29 March 1990 External T.I. 74355 F - Reserves/Contingent Liabilities

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.

SUBJECT:  24(1)

This is in reply to your memorandum dated September 15, 1989 with respect to the application of paragraph 18(1)(e) of the Income Tax Act (the "Act") to  24(1)  in respect of estimated claims.  We apologize for the delay.

Background

24(1)

24(1) Position

(1)     The decision in Day & Ross Limited vs The Queen, (76 DTC 6433 F.C.-T.D) ("Day & Ross") supports its position.

(2)     

(3)     24(1)

(4)     

(5)     

(6)     Paragraph 18(1)(e.1) of the Act has no retroactive effect and should not be used as the disallowing provision for pre-1988 years.

Our Position

In TNT Canada Inc. (88(2)CTC 91) the court held that the taxpayer, a transport operator, has not entitled to deduct actual and estimated amounts in respect of damage claims by virtue of the restriction in paragraph 18(1)(e).  In reaching this decision Cullen, J. distinguished the Day & Ross case on the basis chat the number and actual value of claims were known and therefore were expenses that were definitely owing and payable.  In this regard Cullen, quoted Dube, J. as follows:

     "The amounts booked as accident and cargo claims were so entered for that year because the specific events leading to the claims had occurred in that year. The accountants did not set aside approximate amounts as "reserve", against contingencies, these amounts were booked as definitely payable because the premiums had been earned, the accidents had occurred, the claims had been filed, (the investigations had taken place, the quantum of damage assessed, and the amounts entered."

Cullen, J. went on to distinguish the fact situation in the TNT case as follows:

     "The claim could be resolved in a number of ways, clearly making the sum posted contingent, i.e. payment has an event that might or might not happen.  The claim could be resolved, for example, in The following ways after an investigation:

      1.      pay it in full;

     2.     partial payment to customer because claim overstated;

     3.      denied in its entirety (eg. claims not filed on time, claims filed without proper     documentation).

     Therefore, the amount claimed as expenses vas very clearly contingent and therefore not deductible under paragraph 18(1)(e) of the Act 1.

In our view, paragraph 9 of IT-215R, which provides that a taxpayer is entitled to a deduction if the amount of the liability is ascertained and unconditional, is consistent with the jurisprudence referred to above.

24(1)

would seem to support the view that the amount of the claims were not ascertainable at the time provision was being made for tax purposes.  The fact that the amount of the provision was conservative is not relevant.

24(1)

was dealt with in TNT.  Cullen, J. made the following comment;  

     "However, the case law is clear on the point that the fact of acceptability in accounting does not in itself make the expenditure in question a proper deduction for tax purposes.  In Harlequin, (74 DTC 6642), Mahoney, J. found that the account set up to provide for the contingent liabilities was a contingent account and that "no deduction in respect of that account, even to the extent that generally accepted accounting principles required it to be made, is permitted in the calculation of the plaintiff's taxable income".

He then concluded, and we agree, that paragraph 18(1)(e) of the Act overrides generally accepted accounting principles.

24(1)

we would again refer to the fact situation in the TNT case.  The events there (i.e. damage to cargo) had occurred before the end of the taxation year in which the taxpayer sought to take a deduction for tax purposes.  The quantum of the reported and unreported claims were however not resolved and therefore the amount of the liability had not been ascertained but rather was contingent.  In other words until all of the requirements to establish the claim, including the investigation thereof, have been completed the liability provided for represents a contingent liability.

As to paragraph 18(l)(e.l) we would suggest that it is not relevant  to this particular case.  Paragraph 18(1)(e.l), which deals with actual expenses that are unpaid rather than with reserves or contingent accounts only applies to claims received by insurers under insurance policies.  We have not been provided with any information that would support that is the case here. Clearly, we would not agree with a view that anyone who fails to or decides not to obtain insurance or anyone who has a deductible under a policy is an insurer.  Apart from this the claims to which paragraph 18(1)(e.1) applies are those in respect of policies  issued by the insurer.  Is  24(1)  contending that the rental contracts they enter into with their customers constitute insurance contracts?  We would not have thought this to be the case although we have not reviewed a particular contract.

Finally our views as expressed above would not be altered even if a review of the facts allowed review of the facts allowed for a conclusion that  24(1)  is an insurer.

We hope our comment are of assistance to you.

ChiefFinancial Institutions SectionFinancial Industries Division Rulings Directorate