) $325,000

Losses between $1,500 and $15,000 (average last eight years) ex-

Cluding total losses 5,000

$330,000

After tax cost (Say) 50% $165,000

(B) Captive Insurance Method

Hull and Machinery insurances subject $1,500 deductible .... $429,000

After tax cost (Say) 50% 214,500

Less underwriting profit as per proforma Financial Statement $ 95,905

Net after tax cost $118,595

Mr Dean wrote:

Of course, to compare the Captive approach to the Conventional approach, one must also examine tax implications and these are still not entirely clear. For the moment, however, it appears you should be able to expense the full premium paid to the captive, whereas any profits of the subsidiary, if domiciled, for instance, in Bermuda, would not be taxable in Canada.

(d) He received a letter dated November 30, 1972 (Exhibit R-37) sent by Clarkson, Gordon & Co, taxation consultants of the appellant company. The third paragraph reads as follows:

We expressed to you our belief that if the Canadian tax authorities were aware of the self-insurance operation being carried on by the Bermuda captive insurance company on behalf of Bonavista, it was likely that the arrangement would be attacked. The tax authorities would appear to have three possible avenues of attack.

(1) They might attempt to assess the Bermuda company on its total income as a resident of Canada on the basis that the company was in fact managed and controlled in Canada.

(2) They might attempt to assess the Bermuda company as a non-resident company carrying on business in Canada if they felt that they could successfully establish that the company was carrying on business through an agent in Canada.

(3) They might attack on more general grounds, by, for example, taking the position that the overall arrangement amounted, in substance, to self-insurance of risks by Bonavista. If this approach were taken the tax authorities might attempt to disallow a portion of the premiums paid by Bonavista in the aggregate at least equal to the profit of the Bermuda company. While we believe that it would be much more difficult to assess on this basis, recent court decisions have encouraged the tax authorities to believe that they would be upheld by the courts where the arrangements appear to have been devised primarily for tax avoidance purposes.

At pages 4 and 5 one can read:

The problem outlined in point 3 on page 2 concerning a non-resident insurance company would appear to be equally applicable with respect to premiums paid to a Canadian insurer. We believe it is essential that such a company be in fact totally separated from Bonavista and the personnel of Bonavista. We also believe that it is highly desirable for the insurance company to have its own full time employees, including a person experienced in the insurance industry (this would not prohibit the company from using the services of Reed Shaw Osler). It would also be desirable for such a company to insure property other than that belonging to Bonavista.

(e) He received from Mr Dean, Vice-President of Reed Shaw Osler Limited, a letter, “Private and Confidential’, dated March 13, 1973, with which was transferred a legal opinion of the firm Stikeman, Elliott, Robarts & Bowman dated March 5, 1973 (Exhibit R-39) written to Mr Whiting of Reed, Shaw, Osler Limited. The heading reference of this opinion reads as follows: “Re: Taxation — Foreign Affiliates (Captive Insurance Companies)”. The problem which is the object of this opinion is described in the first lines:

You have asked us to consider the deductibility under the Income Tax Act of premiums paid by certain of your clients to subsidiary captive insurance company.

They explained, after, the difference between the funding captive and the pure captive.

The essential difference between the funding captive and the pure captive is that the funding captive either does not reinsure or reinsures at rates equal to those that it would pay locally for insurance above its retention level. The pure captive reinsures for losses above its retention level at premiums that are substantially lower than conventional rates, as the result of treaties set up to accept risks of companies with particularly high quality loss prevention measures.

The chief advantage of such arrangements appears to be that the insured company achieves in substance a measure of self-insurance, through a subsidiary, or a saving through the favourable treaty rates of reinsurance, although it deducts the full amount of the conventional premium in computing its income. The profit earned by the captive remains in Bermuda and may be returned by way of dividends to the parent.

In your letter you state that in the case of pure captives the principal earnings emanate from underwriting results and taxation benefits are of secondary importance. It must, of course, be borne in mind that the earnings result directly from payments made by the parent company, to the extent that they exceed the amounts necessary to maintain an adequate degree of reinsurance at the favourable rates available under the treaties. The advantage appears to consist less in the profits earned by the offshore captive as in the deductibility of the conventional premium by the parent coupled with the saving of the difference between the premiums paid and the cost of reinsurance, which amount can be returned to the parent by way of dividends.

I shall attempt to deal with the problem under five headings, as follows:

A: The Funding Captive without Reinsurance;

B: The “Front Company”;

C: Reinsurance;

D: Acceptance by Subsidiary of risks not Controlled by Parent;

E: Other Considerations.

