Date: 20080115
Docket: A-490-06
Citation: 2008 FCA 14
CORAM: DÉCARY
J.A.
PELLETIER
J.A.
RYER
J.A.
BETWEEN:
HER MAJESTY THE QUEEN
Appellant
and
THE NATIONAL LIFE ASSURANCE
COMPANY OF CANADA
Respondent
REASONS FOR JUDGMENT
RYER J.A.
[1]
This is an
appeal from a decision of Hershfield J. of the Tax Court of Canada (2006 TCC
551), dated October 13, 2006, allowing the appeal of The National Life
Assurance Company of Canada (the “taxpayer”) from reassessments of its income
tax liability for its 1997 and 1998 taxation years pursuant to the Income
Tax Act, R.S.C. 1985, c. 1 (5th Supp.) (the “ITA”). The reassessments
reduced the amount of the policy reserve deduction that the taxpayer claimed
pursuant to subparagraph 138(3)(a)(i) for its 1997 and 1998 taxation
years, with the result that the taxable income of the taxpayer was increased in
each of those years.
[2]
The issue
before this Court relates to the calculation of the amount of the deduction
that the taxpayer is entitled to claim as a policy reserve, pursuant to
subparagraph 138(3)(a)(i) (the “Policy Reserve Deduction”), in respect
of certain of its segregated fund policies, as defined in subparagraph 138.1(1)(a)
(the “Segregated Fund Policies”), in each of the taxation years under
consideration. The resolution of this issue requires the Court to interpret
paragraph 1406(b) of the Income Tax Regulations, C.R.C., c. 945
(the “ITR”), which provides a direction with respect to the calculation of an
amount that is an essential component in the determination of the Policy
Reserve Deduction. Unless otherwise indicated, all statutory references in
these reasons are to the corresponding provisions of the ITA and the ITR for
the taxation years under consideration.
INTRODUCTION
[3]
A
Segregated Fund Policy is a life insurance policy, within the meaning of
subsection 248(1) (a “life insurance policy”), under which the life insurer,
within the meaning of subsection 248(1) (a “life insurer”), has an obligation
to make benefit payments (“Variable Benefit Payments”) that vary in amount
depending upon the fair market value of a specific group of properties that
have been segregated from the other assets of the life insurer and are
maintained in a separate fund (a “Segregated Fund”, within the meaning of
subsection 138.1(1)). A Segregated Fund Policy may also contain an obligation
on the part of the life insurer to make a payment (a “Minimum Guaranteed
Benefit Payment”) to ensure that Variable Benefit Payments made thereunder are
not less than a minimum amount.
[4]
According
to the publication of the federal Department of Finance, Canada's Life and Health Insurers
(September 2002),
segregated funds may be described in the following terms:
Segregated
funds, available only from life and health insurance companies, are similar to
mutual fund products offered by other financial institutions in that they offer
shares of investment funds in a variety of securities (e.g. equities, bonds,
balanced funds). However, they differ from mutual fund products in that a
minimum percentage of the investment – usually 75 percent or more – must be
returned to the investor when the fund matures. The term “segregated” is used
because the funds must be kept separate, or segregated, from the other assets
of the insurance company.
The nature of segregated funds has also been described in Norwood
on Life Insurance Law in Canada, 3rd ed. (Toronto: Carswell, 2002) at page 81, as follows:
Variable
insurance or annuities, under both individual and group policies, are
distinguishable by the fact that the amount of the benefits or values varies
depending on the market value, from time to time, of the specific segregated
assets which the insurer holds as its reserves for the policies. In other
words, the benefits and values are not fixed or guaranteed. The insurer,
however, may include a certain minimum guaranteed surrender or maturity benefit
and, if so, the marketing of these policies is given exemption from securities
legislation. [Footnote: Usually, the insurer guarantees a 75 percent
surrender or maturity value.] But, with or without such minimum guarantees,
the contractual aspects of all variable policies are governed by the life insurance
legislation applicable to life insurance contracts.
