29 October 1990 Internal T.I. 900699 F - Reserve for Unearned Premiums of an Insurance Business

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)

We are writing in response to your referral regarding the above referenced taxpayer and certain concerns expressed by the Edmonton District Office in their memorandum of January 30, 1990 to your division.

Briefly, the primary concern is that the corporation maintains that it is carrying on an insurance business and is, accordingly, entitled to a reserve for unearned premiums pursuant to paragraph 20(7)(c) of the Income Tax Act (the "Act") as calculated according to section 1400 of the Income Tax Act Regulations (the "Regulations"). 24(1)

24(1)

While we do not have any expertise as to what would constitute a "reasonable commission" we agree with Stan Trevor that this must be considered given that we are dealing a with a non-arm's length arrangement.

We would further note that, with respect to the dealer commissions, an argument can be advanced that this particular expense should be deducted for tax purposes on the same basis that the insurance premiums are included in income. 24(1)

The unearned premiums reserve is an allowance which is specifically authorized by the Act with respect to insurers. There is, however, no specific provision which provides for the deduction of the dealer commission expenses in full in the year and, consequently, this deduction is contrary to generally accepted accounting principles.

It is our view that income for tax purposes is to be determined in accordance with ordinary accounting principles subject to any specific provisions of the Act which either authorize or mandate an exception to those principles. In the present case, 24(1)  The first exception is mandated by paragraph 138(1)(c) of the Act to include in the taxpayer's income all amounts received in respect of its insurance business in the year irrespective of whether such amounts relate to the current or a future year. The second exception authorizes the taxpayer to claim a reserve pursuant to paragraph 20(7)(c) of the Act with respect to the unearned portion of any insurance premiums received in the year which were included in income pursuant to paragraph 138(1)(c) as noted above. This authorized deduction is discretionary as the taxpayer may claim any amount subject to certain maximum limitations. There is, however, neither a mandatory nor a discretionary allowance in the Act which permits the taxpayer to depart from generally accepted accounting principles and deduct the full amount of dealer commissions in the year as a period expense.

This view was supported by the Federal Court - Trial Division in The Queen v. Metropolitan Properties Co. Limited (85 DTC 5128). The issue at hand was the deduction of costs incurred by the taxpayer, a property developer, in installing certain services and improvements with respect to residential subdivisions under development. The taxpayer deducted the costs as a current expense for tax purposes but had inventoried the amount for financial statement purposes. The Crown maintained that profits for tax purposes should be ascertained on ordinary principles of commercial trading and, since the financial statements of the taxpayer presented a proper method of accounting for public purposes, the taxpayer must bring itself within a specific provision of the Act in order to justify a different method of calculating income for tax purposes.

In holding for the Crown, Walsh, J. reached, inter alia, the following conclusions;

     "1.  General Accepted Accounting Principles (GAAP) should normally be applied for taxation purposes also, as representing a true picture of a corporation's profit or loss for a given year.

     2.   By exception they need not be applied for income tax purposes if there is some section or sections of the Income Tax Act which justify or require a departure from them or do not correspond with what are commonly accepted business and commercial practices."

and

     "5.  The fact that there is nothing in the Income Tax Act to prevent such deductions from being treated as current expenses and deducted as such for income in the year in which they are made is not sufficient justification for departing from GAAP principles in dealing with them in this way. It is the converse argument which should be adopted to the effect that these principles should only be departed from if something in the Act specifically requires or authorizes this. Parliament has addressed itself to and dealt with the treatment to be given to other types of developers expenses but has not specifically dealt with the type of expenses with which we are concerned here, and failure to do so results in the desirability of applying generally accepted commercial and business practice as reflected in the GAAP principles".

Accordingly, to the extent that it can be demonstrated that the proper method of accounting for the dealer commission expense pursuant to generally accepted accounting principles is to recognize such expense over the term of the insurance policy, it is our opinion that the conclusions reached in the aforementioned jurisprudence are applicable such that a reasonable argument can be made that the write-off of the commissions as a current expense can be denied.

We trust that our comments are of assistance to you.

for DirectorFinancial industries DivisionRulings Directorate