The heading D must be quoted:

D: Acceptance by Subsidiary of risks not Controlled by Parent

Assuming that such risks are bona fide and substantial it is my view that the acceptance of such risks decreases the likelihood of a successful attack by the Department of National Revenue, since to the extent that other risks are accepted, the subsidiary functions less as a vehicle for the parent — whether the purpose be tax or otherwise — and more as a genuine insurance company.

(f) On March 19, 1973, he wrote to Mr Ellison, lawyer and future director of Humber (Exhibit R-41), asking him to incorporate Humber.

(g) Humber was incorporated on May 10, 1973.

(h) An insurance policy No JP73/MC/222 (Exhibit R-63) was issued by Humber Insurance Co Ltd to cover the vessels of the appellant for the period of October 18, 1973, to October 18, 1974. The full premium payable was $392,555.75. The value of the insured vessels was $13,320,000. The deductible portion for each vessel was $2,500.

(i) He recognized a note dated March 13, 1973, written by Mr Horrick of Reed, Shaw, Osler Limited stating that the witness “was in a meeting with the entire Russell family. According to Dave (the witness) they ruled out Nova Scotia, PEI, Quebec, and now Ontario, leaving NB, Nfld, Western Provinces and Bermuda” (Exhibit R-40, SN I, pages 75 and 76):

236. Q And you were ruling out a Canadian Company, would I be correct . . .

because of the large funding that would be required?

A That was my understanding. Yes. And . . . actually the funding and the insurance aspect of it. I believe they had some sort of an insurance guarantee for federal governments and this type of thing. I’m not really aware of it, but I think it was a contributing factor. It was just too big for us to handle.

(SN I, page 77)

(j) He recognized a letter dated March 19, 1973, written by him to Mr J A Ellison, lawyer from Bermuda. He explained, among other things, that the directors of the insurance company . . can be Bermuda residents”. He also added:

It is important . .. that for taxation reasons the company should be managed in Bermuda. However whatever legal steps are necessary must be taken to protect the ownership interest. (Exhibit R-41; SN I, pages 78 and 79, Q 241 to Q 244)

(k) In the “Note to the Financial Statement — December 31, 1974 and December 31, 1973” of Humber Insurance Company, one can read:

The company was incorporated on May 10, 1973 and is a wholly-owned subsidiary of a Canadian company, the Lake Group Ltd. The company derives its insurance income from insuring its parent’s fishing fleet for hull and machinery risks. (Exhibit R-82)

The auditor’s report is dated April 16, 1975. At that time, the Russell family was no longer involved in the appellant company.

(l) To his knowledge, Humber only entered into one reinsurance contract and had only one stop less insurance policy (SN I, page 100, Q 328 to Q 330).

(m) The management fees of Insurance Managers Limited were $12,500 in 1974.

(n) A new insurance policy (Policy No JP/74/M/001) was issued by Humber in favor of the appellant company for a 12-month period, effective from October 18, 1974. The annual premium was $315,000. The value of the insured vessels was nearly $18,000,000. The deductible portion for each vessel was $2,500. This policy is dated January 18, 1975. (Exhibit R-78)

(o) In a memorandum dated June 10, 1976, Mr David Brown, the financial man for Insurance Managers Limited, wrote to Mr John Tuddenhan the following:

I have detailed out on appendix 1 a summary of the net income which was achieved in the 2 years Humber underwrote the Bonavista coverage. As you will see the results were extremely good, as although there were four notifications of losses, in fact, none of these became a claim against the captive. Up to 31st December, 1975, the retained earnings amounted to $217,688. With such profitability it was indeed a surprise that the Lake Group decided not to continue the captive business even though they would be required to possibly pay tax to the Canadian Government on such income. The company remains in our office, however, at this time all that we are required to do is turn over their time deposits, and pay local expenses. In view of this, our fee was adjusted down to a nominal $2,500 per annum, which is the usual fee for handling such a small part of a captive’s business. I also attach a copy of the latest financial position of Humber Insurance as at 31st March, 1976, (appendix 6). (Exhibit R-107)

(p) Tax was not the consideration when Humber was formed.

