The Victory Reinsurance Company Limited (Canadian Branch) v. Minister of National Revenue, [1992] 2 CTC 2200

Taylor, T.C.C.J.:—These are appeals heard in Toronto, Ontario, on April 1, 1992, against income tax assessments for the years 1985 and 1986 in which the Minister of National Revenue included in the calculation of the Gross Investment Revenue (G.I.R.) of the appellant the reserves for re-insurance ceded by the appellant to unregistered issuers of insurance. The other major elements in that calculation are the Canadian Investment Fund (C.I.F.) and the Canadian Reserve Liabilities (C.R.L). The contested amounts were based on subsection 138(9) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") and several parts of section 2400 of the Regulations to the Act (Regulations). The issue before the Court in these appeals is whether the appellant was correct in excluding the amounts of $5,043,000 in 1985 and $6,364,000 from the C.R.L. as part of the total calculation.

No witnesses were called, an agreed statement of facts was filed and the annual returns supplied to the Superintendent of Insurance for the relevant years were provided to the Court at the trial. In addition, the Court had available the usual documentation from the respondent, which included the income returns and financial statements filed with Revenue Canada. The agreed statement of facts read:

AGREED STATEMENT OF FACTS

1. The Victory Reinsurance Company Ltd. (the "taxpayer") is a corporation incorporated under the laws of the United Kingdom and carries on a reinsurance business on a world wide basis, including through a branch in Canada.

2. The taxpayer is registered under Part VII of the Canadian and British Insurance Companies Act R.S.C. 1986, c. 1-12, as amended, to carry on the business of insurance in Canada.

3. The taxation year of the taxpayer is the calendar year.

4. During its 1985 and 1986 taxation years in the course of carrying on its reinsurance business in Canada, the taxpayer entered into reinsurance treaties (the "Reinsurance Treaties”) with primary insurers pursuant to which the taxpayer reinsured a portion of the risks underwritten by primary insurers under both life insurance and "other than life” insurance policies.

5. During its 1985 and 1986 taxation years the taxpayer reinsured or retroceded a portion of certain of the risks reinsured by the taxpayer in the course of carrying on its reinsurance business in Canada in respect of its "other than life” insurance business pursuant to agreements (the Retrocession Treaties") with reinsurance companies, including certain reinsurers (the Unregistered Retrocessionaires") who were not resident in Canada and who not registered to carry on the business of insurance in Canada.

6. The Unregistered Retrocessionaires assumed a portion of the risk assumed by the taxpayer pursuant to the Reinsurance Treaties and the taxpayer ceded a portion of the premium to the Unregistered Retrocessionaire.

7. For its 1985 and 1986 fiscal periods the taxpayer filed the Annual Statements required by the federal Superintendent of Insurance. The taxpayer's Annual Statement for 1985 is Exhibit A hereto; the taxpayer’s Annual Statement for 1986 is Exhibit "B" hereto. [1]

8. The Annual Returns contain an entry entitled "reserve for reinsurance ceded to unregistered companies" in respect of reinsurance with Unregistered Retrocessionaires. Particulars of the calculation of this amount for the 1986 taxation year are found at Exhibit 44 to the 1986 Annual Statement; for the 1985 taxation year, particulars are found in Exhibit 32 to the 1985 Annual Statement.

9. For the purpose of determining its Canadian reserve liabilities defined in subsection 2405(3) of the Regulations to the Income Tax Act, the taxpayer excluded the reserve for reinsurance ceded to unregistered companies of $5,043,000 in 1985 and $6,364,000 in 1986. The taxpayer has appealed with respect to the exclusion of $6,246,000 in its 1986 taxation year.

10. “ Canadian Reserve Liabilities” are defined in subsection 2405(3) of the Regulation as:

. . . the aggregate amount of the insurer’s liabilities and reserves (other than liabilities and reserves in respect of amounts payable out of segregated funds) in respect of its insurance policies in Canada, as determined for the purposes of the relevant authority at the end of the year.

11. In assessing the taxpayer for its 1985 and 1986 taxation year, the respondent included the aforesaid amounts in the taxpayer's Canadian Reserve Liabilities on the basis that it was a reserve or liability and at all material times the Superintendent of Insurance for Canada required that insurers report and reserve for risks reinsured by unregistered insurers in determining their Canadian reserve liabilities.

