17 August 1989 Income Tax Severed Letter 7-3960 - [890817]

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.

Dear Sirs:

This is in reply to your letter of May 8, 1989, concerning farm mutual insurers, which has been referred to us for reply.

Our views regarding the issues raised are as follows:

(a) (i) The rules in subsection 149(10) of the Income Tax Act (the "Act") do not apply where an insurer ceases to be totally or partially exempt by reason of paragraph 149(1)(t) of the Act. Therefore, paragraph 149(10)(b) of the Act has no application in computing for purposes of subsection 149(4.1) the amounts deemed to have been claimed or deducted in each of the preceding years.
• (ii) Subsection 149(4.1) requires a determination of the amounts the insurer is deemed to have claimed or deducted for all preceding taxation years. There in no authority in the Act to permit the insurer to consider the deemed amounts for only the 10 preceding taxation years.
• (b) The Department of Finance has proposed amendments to paragraph 1400(e) of the Regulations, which will require discounting of all reserves respecting unpaid claims even if the time element is not significant, but the 955 discount will not apply to undiscounted liabilities. However, as of the present time the proposed amendments to paragraph 1400(e) have not been finalized and enacted.
• (c) For purposes of paragraph 20(7)(c) of the Act, paragraph 1400(a) of the Regulations permits an insurer to claim a reserve in respect of the unearned premium for the policy. The reserve may not exceed the unearned portion of the net premium for the policy at the end of the year determined by apportioning the net premium equally over the period to which the premium pertains.
• Subsection 1404(2) of the Regulations defines the phrase "net premium for the policy" to mean the amount by which the premium which was paid by a policyholder for a policy exceeds the acquisition costs of the policy.
• Subsection 1404(2) of the Regulations defines "acquisition costs" of property and liability policies for taxation years 1987 and subsequent to be 205 of the premium which has been paid by the policyholder for the policy. Transitional rules in subparagraph 1404(2)(a)(v) and (vi) provide varying rates for the acquisition costs of policies acquired before 1987. These rates are as follows:

Year                                  % of premium
     1977  and prior                             0
     1978                                        2
     1979                                        4
     1980                                        6
     1981                                        8
     1982                                       10
     1983                                       12
     1984                                       14
     1985                                       16
     1986                                       18

(d) (i) A farm mutual would be eligible for the small business deduction provided it was throughout the taxation year a Canadian- controlled private corporation.
• (ii) Whether or not investment income is considered active business income is a question of fact which can only be determined after all the facts and details of a particular case have been established and reviewed.

We do however, provide the following general comments. It is our view that where cash that is temporarily surplus to the needs of the business is invested in short-term income-producing investments, those investments may be considered to be used in the business. Therefore. income from such investments would be considered to pertain to or be incident to that business. However,substantial amounts of cash and deposits which are obviously in excess of that required for use in the business and that are retained in the corporation on a permanent basis would not be considered to be funds used in the business. Rather such funds would be considered as permanently set aside for non- qualified uses (i.e. uses other than in an active business). The income from such investments would not be considered to pertain to or be incident to an active business. Generally, as long as the investment funds do not exceed the insurer1s reserve and liquidity requirements, and reasonable accumulation for special projects or expected large expenditures (e.g. down payment for purchase of assets or major repairs to assets) the investment of funds would be considered to pertain to or be incident to the insurance business and so would be active business income

We trust this will be of assistance to you.