As I have said under oath as a Witness here and as my job at that time was forward planning. Tax was to be considered, but it was not the consideration when this company was formed. That’s what I’m saying under oath . . . it’s as simple as that. I didn’t care what the tax situation was down the road, pay tax or otherwise . . . it’s like death . . . you can’t avoid it, eh . . . somewhere down the road we had to pay tax. (SN I, page 97, Q 313)

3.04 In is examination-in-chief, the appellant’s second witness Mr James S Horrick, Executive Vice-President for Eastern Canada of Reed Shaw Stenhouse in Toronto, testified that:

(a) He joined the original firm Reed Shaw McNaught in 1966. It was an international insurance brokerage firm founded in about 1850. It merged in 1968 with a firm by the name of Osler Hammond and Nanton, and 1971 with a firm by the name of Stenhouse and Partners. In the years involved (1973 and 1974), he was the Senior Vice-President and Manager of the Montreal operations. He moved to Toronto in late 1975. (SN II, pages 4 and 5).

(b) In his dealings with the appellant company, he dealt primarily with David Lunnen and occasionally with the President, Paul Russell. The witness was the voice of his firm but he was backed up by the marketing team. The individuals of this team also communicated with the appellant company (SN II, pages 6 and 7).

(c) Mr Dean, who was Vice-President of the brokerage firm in the years involved, is the marine expert for eastern Canada. He is located in Montreal.

(d) An insurance broker is an individual who does not underwrite risks himself, but who acts as a middle man between clients who want to be insured and the insurance companies. In the maritime risks, there are about twelve companies who are competitive. Lloyd’s of London dominates the market. It is a dominant force in the marine world: “They are made up of hundreds of syndicates of individuals who collectively form Lloyd’s”. However, a broker ordinarily counsels his client not to have a single underwriter. (SN II, page 9).

(e) In the early 1970s, the cost of insurance was going up. Insurance companies:

. .. use various factors to set their rates, such as their own loss experience, world loss experience, inflation, which affects the costs of repairs of vessels and the availability of re-insurance to them, and the cost of that re-insurance. If that is on the rise, then, their rates have to increase. At that time, I believe all these factors were placed. (SN II, page 12, Q 31)

(f) . . if your rates are on the increase, you look at deductibles” provided in case of damages. The deductibles of $21,250 for most of the appellant’s vessels was fairly high. If:

. . . you reach a point in deductible . . . in a normal insurance company that they just will not allow further credits so you are almost at a stalemate, then . .. you start looking for different markets around the world.

In the world market, at that time, there were Lloyd’s and some Canadian and American companies:

. .. who were offering coverage for fish boats. And, we were not just able to come up with the proper program. We, within the Company, looked at captive insurance company approach.

(SN Il, pages 12, 13, 14 and 15)

(g) In his opinion:

. . . the captive insurance company is an insurance company formed by a company who initially starts off insuring risks, its own risks, with the intention in mind to build on that base so that it can then diversify and have a subsidiary that becomes an insurance company, a full-fledged insurance company, insuring risks of others.

(SN Il, page 16, Q 45)

(h) He had a lot of experience with captive insurance companies through Reed Stenhouse.

(i) He was personally involved in the investigation made by the appellant “to find out the basis involved in forming a Canadian insurance company.” (SN II, page 17, Q 52)

(j) It was not financially possible to incorporate a Canadian insurance company:

We found, number one, that the capitalization of that Company was extremely high, somewhere in the vicinity of a million, ($1,000,000), two million and a half dollars and the regulations of forming an insurance company, I must at this point, just divert it a bit to say thank goodness we have these regulations in Canada which control insurance companies and what they can do, but if you are trying to assist a client in forming an insurance company, with that amount of money, and all the regulations, he just could not start one in Canada.

(SN II, pages 17 and 18, Q 53)

The appellant company could not invest that amount of money.

(k) The appellant company cannot take out a separate stop loss insurance in its own name to protect itself against a major disaster. It is available only to an insurer such as Humber Insurance.

. . . if you can protect, normally, we look at the in-going premium into the Captive as a level to start at for the first year, and we say, well, what we don’t want to do is incur a loss. If we can buy insurance, excess of that in-going premium, at a reasonable cost, and it is wise to protect the Captive. So, the stop loss in the Bonavista case was . . . the losses were stopped at one hundred thousand dollars ($100,000). So, as soon as the Insurance Company had lost one hundred thousand dollars ($100,000) in claims, then, Insurers . . .

(SN ll, pages 20 ad 21, Q 60).

Then, the stop loss insurers would come in for the next two hundred and fifty thousand dollars ($250,000), which was .. . the maximum that we could purchase.

(SN II, page 21, Q 62)

The underwriters would not give this protection to a company that is not a registered insurance company.

(l) Insurance Managers Limited was formed by Reed, Shaw, Osler specifically for the purpose of providing services to captive insurance companies (SN Il, page 23, Q 71). It manages about 10 captive insurance companies in Bermuda.