The Policy Reserve Deduction Generally
[5]
Life
insurance corporations, within the meaning of subsection 248(1) (“life
insurance corporations”), are subject to taxation under the ITA in the same
general manner as other corporations, but they are also subject to a number of
special rules that recognize the unique nature of the life insurance industry.
In computing its income for a taxation year, a life insurer is required to
include all premiums that it receives and is permitted to deduct all benefits
that it pays under its life insurance policies. While the ITA generally
prohibits the deduction of reserves in respect of contingent liabilities, life
insurance corporations are permitted to deduct reserves in respect of a number
of types of contingent liabilities. The ITA also requires that the amount of
any reserve that is deducted by a life insurance corporation in a taxation year
must be included in the computation of its income for its next taxation year.
[6]
A life
insurer is entitled to deduct a Policy Reserve Deduction for a taxation year in
respect of its life insurance policies. A separate policy reserve is determined
in respect of each of the life insurance policies of the life insurer, pursuant
to the applicable provisions of the ITR, and the aggregate of those individual
reserves is the Policy Reserve Deduction that the insurer may claim for the
year. For post-1995 insurance policies, as defined in subsection 1408(1)
(“post-1995 insurance policies”), such as those under consideration in this
appeal, the applicable provision is subsection 1404(1). Paragraph (a) of
that provision stipulates that the maximum amount that may be claimed by the
life insurer for a taxation year in respect of those policies is the amount
determined under subsection 1404(3) in respect of the life insurer for that
year, provided that amount is positive.
[7]
The amount
determined under subsection 1404(3) for a taxation year in respect of the post-1995
life insurance policies of a life insurer is the positive or negative amount
determined by the formula A + B + C + D – M (the “Tax Reserve Formula”).
Component A of that formula (the “component A amount”), the only item that is
relevant for the purposes of this appeal, is an amount in respect of the
post-1995 life insurance policies of the life insurer for a taxation year equal
to the lesser of the two amounts:
(a) the
total of the reported reserves, as defined in subsection 1408(1), (a “Reported
Reserve”) of the insurer at the end of the year in respect of those policies;
and
(b) the
total of the policy liabilities, as defined in subsection 1408(1), (a “Policy
Liability”) of the insurer at the end of the year in respect of those policies.
[8]
The
Reported Reserve in respect of a life insurance policy is defined in subsection
1408(1) to mean, essentially, the amount of the reserve that would be reported
to the life insurer’s regulator in respect of the insurer’s potential liability
under the policy in respect of a year if the reserve had been determined
without reference to projected income and capital taxes (other than the tax
payable under Part XII.3 of the ITA). The Policy Liability in respect of a life
insurance policy is defined in subsection 1408(1) to mean, essentially, the
amount of the reserve of the insurer in respect of its potential liability under
the policy in respect of a year, determined in accordance with accepted
actuarial practice, but without reference to projected income and capital taxes
(other than the tax payable under Part XII.3 of the ITA).
Income Tax Treatment of Segregated Funds
[9]
For income
tax purposes, Segregated Fund Policies are considered to be so fundamentally
different from other life insurance policies that they are governed by specific
rules under the ITA. Those rules are contained in section 138.1 and may be
summarized as follows:
(a) an inter
vivos trust (a “Related Segregated Fund Trust”) is deemed to have been
created and to continue in existence while a Segregated Fund is in existence
and the value of the properties held in it determines the amount of any
benefits (i.e. Variable Benefit Payments) payable under the related Segregated
Fund Policies (paragraph 138.1(1)(a));
(b) all
property in the Segregated Fund and all of the income generated by that property
are deemed to belong to the Related Segregated Fund Trust and not to be the
property or income of the life insurer (paragraph 138.1(1)(b));
(c) the
life insurer is deemed to be the trustee of the Related Segregated Fund Trust
(paragraph 138.1(1)(c));
(d) holders
of Segregated Fund Policies who have paid premiums that were used to fund
property in a Segregated Fund are deemed to have an interest in the Related
Segregated Fund Trust that is not in any particular property in the Segregated
Fund and those premiums are deemed not to be premiums paid under the Segregated
Fund Policy (paragraph 138.1(1)(e));
(e) the
income of the Related Segregated Fund Trust is deemed to be payable to its
beneficiaries, the holders of the Segregated Fund Policies, in amounts to which
they are entitled under the terms of those policies (paragraph 138.1(1)(f));
and
(f) the
obligation of the life insurer to make benefit payments under a Segregated Fund
Policy that vary with the fair market value of the property in the Segregated Fund
at the time that such benefits become payable (i.e. Variable Benefit Payments) are
deemed to be obligations of the Related Segregated Fund Trust, and not the life
insurer, and any amount received by a policyholder in respect of those
obligations is deemed to be proceeds from the disposition of an interest in the
Related Segregated Fund Trust (paragraph 138.1(1)(j)).
