Canassurance, Cie D’assurance-Vie Inc. v. Her Majesty the Queen, [1991] 2 CTC 214, [1991] 1 CTC 563, [1991] DTC 5179, [1991] DTC 5535

Dubé, J. [Translation]:—The question to be resolved in this tax case is whether the interest paid by the plaintiff in the 1983, 1984 and 1985 taxation years can be deducted from tax pursuant to the provisions of subparagraph 20(1)(c)(i) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the 'Act"). In particular, were the amounts in question paid pursuant to a legal obligation to pay interest on the money borrowed?

The plaintiff ("Canassurance") was initially know as Compagnie Mutuelle d'Assurance-Vie de Québec ("Mutuelle" or “the company") and subsequently as Croix-Bleue Vie Du Québec Inc. It should be noted that, to begin with, the Association d'hospitalisation du Québec (“the Association") was created by S.Q. 1942, c. 102. By a private Act assented to on February 11, 1959 (S.Q. 1958-59,

c. 183), the governors of the Association were formed into a mutual life assurance company under the aforementioned name of Mutuelle, a corporation without share capital. In 1986, pursuant to another private Act (S.Q. 1986,

c. 134), this company was continued as a joint stock company under the new corporate name Croix-Bleue Vie du Québec Inc. In 1987 the latter company changed its name to that of Canassurance, Compagnie d'Assurance-Vie Inc.

The aforementioned enabling Act of 1959 provides in its preamble that the Association, a non-profit mutual benefit association formed to provide hospital care and treatment as well as medical services, wishes to render wider services by forming a mutual life assurance company, the management and direction of which will initially be controlled by the Association, which will acquire the assets and assume the liabilities of the Association. To this end the Act provides that certain governors of the said Association and those working with them pursuant to section 4 of the Act will form a mutual life assurance company.

Section 16 provides that the company so created by the Act should at all times possess a reserve fund of at least $200,000 (which may be subscribed by the Association) and that the company "may pay on such subscription or any balance thereof interest at a rate not exceeding five per centum per annum". The company “may at any time", if its financial situation permits and with the approval of the Superintendent of Insurance, “reimburse the whole or any part of the aforesaid subscription". Subsequently, the amounts subscribed by the Association to the Canassurance reserve fund were as follows:

1963 $ 500,000

1964	$	500,000
1966	$ 1,000,000
1969	$ 1,462,544
1970	$	623,895
1971	$ 5,401,961
1972	$	592,035
1973	$	668,546
	$11,248,981

Between 1960 and 1979 the company made no reimbursement to the Association in respect of the aforementioned subscriptions. On the other hand, between 1980 and 1982 the company paid the Association $1,400,000. During the years at issue, the company paid the Association $560,000 for each of the years 1983, 1984 and 1985.

A resolution by Mutuelle dated February 10, 1960 authorized it to sign an agreement with the Association to pay interest on the amount subscribed to the Mutuelle reserve fund by the Association. The said resolution, written in English, reads as follows:

The following resolution authorizing the Company to sign an agreement with Québec Hospital Service Association regarding the payment of interest on the amount subscribed by the Association to the reserve fund of the Company, was unanimously approved:

Resolved that the Vice-Chairman of the Board and the Treasurer be authorized to sign, for and on behalf of the Company, an agreement with Québec Hospital Service Association in regard to the subscription by the Association of FIVE HUNDRED THOUSAND DOLLARS ($500,000) in the reserve fund of the Company, whereby the Company shall agree to pay interest annually on such subscription, or any balance thereof, at the rate of THREE AND SIXTY-FIVE HUNDREDTHS PER CENTUM (3.65%) per annum for the year 1960, and for each year thereafter at an annual rate equal to the average rate of interest earned on the Association's interest-bearing investments in the preceding year as determined by the auditors of the Association but not to exceed FIVE PER CENTUM (5.0%).