(m) In 1973, 1974 and 1975, the executives were Mr Jim Mylrea (former President of Reed, Shaw, Osler) as President, Mr Bob Whiting (former Senior Vice-President) as Vice-President and Mr David Brown. The company then had 7 to 8 employees. In 1981, there were 40 employees.

(n) After the investigation concerning Canadian incorporation, he was in favor of a captive insurance company being set up in Bermuda. The decision was based solely on insurance broking and not on tax consideration because “. . . I have no idea of tax . ..” (SN II, page 26, Q 83 and Q 84).

(o) The capitalization of an insurance company in Bermuda was $120,000. The regulations are far less restrictive in Bermuda than in Canada (SN Il, page 27, Q 87 and Q 88).

(p) The major risk of Humber, as an insurance company, was retaining the first $50,000 of each claim over and above the $25,000 which was the deductible of the appellant. (SN II, pages 28 and 29, Q 93, Q 94 and Q 95).

(q) When Humber was formed, it was contemplated to insure not only the risks of the appellant but also of other companies. However, in the initial stages, it was too small. Only the appellant was insured.

(r) With Humber, the appellant gained:

(a) the policy that was issued to it, reducing its deductible substantially down to $2,500;

(b) the capability to assume additional coverage which could be obtained in the conventional market or at competitive rates.

(SN II, page 34, Q 117)

(s) The premiums charged to the appellant were determined by Insurance Managers Limited and Reed, Shaw, Osler, after going to the market place and especially checking with Lloyd’s (SN II, page 35, Q 121).

(t) The first year (1972-73), reinsurance was purchased from Lloyd’s and a group of other companies. The second year (1973-74), it was Commonwealth Insurance Company that reinsured at a reduced price; such saving was then passed on to the appellant. (SN II, page 37, Q 132 and Q 133). In 1975, the appellant was purchased by Lake Group Limited. The reinsurance was purchased from the third company. Afterwards, the insurance market was a “soft market”, the rates had been decreasing. It became no longer economical to utilize Humber. In 1972-73, it was impossible to foresee that the insurance market was going to change. (SN II, page 39, Q 140 and Q 141).

(u) Mr Dean, the top marine individual, is not a tax expert. However, he wrote the letter showing the tax comparison between the conventional method and the captive method (see paragraph 3.03(c) above).

(v) There was an allowance on reinsurance premiums of $12,997 which was added back to Humber as a commission. Such a rebate would not have been granted if the appellant had decided to go to the market itself, because it was not an insurance company (SN II, pages 45 and 46, Q 169 and Q 170).

(w) In fact, Humber had to pay $9,000 a year for the stop loss protection (SN II, page 45, Q 174).

(x) In October 1972, there were discussions between the appellant’s authorities and Reed, Shaw, Osler towards setting up a captive insurance company (Exhibit R-50).

3.05 In cross-examination, Mr Horrick testified that:

(a) Generally speaking, to obtain policies from underwriters an insurance company presents to them the risk and asks for quotations. In receiving them, the best are selected. However, if a company such as Lloyd’s has the best quotation, the insurance company goes back to the other companies asking if they would accept a portion of the risk based on what Lloyd’s required. If they agree, the risk is shared between Lloyd’s and the other companies. (SN II, pages 54 and 55, Q 206 and Q 207).

(b) After the incorporation, Humber, as reinsurer, asked the existing underwriters if they would accept the risk as a reinsurance instead of direct insurance; they agreed. There was a clause in the policy called “no claim as a return”. Humber did not receive a return. However, the appellant had a rebate. (SN II, pages 58 and 59, Q 226).

(c) To fix the premium of $392,000 (Endorsement 6), they used the rate prevailing on the market.

(d) Reed, Shaw, Stenhouse manages some 40 or 50 captives and “they are all accepting reinsurance risks . . . of other corporations” not associated and not related to the first one. (SN II, page 70, Q 279 and Q 280).

4. Law — Cases at Law — Analysis

4.01 Law

The main provisions of the Income Tax Act involved in the present case are sections 3, 4, 9; subsection 245(1) and paragraphs 18(1 )(a) and (e). However, subsection 245(1) is the provision on which the reassessment is based. It reads as follows:

Sec 245 Artificial transactions

(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.

