Date: 19991108
Docket: 98-363-IT-G
BETWEEN:
THE MANUFACTURERS LIFE INSURANCE COMPANY
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
O'Connor, J.T.C.C.
[1] This appeal concerns the interpretation of certain
provisions of Parts I.3 and VI of the Income Tax Act
(Canada), R.S.C. 1985, c.1 (5th Supp.)
("Act"). The said Parts impose a capital tax on
certain corporations including life insurance corporations
carrying on business in Canada. The principal issue is whether
the Appellant's "net deferred realized gains" are
to be included in the Appellant's capital base for the 1989,
1990 and 1991 taxation years.
FACTS:
[2] The principal facts which are based upon an Agreed
Statement of Facts are as follows:
1. Throughout each of its 1989, 1990 and 1991 taxation years,
the Appellant was a "financial institution" as defined
for the purposes of Part I.3 and Part VI of the Act and an
"insurance corporation" as defined by subsection 248(1)
of the Act.
2. Throughout each of its 1989, 1990 and 1991 taxation years,
the Appellant was resident in Canada for the purposes of the
Act and carried on a life insurance business in Canada and
outside Canada.
3. Throughout each of its 1989, 1990 and 1991 taxation years,
the Appellant was governed by the Canadian and British
Insurance Companies Act (Canada) and the regulations made
thereunder and was required by law to report to the
Superintendent of Financial Institutions (Canada) (the
"Superintendent"). The Superintendent is the same
official referred to in subparagraph 181(3)(b)(ii) of the
Act.
4. The Appellant filed with the Superintendent annual
financial statements in respect of the Appellant's life
insurance and accident and sickness business as at December 31,
1989, December 31, 1990 and December 31, 1991 (the "Annual
Statements").
5. Each of the Annual Statements contains a statement of
"Assets" and a statement of "Liabilities, Capital
and Surplus" which together form a balance sheet (the
"Balance Sheets").
6. Each of the Annual Statements also contains an "Income
Statement" for the year then ended (the "Income
Statements") and a "Reconciliation of Unappropriated
Earned Surplus" for the year then ended (the "Surplus
Statements").
7. Each of the Annual Statements (and the Balance Sheet, the
Income Statement and the Surplus Statement included therein) was
prepared in accordance with the requirements of the relevant
legislation and regulations (specifically, the Canadian and
British Insurance Companies Act (Canada) and the regulations
made thereunder) and the instructions for the preparation of such
annual financial statements issued by the Office of the
Superintendent of Financial Institutions applicable at the
relative times (collectively, the "Rules").
8. The Rules specify the statutory accounting and reporting
requirements for annual financial statements of life insurers.
The statutory principles are oriented to solvency-based financial
reporting. The prescribed form of the annual financial statements
reflects these legislative requirements. Other than in the
defined areas of differences covered in the Rules, the underlying
basis for accounting and financial reporting incorporated in the
Rules and the annual financial statements is intended to conform
to generally accepted accounting principles.
9. Since 1992, the Insurance Companies Act (Canada),
which replaced the Canadian and British Insurance Companies
Act (Canada), has required that the annual financial
statements of a life insurer be prepared in accordance with
generally accepted accounting principles, the primary source of
which is the Handbook of the Canadian Institute of Chartered
Accountants (the "CICA Handbook"), except as otherwise
specified by the Superintendent. The accounting principles
applicable to the accounting for investments of a life insurer
adopted as generally accepted accounting principles for life
insurers and prescribed by the Insurance Companies Act,
and which are now set out in the CICA Handbook, are substantially
the same as the accounting principles that were prescribed by the
Rules applicable to the accounting for investments of a life
insurer before 1992.
10. Each of the Annual Statements (and the Balance Sheet, the
Income Statement and the Surplus Statement included therein) was
accepted by the Superintendent as filed by the Appellant (without
requiring any changes thereto).
11. Each of the Annual Statements was required to include, and
did include, a report from the auditors of the Appellant to the
Superintendent. Each such report contained a statement in
substantially the following form:
"In our opinion, based upon our examination and the
opinion of the Company's Valuation Actuary, these financial
statements present fairly the financial position of the Company
as at December 31 [of the relevant year] and the results of its
operations and the changes in its financial position [excluding
segregated funds] for the year then ended in respect of the
Company's life insurance and accident and sickness business
in accordance with the accounting principles described in the
notes accompanying the financial statements."
12. In its Balance Sheets, the Appellant was required by the
Rules to carry its investments in bonds, shares, real estate and
mortgage loans at carrying values prescribed by the Rules. For
this purpose, in general terms, under the Rules, the total
carrying values of a life insurer's investments are required
to be determined as follows:
(i) In the case of investments in bonds and mortgage loans,
the carrying values take into account any repayments of
principal, any amortization of any premium or discount and the
unamortized portion of any net realized gains and losses arising
on the sale or other disposition of such investments.
(ii) In the case of investments in real estate, the carrying
values take into account any encumbrances and depreciation, any
amortization of unrealized increases and decreases in the fair
market values of such investments and the unamortized portion of
any net realized gains and losses arising on the sale or other
disposition of such investments.
(iii) In the case of investments in shares, the carrying
values take into account any amortization of unrealized increases
and decreases in the fair market values of such investments and
the unamortized portion of any net realized gains and losses
arising on the sale of such investments.
13. In its Balance Sheets, the Appellant reported the total
carrying value of its bond investments net of an "Adjustment
for Unamortized Gain on Disposal" as required by the Rules
as follows:
UNAMORTIZED GAINS ON BONDS
|
YEAR
|
CANADIAN
|
FOREIGN
|
TOTAL
|
|
1989
|
$59,119,000
|
$74,662,336
|
$133,781,336
|
|
1990
|
$23,986,000
|
$(107,864,821)
|
$(83,878,821)
|
|
1991
|
$99,014,627
|
$89,565,000
|
$188,579,627
|
14. In its Balance Sheets, the Appellant reported the total
carrying value of its share investments net of a "Formula
Adjustment in Respect of Gains" as required by the Rules as
follows.
UNAMORTIZED GAINS ON SHARES
|
YEAR
|
CANADIAN
|
FOREIGN
|
TOTAL
|
|
1989
|
$133,496,000
|
$285,345,251
|
$418,841,251
|
|
1990
|
$120,244,000
|
$242,228,542
|
$362,472,542
|
|
1991
|
$87,956,000
|
$446,719,000
|
$534,675,000
|
15. In its Balance Sheets as corrected with the consent of the
Minister, the Appellant reported the total carrying value of its
real estate investments net of a "Formula Adjustment"
as required by the Rules as follows:
UNAMORTIZED GAINS ON REAL ESTATE
|
YEAR
|
CANADIAN
|
FOREIGN
|
TOTAL
|
|
1989
|
$201,933,176
|
$36,005,486
|
$237,938,662
|
|
1990
|
$202,984,097
|
$37,603,538
|
$240,587,635
|
|
1991
|
$191,004,425
|
$41,497,769
|
$232,502,194
|
16. In its Balance Sheets, the Appellant reported the total
carrying value of its mortgage loan investments by adding thereto
an "Adjustment for Unamortized Loss on Disposal" as
required by the Rules as follows:
UNAMORTIZED LOSSES ON MORTGAGE LOANS
|
YEAR
|
CANADIAN
|
FOREIGN
|
TOTAL
|
|
1989
|
$166,656
|
$2,794,536
|
$2,961,192
|
|
1990
|
$525,843
|
$1,223,458
|
$1,749,301
|
|
1991
|
$472,531
|
$861,497
|
$1,334,027
|
17. The Appellant's Unamortized Gains on Bonds, the
Appellant's Unamortized Gains on Shares and the
Appellant's Unamortized Gains on Real Estate were not, and
were not required by the Rules in the years under appeal to be,
reported by the Appellant as part of the "Liabilities"
or the "Capital, Surplus and Reserves" of the Appellant
in its Balance Sheets.
