Excelsior Life Insurance Co. v. The Queen, 85 DTC 5164, [1985] 1CTC 213 (FCTD)

Joyal, J:—This is an appeal by the plaintiff from a notice of reassessment dated March 9, 1981, confirmed by the defendant on May 3, 1983, with respect to certain taxes imposed under Part XII of the Income Tax Act. The issue between the parties is exclusively one of statute interpretation and the trial proceeded on the basis of an agreed statement of facts.

Part XII of the Income Tax Act imposes a special tax on life insurance companies. The charging provision in Part XII is subsection 208(1) which states:

208. (1) Every life insurer shall pay a tax for a taxation year equal to 15 per cent of its taxable Canadian life investment income for the year.

It sounds simple enough. A life insurer need only calculate its taxable Canadian life investment income and pay a 15 per cent tax thereon. The difficulty, however, is in determining what is a life insurer’s taxable Canadian life investment income for the year. This is where the issue lies between the parties.

Before pursuing the several intricate provisions of Part XII or before attempting to make one’s way through its labryinth of verbalized mathematical formulae, a quick look at policy considerations behind the enactment of Part XII might be useful.

The traditional form of a life insurance contract contains two elements, one being the actuarily quantified risk factor, the other being the savings or investment part of the policyholder’s annual premium. For any given premium, part of it is cost of the risk and the balance is savings. The savings portion is invested by the insurer and the income accrues to the benefit of the policyholder from year to year. Historically, this income has not been subject to any investment income tax, a situation somewhat unfair to other taxpayers who preferred to purchase term insurance from an insurer at lower cost and invest the surplus funds privately. The income from such investment was naturally taxed in the usual way.

Both the plaintiff and the defendant in this appeal agree that Part XII is essentially a tax on the investment income of the risk cum investment type of insurance policy. For obvious reasons, however, it would have been administrative chaos to attempt to impose such a tax directly on each policyholder. As a result, the Part XII tax attempts to balance the equities, so to speak, in charging life insurers with a 15 per cent tax on the pool of investment income earned from such a policyholder and accruing to his benefit.* [1]

One must remember, however, that life insurance companies otherwise pay tax on their profits, a tax which is indirectly borne by their shareholders. It was required, therefore, that the special 15 per cent tax be imposed in such a fashion as would charge the policyholder with it and not result in an additional tax on the insurer.

Further background comment is required before analyzing the provision of Part XII of the Income Tax Act. It relates to the peculiarities of life insurers, the manner in which they categorize the funds they receive, either by way of premiums or by way of investment returns and the obligation of life insurers to comply not only with the more general provisions of the Income Tax Act but with the more specific provisions of the Canadian and British Insurance Compan- les Act.* [2] It is under this latter statute that a life insurer must include in its liabilities a reserve for all unmatured obligations guaranteed under the terms of insurance policies issued by it. This requires the establishment by the life insurer of “segregated” funds and, as a corollary, “non-segregated funds”. More on that later.

Finally, because of the multitude of cross-references upon cross-references in specific provisions of the Income Tax Act relating to life insurers, it might be wise to outline a series of definitions for particular words or expressions found in Part XII of the statute and relating to the issue before me.

List of Definitions

1. Subsection 209(1) defines “Gross Canadian Life Investment Income” as follows:

209. (1) Gross Canadian life investment income.—A life insurer’s gross Canadian life investment income for a taxation year is the amount, if any, by which the aggregate of

(a) an amount equal to

(i) where subsection 138(9) applies but the insurer has not elected under that subsection in respect of the year, such part of its gross investment revenue for the year from its non-segregated property as is required by paragraph (b) of that subsection to be included in computing its income for the year from carrying on its life insurance business in Canada, and

(ii) in any other case, its gross investment revenue for the year from such of its non-segregated property as was property used in the year in, or held in the year in the course of, carrying on its life insurance business in Canada, and

(b) the amounts required by subsection 138(4) to be included in computing the insurer’s income for the year, other than amounts deducted under paragraph 138(3)(a) in computing its income for the immediately preceding taxation year,

exceeds the aggregate of the amounts deductible under paragraphs 138(3)(b), (c) and

(d) in computing the insurer’s income for the year.