12. The respondent then purported to designate as insurance property, pursuant to paragraph 138(12)(I) of the Act and paragraph 2400(1)(e) of the Regulations, additional investment property of the taxpayer in respect of the disputed amounts of mean Canadian Reserve Liabilities for the 1985 and 1986 taxation years.

13. As a result of the foregoing determination and designation, the respondent reassessed the taxpayer on the basis that its gross investment revenue from such additional Insurance Property must be included in computing the income of the taxpayer for the purposes of the Act, pursuant to subsection 138(9) of the Act.

Appellant’s position and argument

By way of an introductory comment, counsel for the appellant stated:

I should also advise you that with respect to the 1985 tax assessment it is a nil assessment, so the appeal in respect of 1985 is not proceeding asking for any change in the 1985 assessment, but because of the carry forwards we have left the materials in and if there is a reassessment we would want the Minister to reassess looking at the appropriate amount to be carried forward for the 1986 return in respect of these reserve liabilities, et cetera.

Counsel for the appellant then presented a carefully constructed and well- prepared argument, which followed the general thrust summarized at the start in this way:

This appeal involves the proper interpretation of the term Canadian reserve liabilities as found in section 2405 of the Regulations and specifically whether the reserves for reinsurance ceded to unregistered reinsurers fits within the definition as a reserve in respect of” insurance policies in Canada". The key here is whether it is a reserve in respect of the policies and our submission is that it is not.

The Argument in essence will be that on the key facts assumed by the Minister as set out in paragraph 2(b) of the Reply which states that at all material times the Superintendent of Insurance for Canada required that insurers report a reserve for risks reinsured by unregistered insurers in determining their Canadian reserve liabilities, that that assumption is incorrect because the Superintendent does not require anything with respect to the term Canadian reserve liabilities. Canadian reserve liabilities is just an income tax term. Secondly is the argument I just gave to you which it is not a reserve with respect to policies. Thirdly, that the Munich Reinsurance case [1992] 1 C.T.C. 2004, 91 D.T.C. 1137, although similar, is distinguishable having dealt with hail insurance which arguably is more related to a policy than this unregistered reinsurance amount.

[Emphasis added.]

According to counsel for the appellant C.R.L is “just an income tax term", and therefore, the mere fact that Victory reports to the Superintendent a "reserve for risks reinsured by unregistered insurers” should not determine automatically that this reserve (for risks reinsured by unregistered insurers) should be included as part of the C.R.L. Counsel essentially put forward the proposition that any determination of this matter should be based on very narrow interpretations of the relevant sections of the Act and Regulations. I can best address counsel's position by quoting some portions directly from the heart of the argument:

. . .. under the Income Tax Act provisions relating to these insurance amounts is that the taxation on the insurance companies not being at all like the tax paid by anyone else, the Minister (then) makes certain property as “insurance property" under the Act and as a result increases the gross investment income from that property for tax purposes and thereby increases the taxes payable.

The main issue is whether these reserves are reserves in respect of insurance policies and the arguments that I will be making can be broken down into four although they do perhaps merge. The first argument is that the draftsmen of the Income Tax Act as we will see have expressly made distinctions between reserves in respect of insurance policies" and "reserves in respect of an insurance business”. They have done it in the Act and in particular in these sections of the Regulations and as a result must have been intended to mean different things. C.R.L only applies to insurance policies and not in respect of business decisions such as where to reinsure. Secondly, that this is a reserve required to be reported to the Superintendent because the taxpayer made the financial decision to reinsure outside of Canada and it is a reserve in respect of, in essence, the credit worthiness or lack of credit worthiness of these unregistered reinsurers. Thirdly, that policy reserves, which we will go to in the Act, are a concept known in the Act and they are not the same as reserves in respect of the insurance business. Finally, that the policy reserves reported to the Superintendent are different than these other types of reserves reported to the Superintendent of Insurance.

[Emphasis added.]

In support of these alleged distinctions, counsel reviewed for the Court the financial information and annual returns filed for the years in issue with the Superintendent of Insurance, and attempted to show that the appellant and presumably all similar insurers, should not be taxed on a basis which included the reserve" at issue here.

Respondent's position and argument

Counsel for the respondent reiterated the material facts of this matter, pointed out the apparently clear connection of the "reserve" to the requirements of the Act and the Regulations, and rested largely on the comments made and the result determined in Munich, supra.

