Her Majesty the Queen v. Marsh & McLennan Limited, [1981] CTC 410, 81 DTC 5307

Jerome, ACJ:—This action, although in the form of a trial is, pursuant to the Income Tax Act, RSC 1952, c 148, section 172, an appeal from the decision of the Tax Review Board [1979] CTC 2388; 79 DTC 314. The head-note at 315 provides an accurate and concise summary of the issues of fact and law and of the conclusions of the Board, as follows:

The taxpayer insurance brokerage company received premiums from clients and was required to remit such premiums, less its commission, to the appropriate insurance companies. The vast majority of its income came from commissions. There was often a delay of approximately two months between the date on which the taxpayer received the premiums and the date on which it paid them to the insurance companies. During this period, the taxpayer would invest such “unremitted premiums” in short-term obligations, and in 1976 received $1,345,632 in interest on such investments. The taxpayer contended that this sum was part of its “Canadian investment income” eligible for the dividend refund under subsection 129(1) of the Income Tax Act because: (1) it did not constitute income from a separate, active business of investing (2) it was not essential to or an integral part of the brokerage business so as to have become income from that business, and

(3) it was income from property which property was not used or held in the course of carrying on business. The Minister classified the interest on unremitted premiums as income from the taxpayer’s business. He contended that the taxpayer did not own the unremitted premiums which generated the interest income and that therefore no dividend refund under subsection 129(1) was available to the taxpayer. In the event that the unremitted premiums were owned by the taxpayer, the Minister alleged that the income therefrom was income from an active business. The taxpayer rejected the Minister’s analysis, and appealed to the Tax Review Board.

Held: The taxpayer’s appeal was allowed. Since the insurance companies could not demand the unremitted premiums until the date they were due, the taxpayer, in the interim, owned those funds and was free to invest them. Interest income from short-term investments was only a subsidiary or ancillary part of the taxpayer’s operation, which part did not constitute either an adventure in the nature of trade or an active business. Such income fell within the definition of “Canadian investment income”, and the taxpayer’s appeal was therefore allowed.

This matter came on for trial at Toronto on May 5, 1981. There was no evidence for the plaintiff and one witness for the defendant, John Charles Meuller, chief financial officer of the defendant Marsh & McLennan, Limited. the defendants Harry Price and Hillborn Insurance Limited in related action number T-3556-79, are wholly-owned subsidiaries of Marsh & McLennan, Limited, so that evidence and argument and judgment in this matter apply equally to them. In addition to the evidence of Mr. Meuller, some twelve exhibits were filed for the defendant, and upon completion of all evidence on that day, the matter stood over to May 26, 1981, for argument.

After careful consideration of the evidence and of the very able presentation by both counsel, and after an examination of the relevant jurisprudence, I find that the determination by the Board, both in respect to relevant facts and to applicable law, is fully in accord with my own.

The central question of fact relates to the ownership of funds received by the defendant from its insured clients. Obviously, these funds carry with them the obligation upon the defendant to place insurance on behalf of the customer and to pay for it. On the other hand, all evidence indicates that the general practice in the industry is for the underwriter to place insurance, when requested by an established agent, and to rely entirely upon the good credit of such agent to make payment as and when required by the underwriter. In fact, in almost every case, it is only upon confirmation that the underwriter has bound itself to the risk, that the defendant renders an account to its customer, so that the placing of insurance clearly precedes the receipt of any funds by Marsh & McLennan, Limited. Although the bulk of its business is with 35 or 40 major companies around the world, the defendant does deal with over 200 underwriters, and there is great variation, not only in the content, but in the form of agreement. In many cases, a substantial volume of business has been done over many years under nothing more than an oral understanding. It is true that in the case of some underwriters, written agreements exist which might be construed in such a way as to place their agents in the position of a trustee of unremitted premiums, but such formal agreements are the exception rather than the rule. In the small mi- nority of cases where they do exist, they are not honoured, and even in such situations, there is no evidence whatsoever of any attempt to identify what proportion of the defendant’s general receipts might be so classified. The time period within which the underwriter demands payment varies with each company but, routinely, runs to 60 and, exceptionally, to 90 days. There is no evidence that any underwriter has ever attempted to place the defendant under any restrictions in respect to these moneys and all evidence points in the opposite direction, ie, that the defendant has always enjoyed complete authority in the management of these funds, free from even the slightest suggestion of control by any of the underwriters with whom it does business. In my opinion, the defendant taxpayer is the owner of the funds it receives in payment from its insured customers. The evidence confirms the usual obligations of agents in the general insurance business, both to their insured and to their underwriter, but falls far short of establishing anything in the nature of a trust which would be sufficient too dislodge the defendant’s ownership of its gross revenues.