An agreement dated February 1960 between the same two parties states that Mutuelle will pay annual interest on the subscription of $500,000, as provided by the aforementioned resolution.

Similar agreements between the two parties concerned were filed at the hearing for 1963 and 1964.

The financial statements of the Association and of Mutuelle were also filed for 1961, 1962, 1963 and 1964. In the 1961 statement, the sum of $174,380 is listed under "Other Accounts Receivable and Accrued Interest on Investments” as among Mutuelle's assets. The same amount is shown in the accounting notes of the Association for the same year. The same is true, in different amounts, of the accounting statements for 1962, 1963 and 1964.

An extract from Mutuelle's accounts for 1980 indicates under “Interest on Subscription to Reserve Fund” the sum of $225,000 for the preceding year and $280,000 for the current year. The minutes of the Mutuelle meeting dated October 22, 1981 contain the following paragraph:

A payment of $280,00 has been made representing interest payable to Association d'Hospitalisation du Québec on the subscription to the reserve fund of $11,249,000.

The Association's financial report and statements for 1981 indicate under assets a subscription to the Mutuelle reserve fund in the amount of $11,249,000.

The minutes of the Mutuelle meeting for April 28, 1982 contain the following passage:

A payment of $560,000 was made representing interest payable to Association d'Hospitalisation du Québec on the subscription to the reserve fund of $11,249,000.

Those of April 27, 1983 contain the following passage:

A payment of $560,000 was made representing interest payable to Association d'Hospitalisation du Québec on the subscription to the reserve fund of $11,249,000.

An extract from Mutuelle’s accounts for 1981 indicates under "Interest on Subscription to Reserve Fund" the amount of $280,000 for the preceding year and $560,000 for the current year.

On November 27, 1986 the Mutuelle treasurer sent the Association a letter, the following paragraph of which is worth reproducing:

In accordance with the resolution adopted by the board of directors on November 25 last, we enclose a cheque in the amount of $1,687,347.15, being interest for 1984, 1985 and 1986 on advances made by the Association d'hospitalisation du Québec to La Compagnie Mutuelle D’Assurance-Vie du Québec, which amount to $11,248,981.00.

The minutes of the meeting of the Mutuelle board of directors held on November 25, 1986 contain three resolutions dealing with the repayment of interest owed for 1984, 1985 and 1986. These resolutions indicate that the interest owed on advances of $11,248,981 made by the Association was not paid and that this situation should be corrected.

The Association's financial report and statements for 1983 indicate the following item: "Subscription to Reserve Fund of La Compagnie Mutuelle d'Assurance-Vie du Québec" (note 3), and the amount of $9,046,000 is given for 1983 and $8,902,000 for 1982. Note 3 above and note 5 may be reproduced:

3. Subscription to La Compagnie Mutuelle d'Assurance-Vie du Québec Reserve Fund

	1983	1982
Subscription to
reserve fund	$11,249,000	$11,249,000
Provision for
loss in value	(2,203,000)	(2,347,000)
	$ 9,046,000	$ 8,902,000
5. Non-arm's length operations

The Association received $560,000 during the fiscal year (560,000 in 1982) in payment of interest on the subscription to the Compagnie Mutuelle d’Assurance-Vie du Québec reserve fund.

There is a relationship between the Association d'Hospitalisation du Québec and the Compagnie Mutuelle d'Assurance-Vie du Québec when they jointly offer various services to their mutual customers.

The plaintiff also filed the 1986 annual report of the Croix Bleue Québec (successor to Mutuelle and predecessor of Canassurance). It referred in particular to clause 6(b) of the heading "Correction for Preceding Fiscal Year”, which reads as follows:

6. (b) Further, during the fiscal year the Association received interest from La Compagnie Mutuelle d'Assurance-Vie du Québec, $562,000 of which was for the year ending December 31, 1985 and $563,000 for the year ending December 31, 1984. Income for the year ending December 31, 1985 was increased by $562,000 and unallocated surplus oy $1,125,000. The Association feels that this correction will avoid any distortion of the results for the fiscal years in question.