[10]
The impact
of these rules on a life insurer is significant. Under paragraph 138.1(1)(e),
premiums paid by policyholders under Segregated Fund Policies are deemed not to
have been paid as premiums under those policies. Accordingly, unlike premiums
received by a life insurer under other types of insurance policies, premiums
received by an insurer under a Segregated Fund Policy are not required
to be included in the income of the life insurer for the year of receipt. Moreover,
under paragraph 138.1(1)(j), the obligations of the life insurer to make
Variable Benefit Payments are deemed to be the obligations of the Related
Segregated Fund Trust, and not the life insurer. Accordingly, unlike benefit
payments made by a life insurer under other types of insurance policies, Variable
Benefit Payments made by a life insurer under a Segregated Fund Policy are not
deductible to the life insurer in computing its income for the year of payment.
The Policy Reserve Deduction and
Segregated Fund Policies
[11]
Although
section 138.1 provides specific rules with respect to the taxation of life
insurers in respect of their Segregated Fund Policies, that section is not a
complete code and does not preclude the application of the other provisions of
the ITA that apply to life insurers. In particular, nothing in section 138.1 or
in any other provision of the ITA prevents a life insurer from claiming a
Policy Reserve Deduction in respect of its Segregated Fund Policies. However,
in recognition of the special characteristics of Segregated Fund Policies,
paragraph 1406(b) mandates adjustments to the determination of the
Policy Reserve Deduction in respect of those policies. That provision, which
is at the heart of this appeal, reads as follows:
|
1406. Any amount determined under section 1404 or 1405
shall be determined
(b) without
reference to any liability in respect of a segregated fund (other than a
liability in respect of a guarantee in respect of a segregated fund policy).
|
1406. Les montants déterminés selon les articles 1404 et
1405 sont calculés comme suit :
b)
compte non tenu du passif relatif à un fonds réservé, sauf le passif relatif
à une garantie au titre d’une police à fonds réservé.
|
[12]
Paragraph
1406(b) provides that the Policy Reserve Deduction that a life insurer
may claim in respect of the Segregated Fund portion of its Segregated Fund
Policies does not include any liability in respect of a Segregated Fund other
than a liability in respect of a guarantee in respect of a Segregated Fund
Policy.
BACKGROUND
[13]
The basic
facts are relatively straightforward, which is, no doubt, why the hearing
before the Tax Court of Canada proceeded on an Agreed Statement of Facts.
[14]
The
taxpayer was a life insurance corporation at all times during the taxation
years that are under consideration in this appeal. In those taxation years, the
taxpayer issued policies, known as “UltraFlex policies”, that constituted Segregated
Fund Policies (“UltraFlex policies”). The Segregated Fund Policies that are the
subject of this appeal are post-1995 insurance policies.
[15]
An
UltraFlex policy was described in the Agreed Statement of Facts as “a flexible
premium variable deferred annuity which offers both segregated funds and
Guaranteed Accounts (similar to GICs) investment options. Policyholders may
choose to purchase units of any of five Segregated Funds and/or deposit funds
into Guaranteed Accounts”.