18. In the years under appeal, the Appellant reported total
"Capital, Surplus and Reserves" in its Balance Sheets
(prepared using the equity method of accounting for its
subsidiary companies) as follows:
CAPITAL, SURPLUS AND RESERVES
YEAR TOTAL (in $thousands)
1989 $1,911,624
1990 $2,065,989
1991 $2,291,811
19. In calculating both its capital and its taxable capital
employed in Canada for the purposes of Part I.3 of the Act
for the 1989 taxation year, and for the purposes of Part I.3 and
Part VI of the Act for the 1990 and 1991 taxation years,
the Appellant's Returns did not include any amount in respect
of the above mentioned Unamortized Gains.
20. The Minister's reassessments of the Appellant under
Parts I.3 and VI of the Act in issue consist of five
notices of reassessment dated September 16, 1994 and numbered
855097, 855100, 855101, 855102 and 855103 (the
"Reassessments").
21. In issuing the Reassessments, the Minister included the
Canadian Portion of the Unamortized Gains on Bonds, Shares and
Real Estate in calculating the Appellant's taxable capital
employed in Canada as defined for the purposes of Parts I.3
and VI of the Act for the relevant taxation years pursuant
to subclause 181.3(1)(c)(ii)(B)(I) and clause
190.11(b)(ii)(A) of the Act, respectively, as being
"reserves" of the Appellant that may reasonably be
regarded as having been established in respect of the
Appellant's insurance business carried on in Canada.
22. In issuing the Reassessments and calculating the
Appellant's taxable capital employed in Canada for the
purposes of Part I.3 of the Act for the 1989 taxation year
and for the purposes of Part I.3 and Part VI of the Act
for the 1990 and 1991 taxation years, the Minister did not reduce
the Appellant's taxable capital employed in Canada by the
Canadian Portion of the Unamortized Losses on Mortgage Loans.
23. In issuing the Reassessments, the Minister increased the
Appellant's tax payable under Part I.3 and Part VI of the
Act by the following amounts:
ADDITIONAL TAX ASSESSED
|
YEAR
|
PART I.3
|
PART VI
|
|
1989
|
$348,067
|
-
|
|
1990
|
$607,624
|
$3,733,741
|
|
1991
|
$755,950
|
$4,724,688
|
24. There are several paragraphs in the Agreed Statement of
Facts confirming that, although the Reassessments characterized
the Unamortized Gains as reserves, the Minister, after the dates
for further reassessment were statute barred, by an Amended Reply
to the Appellant's Notice of Appeal put forth an alternative
submission that the said Unamortized Gains were "other
surpluses".
25. Notices of Objection for each of the Reassessments were
filed by the Appellant with the Minister on or before December
13, 1994.
26. After service of the Notices of Objection, the Minister
neither vacated nor confirmed the Reassessments. No other
assessment or reassessment or additional assessment of the
Appellant under Parts I.3 and VI of the Act in respect of
the 1989, 1990 and 1991 taxation years was made by the Minister
after service of the Notices of Objection and before the
Minister's Reply to the Appellant's Notice of Appeal in
this matter was filed with this Court on April 27, 1998.
27. There are two broad categories of deferred realized gains
and losses arising from dispositions of investments of the
Appellant in or prior to the relevant taxation years. The first
category of such deferred realized gains and losses comprises the
gains and losses arising on dispositions by the Appellant of
bonds and mortgages. The amounts of such gains and losses that
were deferred and remained unamortized by the Appellant in its
Balance Sheets are the Unamortized Gains on Bonds and the
Unamortized Losses on Mortgages. The second category of such
deferred realized gains and losses comprises the gains and losses
arising on dispositions by the Appellant of shares of the capital
stock of other corporations and real estate investments. The
amounts of such gains and losses that were deferred and remained
unamortized by the Appellant in its Balance Sheets are the
Unamortized Gains on Shares and the Unamortized Gains on Real
Estate.
28. Under the Rules, the Unamortized Gains on Bonds and the
Unamortized Losses on Mortgages were required to be, and were,
reported by the Appellant in the Balance Sheets as an adjustment
to the total carrying value of the appropriate class of
investments.
29. Under the Rules, gains and losses arising on dispositions
of bonds and mortgages by the Appellant to arm's length
purchasers are required to be deferred and amortized into
earnings (and are not recognized and included in earnings in the
year of disposition). Only a prescribed portion of such gains and
losses is amortized and included in the earnings of the Appellant
in the year of disposition, with the balance being deferred and
amortized into earnings in subsequent years on a periodic basis.
In the case of gains (and losses) on bonds and mortgages, the
amount of the gain (or loss) is amortized into earnings in equal
amounts over a period equal to the lesser of twenty years or the
period to maturity of the investment disposed of. The amounts of
such gains and losses that were deferred and remained unamortized
by the Appellant in its Balance Sheets are the Unamortized Gains
on Bonds and the Unamortized Losses on Mortgages.
30. Under the Rules, such a deferral and amortization of gains
and losses is not effected by way of an inclusion of the gain or
loss in the Income Statement in the year of disposition followed
by a deduction of the deferred portion of the gain or loss as an
expense in the Income Statement or as an appropriation of
retained earnings or surplus in the Surplus Statement in that
year. Rather, only a prescribed portion of the gains and losses
for that year and all prior years is required to be amortized and
included in the earnings of the Appellant in the Income Statement
for that year. The prescribed portion is determined in a Schedule
in the Annual Statement.
31. Where a bond or mortgage is acquired at a premium or
discount relative to its principal amount, the Rules require such
premium or discount to be amortized into earnings on a
"yield to maturity" basis over the term to maturity of
the investment and to be deducted from or added to the carrying
value of the investment in the Balance Sheet to that extent. The
Rules do not require unrealized increases or decreases in the
market value of a bond or mortgage to be amortized into earnings
prior to the disposition of the investment.
32. Under the Rules, the Unamortized Gains on Shares and the
Unamortized Gains on Real Estate were required to be, and were,
reported as an adjustment to the total carrying value of the
appropriate class of investments.
33. Under the Rules, gains and losses arising on dispositions
of shares or real estate investments to arm's length
purchasers are required to be deferred and amortized into
earnings (and are not recognized and included in earnings in the
year of disposition). Only a prescribed portion of such gains and
losses is amortized and included in the earnings of the Appellant
in the year of disposition, with the balance being deferred and
amortized into earnings in subsequent years at a uniform rate on
a declining balance basis. In the case of gains on shares, the
amount of the gain is amortized into earnings at the rate of 15%
per year of the unamortized balance of such gains. In the case of
gains on real estate, the amount of the gain is amortized into
earnings at the rate of 10% per year of the unamortized balance
of such gains. The amounts of such gains and losses that were
deferred and remained unamortized by the Appellant in its Balance
Sheets are the Unamortized Gains on Shares and the Unamortized
Gains on Real Estate.
34. Under the Rules, such a deferral and amortization of gains
and losses is not effected by way of an inclusion of the gain or
loss in the Income Statement in the year of disposition followed
by a deduction of the deferred portion of the gain or loss as an
expense in the Income Statement or as an appropriation of
retained earnings or surplus in the Surplus Statement in that
year. Rather, only a prescribed portion of the gains and losses
for that year and all prior years is required to be amortized and
included in the earnings of the Appellant in the Income Statement
for that year. The prescribed portion is determined in a Schedule
in the Annual Statement.