2. Subsection 209(2) defines “Net Canadian Life Investment Income” as follows:

209. (2) Net Canadian life investment income.—A life insurer’s net Canadian life investment income for a taxation year is its gross Canadian life investment income for the year minus the aggregate of

(a) its outlays or expenses that were deductible under Part I in computing its income for the year to the extent that such outlays or expenses were laid out or incurred by it for the purposes of managing its non-segregated property, the gross investment revenue from which may reasonably be regarded as having been included in its gross Canadian life investment income for the year;

(b) interest payable by the insurer in respect of the year pursuant to a legal obligation

incurred by it in the course of carrying on its life insurance business in Canada;

(c) amounts deductible under paragraph 20(1)(a) in computing the insurer’s income for the year in respect of a depreciable property at least 80 per cent of which was used regularly by it for the purpose of earning its gross Canadian life investment income for the year; and

(d) 50 per cent of the aggregate of each amount deductible under Part I in computing the insurer’s income for the year from carrying on its life insurance business in Canada, except to the extent that such amount

(i) is included in any of the amounts determined in respect of the insurer for the year under paragraph (a), (b) or (c),

(ii) is deductible under subsection 138(3) in computing its income for the year from carrying on its life insurance business in Canada,

(iii) was paid or payable by the insurer under a life insurance policy before the end of the year,

(iv) was an outlay or expense laid out or incurred by it for the purpose of earning income from its group life insurance business, or

(v) was payable by the insurer to a province as a tax in respect of premiums collected by it in the year under life insurance policies.

3. Subsection 209(3) defines “Taxable Canadian Life Investment Income” as follows:

209. (3) Taxable Canadian life investment income.—A life insurer’s taxable Canadian life investment income for a taxation year is the amount, if any, by which its net Canadian life investment income for the year exceeds the aggregate of

(a) the interest element for the year for

(i) each class of the insurer’s existing fixed-premium life insurance policies in Canada, and

(ii) each class of the insurer’s life insurance policies in Canada that were issued or effected as registered retirement savings plans or pursuant to such plans or to deferred profit sharing plans or registered pension funds or plans;

(b) the amount, if any, by which the insurer’s income for the year from carrying on its life insurance business in Canada, computed in accordance with Part I, exceeds any amount deducted by the insurer under paragraph 11 l(l)(a) in respect of noncapital losses in computing its taxable income for the year; and

(c) the aggregate of each amount (other than any portion thereof that is determined in prescribed manner to have been a return of capital) that a policyholder became entitled to receive in the year from the insurer under a life insurance policy in Canada other than a policy described in paragraph (a), to the extent that such amount is required by paragraph 56(1)(d) or paragraph 148(1)(a) to be included in computing the policyholder’s income or is an amount referred to in paragraph 212(l)(o).

The result of all the foregoing calculations, starting from gross, to net, to taxable, determines the amount on which the 15 per cent tax under subsection 208(1) is imposed.

It is the position of the plaintiff that in filing its tax return for the year 1976 pursuant to the formula set out in Part XII, it has properly complied with its requirements. Counsel for the plaintiff suggests that a proper reading and analysis of Part XII stands by itself in the calculation of tax imposed thereby, that it constitutes a particular code containing within its parameters a special, unique and pragmatic formula to determine the taxpayer’s “taxable Canadian life investment income” on which bottom line the 15 per cent is levied.

Specifically, counsel for the plaintiff argues that the starting point to get through the maze of Part XII is subsection 209(1) which defines “gross Canadian life investment income”. In simpler terms, but not necessarily all-inclusive ones, it includes the gross investment revenue from the insurer’s gross investment in non-segregated property (subparagraph 209(l)(a)(ii)). Such gross investment revenue of a life insurer is defined in paragraph 138(12)(e) of the Act to mean “the aggregate of all taxable dividends, interest, rentals and royalties included in its gross revenue for the year, . . .”.