Analysis

As counsel for the appellant indicated the four points recited in her argument do merge. In fact, point number one and point number three refer to the same basic position of counsel, that the Court should regard the reserve at issue as related to business, not policies. This is really the first argument. Equally point two and point four, as I see it, deal with basically the same contention—that the reserve at issue arises from a requirement of the Superintendent, and should not reflect the income tax position adversely. The contention of counsel for the appellant is that the simple "business" decision to reinsure with an unlicensed company should not of itself occasion a further income tax impact, no matter how this must be reported to the Superintendent. This is really the second argument.

Turning to the first argument above, I would note the comments on the legislation and regulations provided in Munich, supra on page 2008 (D.T.C. 1139). In Munich, the appellant's position was indicated by the learned judge to be:

Counsel for the appellant submitted that the definition of "Canadian reserve liabilities” is narrower than the type of liability or reserve that is included in the computation of “ Canadian investment fund” since the former definition includes only those reserves and liabilities in respect of insurance policies in Canada, rather than all those incurred or provided for in the course of carrying on the property and casualty insurance business in Canada.

Munich, supra dismissed the argument that the reserve at issue must be “traceable to specific policies". As I see it, in this matter, counsel is making the same point, but perhaps a little more broadly. According to counsel the decision not only to reinsure, but to reinsure with an unregistered company had to do with the insurance business, and had no relation to the insurance policies, since subsection 138(9) above employs the term "carrying on that business in Canada" [emphasis mine], as contrasted with the term from Regulation 2405 “in respect of its insurance policies in Canada" [emphasis mine]. That view point from counsel as I understand it, seems to rest on the presumption that the reinsurance business originating in Canada and ceded to Victory (UK) does not deal with or in, insurance policies, but is somehow a part of the investment business of the appellant. None of the specific reinsurance agreements under which the appellant company assumes part of the risk from the primary insurers, or any of the other agreements by which it reinsures (also referred to as cedes or retrocedes) with an unregistered insurer were filed in the Court. The Court has no documented evidence that such agreements on either side of the appellant's business would be excluded under the term "contract of insurance” from the Insurance Act definition of "business of insurance” (see Munich, supra):

. . . the making of any contract of insurance, and includes any act or acts of inducement to enter into a contract of insurance, and any act or acts relating to the performance thereof or the rendering of any service in connection therewith;

The first argument of counsel simply does not hold together. In my view, the argument by the appellant that the reserve is related to business not policies is at best a spurious one. In this appeal at least, such a direct connection is readily discernable. It would probably be possible to dismiss these appeals on that ground alone—the first argument having already been dealt with in Munich, supra. However, we shall review the second argument above, since it was the view of counsel that it had not been completely addressed in Munich, supra.

On this second argument. I doubt that the situation is quite as simple as described by counsel for the respondent—if the Superintendent of Insurance requires it, the Income Tax Act requires it too". The circumstances must also be consonant with the Act, but I do agree that it would be for the appellant to show that the specific relevant circumstances in an individual case did not fit into the provisions of the Act.

The appellant in this matter, because of a "nil" assessment, had withdrawn the appeal with respect to the 1985 year, in which the amount at issue had been $5,043,000. The $5,043,000 above had arisen by virtue of the appellant taking that amount out of the" Head Office Account” in the year 1985, which account would appear to be similar for purposes of this appeal to a“ "Surplus" account in more conventional accounting systems. The 1985 Annual Report contains the following note:

EFFECTIVE JANUARY 1, 1985 THE COMPANY TRANSFERRED ITS RETROCESSION OF CANADIAN BUSINESS PRINCIPALLY TO UNLICENSED REINSURERS TO THE CANADIAN BRANCH.

This action apparently triggered the requirement to create the reserve and report it to the Superintendent, since only the unregistered reinsurers (in this case Victory (UK)) are required to be reported by the Superintendent.

