2000 Ruling 2000-0032363 - REINSURANCE

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues: Whether or not a single reinsurance premium paid under an indemnity reinsurance arrangement where the reinsurance is 100% co-insurance, would be considered a premium paid/received in the ordinary course of carrying on an insurance business and therefore deductible from and includable in income for the purpose of sections 9

Position: To the extent the amount of the premium is reasonable, it will be considered to have been paid/received in the course of carrying on an insurance business and is therefore deductible in computing the income of the payor pursuant to section 9 and must be included in the income of the recipient pursuant to section 9.

Reasons: Under an indemnity reinsurance arrangement, the original insurer retains the ultimate liability to the policyholders under the policies and the reinsurance of risks is considered to be an ordinary part of the carrying on of an insurance business.

XXXXXXXXXX 							2000-003236

Attention: XXXXXXXXXX

XXXXXXXXXX , 2000

Dear Sir:

Re: Advance Income Tax Ruling Request for
XXXXXXXXXX ("C Co")
XXXXXXXXXX ("A Co")
XXXXXXXXXX ("Y Co")

This is in reply to your letter of XXXXXXXXXX, wherein you requested an advance income tax ruling in respect of the above named taxpayers. We also acknowledge the information provided in subsequent correspondence and during our various telephone conversations in connection with your request (XXXXXXXXXX).

We understand that, to the best of your knowledge and that of the taxpayers involved: none of the issues involved in the ruling request

(i) is in an earlier return of the taxpayer or a related person,

(ii) is being considered by a tax services office or taxation centre in connection with a previously filed tax return of the taxpayer or a related person,

(iii) is under objection by the taxpayer or a related person,

(iv) is before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has not expired, and

(v) is the subject of a ruling previously issued by the Directorate;

Unless otherwise stated, all references to a statute are to the Income Tax Act R.S.C. 1985 (5th Supp.), c.1, as amended, (the "Act") and all terms and conditions used herein that are defined in the Act have the meaning given in such definition unless otherwise indicated.

Facts

Our understanding of the facts, proposed transactions and the purpose of the proposed transactions is as follows:

1. A Co is a Canadian corporation which carries on a life insurance business as defined in subsection 248(1), for purposes of the Act. The company was incorporated under the XXXXXXXXXX Insurance Companies Act. A Co is a subsidiary of XXXXXXXXXX ("B Co"). In addition to XXXXXXXXXX common and XXXXXXXXXX preferred shares owned by B Co, XXXXXXXXXX preferred shares are owned by XXXXXXXXXX and XXXXXXXXXX preferred shares are owned by A Co directors.

2. B Co is a corporation continued under the XXXXXXXXXX operating as a management services corporation and ultimate parent for The B Co group of companies. The B Co group of companies includes, among others, A Co, B Co, C Co, XXXXXXXXXX ("D Co"), and XXXXXXXXXX ("E Co"). B Co is a Canadian Controlled Private Corporation ("CCPC") as defined in subsections 248(1) and 127(5) for the purposes of the Act.

3. C Co is a Canadian corporation and a life insurer as defined in subsection 248(1), for purposes of the Act. C Co is incorporated under the Insurance Company Act (a federal statute). C Co is a subsidiary of D Co, which in turn is a wholly-owned subsidiary of B Co. D Co owns XXXXXXXXXX common shares of C Co. The remaining XXXXXXXXXX common shares of C Co are owned by persons unrelated to B Co, D Co, E Co, C Co and A Co.

4. D Co is a holding company for the financial services arm of B Co group of companies. B Co owns all the XXXXXXXXXX common shares of D Co. D Co is a CCPC as defined in subsections 248(1) and 127(5) for the purposes of the Act.

5. E Co is a Canadian corporation and a non-life (property and casualty) insurer for purposes of the Act. E Co is a subsidiary of D Co. A Co was originally acquired by E Co from an unrelated party in XXXXXXXXXX. Ownership of A Co was transferred to B Co in XXXXXXXXXX.