The evidence also confirms that the defendant’s principal business is that of an insurance agent and that the placing of these funds, always in shortterm certificates, and almost always with chartered banks, is handled entirely by financial control officers in each region who, in addition to their general managerial responsibilities, are required to devote no more than a few minutes every day or every few days to this financial control function. It is clear, therefore, that whether it be in terms of percentage of income, time and attention required or the nature of the business involved, the transactions in question here are incidental to the main business of the defendant and could not, in my opinion, be construed as constituting, in any sense of the word, an active business in their own right.

In my opinion, the earning of income from funds placed on deposit in this way is fundamentally an investment transaction and since this taxpayer is not in the investment business, such income would appear, on a prima facie basis, to come within the intent of paragraph 129(4)(a) which reads as follows:

“CANADIAN INVESTMENT INCOME” AND “FOREIGN INVESTMENT INCOME” DEFINED

(4) In subsection (3),

(a) “Canadian investment income” of a corporation for a taxation year means the amount, if any, by which the aggregate of

(i) the amount, if any, by which the aggregate of such of the corporation’s taxable capital gains for the year from dispositions of property as may reasonably be considered to be income from sources in Canada exceeds the aggregate of such of the corporation’s allowable capital losses for the year from dispositions of property as may reasonably be considered to be losses from sources in Canada,

(ii) all amounts each of which is the corporation’s income for the year (other than exempt income or any dividend the amount of which was deductible under section 112 from its income for the year) from a source in Canada that is a property (other than a property used or held by the corporation in the year in the course of carrying on a business), determined, for greater certainty, after deducting all outlays and expenses deductible in computing the corporation’s income for the year to the extent that they may reasonably be regarded as having been made or incurred for the purposes of earning the income from that property,

(iii) all amounts each of which is the corporation’s income for the year (other than exempt income) from a source in Canada that is a business other than an active business, determined, for greater certainty, after deducting all outlays and expenses deductible in computing the corporation’s income for the year to the extent that they may reasonably be regarded as having been made or incurred for the purpose of earning the income from that business,

exceeds the aggregate of amounts each of which is a loss of the corporation for

the year from a source in Canada that is a property or business other than an active business; and

Any doubt, of course, must be resolved in reference to the precise language of the statute, and in this respect, a number of decisions prior to 1974 have established that, in the terms of subparagraph (ii), “property” includes money, so that income from invested money may be “income from a source in Canada that is a property”. The 1974 amendment added the words “other than a property used or held by the corporation in the year, in the course of carrying on a business”. In the interpretation of this exception, some assistance can be derived from decisions which relate to a different, but clearly analogous distinction, ie, between income from assets or transactions of a capital as opposed to a trading nature, eg, in the Canadian jurisprudence, Tip Top Tailors Limited v MNR, [1957] SCR 703; [1957] CTC 309; 57 DTC 1232, and in the British jurisprudence, Davies (HM Inspector of Taxes) v The Shell Company of China Ltd (1951), TR 121 and Imperial Tobacco Co (of Great Britain and Ireland) v Kelly, [1943] 25 TC 292. In the Davies case, Shell Oil received deposits from distributors in China as security for their performance and the parent company converted the deposits to Sterling currency and, as a result, realized a gain when called upon to refund the deposits in due course. It is interesting to note that, notwithstanding the several aspects in which these moneys were related to the operational side of the business, the Court concluded that the gains were capital rather than trading profits. In the Imperial Tobacco decision, the company made a similar purchase of foreign currency, but since it was for the purpose of ongoing purchases of tobacco, which obviously was the taxpayer’s stock-in- trade, the Court reached the opposite conclusion. In the Tip Top Tailors decision, the Court similarly concluded that the purchase of foreign currency for the purpose of acquiring cloth, the taxpayer’s stock-in-trade, was a trading transaction. These decisions were extensively reviewed in Vancouver Pile Driving & Contracting Co Ltdv MNR, 25 Tax ABC 369; 63 DTC 1007, where the taxpayer had posted a sum of money as security for performance with a provincial authority and replaced the cash with a Dominion of Canada Bond purchased for the purpose. The issue was whether a subsequent loss suffered on the sale of the bond was a loss of capital or income. It is significant that the decision of the Exchequer Court confirmed the finding of a capital loss, notwithstanding the fact that the asset had been used to assist the operational side of the business. The judgment of the Court was delivered by Thurlow, J, as he then was, who said, in part:

In approaching the problem whether the loss in question was a loss of capital within the meaning of s. 12(1 )(b) it is I think important to note that the appellant’s business was that of making and carrying out construction contracts and that it did not include dealing in bonds. From this it appears to me to follow, prima facie at least, that a gain or a loss through appreciation or depreciation of bonds held by the appellant would find no place in a computation of the profit from its business but would simply be an item of capital. Moreover in my opinion neither the fact that the purpose of the company when purchasing the bonds was to hold them only for a short or limited time nor the fact that the company had no idle funds available for investment — other than a sum borrowed for the purpose of making a security deposit — would serve to change the prima facie nature of the purchase of such bonds from that of a capital transaction into one on its trading or business account or the gain or loss that might result from their subsequent appreciation or depreciation into one of a trading as opposed to one of a capital nature.