Continuing this examination of the Annual Report it is noted that the amount which was at issue for 1985 of $5,043,000 is shown on Exhibit 32 of the Annual Report for that year and consists of:

That same amount of $4,716,000 appears as unpaid amounts" on Exhibit 33. The title heading for Exhibit 33 is:

CLAIMS AND ADJUSTMENT EXPENSES IN RESPECT OF IN CANADA BUSINESS CEDED TO UNREGISTERED REINSURERS REVIEW OF CLAIMS SETLLEMENTS AND UNPAID AMOUNTS REPORTED IN PREVIOUS ANNUAL STATEMENTS

Exhibit 26 of the Annual Report for 1985 is entitled:

"UNEARNED PREMIUMS AND UNPAID CLAIMS—IN CANADA" and shows an amount of $4,961,000 as "UNPAID CLAIMS—REINSURANCE CEDED", as well as an amount of $327,000 as "UNEARNED PREMIUMS—REINSURANCE CEDED”

Obviously, the $327,000 is identical from this Exhibit (#26) to that earlier noted and found on Exhibit 32 above. The difference between the amount of $4,961,000 (Exhibit 26) and $4,716,000 (Exhibits 32 and 33) was not reconciled for the Court, but it would appear quite evident that the terms "Outstanding Loans Receivable and Unpaid Claims”, in this context are virtually interchangeable, and I have no reason to doubt that the $4,716,000 above forms the major part of the $4,961,000 above.

The 1985 reserve (taken from "Head Office Account") formed the basis to which a further amount of $1,203,000 had been added in 1986 to make the amount remaining in issue for 1986—$6,246,000. The $1,203,000 added above was itself taken out of the "Head Office Account” in 1986. On this aspect of the matter, the appellant had submitted in the copy of the notice of objection filed with the Court the following:

The reserves for reinsurance ceded to unregistered companies—are merely allocations of retained earnings to another balance sheet caption, reserves required by OSFI". [2] They are not liabilities or reserves in that they are not payable currently or in the future, nor did they emanate from, or have an effect on, the income statement. Assets are not required to discharge these items; therefore, they are not liabilities and should not be included as Canadian Reserve Liabilities.”

[Emphasis added—these comments are referenced later.]

In the copy of the Annual Report for the year 1986 filed with the Superintendent and submitted to the Court as evidence, is an“ Exhibit 44" entitled:

Exhibit 44—RESERVE FOR REINSURANCE CEDED TO UNREGISTERED COMPANIES—CANADIAN BUSINESS—AND CALCULATION OF REQUIRED COVERAGE FOR THE PURPOSES OF THE TEST OF ADEQUACY OF DEPOSIT

The amount at issue for 1986 appears thereon and is composed of:

The reserve here at issue is for specific reasons, the descriptions given from Exhibit 44 above—not simply because Victory (Can) reinsures with Victory

(UK) part of the reinsurance it has already assumed, a position which Counsel for the appellant implied in her argument. The amount of $6,246,000, is also shown in Exhibit 5—"Changes in reserve required by the Superintendent", and shown under the heading of" Head Office Account and Reserves" included on the Liability side of the Balance Sheet, all again on the Annual Reports required by the Superintendent.