[16]
Where a
policyholder under an UltraFlex policy has chosen to purchase units of a Segregated
Fund, that policyholder will be entitled to both Variable Benefit Payments and
a Minimum Guaranteed Benefit Payment.
[17]
During the
period in which a policyholder holds units in a Segregated Fund under an UltraFlex
policy, the value of those units will be affected by fluctuations in the market
value of the properties in that Segregated Fund and by:
(a) additional cash contributions
to the Segregated Fund;
(b) investment returns
generated by the assets in the Segregated Fund;
(c) commissions,
administrative charges and management fees payable to the life insurer out of
the assets in the Segregated Fund;
(d) payments of death
and maturity benefits to policyholders; and
(e) payments
to policyholders on redemptions or surrenders of their units prior to death or
maturity of their policies, less any applicable redemption or surrender
charges.
[18]
For the
taxation years under consideration, the relevant authority, within the meaning
of subsection 248(1), of the taxpayer was the Superintendent of Insurance under
the Insurance Companies Act, S.C. 1991, c. 47, and the taxpayer was
required to report to the Office of the Superintendent of Financial
Institutions (“OSFI”) pursuant to that legislation. In those years, the taxpayer
filed reports with OSFI that contained policy reserve calculations in respect
of its life insurance policies, including its UltraFlex policies. There
is no dispute with respect to any of the computations made by the taxpayer in
calculating either the Reported Reserves or the Policy Liabilities in respect
of its UltraFlex policies for those years.
[19]
A single
policy reserve is determined in respect of each UltraFlex policy
notwithstanding that each such policy may contain a Guaranteed Account portion
and a Segregated Fund portion. It is only the policy reserve calculations in
respect of the Segregated Fund portion of the UltraFlex policies that are in
issue in this appeal.
[20]
The
methodology that was used by the taxpayer to calculate its policy reserves in
respect of the Segregated Fund portion of the UltraFlex policies, for
regulatory purposes, was described in the actuarial reports that the taxpayer
filed with OSFI. That methodology consisted of a formula (the “Actuarial
Reserve Formula”) that was reproduced at page 604 of the Appeal Book, in
respect of the 1997 filing with OSFI, as follows:
5.3.2 RESERVE
for SEGREGATED FUND LIABILITIES
Total reserve
for this block of business can be described by the following formula
Total
Reserve = A + B + C
A
= A liability equal to the segregated fund account balance. This liability
is included in National Life’s Segregated Fund Statements and, therefore, not
part of the general fund reserve.
B
= A “PPM Reserve” calculated as the present value of future commissions,
investment and administrative expenses, less the present value of future
management fees and surrender charges. Since renewal management fees and
loadings are greater than the renewal commissions and expenses, “B” is usually
a negative number.
C
= Reserve for minimum death and maturity benefit guarantees.
The amounts determined under elements A, B and C of the
Actuarial Reserve Formula are referred to in these reasons as the “sub-component
(i) amount”, “sub-component (ii) amount” and “sub-component (iii) amount” respectively.
[21]
This
methodology utilized the so-called “policy premium method”, or “PPM”. In the
years under consideration, this methodology was in accordance with generally
accepted actuarial practice as prescribed by the Canadian Institute of Actuaries,
and with generally accepted accounting principles as prescribed by the Canadian
Institute of Chartered Accountants.
[22]
A summary
of the calculation of the policy liability of the taxpayer in respect of the Segregated
Fund portion of the UltraFlex policies is reproduced at page 608 of the Appeal
Book in respect of 1997 and at pages 806 and 807 of the Appeal Book in respect
of 1998. Copies of those summaries are attached to these reasons as Appendices
“A” and “B” respectively. The references in those summaries to “Individual
Annuities” are references to the Segregated Fund portions of the UltraFlex
policies. The amounts referred to in column 5 of each of those summaries
(“Total Liabilities”) are the actuarially determined policy reserves in respect
of the Segregated Fund portions of the UltraFlex policies (totalling
approximately $274,193,000 for 1997 and $375,628,000 for 1998). The amounts
referred to in column 2 of each of those summaries (“Liabilities Carried in the
Segregated Fund” – the sub-component (i) amount) are required to be, and were
in fact, separately reported in the taxpayer’s annual report on Form OSFI 85 as
“contractholders’ equity”.