Once “gross Canadian life investment income” as above calculated is determined, the next step is to establish “net Canadian life investment income”. The process for this is found in subsection 209(2) which lists in paragraphs (a) to (d) thereof certain amounts or expenses or outlays which are deducted from the “gross” income. These deductions may be summarized as follows:

1. outlays or expenses deductible under Part I of the Act to the extent that these are related to managing non-segregated property and the gross revenue of which may reasonably have been included in the insurer’s gross Canadian life investment income, (209(2)(a) );

2. all interest payments incurred in the course of carrying on the insurer’s life insurance business in Canada; ie whether such interest payments are payable with respect to segregated or non-segregated property, (209(2)(b) ):

3. capital cost allowances on depreciable property so long as 80 per cent of it was used to earn “gross Canadian investment income’’ (paragraph 209(2)(c)), including therefore income from segregated funds if not exceeding 20 per cent of total depreciable property (209(2)(c));

4. one half or 50 per cent of total deductions allowed under Part I in computing the insurer’s income for the year from carrying on its “life insurance business in Canada” (209(2)(d)).

Included as a deduction made by the plaintiff under the last-mentioned paragraph, ie paragraph 209(2)(d), are moneys listed as ‘’management fees” in the amount of $634,675, an amount identical to that claimed by the plaintiff in its Part I tax return and not otherwise disputed by the defendant.

It is this amount which the defendant challenges as includible in the calculation of the tax imposed under Part XII. Counsel for the defendant urges a more selective and, at the same time, a more consistent approach to such outlays. Counsel argues that expenses deductible under that paragraph must be limited to the expenses relating to gross investment income from non-segregated property and not to similar expenses relating to segregated property. This interpretation, counsel suggests, is more consonant with the scheme of the Act taken as a whole and specifically with paragraph 4(1 )(a) of the Act. One must read in the provisions of Part XII, he says, the application of the “source” rule. In effect, therefore, there must be a matching of outlays and expenses to each individual source of income, ie income from “segregated” and “non-segregated” property. The effect of this interpretation is to limit the management fee claimed to 50 per cent of such fee as applicable to non-segregated property only.

To advance his cause, counsel for the defendant suggests that an overriding principle of the Income Tax Act which assists in the interpretation of many of its provisions is found in Part I of the statute where the element of “source” is established. Subsection 4(1) in Part I is a general provision. It speaks “For the purposes of this Act” and not for the purposes of Part I. It contains no exception clause, ie an expression akin to “unless otherwise provided”. Its “sourcing” rule aids us in interpreting some other more obscure provisions of the statute. Counsel quotes from Driedger* [3] and from Mr Justice Estey’s decision in the Stubart Investment caset [4] which establish that the whole scheme of a statute must be respected when interpreting a particular provision thereof and an interpretation more in conformity with such scheme must be favoured.

In essence, the case for the defendant is that segregated funds and nonsegregated funds as these apply to life insurers are equated with “sources” of income under subsection 4(1) of the statute. This I view to be the basic argument behind the defendant’s assessment and the defendant’s own interpretation of paragraph 209(2)(d) of the statute.

It is a tempting argument and I should give full credit to counsel for its able presentation. With respect, however, I must disagree with it. I find myself much more readily adopting the position of the plaintiffs counsel. My reasons may be briefly summarized as follows:

1. An analysis of what constitutes segregated and non-segregated funds applicable to life insurers discloses that there are included in their respective genus any number of income sources. These sources are not individually related to a “source” as that word has been adopted or interpreted in subsection 4(1). Indeed, each fund has common sources ie interest income, dividend income, royalty and rental income, and other income, which are not there by reason of the “source” provision in subsection 4(2) but by reason of section 81 of the Canadian and British Insurance Companies Act which imposes on an insurer the obligation to segregate certain funds to meet its reserve commitments to its policy- holders.

2. I should not believe that the application of “source” in subsection 4(1) to the genus of a segregated fund “source” in the narrow confines of Part XII is warranted. In that regard, I hold to the view that Part XII is substantially a specific tax treatment code with ingenious and quite unique calculations set out for the purpose of imposing some tax on policyholders whose insurance income would otherwise be tax free. The intricate detailing of the whole of Part XII will be observed. It will be noted that Part XII provides for the determination of “gross Canadian life investment income”, of “net Canadian life investment income” and finally, of “taxable life investment income”. It seems clear from the care with which these provisions are drafted that the bottom line on which the charging provision of subsection 208(1) applies is the result of a distinct and calculated approach to a special taxation scheme.