From a purely record keeping and reporting viewpoint the requirement of the Superintendent is met by Victory (Can) showing the amount at issue separately from the “Head Office Account", and in this instance it is accomplished by taking the amount out of the" Head Office Account” and showing it as a "reserve". In effect, a portion of the surplus investment of Head Office (Victory UK) in Victory (Can) has been dedicated to the reserve it would appear. This process for recording the situation mandated by the Superintendent seems quite adequate. But for purposes of reporting to Revenue Canada, the transactions could be shown by setting up an amount for 1986 on the asset side of the Balance Sheet as "Outstanding Loans (or unpaid claims) recoverable from Assuming Company" of $5,897,000, and a corresponding liability or reserve on the liabilities side; as well as an account on the asset side "Unearned Premiums on Deposit with Assuming Company" of $349,000 and a corresponding liability or reserve on the liability side. This procedure would leave the "Head Office Account” untouched and might have the added advantage of identifying and distinguishing the elements of such an amount very clearly. I do not say that approach is necessary, merely that it could be done. The amount at issue may be regarded as nothing more than a dedicated part of the "Head Office Account"—essentially a surplus or head office investment account of some kind, and easily caught in the calculation under the Regulations; there is certainly a good argument that both the $349,000 above and the $5,897,000 above represent a form of a reserve, even if that title may seem a bit odd; and finally, any argument that the amounts are not at least some form of liability is on the weakest of grounds. The $349,000 unearned premiums have been turned over in effect to Victory (UK); and the outstanding losses recoverable $5,897,000 are in reality unpaid claims going back as far as 1982—(see Exhibit 45 for 1986). It would appear from the breakdown on Exhibit 44 (shown above) that when losses have occurred for which Victory (UK) is responsible as a result of reinsurance ceded, and these amounts have not been paid to Victory (Can) before the end of the fiscal period, the company is required to apprise the Superintendent of this situation. Exhibit 44 indicates that there have been claims against policies made to Victory (Can), and Victory (Can) has claimed or is entitled to claim against Victory (UK) for all or a portion of the claims—some of which appeared to have resulted in“ losses"—that is an excess of claims made over premiums charged, as I would understand it. This amount basically is an inter-company account receivable to Victory (Can) and the Superintendent wants it to be clearly identified. It is difficult for counsel for the appellant to uphold that outstanding losses recoverable from an assuming company for reinsurance ceded covering both policy liability and premium income, is an item completely divorced from the experience of premiums and claims arising directly from insurance policies and identifiable specific policies, if necessary. Ultimately Victory (Can), the appellant would be held responsible for these. It has not been shown that "they are not payable currently or in the future”; and it is clear from this analysis that they "emanate from”, and do have an effect on the income statement". These critical views expressed in the notice of objection, supra and supported by counsel for the appellant are therefore rejected. The reason the Superintendent wants this amount identified separately and as a reserve is because he holds no security from this unregistered retrocessionaire and the primary policy holders and then the actual parties insured, theoretically—could lose out in case of a claim. From this information, the Superintendent then requires the appellant to calculate the adequacy of deposits which it retains in Canada for just such an eventuality. That requirement (adequacy of deposits) of the Superintendent, however, has nothing to do directly with the calculation of the liability of the appellant for income taxes, but that was not the point argued by counsel for the appellant, but some rationale for characterizing these amounts in a different manner for purposes of Revenue Canada must be established for the appellant to succeed. All the above taken directly from the Annual Reports, points toward a conclusion that the amount at issue, $6,246,000 represents a" reserve"—for the purposes of the relevant authority at the end of the year". Whether that amount is a "reserve" in the more specific accounting sense of that word, is quite academic, although the question was raised. That is what it is called by the Superintendent for the purposes of the Superintendent. But looking at the two component parts of the amount as detailed above in Exhibit 44, it is not difficult to understand the reason the respondent requires it to be included as a reserve" and as part of the calculation described in the Regulations under the Act.

On this “Annual Report" versus" Income Tax Return” argument of counsel, except for minor adjustments the revenue and expense amounts dealing with insurance premiums have been carried from the Annual Report for the Superintendent, directly to the financial statements provided to Revenue Canada with the income tax return. Using only the non-life part of the operation as an example the comparisons are:

The redeeming feature of course at least for Revenue Canada, is that the insurance company also has earned income from investments arising largely from insurance premiums held by it, which can turn the above losses into profits. For the years in question, the investment results were:

Put in this light, it is not difficult to see the concerns of Revenue Canada. There is no indication in the Annual Report that assets are held any place other than Canada by this appellant, only the interaction with Victory (UK) related to the reinsurance ceded. Even if they were held in different places, it is the allocation of the investment income based on the formula provided in the Act which is required. It is not difficult to conceive that the difference in net income reported to the Superintendent, and that reported to Revenue Canada as shown above, is related directly to the exclusion of the reserves at issue in this appeal from the calculation in the calculation base of G.I.R., C.I.L., and C.R.L.

It may be—as indicated at the trial by counsel—that the Act and the Regulations are unnecessarily and unreasonably complicated and convoluted. Using one hundred words when ten might do, and setting up situations that require review, and rereview of the same sections of the Act and Regulations over and over again, in order to follow the interpretations and calculations may indeed be a burden. However, insurance is a business where the fine print can become of enormous importance under critical circumstances, and perhaps that philosophy is carried forward to deal with the impact of income taxes. But it is not for the Court to re-write the Act and the Regulations, only to interpret them. The simple requirement of determining net income for insurance operations from the premium record, and adding to that a realistic portion of the investment income applicable to Canada does not appear to me to be a terribly difficult task—and that is all that is done in the end analysis for income tax purposes.

Summary

In my view, the appellant has failed to establish on the facts alone the foundations necessary to substantiate the positions taken, also the appellant's own documentation puts into serious question those positions, and the relevant jurisprudence [3] does not support the assertions of the appellant. There is no basis upon which the Court can agree that the use of the term "insurance business" has some substantially different connotation from "insurance policies" as far as this issue is concerned. And there is no support for the view that the reserve which is reported to the Superintendent, representing an element in the calculation of income, warrants some different treatment when reported to Revenue Canada.

The appeals are dismissed.

Appeals dismissed.