The only witness at the hearing, Mr. Claude Ferron, president of the Association and of Canassurance since 1982, explained to the Court that during the years in which the plaintiff was running a deficit it did not pay interest to the Association: the plaintiff had to maintain sufficient reserves to meet the claims of insured parties, which is in any case required by law. Both companies operate at the same address, have the same offices and share the same employees. As indicated by the minutes of December 18, 1959, the Mutuelle by-laws provide that to be a director of the company a person must be a member, and, so long as the reserve fund subscribed by the Association has not been repaid, each of the governors of the said Association may become a director of the Company.

There are some 35 or 36 governors of the Association and about ten of them sit on the Canassurance board of directors, thus constituting a majority on the board.

The plaintiff alleged that the amounts paid by it to the Association are interest which it had to pay pursuant to a legal obligation. Even if section 16 of the Act creating the company is permissive and not mandatory, it allows the Association to subscribe to the plaintiff's reserve fund and authorizes the latter to pay interest at a rate not exceeding 5 per cent a year. Under that Act the company may at any time reimburse the whole or any part of the subscription, if its financial situation permits and with the approval of the Superintendent of Insurance. In accordance with the Act, the Association in fact subscribed $11,248,981. A resolution of Mutuelle authorized it to sign an agreement with the Association for the payment of interest on the amount subscribed and that resolution required the company to pay interest as provided: "the Company shall agree to pay interest annually on such subscription". The subsequent agreement between the two parties provides that Mutuelle will pay annual interest, as mentioned in the resolution.

Counsel for the plaintiff alleged that the subscription in question must reflect one of three possible situations. It is either a capital contribution made by the Association as a shareholder, a gift by the Association to the plaintiff or an interest-bearing loan.

In his submission, the first situation is impossible since the Association is not a shareholder in the plaintiff under the provisions of the Act creating the latter, and in particular section 4, which provides that any person who owns a contract issued by the company is a member thereof. Under section 11 only owners of a contract may benefit from the distribution of profits.

Counsel further submitted that it cannot be a gift, since section 16 of the said Act provides that the Association may subscribe to the reserve fund. As we have already seen, the section also mentions a rate of interest and repayment. Further, all the aforementioned financial reports and statements, both of the Association and the plaintiff, clearly establish that both parties have always considered and still consider the amounts in question to be interest-bearing subscriptions, not gifts.

The plaintiff accordingly asked the Court to conclude that it can only be an interest-bearing loan.

Counsel for the plaintiff also relied on articles 1773, 1774, 1779, 1782, 1783 and 1785 of the Civil Code in identifying all the essential aspects of an interestbearing loan, aspects which he submitted are present in the subscriptions paid by the Association.

Counsel for the defendant, for his part, alleged that the real problem is not determining whether the subscriptions are interest-bearing loans, but whether they are interest-bearing loans deductible under subparagraph 20(1)(c)(i) of the Act, as not all interest on a loan is deductible, only that which meets the requirements mentioned in paragraph 20(1)(c) and in the case at bar in the subparagraph in question, which reads as follows:

20.(1) Notwithstanding paragraphs 18(1) (a), (b) and (h), in computing a taxpayer's income for a taxation year from a business or property, there may be deducted such of the following amounts as are wholly applicable to that source or such part of the following amounts as may reasonably be regarded as applicable thereto:

(c) an amount paid in the year or payable in respect of the year (depending upon the method regularly followed by the taxpayer in computing his income), pursuant to a legal obligation to pay interest on

(i) borrowed money used for the purpose of earning income from a business or property (other than borrowed money used to acquire property the income from which would be exempt or to acquire a life insurance policy) .. .