6. C Co currently carries on both life and non-life (A&S) insurance businesses in Canada. C Co's life insurance business consists of a full range of life and annuity insurance products in both the individual and group markets.

7. A Co's insurance business consists solely of a closed block of group and individual annuity policies (the "Reinsured Block"). The overwhelming majority of annuitants are residents of Canada. No new annuity contracts have been issued by A Co since XXXXXXXXXX . As at XXXXXXXXXX, A Co has incurred substantial cumulative financial statement operating losses resulting in a deficit for financial reporting purposes of $XXXXXXXXXX.

8. XXXXXXXXXX ("X Co") is a US reinsurance corporation and a non-resident of Canada for purposes of the Act. X Co is registered under the Insurance Companies Act and carries on a reinsurance business in Canada under the name X Co Branch which includes reinsurance of liabilities under life insurance policies. X Co, or its parent Z Co, intend to incorporate a new reinsurance subsidiary company in Canada which will be called Y Co, and is seeking regulatory approval to do so. It is anticipated that this approval will be granted XXXXXXXXXX. Neither X Co, nor its parent or subsidiaries, is related to or associated with any member of B Co group of companies for purposes of the Act.

Proposed Transactions (In Order)

9. A Co will pay $XXXXXXXXXX to redeem and cancel the XXXXXXXXXX preferred shares of A Co held by the registered charities.

10. B Co will transfer the XXXXXXXXXX common and XXXXXXXXXX preferred shares (the "transferred shares") of A Co it owns to C Co. The purchase and sale price will be equal to the fair market value of the transferred shares determined at the date of transfer by independent review. The transfer price is currently estimated to be $XXXXXXXXXX which will be paid with consideration consisting of $XXXXXXXXXX cash and common shares having a fair market value of $XXXXXXXXXX. B Co and C Co will jointly elect under section 85 of the Act at the amount that is the lesser of the fair value of the transferred shares and their adjusted cost base to B Co. The adjusted cost base of the transferred shares and the fair market value of the transferred shares are not less than $XXXXXXXXXX. The agreement of purchase and sale will include a purchase price adjustment clause.

11. C Co will transfer approximately $XXXXXXXXXX of cash to A Co as a non-interest bearing demand loan. The purpose of the loan will be to provide funds to A Co to enable it to complete the reinsurance transaction discussed in paragraphs 12 through 20.

12. A Co will enter into a quota-share indemnity reinsurance agreement (the "Reinsurance Agreement") with Y Co by which Y Co will reinsure 100% of A Co's obligations in respect of the Reinsured Block.

13. You have advised that the key points of the Reinsurance Agreement are as follows:

a) The risk commencement date ("Effective Date") will be XXXXXXXXXX.

b) The closing date will not be later than XXXXXXXXXX (the "Closing Date"). The Closing Date is partly dependent upon the timing of XXXXXXXXXX ability to legally accept reinsurance.

c) Reinsurance will be on a co-insurance basis whereby Y Co will reinsure and pay for XXXXXXXXXX% of the policy benefits payable by A Co. A Co will continue to be primarily obligated to its policyholders under the Reinsured Block and will not have sold, discontinued or in any way disposed of the business that included the issuance of the policies in respect of which risk is to be reinsured.

d) On the Closing Date, A Co will pay a single reinsurance premium (the "Premium" of approximately $XXXXXXXXXX to Y Co. Payment of the Premium will be made by way of title transfer to certain bonds and mortgages owned by A Co and a cash payment for the balance. It is intended that the total value of the assets and cash transferred to Y Co will be equal to the fair market value of the liabilities being assumed by Y Co on the Closing Date, less a $XXXXXXXXXX reinsurance commission to be paid by Y Co to A Co.

e) A Co will continue to administer the policies in the Reinsured Block. Y Co will pay to A Co a monthly coinsurance expense allowance for each month after the Effective Date. Such fees will be paid monthly in arrears within XXXXXXXXXX days of the end of the calendar month.

f) A Co can recapture the reinsured business, at its discretion, after the Closing Date. In the event of recapture, the entire amount of business remaining in force on that date must be recaptured. The terms of recapture will be provided for in the Reinsurance Agreement.

g) C Co must obtain the consent of A Co prior to an assignment of the Reinsurance Agreement to a third party.