[23]
In
computing its income for its 1997 and 1998 taxation years, the taxpayer
determined the amount of its Policy Reserve Deduction in respect of the
Segregated Fund portion of the UltraFlex policies without reference to the sub-component
(i) amounts and sub-component (ii) amounts.
[24]
The
Minister reassessed the taxpayer for its 1997 and 1998 taxation years on the basis
that paragraph 1406(b) requires the calculation of the amount of the Policy
Reserve Deduction in respect of the Segregated Fund portion of the UltraFlex
policies to be made on a basis that included the sub-component (ii) amounts.
The effect of the reassessments was that the Policy Reserve Deduction of the
taxpayer was reduced by $7,922,000 in respect of its 1997 taxation year and by
$15,770,000 in respect of its 1998 taxation year, and that the taxable income
of the taxpayer for each of those taxation years was increased by $7,922,000
and $7,848,000 respectively.
[25]
The
taxpayer objected to these reassessments, the Minister confirmed them and the
taxpayer appealed to the Tax Court of Canada.
THE DECISION OF THE TAX COURT OF CANADA
[26]
Hershfield
J. explained the key provisions of the ITA and the ITR that operate to provide
a Policy Reserve Deduction to a life insurer in respect of post-1995 life
insurance policies. He focused on subsection 1404(3), which sets out the Tax
Reserve Formula that gives rise to the maximum tax actuarial reserve (essentially
the Policy Reserve Deduction) that may be claimed by a taxpayer in a year. In
the circumstances, he determined that the relevant portion of the Tax Reserve
Formula was the component A amount, which is the lesser of the two amounts: the
Reported Reserves and the Policy Liabilities in respect of the UltraFlex
policies at the end of the years in question.
[27]
Hershfield
J. found that the amounts of the Reported Reserves and Policy Liabilities were derived
from “formalistic actuarial calculations” that are “wholly external” to the ITA
and the ITR, and are required to be made in accordance with three components
that are essentially the same as the three components in the Actuarial Reserve
Formula. He then concluded that the Reported Reserves and Policy Liabilities are
required to be recalculated on the basis set forth in paragraph 1406(b),
which he concluded was directed at the three components in the Actuarial
Reserve Formula.
[28]
The issue
before Hershfield J. was whether paragraph 1406(b) requires the sub-component
(ii) amount to be excluded from the calculation of the component A amount for
the purpose of determining the amount of the Policy Reserve Deduction that the
taxpayer was permitted to claim in respect of the UltraFlex policies for the
1997 and 1998 taxation years.
[29]
Hershfield
J. concluded that while the intended outcome of the application of the
Actuarial Reserve Formula is to derive a liability of the taxpayer, it does not
necessarily follow that each component of the Actuarial Reserve Formula is,
itself, a liability. Accordingly, he found that the sub-component (ii) amount
cannot, for that reason, be excluded from the calculation of the component A amount.
He nonetheless concluded that, whether or not it is itself a liability, the sub-component
(ii) amount, or alternatively its core elements, are calculated with reference
to liabilities in respect of a Segregated Fund, and on that basis, the sub-component
(ii) amount is to be excluded from the calculation of the component A amount.
This result flowed from the broad language of paragraph 1406(b), which
provides that the component A amount must be determined without reference to any
liability in respect of a Segregated Fund, which includes any policyholder
liability in addition to any life insurer liability in respect of a Segregated
Fund. Accordingly, he allowed the appeal.