4.02 Cases at Law

Counsel for both parties referred the Board to the following cases:

1. Littlewoods Mail Order Stores Ltd v McGregor (H M Inspector of Taxes); Littlewoods Mail Order Stores Ltd v CIR (1969), 45 TC 519;

2. Dominion Taxicab Association v MNR, [1954] CTC 34; 54 DTC 1020;

3. Dominion Bridge Company Limited v The Queen, [1975] CTC 263; 75 DTC 5150;

4. Dominion Bridge Company Limited v The Queen, [1977] CTC 554; 77 DTC 5367;

5. Front & Simcoe Limited v MNR, [1960] CTC 123; 60 DTC 1081;

6. Louis J Harris v MNR, [1966] CTC 226; 66 DTC 5189;

7. Don Fell Limited et al v The Queen, [1981] CTC 363; 81 DTC 5282;

8. Leonard Mendels v The Queen, [1978] CTC 404; 78 DTC 6267;

9. Natural Retreats of Nova Scotia Ltd v MNR, [1979] CTC 2481; 79 DTC 391;

10. Carnation Company v CIR, [1971] United States Tax Court Reports, p 400;

11. Massey-Ferguson Limited v The Queen, [1977] CTC 6; 77 DTC 5013;

12. Spur Oil Ltd v The Queen, [1981] CTC 336; 81 DTC 5168;

13. E S G Holdings Ltd v The Queen, [1976] CTC 295; 76 DTC 6158.

4.03 Analysis

4.03.1 The essential problem in a case such as this is always the same. It was well described by Justice Cattanach in the Don Fell case (supra):

Tax avoidance is permissible.

The dispute between the parties to these appeals is whether the course followed by the plaintiffs is legitimate tax avoidance rather than tax evasion.

In reassessing the appellant, the respondent assumed that it did not in fact and in law make or incur any disbursement or expense which would be deductible in the computation of its income while it transferred funds to Humber (see subparagraph (b) of the assumptions of fact quoted above in paragraph 2.02).

This assumption substantially refers to the application of subsection 245(1) of the Act (quoted above). Practically, the dispute is whether the expense incurred (payment of premiums) in respect of the operation (formation of Humber), “would unduly or artificially reduce the income”.

For the interpretation of subsection 245(1), I refer to Justice Cattanach in the Don Fell case, (Supra), at 5291:

This concept of an undue or artificial reduction of income includes “sham” transactions and “artificial” transactions.

Sham transactions are those in which a taxpayer has resorted to various “cosmetic” technicalities or devices for the purposes of tax evasion.

Lord Diplock has given the classical and widely accepted definition of the “popular and pejorative” word “sham” in Snook v London & West Riding Investments Ltd ((1967) 1 All ER 518 at 528) reading:

_.. it means that acts done or documents executed by the parties to the “sham” which are intended by them to give to their parties or to the court the appearance or creating between the parties legal rights and obligations different from the actual legal rights and obligations (if any) which the parties intend to create.

Assumption (a) of the respondent (see paragraph 2.02 above) is susceptible to the contention that it covers a “sham”, as defined by Lord Diplock, in that it was not intended by Humber to “provide bona fide insurance protection to the appellant and was not in the insurance business”.

However, subsection 245(1) of the Act, as said by Justice Cattanach, is:

. . . directed not only to sham transactions but to something less as well where the expense, although real, would unduly or artificially reduce a taxpayer’s income.

In Seramco Ltd Supperannuation Fund Trustees v ITC ((1976) 2 All ER 28) Lord Diplock said at page 35:

“Artificial” is an adjective which is in general use in the English Language. It is not a term of legal art; it is capable of bearing a variety of meanings according to the context in which it is used . . .

He added that it is not synonymous with “fictitious” and he went on to say:

Where in a provision of an Act an ordinary English word is used, it is neither necessary nor wise for a court of construction to attempt to lay down in substitution for it, some paraphrase which would be of general application to all cases arising under the provision to be construed. Judicial exegesis should be confined to what is necessary for the decision of the particular case .. .

Bearing this in mind, consideration must be directed to how and why Humber was incorporated, and how the payment of the premiums came into effect in all the circumstances surrounding these operations in order to see if the disbursement incurred “would unduly or artificially reduce the income”. Again, I quote Justice Cattanach in the Don Fell case, (supra):

Standard dictionaries are not authoritative as to the meaning of a word used in the context of a Statute but where that word is an ordinary English word used in that sense resort may be had to those works to ascertain the popular meaning of the word.

The word “unduly” relates to quantum and means “excessively” or “unreasonably” and “artificially” means “not in accordance with normality”.

Collier, J in Sigma Explorations Ltd v The Queen (1975 FC 624) has said at page 632:

The test in deciding whether a deductioin is prohibited by subsection 137(1) must, as I see it, be an objective one. The main source of the evidence relating to it is commonly the taxpayer. The evidence is therefore often subjective in nature. An assessment of its weight and reliability is of necessity required, but in the final analysis the overall finding of undueness or artificiality (or not) is a value judgment based on all the facts and factors.

