20 August 2015 External T.I. 2015-0588871E5 - Taxation of insurance contract commission income

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.

Principal Issues: Whether commission income from insurance contracts can be deferred

Position: Provided general comments

Reasons: Not enough information to provide specific comments

XXXXXXXXXX
Jennifer Omstead
2015-058887

August 20, 2015

Dear XXXXXXXXXX:

Re: Taxation of commission income from insurance contracts

This is in response to your letter of May 11, 2015 concerning the recognition of commission income from insurance contracts for tax purposes.

You described a situation where a taxpayer provides general insurance brokerage services on which a commission is earned. The professional liability insurance that is placed is on a "claims-made" basis and the policy is renewed annually. Since the claims activity of any particular policy year of account can run for many years as claims get settled, all commission income is placed in a trust account and recognized over many years. You noted that the commission income from a single policy year of account is generally distributed 70% during the year when the annual policy is in force with the remaining 30% deferred and recognized over the subsequent approximate 10 years while claims for that policy year of account are settled. You have asked for our views on whether the deferral of 30% of the commission income to subsequent years is an acceptable practice for tax purposes.

Our comments

This technical interpretation provides general comments about the provisions of the Income Tax Act (the "Act") and related legislation (where referenced). It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R6, Advance Income Tax Rulings and Technical Interpretations.

Income Inclusion

Subparagraph 12(1)(a)(i) of the Act provides that any amount received by a taxpayer in a taxation year in the course of a business that is on account of services not rendered or goods not delivered before the end of the year or that, for any other reason, may be regarded as not having been earned in the year or a previous year must be included in computing the taxpayer's income from a business for the taxation year.

Reserves

Subsection 32(1) of the Act provides rules for calculating the reserve that may be deducted by taxpayers carrying on business as an insurance agent or broker in respect of unearned commissions. In this context, the term "unearned commissions" generally refers to commissions received in contemplation of the performance of services in the future. A reserve under subsection 32(1) of the Act is not available in respect of commissions on life insurance contracts. Further, under the terms of subsection 32(1) of the Act, an insurance agent or broker is prohibited from claiming any reserve under paragraph 20(1)(m) of the Act for unearned commissions when calculating commission income from all types of insurance contracts.

Subsection 32(1) of the Act establishes the maximum amount of the reserve for a taxation year as the lesser of two amounts:

a) an amount calculated based on the taxpayer's commissions for the portion of the term of the insurance contracts extending to subsequent taxation years (footnote 1); and

b) the amount that would have been deductible under paragraph 20(1)(m) of the Act for the year if the insurance agents and brokers were entitled to that deduction.

Subsection 32(2) of the Act requires that any amount deducted as a reserve under subsection 32(1) of the Act for a taxation year must be included in income for the immediately following taxation year.

Paragraph 20(1)(m) of the Act provides that reasonable amounts in respect of services that it is reasonably anticipated will have to be rendered after the end of a taxation year may be deducted as a reserve. In our view, the continuing coverage after the end of the current year of a risk described in an insurance contract is not a "service" for which a reserve would be available under paragraph 20(1)(m) of the Act. In addition, for an amount received as an unearned commission to be subject to paragraph 20(1)(m) of the Act, it must be an amount described in paragraph 12(1)(a) of that Act that relates to a binding obligation to provide specific types of client support services after the end of the year. Generally, amounts for services that might be required in relation to claims under the policies (for example, claims adjusting) would not be eligible since they normally would be contingent amounts for which a deduction would be prohibited by paragraph 18(1)(e) of the Act. It is therefore a question of fact which depends on the nature of the agreements providing for commissions for insurance agents and brokers and the services that will be rendered by them. Past experience may be a useful factor in establishing a reserve for services that will be rendered after the end of a year.

We trust that these comments will be of assistance.

Yours truly,

Jenie Leigh
Manager
Financial Institutions Section
Financial Industries and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

FOOTNOTES

Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:

1 To calculate the amount under paragraph 32(1)(a), for each contract, first divide the number of days in the period provided in the insurance contract that fall in years after the end of the taxation year by the total number of days in the period provided in the insurance contract. This proportion is then applied to the amount of commission included in calculating the taxpayer's income for the year, or for a previous taxation year, from the insurance contract (other than a life insurance contract) that has a term that extends beyond the end of the current taxation year. The amount under paragraph 32(1)(a) is the total of all such amounts.