This claim rests on a decision of Dickson C.J. of the Supreme Court of Canada in Bronfman Trust v. The Queen [1987] 1 S.C.R. 32; [1987] 1 C.T.C. 117; 87 D.T.C. 5059 at 124 (D.T.C. 5064; S.C.R. 45):

It is perhaps otiose to note at the outset that in the absence of a provision such as paragraph 20(1)(c) specifically authorizing the deduction from income of interest payments in certain circumstances, no such deductions could generally be taken by the taxpayer. Interest expenses on loans to augment fixed assets or working capital would fall within the prohibition against the deduction of a "payment on account of capital” under paragraph 18(1)(b): Canada Safeway Ltd. v. Minister of National Revenue, [1957] S.C.R. 717; [1957] C.T.C. 335, at pp. 722 and 723 (C.T.C. 339-40) per Kerwin, C.J. and at p. 727 (C.T.C. 344) per Rand, J.

Both parties cited in their favour M.N.R. v. Société Coopérative Agricole du Comté de Chateauguay, [1952] Ex. C.R. 366; [1952] C.T.C. 245; 52 D.T.C. 1129 (Ex. Ct.), affirmed without written reasons by the Supreme Court of Canada, 61 D.T.C. 1205, Société Coopérative Agricole du Canton de Granby v. M.N.R., [1961] S.C.R. 671; [1961] C.T.C. 326; 61 D.T.C. 1205 (S.C.C.) and Société d'Assur- ance des Caisses Populaires v. M.N.R., [1967] Tax A.B.C. 632; 67 D.T.C. 455 (T.A.B.). The defendant further deduced certain principles from Huston v. M.N.R., [1962] Ex. C.R. 69; [1961] C.T.C. 414; 61 D.T.C. 1233 (Ex. Ct.), The Equitable Life Assurance Society of the United States v. Larocque, [1942] S.C.R. 205, Alberta and Southern Gas Co. Ltd. v. The Queen, [1976] C.T.C. 639; 76 D.T.C. 6362 (F.C.T.D.), McCool Ltd. v. M.N.R., [1948] Ex. C.R. 548; [1948] C.T.C. 247; 3 D.T.C. 1202, affirmed by the Supreme Court of Canada, [1950] S.C.R. 80; [1949] C.T.C. 395; 49 D.T.C. 700, The Queen v. MerBan Capital Corporation Ltd., [1989] 2 C.T.C. 346; 89 D.T.C. 5404 (F.C.A.). Clearly, the facts differ in each case and only relate to the circumstances of the case at bar in varying degrees. The following general principles are worth noting.

There are several conditions to be met if one is to benefit from the exemption mentioned in subparagraph 20(1)(c)(i). According to the Federal Court of Appeal in MerBan at 258 (D.T.C. 5412) (the translation is at pages 21-22 of A-1522-84) these conditions are in general as follows:

(i) the interest must be paid or payable pursuant to a legal obligation with respect to borrowed money;

(ii) the borrowed money must be used for the purpose of gaining income from a business or property; and

(iii) the borrowed money cannot be used for property, the income from which would be exempt or to acquire a life insurance policy.

[Emphasis added.]

In the case at bar it is the first condition that presents a problem: was the interest paid to the Association by the plaintiff really paid pursuant to a legal obligation?

The courts have held that the onus is on the taxpayer to establish a borrower-lender relationship in order to benefit from the exemption mentioned in paragraph 20(1)(c) [1] of the Income Tax Act. Cameron, J. of the Exchequer Court of Canada, referring to Inland Revenue Commissioner v. Rowntree & Co. Ltd., [1948] 1 All E.R. 482 at 486 (C.A.) (see also Granby, supra, at 336 (D.T.C. 1210)) adopted this same principle in McCool, supra, at 263 (D.T.C. 1209):

From that subsection it is apparent that interest may be allowed on borrowed capital secured to the lender by note. But it is allowed only on borrowed capital. In my opinion, if there is to be borrowed capital, the taxpayer would have to be in the position of a borrower and some other party would have to be a lender.