STATUTORY PROVISION
[30]
The
principal statutory provision that is relevant to this appeal is paragraph
1406(b) which reads as follows:
|
1406. Any amount determined under section 1404 or 1405
shall be determined
(b) without
reference to any liability in respect of a segregated fund (other than a
liability in respect of a guarantee in respect of a segregated fund policy).
|
1406. Les montants déterminés selon les articles 1404 et
1405 sont calculés comme suit :
b)
compte non tenu du passif relatif à un fonds réservé, sauf le passif relatif
à une garantie au titre d’une police à fonds réservé.
|
ISSUE
[31]
The issue
in this appeal is the application of paragraph 1406(b) to the
determination of the Policy Reserve Deduction that the taxpayer is entitled to
deduct in its 1997 and 1998 taxation years in respect of the Segregated Fund portion
of the UltraFlex policies.
ANALYSIS
General
[32]
The
determination of the Policy Reserve Deduction to which the taxpayer is entitled
in respect of its life insurance policies in the taxation years under appeal
requires the aggregation of each amount that is determined to be a component A
amount in respect of each of those policies.
[33]
The
starting point in the determination of the component A amount in respect of the
UltraFlex policies for the taxation years in question is the determination of
the Reported Reserves and the Policy Liabilities in respect of those policies
for those years. Once determined, those amounts must be adjusted in accordance
with paragraph 1406(b) to produce the actual component A amount in
respect of those policies for those years.
[34]
The
Reported Reserves and Policy Liabilities in respect of the UltraFlex policies of
the taxpayer for the taxation years under consideration are the same amount. The
parties agree that such amount must be the subject of an adjustment under
paragraph 1406(b) but they disagree as to the basis upon which the adjustment
must be made.
[35]
The
parties approached the question of the adjustment of the component A amount that
is mandated by paragraph 1406(b) by reference to the sub-components of
the Actuarial Reserve Formula. They agreed that the sub-component (i) amount should
be excluded from the determination of the adjusted component A amount. The
taxpayer contended that the sub-component (ii) amount should also be excluded
from that determination, while the Crown argued that it should not. While I am
not inclined to say that focusing on the sub-components of the Actuarial
Reserve Formula is misguided, as will be seen, I have chosen a somewhat
different approach to the determination of the appropriate amount of the Policy
Reserve Deduction in respect of the Segregated Fund portion of the UltraFlex
policies for the taxation years under consideration.
Illustration
[36]
The
practical effect of the contentions of the parties can be observed by reference
to the application of the Actuarial Reserve Formula to the Segregated Fund
portion of the UltraFlex policies for 1997, as depicted in the following table.
UltraFlex Policies
Guaranteed
Accounts * N/A
Segregated
Fund
·
sub-component
(i) $ 283,498,000
·
sub-component
(ii) -
9,794,000
·
sub-component
(iii) 489,000
Total
Actuarial Liability $
274,193,000
* The parties
agreed that the Guaranteed Accounts portion of the UltraFlex policies
were not in
issue in this appeal.
Assuming, for the purposes of illustration, that the
Segregated Fund portions of those UltraFlex policies were the only life
insurance policies of the taxpayer for 1997, the amount determined under the
Actuarial Reserve Formula for 1997 in respect of those policies would be
$274,193,000. That amount would then become the component A amount in respect
of those policies, before the application of paragraph 1406(b).
[37]
Under
the Crown’s contention, in the assumed circumstances, the application of
paragraph 1406(b) to exclude only the sub-component (i) amount would
result in the component A amount being -$9,305,000 for 1997. In other words,
according to the Crown, the taxpayer would not be permitted to deduct any
amount as a Policy Reserve Deduction for 1997, and would actually have an
income inclusion, by virtue of paragraph 12(1)(e.1), of $9,305,000 for
that year.
[38]
Under
the taxpayer’s contention, the application of paragraph 1406(b) to
exclude both the sub-component (i) amount and the sub-component (ii) amount would
result in the component A amount being $489,000 for 1997. That amount would
then be the amount of the Policy Reserve Deduction that the taxpayer would be
permitted to claim in that year in respect of the Segregated Fund portion of
the UltraFlex policies.
