3 February 2012 External T.I. 2011-0415771E5 - Taxable capital farm mutual insurance corporation

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: The determination of taxable capital of a farm mutual insurance corporation. In particular, the taxpayer requested clarification of 1) the investment allowance of an insurance corporation; 2) the impact on the determination of taxable capital of reserves in respect of unpaid claims, and unearned premiums; and 3) the impact on taxable capital of the mark-to-market adjustments under section 142.5 of the Act.

Position: General comments provided

XXXXXXXXXX
									2011-041577
									Bob Naufal

February 3, 2012

Dear XXXXXXXXXX :

Re: Taxable capital of a farm mutual insurance corporation

We are writing in response to your e-mail of April 1, 2011, which was forwarded to us on August 2, 2011.

In your email, you describe a farm mutual insurance corporation that has no Part I tax payable on a portion of its taxable income pursuant to paragraph 149(1)(t) and subsection 149(4.1) of the Income Tax Act (the "Act"). The corporation is incorporated without share capital and, in your opinion, is a Canadian-controlled private corporation because all or substantially all of the members are Canadian residents.

You asked three questions in your email, the first of which is whether subsection 125(5.1) of the Act is applicable to the corporation to reduce its business limit for purposes of the small business deduction. This question was answered by another Rulings section on July 29, 2011 (Document 2011-040173).

In addition, you asked the following questions:

1. Is the investment allowance of the corporation limited to shares and long-term debt of related financial institutions, pursuant to subsection 181.3(5) of the Act?

2. What is the impact on the calculation of taxable capital of the corporation for the following:

(a) The reserves for unearned premiums and unpaid claims, pursuant to subsection 1400(3), of the Income Tax Regulations (the "Regulations"); and

(b) The application of the mark-to-market rules in section 142.5 of the Act where the corporation records investments at the lower of cost or market value on its financial statements.

Our Comments

Although Part I.3 tax was effectively eliminated on January 1, 2006, computations under this Part remain relevant for certain purposes of the Act. For purposes of determining the relevant components under Part I.3 of the Act (i.e., capital, investment allowance, taxable capital, or taxable capital employed in Canada, etc.), an insurance corporation that carries on business in Canada, including one described in paragraph 149(1)(t) of the Act, is considered a "financial institution" pursuant to paragraph (b) of that definition in subsection 181(1) of the Act. Accordingly, section 181.3 of the Act is applicable as it governs the computation of such amounts for a financial institution. In addition, subparagraph 181(3)(b)(ii) of the Act generally provides that for purposes of determining the carrying values of the relevant components under Part I.3, an insurance corporation would refer to the amounts that are reflected in the balance sheet as accepted by the Superintendent of Financial Institutions, the superintendent of insurance or a similar provincial authority for regulatory purposes.

With respect to your questions, we provide the following general comments.

Investment allowance of a financial institution

Pursuant to paragraph 181.3(4)(a) and subsection 181.3(5) of the Act, the investment allowance for a taxation year of a Canadian resident financial institution is the carrying value at the end of the year of the aggregate of shares or long-term debt (other than shares or long-term debt included in a segregated fund) of a related financial institution. In addition the following conditions must be met:

(a) the related financial institution is not exempt from tax under Part I.3 of the Act, and

(b) the related financial institution must be either a resident in Canada or use the proceeds of the share or debt in a business carried on through a permanent establishment in Canada.

The term "long-term debt" is defined in subsection 181(1) of the Act in the case of an insurance corporation by reference to the Insurance Companies Act definition of "subordinated indebtedness" where such indebtedness is evidenced by obligations issued for a term of not less than five years.

Capital of a financial institution - Reserves

Subsection 181.3(3) of the Act computes the capital of a financial institution. In this regard, subparagraph 181.3(3)(c)(iii) of the Act provides that the capital of a resident non-life insurance corporation includes the amount of the corporation's reserves for the year except to the extent that they were deducted in computing its Part I income for the year. The term "reserves" is defined in subsection 181(1) of the Act to include all of a corporation's reserves, provisions and allowances including any provision for deferred taxes and derives its meaning primarily from accounting principles. As noted above, the amounts to be utilized in the determination of the relevant Part I.3 components of an insurance corporation are amounts that are reflected in the balance sheet as accepted by the Superintendent of Financial Institutions, the superintendent of insurance or a similar provincial authority for regulatory purposes.

Under paragraph 20(7)(c) of the Act, an insurer may deduct as a policy reserve any amount not exceeding the amount prescribed in respect of the insurer for the year. For this purpose, the policy reserve that is deductible by an insurer is computed in section 1400 of the Regulations. In our view, where a reserve deducted for accounting purposes exceeds the amount deducted for income tax purposes, the excess will be included as a reserve in computing the capital of the insurer pursuant to subparagraph 181.3(3)(c)(iii) of the Act.

Mark-to-market rules

Regarding your last question, it is not clear to us whether you are enquiring about the application of the mark-to-market rules themselves or the application of those rules in connection with the calculation of taxable capital. Without knowing your specific concern and absent a review of a specific fact situation, it is difficult for us to provide any definitive comments. However, we can offer the following general comments on the mark-to-market rules.

Generally, sections 142.2 to 142.6 of the Act (commonly referred to as the mark-to-market rules) govern the income tax treatment of certain securities (for example, certain shares and debt obligations) held by a taxpayer that is a "financial institution". For these purposes, a financial institution is defined in subsection 142.2(1) of the Act to include a corporation referred to in paragraphs (a) to (e.1) of the definition "restricted financial institution" in subsection 248(1) of the Act, and includes an insurance corporation.

Section 142.5 of the Act generally requires a taxpayer that is a financial institution to annually recognize the appreciation or reduction in value of securities that are considered "mark-to-market property" as defined in subsection 142.2(1) of the Act. In this regard, subsection 142.5(2) of the Act requires a taxpayer that is a financial institution to include in computing income, the change in value of its mark-to-market property by deeming the taxpayer to have disposed of the property immediately before the end of each taxation year for proceeds equal to fair market value, and to have reacquired the property at the end of the year at a cost equal to those proceeds.

We trust that our comments will be of assistance.

Yours truly,

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