35. The Rules also require that unrealized increases and
decreases in the fair market values of shares or real estate
investments be recognized and amortized into earnings in the
Income Statement at the rate of 15% per year for shares and 10%
per year for real estate investments, in each case, on a
declining balance basis. The Rules require that amounts so
amortized into earnings be added to or deducted from the total
carrying value of the appropriate class of investments in the
Balance Sheet to that extent.
36. This method of accounting for premiums and discounts, for
realized gains and losses arising on the sale or other
disposition of investments of a life insurer and for unrealized
increases and decreases in the fair market values of investments
of a life insurer follows a long-standing accounting practice
that pre-dates the enactment of Parts I.3 and VI of the
Act, that is considered to be appropriate for the life
insurance industry and that is reflected in the form of the
Annual Statement (and the Balance Sheet, the Income Statement and
the Surplus Statement included therein) required by the Rules.
The underlying accounting principles reflected in the Rules have
since been adopted as generally accepted accounting principles
for the accounting of investments of a life insurer.
37. This accounting practice reflects several unique
characteristics of a life insurer's business: the long-term
nature of the life insurance business and the assets and
liabilities forming part of that business, that a life insurer
does not generally suffer a net reduction in its investments
(with the proceeds of any sale or other disposition of
investments being used by the life insurer to make similar
investments), and that a life insurer's investment objectives
are to match the term of its investments with the term of its
insurance or policy liabilities and produce investment returns
(by way of interest, dividends, rents and other income, gains and
profits) over that term to support its policy liabilities.
38. Under this accounting practice, premiums and discounts,
realized gains and losses and, in the case of shares and real
estate investments, increases and decreases in fair market
values, are considered to be earned (and are recognized as
earnings) over a period commencing with the year of acquisition
of an investment (and not just in the year of maturity, sale or
other disposition of an investment) and, where the investment
sold or otherwise disposed of had a specified term to maturity,
over the period to that maturity date of the investment or, in
any other case, over subsequent years, in each case, as
prescribed by the Rules.
39. Under this accounting practice, any gain or loss realized
on the sale or other disposition of an investment merely reflects
the lower or higher return available on the reinvestment of the
sale proceeds over the longer term and the full amount of such
gains or losses is not considered to be earned and is not
recognized as earnings in the year of sale or other disposition.
That is, a portion of such amount must be deferred (even though
realized) and is not considered to be earned and may not be
recognized as earnings in the life insurer's financial
statements until (and then only to the extent that) the deferred
amount is amortized into the life insurer's earnings as
described herein.
40. Under this accounting practice, premiums and discounts on
bond and mortgage investments and any unrealized increases and
decreases in the market values of share and real estate
investments are considered to be earned and are recognized as
earnings, in part, as (and then only to the extent that) such
amounts are amortized into the life insurer's earnings over
the period commencing with the year of acquisition of the
investment and prior to the sale of the investment. That is, a
portion of any such amount in respect of an investment is
considered to be earned and must be recognized as earnings in the
life insurer's financial statements (even though unrealized)
prior to its being realized on maturity or through a sale or
other disposition of the investment.
41. The result of this accounting method is that such premiums
and discounts, realized gains and losses and unrealized increases
and decreases in value in respect of investments of a life
insurer are considered to be earned and are recognized as
earnings in the life insurer's financial statements in a
periodic manner commencing with the year of acquisition of an
investment (and not just in the year of maturity, sale or other
disposition of an investment) and over subsequent years, in each
case, as prescribed by the Rules.
42. The generally accepted actuarial practices that form the
basis for the actuarial valuation of a life insurer's policy
liabilities are consistent with the method of accounting for
premiums and discounts, realized gains and losses and unrealized
increases and decreases in value in respect of investments of a
life insurer and are unique to life insurance companies and
reflect the unique characteristics of the life insurance business
described herein.
43. In accounting terminology, a "reserve" is
defined to mean an amount which, though not required to meet a
liability or contingency known or admitted or a decline in value
that has already occurred, has been appropriated from retained
earnings or other surplus, at the discretion of management or
pursuant to the requirements of a statute, the instrument of
incorporation or by-laws of a corporation, a trust indenture or
other agreement, for a specific or general purpose such as future
decline in inventory values, general contingencies, future plant
extension and redemption of stocks and bonds. Under accounting
principles applicable to the Appellant and to the preparation of
the Annual Statements, the Appellant's Unamortized Gains on
Bonds, Unamortized Gains on Shares and Unamortized Gains on Real
Estate are not "reserves". The Appellant's
Unamortized Gains on Bonds, Unamortized Gains on Shares and
Unamortized Gains on Real Estate are established before the
Appellant's earnings are ascertained in the Income Statements
and are not considered to be earned, are not an expense in the
Income Statements, and are not appropriations of retained
earnings or other surplus of the Appellant made in the Surplus
Statements.
44. In accounting terminology, a "provision" is
defined to mean (i) an estimated expense that is a charge for
diminution in value of an asset or for an estimated or accrued
liability, or (ii) an estimated amount set up in recognition of a
liability whose extent and timing are uncertain. Under accounting
principles applicable to the Appellant and to the preparation of
the Annual Statements, the Appellant's Unamortized Gains on
Bonds, Unamortized Gains on Shares and Unamortized Gains on Real
Estate are not "provisions". The Appellant's
Unamortized Gains on Bonds, Unamortized Gains on Shares and
Unamortized Gains on Real Estate are not an expense of the
Appellant, are not a charge for diminution in value of an asset
or for an estimated or accrued liability and are not set up in
recognition of a liability of the Appellant the extent and timing
of which is uncertain.
45. In accounting terminology, an "allowance" is
defined to mean (i) a deduction from the recorded value of assets
to reduce them to estimated realizable value, (ii) a stipulated
amount paid to an employee or agent under an arrangement in
respect of expenses, regardless of the expenses actually
incurred, or (iii) a form of price reduction in respect of a sale
of goods or services, e.g. an allowance to compensate for
expenses such as advertising to be incurred by the purchaser.
Under accounting principles applicable to the Appellant and to
the preparation of the Annual Statements, the Appellant's
Unamortized Gains on Bonds, Unamortized Gains on Shares and
Unamortized Gains on Real Estate are not "allowances".
The Appellant's Unamortized Gains on Bonds, Unamortized Gains
on Shares and Unamortized Gains on Real Estate are not
established by the Appellant to reduce the recorded or carrying
value of its assets to their estimated realizable value and are
not amounts paid to employees or agents and are not price
reductions in respect of the sale of goods or services.
46. In accounting terminology, "surplus" is the
excess of net assets over the total paid-in par value or stated
value of the shares of a corporation. Under accounting principles
applicable to the Appellant and to the preparation of the Annual
Statements, the Appellant's Unamortized Gains on Bonds,
Unamortized Gains on Shares and Unamortized Gains on Real Estate
are not "surplus". The Appellant's Unamortized
Gains on Bonds, Unamortized Gains on Shares and Unamortized Gains
on Real Estate are netted against, and reduce, the total carrying
values of its assets or investments and do not form part of the
Appellant's net assets in the Balance Sheets, are not
considered to be earned (and are not recognized as earnings) by
the Appellant until such amounts are amortized into the
Appellant's earnings in its Income Statements and are not
appropriations of retained earnings or other surplus of the
Appellant made in the Surplus Statements.