Interpretation of
Paragraph 1406(b)
[39]
The
text of paragraph 1406(b) of the ITR is relatively short and bears repetition:
|
1406. Any amount determined under section 1404 or 1405
shall be determined
(b) without
reference to any liability in respect of a segregated fund (other than a
liability in respect of a guarantee in respect of a segregated fund policy).
|
1406 Les montants déterminés selon les articles 1404 et
1405 sont calculés comme suit :
b)
compte non tenu du passif relatif à un fonds réservé, sauf le passif relatif
à une garantie au titre d’une police à fonds réservé.
|
[40]
In
the circumstances of this appeal, the opening words of section 1406 contemplate
that it is the component A amount in respect of the Segregated Fund portion of
the UltraFlex policies that must be determined in accordance with the
directions contained in paragraph 1406(b). That provision directs that
the component A amount must be determined without reference to “any liability
in respect of a segregated fund” but then goes on to require that such amount
be determined having regard to “a liability in respect of a guarantee in
respect of a segregated fund policy”.
[41]
Some
assistance in the discernment of the appropriate interpretation of the term
“liability” in paragraph 1406(b) can be found by reference to the
statutory context of that provision, as well as its purpose.
[42]
Paragraph
1406(b) plays a part in the ascertainment of the Policy Reserve
Deduction that a life insurer may claim in respect of its future payment
obligations under each of its Segregated Fund Policies. The ascertainment of
the amount of that deduction has essentially been left to the actuarial
profession, having regard to the definitions of Reported Reserves and Policy Liabilities,
which underpin the determination of the component A amount. Accordingly, a
contextual consideration of the term “liability” in paragraph 1406(b) indicates
that it should be given a meaning that is consistent with the actuarial
interpretation of that term and therefore should be interpreted to mean a
liability as determined under actuarial principles.
[43]
The
broad purpose of paragraph 1406(b) is to reconcile the different
regulatory and income tax treatments of life insurers in respect of their
obligation to make Variable Benefit Payments under Segregated Fund Policies,
whether or not such policies also contain an obligation to make a Minimum
Guaranteed Benefit Payment. In the circumstances under consideration, the
taxpayer was obligated to make both types of benefit payments under the
UltraFlex policies.
[44]
For
regulatory and legal purposes, the obligations to make Variable Benefit
Payments and a Minimum Guaranteed Benefit Payment under a Segregated Fund Policy
are obligations of the life insurer. However, for income tax purposes, only the
obligation to make a Minimum Guaranteed Benefit Payment rests with the life
insurer. By virtue of paragraph 138.1(1)(j), the obligation to make Variable
Benefit Payments is deemed to be the obligation of the Related Segregated Fund
Trust, and not the life insurer.
[45]
As
a result, it would be inappropriate to permit a life insurer to claim a Policy
Reserve Deduction in respect of an obligation to make Variable Benefit Payments
when the life insurer is deemed, for the purposes of Part I of the ITA, not to
have that obligation. The purpose of paragraph 1406(b) is to provide the
necessary reconciliation by reducing the component A amount, and therefore the
Policy Reserve Deduction that a life insurer may claim in respect of the
Segregated Fund portion of a Segregated Fund Policy, to the extent that the
component A amount includes an amount in respect of the obligation of the life
insurer to make Variable Benefit Payments.
[46]
Paragraph
1406(b) uses the term “liability” twice. It refers to a liability in
respect of a Segregated Fund and to a liability in respect of a guarantee in
respect of a Segregated Fund Policy. In my view, the initial use corresponds to
the actuarial liability of a life insurer in respect of its obligation to make
Variable Benefit Payments under such a policy and the second use corresponds to
the actuarial liability of the life insurer in respect of its obligation to
make a Minimum Guaranteed Benefit Payment under such a policy. Furthermore,
I interpret that provision as mandating a reduction in the component A amount of
a life insurer in respect of the Segregated Fund portion of a Segregated Fund
Policy, for a particular taxation year, by an amount equal to the actuarially
determined liability of the life insurer in respect of its obligation to make Variable
Benefit Payments under such portion of such a policy for that year. It is
apparent from the bracketed words in paragraph 1406(b) that this
mandated reduction does not extend to any actuarially determined liability of
the life insurer in respect of its obligation to make a Minimum Guaranteed Benefit
Payment under such portion of such a policy in that year.