I repeat that the taxpayer’s evidence at trial as to what his intention was, although given in all sincerity, is only part of the evidence. Statements as to intention must be considered along with the objective facts.

4.03.2 It is a proven and undisputed fact that Humber, during the years involved, was a captive company. It only wrote one policy a year: the one issued to the appellant. In fact, according to Mr Lunnen (paragraph 3.02(n)), 48% of Humber’s shares were owned by Bonavista Fish Meals and Oils Limited (a wholly owned subsidiary of the appellant), 47% by the members of the Russell family (which own about 70% of the appellant’s shares), and 5% by Mr Lunnen, controller of the appellant company (paragraph 3.02(b)). Later in 1975, Humber became a wholly owned subsidiary of the Lane Group Limited (paragraph 3.03(k)). In fact, at any time during the years involved (1973 and 1974), Humber was not in the legal control of the appellant. It was in the legal control of Bonavista Fish Meals and Oils Limited and the members of the Russell family. In such circumstances, is it possible for Humber to provide bona fide insurance protection and to be in the insurance business?

Counsel for the respondent, who contends the negative, gave the following arguments. First, he referred to the book “Cases on the Canadian Law of Insurance” edited by Marvin G Bear, James A Rendall and Howard Snow, Second Edition, 1978, published by Carswell Company Limited. In Section 2 of Chapter 1, “History and Basic theory of Insurance”, some basic principles of insurance theory are explained (pages 2 and 3):

At the heart of the actuarial concepts relating to insurance are probability theory and the ‘law of large numbers”. “Probability” is the term used to refer to the arithmetic fraction which states the chance of a particular event occurring. For example, if experience shows that of 10,000 houses 30 are destroyed by fire in the course of a year, the probability of loss by fire of a particular house for a particular 12 month period is 30/10,000.

The fundamental principle of insurance is “pooling” of risks.

The essence of insurance is “risk spreading” through the “pooling” technique. This may be done by the property owners themselves through some kind of mutual arrangement whether crude or sophisticated in design, as discussed above. However, the essence of the insurance industry as a 20th century business phenomenon is “risk shifting”. In return for a premium, carefully calculated by reference to amount of risk (ie the amount of insurance cover) and degree of risk (ie an assessment of whether the insured’s property is exposed to an average chance of loss by fire, or is more or less likely to be destroyed by fire than the average property) the insured “shifts” his risk to the insurance company. From the insurer’s point of view, it is stilll the “pooling” which makes the scheme work. But now all the organization and administration, and much of the solicitation of participants, is handled by the insurance company.

In Helvering v Le Gierse, 312 US 531 (1941), at 539 the Court says concerning the above principles:

Historically and commonly insurance involved risk-shifting and risk-distributing.

Counsel for the respondent also referred to the American case, Carnation Company v Commissioner of Internal Revenue, (supra). The facts are summarized as follows:

Petitioner and an unrelated insurance company entered into an “insurance” agreement. Simultaneously, the unrelated insurance company “reinsured” 90 percent of its risk under that agreement with petitioner’s wholly owned Bermudan subsidiary. However, before the unrelated insurance company would participate in the “reinsurance” agreement, petitioner had to give its wholly owned Bermudan subsidiary access upon demand to an additional $2,880,000 in capital contributions. Without regard to the demand agreement, petitioner’s capital contribution to its wholly owned Bermudan subsidiary was $120,000.

Counsel for the respondent quoted the arguments given by the Commissioner of Internal Revenue in the Carnation case, (supra), at 405, which were finally accepted by the Court:

While the organization of respondent’s brief makes no clear distinction among them, four separate theories are advanced to support respondent’s determination that petitioner is not entitled to deduct as an ordinary and necessary business expense the entire amount paid to American Home. First, citing Helvering v LeGierse, 312 US 531 (1941), and Commissoner v Treganowan, 183 F 2d 288 (2d Cir 1950), respondent argues that risk-shifting is an ingredient necessary to insurance; that to the extent petitioner’s risk was “reinsured” with its own subsidiary, its risk was not shifted; and therefore, that 90 percent of petitioner’s payment to American Home, which amount ultimately was received by petitioner’s subsidiary, was not paid to American Home as a deductible insurance premium. Second, citing Spring Canyon Coal Co v Commissioner, 43 F 2d 78 (10th Cir 1930), cert denied 284 US 654 (1931), and Pan-American Hide Co v Commissioner, 1 BTA 1249 (1925), respondent contends that no deduction is allowed for amounts set aside as self-insurance; that to the extent petitioner’s risk was “reinsured” with its own subsidiary petitioner was engaged in an indirect form of self-insurance; and therefore that 90 percent of petitioner’s payment to American Home, which amount ultimately was received by petitioner’s subsidiary, was an amount set aside for self-insurance and nondeductible. Third, respondent argues that 90 percent of petitioner’s payment to American Home, which amount ultimately was received by petitioner’s subsidiary, was not “paid or incurred” by petitioner within the meaning of section 162 because that amount remained within petitioner’s economic family and under its practical control. Fourth, respondent contends that the grant of a deduction in respect of any expenditure is predicated on value being received in exchange for such expenditure; that nothing of value was received by petitioner in exchange for 90 percent of its payment to American Home because ultimately petitioner bore the risk of loss on all reinsurance of petitioner’s risk with its subsidiary; and therefore that 90 percent of petitioner’s payment to American Home was not a deductible insurance premium.

In the said Carnation case, the Court held:

Held, to the extent that petitioner’s risk was “reinsured” with its wholly owned Bermudan subsidiary, its risk of loss had not shifted, its agreement with the unrelated insurance company was not insurance, and its payment to the unrelated insurance company was not deductible as an ordinary and necessary business expense for insurance. Helvering v LeGierse, 312 US 531 (1941), followed.

At 415 of the Carnation case the Court said:

LeGierse is based on the principle that an agreement may resemble insurance in form yet lack an ingredient essential to insurance. The Supreme Court held that such an agreement may not be characterized as insurance and the proceeds therefrom may not be characterized as proceeds from insurance.

In the latter case it was 90% of the risk that was reinsured with a wholly owned subsidiary of Carnation which was declared by the Court as not having been shifted and hence not deductible.

However, in the present case it is the part which was reinsured with Lloyd’s et al that the respondent considers as having been shifted and hence deductible. It is the part that was not reinsured that the respondent considered as not having been shifted.

Humber was not a wholly owned subsidiary of the appellant. It was not under the legal control of the appellant. Indeed, the appellant did not own one share of Humber; the shareholders being Bonavista Fish Meals and Oils Limited (48%) and the members of the Russell family, as explained at the beginning of this paragraph. Humber, the appellant and Bonavista Fish Meals and Oils Limited have their own legal entities which are different from the entities of their own shareholders. One of the requirements to allow the appeal would be that the corporate veil not be lifted. If the corporate veil was lifted, Humber would be considered as the same company as the appellant, and the part of the risk not reinsured by Humber would be considered as not shifted by the insured (the appellant) to the insurance company (Humber).

To lift the corporate veil, the Board must answer affirmatively to the following question: In the present case, was the appellant really carrying on the business? To answer such a question, Atkinson, J, in the matter of Smith, Stone and Knight Ltd v Lord Mayor, Aldermen and Citizens of the City of Birmingham, [1939] 4 All ER 116, established (on the basis of cases at law) six criteria which were used in the Dominion Bridge Co Ltd case, (supra), by Décary, J; and in the Natural Retreats of Nova Scotia case, (supra). They are summarized and adapted to the present case as follows:

1. Q Were the profits of Humber treated as those of the appellant?

A This question must be answered in the negative. The profits were totally used by Humber as reinvestment — no evidence is to the effect that an amount was lent without interest to the appellant.

2. Q Were the persons conducting the business of Humber appointed by the appellant?

A The answer is negative. Humber was administered by Insurance Managers Limited, a company unrelated to the appellant and located in Bermuda (paragraph 3.02(m)). The directors and officers of Insurance Managers Limited were not shareholders or employees of the appellant company and were not nominated by the appellant (paragraphs 3.02(p) and (q) and 3.04(m)).

3. Q Was Humber the head and the brain of the transaction?

A The answer is positive. Insurance Managers Limited, which administered Humber, was formed by Reed, Shaw, Osler, for the purpose of providing services to captive insurance companies (paragraph 3.04(1)). It was experienced — it managed about 10 captive insurance companies in Bermuda.

4. Q Did Humber govern the transaction and decide on an objective basis the amount of insurance premiums?

A The answer is positive. To fix the rates of the insurance premiums, Humber used the rates prevailing on the market (paragraph 3.05(a),

(b) and (c)).

5. Q Did Humber make the profits by its skill and direction? and

6. Q Was Humber in effectual and constant control?

A The answers are positive, as it appears from the answers to the above questions and from the testimonies of Messrs Lunnen and Hor- rick (paragraph 3.02(t) and (u)).