47. A life insurer's policy liabilities are its future
liabilities in respect of its life insurance policies. The extent
and timing of such liabilities is uncertain. The amount of such
liabilities determined by actuarial valuation is an estimated
amount established to meet the life insurer's future
liabilities in respect of its life insurance policies, and is
reported as part of the life insurer's
"Liabilities" in its Balance Sheet included in its
Annual Statement for the year then ended.
48. A life insurer's policy liabilities that may
reasonably be regarded as having been established in respect of
the life insurer's insurance business carried on in Canada
are required to be included in calculating the life insurer's
taxable capital employed in Canada as defined for the purposes of
Parts I.3 and VI of the Act pursuant to subclause
181.3(1)(c)(ii)(B)(I) and clause 190.11(b)(ii)(A)
of the Act, respectively, except to the extent such
amounts are deductible under Part I of the Act.
49. A life insurer's deferred realized gains and losses on
its investments are not part of its policy liabilities.
50. In the life insurance industry and a life insurer's
annual financial statements, a life insurer's policy
liabilities are also referred to as its "actuarial
reserves" or "policy reserves". Increases in a
life insurer's policy liabilities (or actuarial reserves)
over a year are an expense in the Income Statement for the
year.
51. In the life insurance industry and a life insurer's
annual financial statements, a life insurer's deferred
realized gains and losses on its investments are not referred to
as "reserves", "provisions",
"allowances" or "surplus". Increases in a
life insurer's deferred realized gains over a year are not an
expense in the Income Statement for the year and are not an
appropriation of retained earnings or surplus made in the Surplus
Statement for the year.
52. A life insurer is permitted a deduction "as a policy
reserve" for its policy liabilities in respect of its life
insurance policies in computing its income under Part I of
the Act to the extent prescribed in the regulations made
under the Act.
53. A life insurer's realized gains and losses on such of
its investments as are, for the purposes of Part I of the
Act, used by it in, or held by it in the course of,
carrying on its life insurance business in Canada are included in
computing its income under Part I of the Act in the year
such gains and losses are realized even though such amounts may
be deferred and not considered to be earned in that year under
the accounting principles applicable to the life insurer and the
preparation of its Annual Statements. No deduction in computing
the life insurer's income under Part I of the Act as a
reserve or otherwise is permitted in respect of such deferred
realized gains or losses, and no such deduction was claimed by
the Appellant as a reserve or otherwise under Part I of the
Act in respect of such deferred realized gains and
losses.
SUBMISSIONS OF COUNSEL FOR THE APPELLANT:
[3] Capital taxes for a taxation year are imposed on the
Appellant as a percentage of its "taxable capital employed
in Canada" for the year. In general terms, the
Appellant's "taxable capital employed in Canada"
for a year is equal to the sum of
(i) the carrying value of the Appellant's tangible
property used in Canada (the meaning of which is not an issue in
this appeal),
(ii) the Canadian proportion (described below) of the
Appellant's "taxable capital" for the year
(described below), and
(iii) the amount, if any, by which the Appellant's
"reserves" for the year (a defined term) in respect of
its insurance business carried on in Canada exceed the amount of
its reserves that are deductible (or have been deducted) in
computing its income under Part I of the Act.
[4] The expression "taxable capital" for a year is
equal to the taxpayer's "capital", net of certain
deductions not relevant to this appeal. A taxpayer's
"capital" is defined to include its world-wide
"retained earnings, contributed surplus and any other
surpluses" as at the end of the year. However, only the
Canadian proportion of its "taxable capital" is
included in its "taxable capital employed in Canada"
for the year. The Canadian proportion is equal to the proportion
that the Appellant's Canadian policy liabilities (determined
as prescribed in the capital tax rules) as at the end of the
taxation year are of its total policy liabilities (determined as
prescribed in the capital tax rules) as at the end of that
year.
[5] The Appellant submits that its net deferred realized gains
are neither "reserves" (which are defined to mean
"reserves, provisions and allowances") nor "any
other surpluses" (which are not defined), and, therefore,
are not required to be included in computing its capital tax base
pursuant to those rules.
[6] The parties agree that the Appellant's net deferred
realized gains are not "reserves",
"provisions", "allowances" or a
"surplus" under accepted accounting meanings and the
accounting principles applicable to the preparation of the
Appellant's annual financial statements (and its balance
sheets). The issue for determination is whether the meaning to be
given to those words for the purposes of the capital tax rules is
the accepted accounting meaning or whether those words have some
other meaning for the purposes of the capital tax rules that
would include the Appellant's net deferred realized
gains.
[7] To consider the proper characterization of net deferred
realized gains in the context of the capital tax rules, it is
helpful to review the financial reporting requirements for life
insurers, the nature of the life insurance business and its
policy liabilities, the role of investments and investment
returns in that business and the accounting method for
investments of a life insurer all as described in the Agreed
Statement of Facts.
[8] Subparagraph 181(3)(b)(ii) of the Act states
that, for the purposes of determining the carrying value of a
life insurer's assets or any other amount for the purposes of
the capital tax rules in Part I.3, the amounts reflected in the
balance sheets accepted by the Superintendent are required to be
used.
[9] The Annual Statements (including the Balance Sheets, the
Income Statements and the Surplus Statements) were prepared and
filed as required by the Rules in the form prescribed and
accepted, as filed, by the Superintendent.
[10] The accounting principles underlying the Rules reflected
a long-standing accounting practice considered to be appropriate
for the life insurance industry. The accounting practice is
prescribed by the rules and reflects the unique characteristics
of the life insurance business. It is reflected in the form of
the annual financial statements and applied to the Appellant in
the years under appeal.
[11] The accounting practice prescribed by the Rules pre-dates
the enactment of the capital tax rules.
[12] Consistent with the method of amortization before
maturity or disposition, the Rules also require that gains and
losses arising on dispositions of bonds and mortgages by the
Appellant to arm's length purchasers be deferred and
amortized into earnings in the Income Statements beginning with
the year of disposition in equal amounts over a period equal to
the lesser of twenty years or the period to maturity of the
investment disposed of. As noted above, each year, when the
requisite portion is recognized as earned in the Income
Statements, it is added to or deducted from retained earnings and
the Canadian proportion of such retained earnings is included in
the life insurer's capital tax base.
[13] Similarly, gains and losses arising on dispositions of
shares or real estate investments by the Appellant to arm's
length purchasers are required to be deferred and amortized into
earnings in the Income Statements at a uniform rate beginning
with the year of disposition. The rate is 15% for shares and 10%
for real estate per year of the unamortized balance of such gains
(on a declining balance basis). As in the case of bonds and
mortgages, each year, when the requisite portion is recognized as
earned in the Income Statements, it is added to or deducted from
retained earnings and the Canadian proportion of such retained
earnings is included in the life insurer's capital tax
base.
[14] This method of accounting for investments and investment
returns of a life insurer prescribed by the Rules
(i) presents fairly the financial position of the life
insurer,
(ii) is consistent with the actuarial valuation of the life
insurer's policy liabilities,
(iii) is even-handed in its recognition of both realized and
unrealized investment returns as earnings and retained earnings
of the life insurer,
(iv) is even-handed in its effects on the carrying values of
investments of the life insurer, and
(v) is even-handed in its effects on the capital tax base of
the life insurer.
[15] This method of accounting is even-handed in its
recognition of premiums and discounts, gains and losses and
increases and decreases in value as earnings of a life insurer in
its Income Statements and as retained earnings in its Balance
Sheets. As described above, such returns are brought into
earnings in the Income Statements and are added to or deducted
from retained earnings in a periodic manner, regardless of
whether such amounts have been realized or are unrealized.