Application
[47]
The
single amount that is determined by the application of the Actuarial Reserve
Formula to the Segregated Fund portion of the UltraFlex policies represents the
aggregation of the actuarial liabilities of the taxpayer in respect of its
obligations to make Variable Benefit Payments and the Minimum Guaranteed
Benefit Payment under those policies. That single amount is the component A
amount in respect of those policies. In my view, the language of paragraph
1406(b) requires the component A amount to be reduced by the full amount
determined under the Actuarial Reserve Formula excluding only the amount
determined to be the actuarial liability of the taxpayer in respect of its
obligation to make the Minimum Guaranteed Benefit Payment under the UltraFlex policies.
[48]
The
actuarial liability of the taxpayer in respect of its obligation to make a
Minimum Guaranteed Benefit Payment under the UltraFlex policies has been
determined. It is the sub-component (iii) amount that appears in the Actuarial
Reserve Formula. Accordingly, the determination of the amount of the reduction
in the component A amount in respect of the Segregated Fund portion of those
policies that is mandated by paragraph 1406(b) becomes a simple matter
of subtraction.
[49]
Reverting
to the illustration in paragraph 35, if the component A amount is $274,193,000
and the actuarial liability in respect of the obligation to make the Minimum
Guaranteed Benefit Payment is $489,000, then the amount of the reduction of the
component A amount would be $274,193,000 - $489,000 or $273,704,000. As a
result, the adjusted component A amount would be $489,000, which would then be
the Policy Reserve Deduction in the assumed circumstances.
[50]
The
effect of this conclusion is that the sub-component (ii) amount may be considered
to relate to the obligation of the taxpayer to make Variable Benefit Payments
under the Segregated Fund portion of the UltraFlex policies (i.e. the
sub-component (i) amount). The Crown argues that this approach is incorrect on
the basis that the sub-component (ii) amount should be considered to relate to
the obligation of the taxpayer to make the Minimum Guaranteed Benefit Payment
under the UltraFlex policies (i.e. the sub-component (iii) amount). With
respect, I cannot agree. The flaw in the Crown’s argument is apparent when one
considers that a given Segregated Fund Policy may not in fact contain an
obligation on the part of the life insurer to make a Minimum Guaranteed Benefit
Payment. The Actuarial Reserve Formula that would be applied to determine the
actuarial liability of the life insurer under such a policy would nonetheless
contain a sub-component (ii) amount, even though there would be no
sub-component (iii) amount (i.e. no amount in respect of an obligation to make
a Minimum Guaranteed Benefit Payment). The sub-component (ii) amount cannot
relate to an obligation to make a Minimum Guaranteed Benefit Payment that does
not exist under a Segregated Fund Policy. This supports the conclusion that the
sub-component (ii) amount relates to the obligation to make Variable Benefit
Payments under a Segregated Fund Policy and, therefore, that such amount must
not be excluded in the determination of the adjusted component A amount in
respect of such a policy in accordance with paragraph 1406(b).
[51]
My
conclusion is essentially the same as that reached by Hershfield J., although I
reached my conclusion using a somewhat different approach. Accordingly, except
to the limited extent referred to below, I would dismiss the appeal.
DISPOSITION
[52]
The
parties agreed that Hershfield J. erred to the extent that he stated that the
result of the reassessment of the 1998 taxation year of the taxpayer in respect
of the issue under consideration in this appeal was an increase in the taxable
income of the taxpayer for that year of $15,770,000. The parties agree that the
amount of that increase was $7,848,000. To that extent only, I would allow the
appeal. Otherwise, I would affirm the judgment of Hershfield J. and would award
costs to the taxpayer.
“C.
Michael Ryer”
“I
agree.
Robert
Décary J.A.”
“I
agree.
J.D.
Denis Pelletier J.A.”
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