To my mind the present case is distinguishable from the Tip Top Tailors case and the Imperial Tobacco case in that while the purchase of the bonds was made because they were needed for the purposes of the security deposit under the contract and were in fact used for that purpose they remained throughout the property of the appellant and they were not used, as was the sterling in the Tip Top Tailors case, nor were they purchased to be used, as were the dollars in the Imperial Tobacco case, to pay obligations incurred in the course of trading operations. They might of course have been sold and the proceeds turned to the payment of trading obligations and while they were deposited as security they were undoubtedly subject to the right of the Bridges Authority to sell them and to apply the proceeds in discharge of the appellant’s obligations under the contract, if occasion therefor should arise, but that in my opinion is far from indicating that the bonds were acquired or deposited to pay trading obligations or, to put it another way, as a step toward the discharge of such obligations.

Fortunately, none of these difficulties exist here. Obviously, a benefit to the taxpayer in the form of earnings from these transactions is a common factor in all of this litigation, otherwise there would be nothing in dispute, but In my opinion, to support a finding that these funds are “a property used or held by the corporation in the year, in the course of carrying on a business”, there must be something more than a mere benefit to the corporation. Surely, there must be some element which integrates the transactions with the taxpayer’s main business and no such element exists here.

The Board earlier considered a very similar situation in March Shipping Ltd v MNR, [1977] CTC 2527; 77 DTC 371, in which the taxpayer was in the business of providing services to shipping companies and received advance payments, somewhat in the nature of retainers, which it invested in short-term deposits. The Board made the following findings: that these were fundamentally investment transactions; that since the taxpayer was not in the investment business, these transactions could only be considered “integral” if the specific function under review formed a necessary part of the whole operation, ie, that it provided a significant impact on the total revenue produced, which it did not; that these investments were subsidiary or ancillary to the taxpayer’s main business and the return was therefore Canadian investment income as defined by subsection 129(4). The following quotations from the reasons of Delmer E Taylor are of interest:

at pages 2529, 372:

There is no question in my mind that the funds can be regarded as property, and it appears to me irrelevant to the issue in this appeal whether or not such property was part of the proprietary interest of the Company, or represented an obligation to customers — the funds themselves were available to the appellant and by all the evidence, completely at the disposition of the Company, providing the terms of the agency agreements were fulfilled.

at pages 2531, 373:

It is my view that since the income was from the crediting of interest by the Bank of Montreal to the appellant for the use of some of the property of the appellant, there is a prima facie case for considering this as investment income rather than the only other alternative remaining available to me — business income. It might well be suggested that it could be investment income and concurrently business income, but it would be necessary, in my view, to show that the business of the appellant was that of investment.

and at pages 2531, 374:

The Company could have refrained from investing the funds (thereby not earning the interest); or used its own or borrowed funds rather than requiring agency deposits (thereby increasing operating expenses). There is no evidence that either of these courses of action would have affected the basic operations of the Company in any way except by less revenue or greater expense. I am conscious that the Company likely would not have been overjoyed at such a result, and obviously chose a normal course — to obtain maximum revenue. However, it is not my conclusion that such a reduction in income or increase in operating cost of $56,972, when viewed against the background of the total operation, can be described as having a significant impact, or decidedly destabilizing effect on the Company’s purpose and objective — that of providing needed services to shipping companies. Rather than being a vital or even component part of the total operation, the investment of these funds could more properly be described as subsidiary or ancillary.

In my view, the conclusions of the Board in the March Shipping matter were entirely valid and were properly relied upon in deciding the Marsh & McLennan matter as it did.

This action arises from a determination made by the Minister of National Revenue of the refund to which the defendant corporation was entitled under section 129 of the Income Tax Act for its 1976 taxation year, which determination was made in a notice of assessment dated October 11, 1977. The determination was based on the taxpayer’s original 1976 return in which it reported income from the transactions which are in issue here of $2,071,547, but claimed only $725,915 as “Canadian investment income” within the terms of section 129. After filing the return, the taxpayer apparently received advice that the entire sum might come within the provisions of section 129 and therefore, upon receipt of the notice of assessment, the taxpayer filed a notice of objection in the usual form, to which the Minister replied with a notification of confirmation and an appeal was launched to the Tax Review Board. It is from the Board’s determination that the whole amount of $2,071,547 is “Canadian investment income” in accordance with subsection 129(4) that this appeal was taken, and for the reasons outlined, I am of the opinion that the Board’s conclusion was the correct one and this appeal must therefore be dismissed with costs, and the matter referred back to the Minister for a reassessment of the refund to which the defendant was entitled during its 1976 taxation year.