[16] As described above, it also produces even-handed effects
on the retained earnings of a life insurer in that it requires
the deferral and amortization of investment returns that would
reduce earnings and retained earnings (unrealized premiums,
unrealized decreases in value and net realized losses) in the
same way that it requires the deferral and amortization of
investment returns that would increase earnings and retained
earnings (unrealized discounts, unrealized increases in value and
net realized gains).
[17] This method of accounting produces even-handed effects on
the total carrying values of a life insurer's investments in
that, as described above, it requires the deferral and
amortization of investment returns that would decrease total
carrying values (unrealized premiums, unrealized decreases in
value and net realized losses) in the same way that it requires
the deferral and amortization of investment returns that would
increase total carrying values (unrealized discounts, unrealized
increases in value and net realized gains).
[18] This method of accounting produces even-handed effects on
the retained earnings of a life insurer and, therefore, on its
capital tax base in that, as described above, it requires the
deferral and amortization of investment returns that would
decrease retained earnings (unrealized premiums, realized
decreases in value and net realized losses) in the same way that
it requires the deferral and amortization of investment returns
that would increase retained earnings (unrealized discounts,
unrealized increases in value and net realized gains).
[19] The Appellant's net deferred realized gains were not,
and were not required by the Rules to be, reported by the
Appellant as part of the "Liabilities" or the
"Capital, Surplus and Reserves" of the Appellant in its
Balance Sheets.
[20] The principal issue is whether or not the Appellant's
net deferred realized gains shown in its Balance Sheets are
"reserves" (defined to mean "reserves, provisions
and allowances") or "any other surpluses" of the
Appellant for the purposes of the capital tax rules.
[21] The taxes payable under Parts I.3 and VI of the
Act by a Canadian resident life insurer are specified as
percentages of the amount, if any, by which its "taxable
capital employed in Canada" for the year exceeds its
"capital deduction" for the year.
[22] The Appellant's "taxable capital employed in
Canada" for a year includes:
(i) the Canadian proportion of the Appellant's
"capital" (net of certain deductions not relevant to
this appeal) for the year (which includes "any other
surpluses"), and
(ii) the amount, if any, by which the Appellant's
"reserves" for the year (which are defined to mean
"reserves, provisions and allowances") in respect of
its insurance business carried on in Canada exceed the amount of
its reserves that are deductible (or have been deducted) in
computing its income under Part I of the Act.
Subsections 181.3(1), (2), (3)
[23] For the purposes of Part I.3 of the Act,
subsection 181(1) states that "reserves" means and is,
therefore, limited to:
the amount at the end of the year of all of the
corporation's reserves, provisions and allowances (other than
allowances in respect of depreciation or depletion) and, for
greater certainty, includes any provision in respect of deferred
taxes.
[24] The terms "reserves", "provisions"
and "allowances" that make up the definition of
"reserves" are not defined. Further, there is no
definition of "any other surpluses" for the purposes of
this Part.
[25] Subsection 181(3) of the Act provides that, for
the purposes of determining any amount under Part I.3 of the
Act in respect of, among other things, the
"capital" of a life insurer (which includes "any
other surpluses" of the life insurer) and the "taxable
capital employed in Canada" of a life insurer (which
includes the "reserves" of the life insurer), the
amounts reflected in the balance sheet accepted by the
Superintendent must be used (that is, in the case of the
Appellant, the Balance Sheets of the Appellant accepted by the
Superintendent).
[26] The provisions of Part VI that are relevant to the issues
in this appeal are, in all material respects, the same as, and
correspond to, the relevant provisions in Part I.3.
[27] As a result, with respect to the issues in this appeal,
Parts I.3 and VI of the Act are to be interpreted in a
consistent manner, and the Appellant's submissions apply
equally to Parts I.3 and VI of the Act for the years under
appeal.
[28] With respect to the principal issue in this appeal, the
Appellant submits that its net deferred realized gains are not
"reserves, provisions and allowances" and are not
"any other surpluses" for the purposes of the capital
tax rules. In the absence of any definition, in accordance with
statutory interpretation principles, "reserves, provisions
and allowances" and "any other surpluses" are to
be interpreted for the purposes of the capital tax rules in
accordance with the ordinary meaning of those words for
accounting purposes, and, in particular, in accordance with the
accounting principles and methods prescribed by the Rules,
reflected in the Annual Statements and Balance Sheets of a life
insurer and accepted by the Superintendent. As the parties have
agreed that, in accordance with those accounting principles and
methods, the Appellant's net deferred realized gains are not
"reserves", "provisions" or
"allowances" and are not a "surplus", this
appeal should be allowed.
[29] There is no express inclusion of deferred realized gains
as "reserves" or as a "surplus" for the
purposes of the capital tax rules. Therefore, the Appellant's
net deferred realized gains will only be required to be included
in its "capital" or "taxable capital employed in
Canada" if they fall within the meaning of "reserves,
provisions and allowances" or "any other
surpluses" for the purposes of the capital tax rules.
[30] As these are undefined terms, it is respectfully
submitted that their meaning must be determined by applying
general principles of statutory interpretation.
[31] The Supreme Court of Canada has set out the proper
approach to ascertaining the meaning of words used in a statute
in Stubart Investments Limited v. The Queen and many
subsequent decisions. In Stubart, addressing the
interpretation of words in the Act, the Court cited
Driedger, Construction of Statutes, as putting the modern
rule succinctly:
... there is only one principle or approach, namely, the
words of an Act are to be read in their entire context and in
their grammatical and ordinary sense harmoniously with the scheme
of the Act, the object of the Act, and the intention of
Parliament.
Stubart Investments Limited v. The Queen, [1984]
1 S.C.R. 536 at 578
[32] It has long been established by the Courts that the
"ordinary sense" of a word is to be determined by
reference to the matters dealt with by the statutory provision
and the persons to whom it is addressed.
[33] Commercial and financial terms, particularly when used in
the Act, are interpreted in accordance with their
accounting meanings. In Bank of Nova Scotia v. The Queen,
the Federal Court of Appeal considered the timing and method of
computing certain foreign tax credits pursuant to section 126 of
the Act and, in particular, the undefined word
"paid" in the statutory provisions in issue. The Court
stated:
Wherever a term is not defined in the Act, then, unless the
context otherwise requires, it must be given its common ordinary
meaning and, where the term is a common commercial or financial
one its meaning must be determined according to ordinary
commercial or financial principles.
...
Generally recognized accounting and commercial principles and
practices are to be applied to all matters of commercial and
taxation accounting unless there is something in the taxing
statute which precludes them from coming into play. The
legislator when dealing with financial and commercial matters in
any enactment, including of course a taxing statute, is to be
presumed at law to be aware of the general financial and
commercial principles which are relevant to the subject-matter
covered by the legislation. The Act pertains to business and
financial matters and is addressed to the general public. It
follows that where no particular mention is made as to any
variation from common ordinary practice or where the attainment
of the objects of the legislation does not necessarily require
such variation, then common practice and generally recognized
accounting and commercial principles and terminology must be
deemed to apply.
Bank of Nova Scotia v. The Queen, [1980] C.T.C. 57 at
59 and 62 (F.C.T.D.), affirmed [1982] 1 F.C. 311 at 318
(F.C.A.)
[34] The Appellant submits that the words in the phrase
"reserves, provisions and allowances" and
"retained earnings, contributed surplus and any other
surpluses" as used in the capital tax rules are commercial
or financial terms. The capital tax rules only apply to financial
institutions and large corporations, and rely on financial
statements and accounting principles. The other references to
"allowances in respect of depreciation and depletion"
and to "any provision in respect of deferred taxes" are
further confirmation of the commercial or financial nature of
these terms. As the words "any other surpluses" are
preceded by the words "retained earnings" and
"contributed surplus", the words "any other
surpluses" must also be considered to be commercial or
financial terms in accordance with the ejusden generis
doctrine.