Because of the substance of the answers to the preceding questions, the Board must conclude that Humber was really carrying on the business and that the corporate veil must not be lifted.

4.03.3 Because of the evidence adduced, as summarized below, the Board must conclude that there was a valid business purpose to the incorporation of Humber:

(a) In the early 1970s, the cost of insurance was going up (paragraphs 3.02(e) and 3.04(e) and (f)) and it was normal to try to find a way to minimize the cost.

(b) The appellant made investigations with a view to forming a Canadian insurance company and determined that it was not financially possible because of the capitalization of $1,000,000 (paragraphs 3.02(i) and 3.04(i) and (j)).

(c) It was easier to form an insurance company in Bermuda because the capitalization was only $120,000 (paragraphs 3.02(o) and (v), and 3.04(o)).

(d) The decision to incorporate Humber, pursuant to the testimonies, was based mainly on insurance broking (paragraphs 3.02(x), 3.03(p) and 3.04(n)).

(e) The formation of Humber gave financial advantages to the appellant concerning insurance (deductible before incorporation of Humber: $22,500 (paragraph 3.03(a); after incorporation: $2,500 (paragraph 3.03(h)). The increase in premiums was due in great part to the increase in value of the vessels. To fix the rates of the premium, Humber used the rates prevailing on the market (paragraph 3.05(a), (b) and (c)).

4.03.4 There is an argument which was pointed out by counsel for the respondent and explained above in paragraph 4.03.2: the fundamental principle of insurance is “pooling risk”. As Humber had only one client, ie the appellant, this requirement was not met. Therefore, the respondent concludes that Humber was not in the insurance business.

The Board thinks that the “pooling” principle, which is based on the probability theory and the “law of large numbers”, applies on tangibles (houses, vessels) and not necessarily on number of clients. In the present case, there were about 20 vessels (trawlers and longliners) valued at $13,000,000. It is true that in maritime insurance that is not a large number or amount. However, it seems to the Board that, in theory, the principle is respected. In practice, Humber applied it and it was financially possible. It must also be added that in the initial stages of Humber (1973 and 1974), the intention was to keep Humber going for a long period of time and later to have other clients than the appellant (paragraphs 3.02(r) and (s), 3.04(q) and (r), and 3.05(d)).

4.03.5 The evidence shows another important issue. Despite the testimonies of Messrs Lunnen and Horrick to the effect that the decision to incorporate Humber was based solely on insurance broking and not on tax considéra- tions (paragraphs 3.02(x), 3.03(p) and 3.04(n)), it is difficult for the Board to find that, after the long and detailed letters received from the taxation consultants: Clarkson Gordon & Co in November 1972 (paragraph 3.03(d)), Stikeman, Elliot, Robarts and Bowman in March 1973 (paragraph 3.03(e)), and also from Mr Ellison’s lawyer from Bermuda in March 1973 (paragraph 3.03(j) ), the appellant company and Reed, Shaw, Osler Limited were not aware of the taxation problems and how to avoid the main errors so as not to be attacked by the Minister of National Revenue. In May 1973, they knew what to do: who would buy the shares, what risks would be reinsured, the management of Humber in Bermuda, etc.

The Board knows all this; however, it is not subsection 247(2) of the Act which is the basis of the reassessment, it is subsection 245(1). Subsection 247(2) reads as follows:

(2) Associated corporations. Where, in the case of two or more corporations, the Minister is satisfied

(a) that the separate existence of those corporations in a taxation year is not solely for the purpose of carrying out the business of those corporations in the most effective manner, and

(b) that one of the main reasons for such separate existence in the year is to

reduce the amount of taxes that would otherwise be payable under this Act

the two or more corporations shall, if the Minister so directs, be deemed to be associated with each other in the year.

In the present case, the problem is not whether one of the main reasons for the separate existence of two corporations in a year is to reduce the amount of taxes that would otherwise be payable under the Act. The problem is whether an expense incurred in respect of a transaction “unduly or artificially” reduces the income.

According to the evidence adduced, the Board thinks that the preponderance of evidence is to the effect that the premiums paid as expenses did not “unduly” (ie excessively or unreasonably) or “artificially” (ie not in accordance with normality) reduce the income. The Board also thinks that the “acts done and documents executed” created actual legal rights and obligations and not only the appearance of rights and obligations, which is a “sham” pursuant to the definition of Lord Diplock (quoted above).

5. Conclusion

The appeal is allowed and the matter referred back to the respondent for reassessment in accordance with the above reasons for judgment.

Appeal allowed.