14. The XXXXXXXXXX preferred shares owned by A Co directors will be purchased for $XXXXXXXXXX and canceled.

15. A Co will be wound-up under section 88 of the Act and its assets distributed to C Co. On the winding-up, C Co will acquire the rights and obligations of A Co under the Reinsurance Agreement.

Purpose of the Proposed Transactions

B Co wants to combine its two Canadian life insurance subsidiaries for business and tax reasons. However, the business plan to combine C Co and A Co does not contemplate the assumption by C Co of the insurance risks related to A Co's in-force policies, unless those risks are fully reinsured, since they are inconsistent with C Co's core business. Nevertheless, C Co believes value can be derived from administering the run-off of A Co's insurance business. Therefore, the business purpose of the proposed transactions is to enable A Co to cede substantially all of its insurance risks to Y Co while retaining responsibility for the management and administration of the policies. In addition, the reinsurance transaction will allow C Co to forge an on-going business relationship with X Co and Y Co that could result in future business opportunities for C Co.

Y Co's purposes for entering into the transaction is to achieve a number of important business objectives. First, the A Co annuities represent an attractive opportunity for Y Co to earn a fair return on its capital. Second, the annuity block will diversify Y Co's overall mortality risk. (The existing business to be domesticated from the X Co branch derives from term and whole life insurance policies. The mortality risk inherent in life insurance is that the insured dies earlier than expected. Conversely, the mortality risk in an annuity is that the annuitant lives longer than expected.) Third, reinsuring the A Co annuity block will help Y Co to establish a reputation as a significant force in the Canadian reinsurance market with the capacity to execute large transactions. Finally, the transaction will significantly increase Y Co's reserves and investments, accelerating Y Co's growth and enabling it to realize economies of scale sooner than would otherwise occur.

Other

Nothing in this ruling should be construed as implying that the Canada Customs and Revenue Agency has agreed to or reviewed the reasonability of the amount of the reinsurance premium, the amount of the reinsurance commission, or any tax consequences relating to the facts, proposed transactions or the purpose of the proposed transactions described herein, other than those specifically described in the rulings given below.

Rulings Given

A. Provided the Closing Date of the Reinsurance Agreement is on or before XXXXXXXXXX, the amount of the premium that has been paid or is payable as of the Closing Date, as described in paragraph 13(d), will be an amount paid or payable, as the case may be, by A Co in the course of carrying on A Co's insurance business for the taxation year ended XXXXXXXXXX. Accordingly, to the extent such amount is reasonable, it will be deductible under section 9 of the Act in computing A Co's income for its taxation year ended XXXXXXXXXX.

B. Provided the Closing Date of the Reinsurance Agreement is on or before XXXXXXXXXX, the amount of the premium received or receivable as of the Closing Date, as described in paragraph 13(d), will be an amount received or receivable, as the case may be, by Y Co in the course of carrying on Y Co's insurance business for the taxation year ended XXXXXXXXXX . Accordingly, the amount will be included under section 9 of the Act or paragraph 12(1)(a) of the Act, as the case may be, in computing Y Co's income for its taxation year ended XXXXXXXXXX.

The rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R3 dated December 30, 1996 and is binding on the Canada Customs and Revenue Agency provided that the proposed transactions are completed before XXXXXXXXXX.

Yours truly,
Manager
Financial Industries Division
Income Tax Rulings Directorate
Policy and Legislation Branch