Sullivan, Driedger on the Construction of Statutes,
(3rd ed., Butterworths) at 203
[35] In using the undefined words "reserves",
"provisions" and "allowances" and "any
other surpluses" for the purposes of the capital tax rules
on large corporations and financial institutions, the legislator
has selected commercial or financial terms with a specific
meaning for accounting purposes.
[36] The accounting meanings of the words "reserves"
and "surplus" have been consistently adopted by
Canadian courts for purposes of capital tax statutes using the
statutory interpretation principles set out.
[37] In the recent case of Oerlikon Aérospatiale
Inc. v. The Queen, both the Tax Court and the Federal Court
of Appeal specifically considered the meaning of the defined term
"reserves" in Part I.3 of the Act. The Minister
argued that only "reserves" in the accounting sense are
contemplated by Part I.3 (contrary to the Minister's position
in this appeal), whereas the taxpayer had argued that
"reserves" in a tax sense should also be included.
Neither party argued (as the Minister now does in this appeal)
that the defined term "reserves" had a meaning broader
than one that included "reserves" in either a tax or
accounting sense. The Minister succeeded at trial. The Tax Court
Judge noted that the terminology used in the Act to
identify the component parts of the capital tax base is that used
by accountants in preparing a balance sheet and held that
"... the meaning to be given to the words
"reserves" and "provisions" in subsection
181(1) of the Act must be the accounting, not the tax
meaning.
Oerlikon Aérospatiale Inc. v. The Queen, [1998]
4 C.T.C. 2821 at 2834 and 2840, (T.C.C.)
[38] The relevant provision in issue was paragraph
181.2(3)(b), which requires that "reserves" be
included in the capital tax base of a non-financial institution
"except to the extent that they were deducted in computing
its income for the year under Part I". The Federal Court of
Appeal concluded that the Tax Court Judge had reached the correct
conclusion, but reasoned as follows with respect to the defined
term "reserves":
As can be seen, with the exception of depreciation and
depletion, this definition is wholly unlimited in scope and
suggests at first glance that any amount which forms part of a
corporation's reserves is contemplated by Part I.3. This
would include all reserves and allowances, whether they be
accounting reserves or tax reserves.
...
Despite this, it is clear that the Tax Court judge properly
held that under paragraph 181.2(3)(b), only accounting reserves
which have not given rise to a deduction under Part I must be
added to the computation of the capital of a corporation:
... Even though by including reserves in the tax sense in
Part I.3 only to deduct them from the computation of the capital,
Parliament seems to have taken a circuitous route, the fact
remains that the result arrived at by the Tax Court Judge follows
from a straightforward reading of the relevant provisions,
without adding anything whatsoever to them.
[39] While the Federal Court of Appeal concluded that,
"at first glance" the defined term "reserves"
was broad enough to include "reserves",
"provisions" and "allowances" in both an
accounting and a tax sense, it did not conclude that a broader
meaning than that could apply. Its conclusion that the Tax Court
Judge "properly" held that only reserves in an
accounting sense that were not deductible under Part I must be
added to the computation of the capital tax base follows only if
the defined term "reserves" is limited to reserves in
an accounting sense and reserves in a tax sense. The Court went
on to find that, while the legislators took a circuitous route,
ultimately only reserves in an accounting sense are to be
included in the capital tax base since, although reserves in a
tax sense are included in the meaning of the word, they are not
included in the capital tax base (because they arise by
definition, only if they have been deducted in computing income
under Part I of the Act and are therefore expressly
excluded form the capital tax base).
[40] The Appellant's net deferred realized gains are not
"reserves in a tax sense" as defined by the Federal
Court of Appeal in Oerlikon because no deduction was
claimed by the Appellant under Part I of the Act as a
reserve or otherwise in respect of such deferred realized gains
and losses. As such, the only remaining meaning that could be
applicable to the Appellant's net deferred realized gains is
"reserves in an accounting sense". The parties have
agreed that the Appellant's net deferred realized gains are
not "reserves", "provisions" or
"allowances" under the applicable accounting
principles.
[41] Parts I.3 and VI of the Act incorporate financial
statements and the accounting terminology underlying such
statements as the basis for the imposition of capital taxes under
those Parts, rather than the income taxation concepts applicable,
for example, in the determination of income for the purposes of
Part I of the Act. Under Parts I.3 and VI of the
Act, the capital tax base is calculated using amounts from
financial statements prepared in accordance with accepted
accounting principles.
In general terms, a corporation is required to compute amounts
relevant in determining its tax payable under Part I.3 of
the Act using generally accepted accounting principles
(GAAP).
Canada, Department of Finance, Explanatory Notes to a Ways
and Means Motion Amending the Income Tax Act and Related Acts
(Ottawa: the Department, June, 1996) at 270
[42] In the case of a life insurer, the accepted accounting
principles are those prescribed by the Rules and reflected in the
Annual Statements and Balance Sheets accepted by the
Superintendent. This is evident in subsection 181(3) of the
Act, which provides that, in the case of a life insurer,
for the purpose of determining any amount under Part I.3 of the
Act, the amounts reflected in the life insurer's
Balance Sheets accepted by the Superintendent are to be used.
[43] This method of accounting is a long-standing accounting
practice considered to be appropriate for the life insurance
business. It pre-dates the enactment of the capital tax rules,
and those rules do not contain any express provisions precluding
the use of this accounting method for capital tax purposes (as
was done, for example, to preclude the use of the equity and
consolidation methods of accounting). In fact, the capital tax
rules are express in their reliance on such Balance Sheets for
life insurers. In the absence of any express statutory provisions
to the contrary, this accounting method must be considered to
have been accepted by Parliament for the purposes of the capital
tax rules applicable to life insurers.
[44] In summary, the Appellant submits that the use of
accounting meanings to interpret the undefined commercial or
financial terms used in the capital tax rules that are in issue
in this appeal is the correct approach for the following
reasons:
(i) The use of accounting meanings is consistent with the
scheme of the capital tax rules in the Act. As described
above, this produces a consistent and coherent framework for the
capital tax rules. The capital tax rules are not based on income
tax concepts but are based on financial statements and concepts
and accepted accounting principles.
(ii) The use of accounting meanings is consistent with
established rules of law in the capital tax context. As described
above, in interpreting undefined commercial or financial terms
used in the context of capital tax, courts have consistently
adopted accounting meanings and have rejected broader meanings.
In none of the cases cited have the courts adopted, for capital
tax purposes, any rules of law established in the income tax
context in respect of the determination of profit.
(iii) The use of accounting meanings is consistent with
well-accepted business principles in the life insurance industry.
This accounting method used by the Appellant reflects a
long-standing practice in the life insurance industry that
pre-dates the capital tax rules and is required under the
applicable laws. The underlying accounting principles have been
adopted by the CICA as being generally accepted accounting
principles in Canada for life insurers.
(iv) And, this accounting method produces an even-handed
picture of the Appellant's capital tax base. It presents
fairly the financial position of the Appellant, is consistent
with the actuarial valuation of the Appellant's policy
liabilities and produces even-handed effects on the
Appellant's capital tax base.