Analysis of tax matters should not be limited to the form of a transaction. Further, though sometimes helpful, the intention of the parties is not necessarily conclusive. One must therefore look at the substance and true nature of the transaction. (Larocque, supra, at 234-35.) In McCool, supra, at 413 (D.T.C. 708), the Supreme Court of Canada discussed the matter as follows:

Terms such as "borrowed capital”, "borrowed money” in tax legislation have been interpreted to mean capital or money borrowed with a relationship of lender and borrower between the parties. Inland Revenue Commissioners v. Port of London Authority, [1923] A.C. 507; Inland Revenue Commissioners v. Rowntree & Co. Ltd., [1948] 1 All E.R. 482; Dupuis Frères Ltd. v. Minister of Customs and Excise, [1927] Ex. C.R. 207; [1917-27] C.T.C. 326. It is necessary in determining whether that relationship exists to ascertain the true nature and character of the transaction.

The facts in the case at bar are similar to those in Caisses Populaires, supra. It therefore seems worth reproducing the conclusions of the Tax Appeal Board which reflect the principles applicable to the matter at 640-41 (D.T.C. 465):

. . . The so-called cash advances did not create any legal obligation to pay interest because, pursuant to the Acts of incorporation, they were payable only after authorization was obtained from the Superintendent of Insurance and after a resolution was adopted to that effect. Moreover, interest payments were in direct proportion to the appellants profits and were solely dependent on them . . . All these elements show, without the shadow of a doubt, that the relationship of the Caisses Populaires, in respect of the appellant, was that of shareholders rather than that of lenders.

In this case there was no obligation to pay interest and the contributions might not be considered a loan used for purposes of earning income but rather a locked up fund, or an obligatory capital stock according to the Acts, and an indispensable element of assets or of goodwill.

Applying the rules taken from the case law, I come to the conclusion that the amounts in question were not paid pursuant to a legal obligation to pay interest on the borrowed money. The amounts paid by the plaintiff are not really in the nature of interest paid under an obligation within the meaning of the Act.

In the case at bar, under its enabling Acts, the plaintiff has to maintain sufficient reserves to meet the claims of insured parties. The Association was authorized to subscribe to the company's reserve fund. The latter is not required to repay the said subscriptions, as repayment of “the whole or any part" depends on its financial position and the approval of the Superintendent of Insurance. The company has discretion as to whether or not it pays interest at a rate not exceeding 5 per cent per annum. There is thus no legal obligation to repay the subscriptions or to pay interest. The 1960 resolution authorizing the company to sign an agreement with the Association regarding the payment of interest on the subscriptions to the reserve fund and the subsequent agreement of the same year between these two parties have not changed the true substance and nature of the transactions in question. The 1986 resolutions did not have the effect of creating a legal obligation to pay interest on the money borrowed, as required under the provisions of subparagraph 20(1)(c)(i) of the Income Tax Act.

As regards the plaintiff's arguments that the Association is not a member or shareholder of the company, the Mutuelle by-laws expressly provide that one must be a member in order to be a director of the company. Under these same by-laws, governors of the Association may become directors of the company until the subscriptions to the reserve fund are fully repaid. In fact, the governors of the Association sitting on the Canassurance board of directors are a majority on the plaintiff's board.

I must accordingly conclude that the amounts in question paid by the plaintiff during the 1983, 1984 and 1985 taxation years cannot be deducted from tax under the provisions of subparagraph 20(1)(c)(i) of the Income Tax Act.

At the start of the hearing counsel for the defendant filed a consent to judgment for a part of the action, that dealing with earnings relating to "Canadian securities". The Deputy Attorney General of Canada accordingly agreed that, in its judgment, the Court should order the defendant to have reassessments made, the effect of which would be to allow the plaintiff to reduce its earnings from "Canadian securities" (paragraph 8(m) of the Defence) in the following amounts:

In the circumstances, the plaintiff will be entitled to its costs.

Judgment for the plaintiff.