3. In this light, the scheme or framework interpretation rule advanced by the defendant might be applicable, but not in the manner suggested by counsel. I would think that such a rule must first be applied to an analysis of Part XII as a whole. Difficulties in the interpretation of its various provisions must be resolved in favour of conformity within the context of that Part before leaping back to section 4 in Part I. Such an internal analysis of Part XII leads me to conclude that paragraph 209(2)(d) speaks for itself in allowing, for the purposes of Part XII, half of the deductions allowed in Part I on the income earned by the life insurer on its life insurance business in Canada. Perhaps this is not the disposition which Parliament intended but I must nevertheless be faithful to the principle that Parliament’s intention is determined by what its statute says and not by what Parliament intended to say in its statute.

4. The foregoing observation should not be construed as an acknowledgment that Parliament’s intention has in fact been frustrated by the language used in paragraph 209(2)(d). Part XII of the statute contains a number of key expressions, each of them well-defined. As noted earlier, “gross Canadian life investment” is defined, “net Canadian life investment income” is defined and “taxable Canadian life investment income” is defined. The expression “‘life insurance business in Canada” is not defined but it can only mean the total operation of a life insurer’s insurance business in Canada no matter what aspects of it might, in due course, come under a “segregated” or “non-segregated” umbrella. Indeed, Part XII contains a number of formulae where these concepts are found. Subparagraphs 209(l)(a)(i) and (ii) specify gross investment revenue from non-segregated property. Paragraph 209(2)(a) speaks of outlays for the purposes of managing “non-segregated property”. It seems clear in these provisions that the “nonsegregated” property is one of the key factors to be fitted into the calculations. When it comes to paragraphs 209(2)(b) and 209(2)(d), however, the key factor appears to be clearly defined as the insurer’s “life insurance business in Canada’’. It will be noted in this respect that for purposes of Part XII, paragraph 209(2)(b) allows an insurer all its interest expense incurred in carrying on its business, whether or not such expense is attributable to segregated as against non-segregated property. Such a selective approach in building up a whole formula on which the special 15 per cent tax is to be levied is further indication to me that the paragraph in dispute should, if at all possible, be construed within the didactic confines of Part XII.

5. If the calculations required to determine “net Canadian investment income’’ allow Life insurance business income deduction under Part I, the 50 per cent limitation thereon gives it some credence. This is the point forcefully advanced by the plaintiffs counsel both in written brief and in verbal argument before me. Such a 50 per cent limitation is indicative of both the ‘’arbitrariness” of many provisions of Part XII as well as the pragmatism applied in resolving in a simple and expedient way the complex calculations which might otherwise have been required to determine what expenses are attributable to the investment or “savings” portion of the insurer’s business and the “risk” portion in its business. Cutting all deductions by half is consonant with the scheme or framework of Part XII and not inconsistent with Part I of the statute.

6. Buttressing this pragmatic or ad hoc approach to paragraph 209(2)(d) are other provisions of subsection 209(2) to which I have referred. Paragraph 209(2)(b) has an arbitrary rule with respect to interest expense. paragraph 209(2)(c) imposes another arbitrary rule with respect to capital cost allowances otherwise allowable under paragraph 20(1 )(a) of the statute. When it comes to paragraph 209(2)(d), the expression “life insurance business in Canada” should not, in my view, carry a connotation different to that found in paragraph 209(2)(b) where the same concept is found. To do so would bring into the wording of the statute something which is not there.

7. Counsel for the defendant warned me against adopting any interpretation of the paragraph which would strike a disharmonie chord with Part I of the statute. An interpretation which is on key with the statute as a whole is to be preferred. I agree with counsel in respect of this principle but I do not agree that my finding brings disharmony to the statute. It merely recognizes a minor counterpoint to the flowing structure of the whole statute.

The succession of the Interprovincial Pipe Line* [5] cases cited by counsel is of limited assistance to the case at bar. These cases deal with the classical “source rule” under subsection 4(1) of Part I of the Income Tax Act or, to be more accurate, the predecessor to that Part. Having found that Part XII contains within its ambit its own internal “source rule” (and I use this expression with some reluctance), I must rely exclusively on the wording of the statutory provision.

The appeal is accordingly allowed and the plaintiffs assessment under Part XII for the 1976 taxation year is referred back to the defendant for the necessary reassessment, the whole with costs.