SUBMISSIONS OF COUNSEL FOR THE RESPONDENT:
[45] The following are excerpts from Respondent's written
submissions:
2. The position of the Respondent is that:
(1) The deferred realized gains [DRG] are "reserves"
or "other surpluses" because the interpretation of
these words in the context of Parts I.3 and VI is not limited to
whether their presentation in the statements acceptable to the
Superintendent of Insurance cause them to be "reserves"
or "other surpluses" for insurance accounting purposes;
these gains have been fully realized and are deferred or
unamortized only for insurance accounting purposes; which is
oriented to solvency-based financial reporting.
...
Background
Department of Finance Technical Notes - Application of Tax
to Financial Institutions
3. The Large Corporations Tax will also be levied on financial
institutions, including insurance corporations. The form of the
tax as it will apply to financial institutions and insurance
companies reflects the dual uses of capital in their business.
Such firms operate as financial intermediaries for which a
financial capital base is required, and generally also use
capital to finance physical assets that are used in their
intermediation business and/or for lease or rent. The new tax
will apply to both of these uses of capital by a financial
institution.
4. For financial institutions (as currently defined under
Part VI of the Income Tax Act and other prescribed financial
corporations) and insurers, capital will include the financial
capital employed by the institution in supporting its financial
activities. The financial capital employed by these institutions
will be similar to capital for Part VI purposes, and generally
consists of the share capital, retained earnings, surpluses,
reserves (other than those which are deducted for tax purposes)
and outstanding long-term debt of the institution at the end of
its taxation year. Deposits and similar liabilities, and
policy reserves (deductible for income tax purposes) in respect
of insurance policies will not be included in financial capital.
Financial capital will be reduced by an investment allowance as
described below. [underlining added]
D.M. Sherman, ed. Income Tax Act, Department of Finance,
Technical Notes, 2nd Ed., (Toronto: De Boo, 1990)
at 840-42.
...
Approach to Interpretation - significance of GAAP
definitions
...
10. It is submitted that the Supreme Court of Canada has
determined that it is a truer picture of profit that will be the
test of any method of income computations. This is a legal
determination that must be made according to the provisions of
the Income Tax Act, established case law principles or
"rules of law" and well established business principles
which include, but are not limited to GAAP. By analogy, it is the
truer picture of capital that should be the test of any method of
capital computation.
11. GAAP is of even less significance for this appeal because
subparagraph 181(3)(b)(ii) states only that "the amounts
reflected in the balance sheet" accepted by the
Superintendent of Insurance shall be used to determine the
carrying value of assets or any other amount. The paragraph does
not state that the accounting treatment appropriate for the
requirements of the Superintendent of Insurance is determinative
for the purposes of Part I.3, rather, it has the more limited
effect that amounts "reflected" in the balance sheet
are the basis for determining the numerical values. This wording
contrasts with the specific reference to "prepared in
accordance with GAAP" applicable to other corporations. The
lack of significance is an appropriate result because
GAAP/Superintendent of Insurance reporting requirements do not
focus on capital tax purposes. They are concerned with solvency.
Only the reflected amounts are relevant for capital tax
purposes.
...
14. The term "Reserve" is defined in the Act.
Subsection 181(1) defines reserves as follows:
"reserves" in respect of a corporation for a
taxation year, means the amount at the end of the year of all of
the corporation's reserves, provisions and allowances (other
than allowances in respect of depreciation or depletion) and, for
greater certainty, includes any provision in respect of deferred
taxes.
15. Dealing first with the concept of reserves, of particular
significance is that "reserve" is defined in the
Dictionary of Insurance published by The Insurance Institute of
Canada (1991) as "[f]unds which are set aside by an
insurance company for the purpose of meeting obligations as they
fall due". The DRG clearly fall within this industry
definition.
16. This is in conformity with a widely accepted commercial
definition of "reserves": "[f]unds set aside to
cover future expenses, losses, claims or liabilities".
Black's Law Dictionary, cited in Canadian
Pacific Limited v. Ontario (Minister of Revenue),
99 D.T.C. 5286 at 5291.
17. Further, the subparagraph excludes from the capital tax
base, any reserve that has been deducted in computing Part I tax.
Therefore it draws into the consideration of the meaning of
"reserve" for purposes of Part I.3, the particular
regime established in respect of accounting for reserves under
Part I of the Act. Note the reference to policy reserves
allowed by regulation and policy loans. These Regulation 1401
reserves include "reserves" which are not in accord
with the CICA definition. The same applies to "actuarial
reserves" which are not taken from surpluses or retained
earnings.
18. It is submitted that the reserves set out under Part I are
not GAAP reserves in that they are not appropriations from
retained earnings, but rather, deductions from the computation of
income, as noted in the following paragraph.
19. A summary analysis of the comparison of the term
"reserve" as used in the accounting sense and as used
for tax purposes can be found in Harris on Canadian Income
Taxation, 4th ed., wherein it states at page
439:
[t]raditionally the term "reserve" was used by
accountants to refer to a wide range of provisions in the
accounts of financial statements for the possible, or probable,
occurrence of future events that would establish the existence of
an expense or loss. Conservative accounting required that
provision be made for any anticipated loss, so that it could be
treated as an expense, as soon as its occurrence appeared
reasonably likely. Because of the tax postponement that could
result if deductions of this nature were freely allowed for tax
purposes, the Act contains a general prohibition against the
deduction by a taxpayer, in computing his income, of "an
amount transferred or credited to a reserve, contingent account
or sinking fund except as expressly permitted by "Part
I...
In recent years, accountants have refined and limited the use
of the term "reserve". The only use of the term that is
now accepted in accounting is to refer to an amount that has been
transferred by book entry from retained earnings or other surplus
to a special shareholders' equity account and that is
intended to recognize the possibility of future losses or
expenses or to show that a portion of retained earnings cannot be
paid in dividends because of contractual or other legal
restrictions. If any such reserve account is no longer required,
its balance is returned to the shareholders' equity account
(e.g. retained earnings) from which it was originally derived. If
an event occurs of a kind for which the reserve was designed to
provide, the resulting cost is not charged against the reserve
account, since an expense was not recognized at the time that the
reserve account was set up; rather, an expense account must be
charged when the expenses materializes. Reserves, in this
accounting sense, must be distinguished from provisions made in
the accounts for expenses that are considered to have been
already incurred but the amount of which may need to be estimated
-- such as provisions for doubtful and accumulated
depreciation.
It is clear, however, that the term "reserve" as
used in the Act, though it is not defined, is being used in the
older, broader, and less precise sense and is intended to include
provisions for doubtful debts and the like ...
20. The term "reserves" used in Part I of the Act is
broader than the meaning of reserves in current accounting
terminology and indicates the broader concept which, it is
submitted, should be applied to the meaning of reserves under
Part 1.3. It is submitted that a broad interpretive approach of
the component elements that make up capital for purposes of Part
1.3 tax is consistent with the general scheme and intention of
Part 1.3 which is to bring into the tax base virtually every
source of capital available to a corporation in the conduct of
its business.
...
24. ... the term "any other surpluses" is found at
the end of the following list:
(ii) the amount of its capital stock (or, in the case of an
insurance corporation incorporated without share capital, the
amount of its members' contributions), retained earnings,
contributed surpluses and another other surpluses.
25. The CICA accounting recommendation itself notes that:
Dictionary definitions of the word "surplus" relate
to a remainder or excess, often in the sense of an arithmetical
difference rather than in the sense of a surfeit or
overabundance. In accounting, "surplus" has long been
used to designate the excess of net assets over the total paid-in
par value or stated value of the shares of a corporation. This
usage is firmly established in company law and finance, and is
not likely to be discontinued.
The convenient usage of the word surplus in the sense
indicated above is recognized.
26. It is submitted that the word "surplus" is a
general term essentially meaning the residue or excess of assets
after liabilities, including capital, have been deducted. The
term incorporates both capital surplus and earned surplus.
...
28. Paragraph 181.3(b)(ii) clearly includes earned and capital
surpluses in the requisite calculation of capital. Although those
terms by themselves are comprehensive, Parliament went further
and expressly enacted that "any other surplus" be
included as part of the capital. Accordingly, it is submitted
that a corporations surplus in any form must be included and it
is submitted that the amounts in question should therefore be
included.
29. In any event, the words "and any other
surpluses" do not have meaning if GAAP is used to interpret
the word "surplus" because under GAAP, there is no
other surplus except retained earnings and contributed surplus.
Therefore, the term "any other surpluses" must mean an
amount that is a surplus for other than GAAP purposes.
...
31. The word "surplus" is not defined in the Act. It
is submitted that it should be given its most reasonable
interpretation in accordance with the ordinary commercial and
financial principles, in the context of the surrounding
circumstances. The Appellant has realized the gains which
therefore represent part of the net assets or financial resources
available to it.
32. The Act requires only that the amounts determined in
accordance with the filing be used. There is no mention in
subsection 181(3) to characterization of the amount. To read
characterization into the provision would be to add words to the
section. Nowhere does it state that the terminology or
nomenclature is to be limited to GAAP or insurance
accounting.
...
ANALYSIS AND DECISION:
[46] Part I.3 of the Act levies a special tax on
corporations in respect of their capital in excess of $10 million
employed in Canada. This annual “Large Corporations
Tax” is payable in addition to the Part VI tax payable on
the capital of financial institutions.
[47] Under section 181.3, special rules apply in computing the
“taxable capital employed in Canada” of
a financial institution that carries on a life insurance
business. In order to calculate the amount of the “taxable
capital employed in Canada”, one needs, inter
alia, to look at the value of the corporation’s
“taxable capital” and
“reserves”.
[48] Paragraph 181.3(3)(b) defines
“capital” as follows.
181.3(3) The capital of a financial institution for a
taxation year is
...
(b) in the case of an insurance corporation that was
resident in Canada at any time in the year and carried on a life
insurance business at any time in the year, the amount, if any,
by which the total at the end of the year of
...
(ii) the amount of its capital stock ..., retained earnings,
contributed surplus and any other surpluses
exceeds the total of
...
[49] In summary, then, the large corporations tax is a sort of
minimum tax. The tax is imposed on a corporation’s capital.
Financial institutions carrying on a life insurance business
include the amount of “reserves” and
“other surpluses” in computing taxable
capital. The issue is what is included in taxable capital.
[50] Subparagraph 181(3)(b)(ii) of the Act
provides that all the relevant information for computing any
amount under Part I.3, including “taxable capital employed
in Canada”, is found in the balance sheet that has been
accepted by the Superintendent of Financial Institutions. The
subparagraph reads as follows.
181(3) For the purposes of determining the carrying value of a
corporation’s assets or any other amount under this
Part in respect of a corporation’s capital, investment
allowance, taxable capital or taxable capital employed in
Canada for a taxation year ...
(a) the equity and consolidation methods of accounting
shall not be used; and
(b) subject to paragraph (a) and except as
otherwise provided in this Part, the amounts reflected in the
balance sheet
...
(ii) accepted by the Superintendent of Financial Institutions,
in the case of a bank or an insurance corporation that is
required by law to report to the Superintendent, ...
shall be used.
[51] Subsection 181(1) defines certain terms applicable to
Part I.3 including “reserves”. The
subsection reads as follows.
181.(1) For the purposes of this Part,
“reserves”, in respect of a
corporation for a taxation year, means the amount at the end of
the year of all of the corporation’s reserves, provisions
and allowances (other than allowances in respect of depreciation
or depletion) and, for greater certainty, includes any provision
in respect of deferred taxes.
[52] In Oerlikon Aérospatiale Inc. v. R.,
referred to above, Archambault J.T.C.C. analyzed the meaning
of “reserves” under Part I.3. The
taxpayer corporation in Oerlikon received advances from
customers for long term defence equipment contracts and it was in
dispute as to how these advances were to be treated for tax
purposes.
[53] The corporation was not a financial institution and
therefore the rules for determining “taxable capital
employed in Canada” were different than those
governing this appeal. Regardless of this fact, the term
“reserves” was in issue and it has the
same meaning throughout Part I.3.
[54] Archambault, J. held that
“reserves” were defined in subsection
181(1) only in an accounting sense. The terminology in Part I.3
is generally to be interpreted in accordance with accounting
principles. He writes:
It therefore goes without saying that the terminology used in
the Act to identify the component parts of capital is that
used by accountants in preparing a balance sheet.
[55] The Federal Court of Appeal varied this analysis stating
that "reserves" should also include "tax
reserves" but did not go any further.
[56] The manner in which the Appellant's balance sheets
treated the unamortized gains was consistent with the Rules and
the accounting principles applicable to the Appellant. Further,
the Superintendent of Financial Institutions accepted the balance
sheets and in my opinion since the balance sheets contained a
Statement of Assets and a Statement of Liabilities, Capital and
Surplus, those statements, as accepted by the Superintendent are
to be relied on for purposes of determining the capital base of
the Appellant. The Appellant did not treat the unamortized
gains as a “surplus” or a
"reserve" in its balance sheets, and the Superintendent
in turn accepted the balance sheets.
[57] Parliament knew or is presumed to have known of the Rules
for preparation of balance sheets by life insurers as the Rules
predated the coming into force of the capital taxes in issue. In
fact the Instructions published by the Superintendent for the
Completion of the ANNUAL STATEMENT states as follows:
6. Statutory Accounting requirements/Generally Accepted
Accounting Principles
The Act and regulations framed thereunder specify the
statutory accounting and reporting requirements. The statutory
principles are oriented to solvency-based financial reporting.
The prescribed Annual Statement (Form OSFI-54) reflects these
legislative requirements. Other than in the defined areas of
differences covered in the legislation, the underlying basis for
accounting and financial reporting incorporated in the prescribed
form is intended to conform to Generally Accepted Accounting
Principles. ...
[58] Moreoever the unamortized gains in issue are only taken
into retained earnings on a periodic basis as described above. As
and when a portion of the gain is taken in, that portion becomes
capital since retained earnings are part of the capital base. It
would seem logical to conclude that before that time the realized
gains are not capital, because they have not under the Rules
become retained earnings.
[59] Again, as mentioned above, a life insurer's policy
liabilities that may reasonably be regarded as having been
established in respect of the life insurer's insurance
business carried on in Canada are required to be included in
calculating the life insurer's taxable capital employed in
Canada as defined for the purposes of Parts I.3 and VI of the
Act pursuant to subclause 181.3(1)(c)(ii)(B)(I) and
clause 190.11(b)(ii)(A) of the Act,
respectively, except to the extent such amounts are deductible
under Part I of the Act. It would appear unreasonable to
include not only policy liabilities in capital but also the
deferred unamortized gains which are established and deferred for
the purpose of meeting the policy liabilities.
[60] I have concluded for the above reasons, in particular
that the balance sheets must be relied on, that the
unamortized/deferred gains are not reserves nor other surpluses.
Therefore I will not address the issue of whether the Minister
was estopped from raising the issue of "other
surpluses" only in the Amended Reply after the dates for
reassessing had expired.
[61] Consequently, the appeals are allowed, with costs and the
reassessments in issue are vacated.
Signed at Ottawa, Canada this 8th day of November,
1999.
"T.P. O'Connor"
J.T.C.C.
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