A-847-87
Her Majesty the Queen (Appellant)
v.
London Life Insurance Company (Respondent)
INDEXED AS: LONDON LIFE INSURANCE CO. V. CANADA (C.A.)
Court of Appeal, Heald, Stone and Desjardins
JJ.A.—Toronto, October 2, 3, 4, 5 and 6; Ottawa,
November 28, 1989.
Income tax — Income calculation — Deductions — Appeal
from trial judgment holding plaintiff/respondent carrying on
insurance business in country other than Canada under Income
Tax Act, s. 138(9) — "Profits generated" test satisfied as
certain acts could only be performed in Bermuda (i.e. delivery
of policies, and assessment of changes in insurability) —
Expenses incurred by wholly-owned subsidiary incorporated
solely for sale of plaintiffs excess computer capacity to public
not deductible — Not related to life insurance business but to
completely new adventure.
Insurance — Whether Canadian life insurance company
carrying on business in Bermuda — "Profits generated" test
satisfied as acts of overriding importance required to be per
formed in Bermuda (i.e. delivery of policies, assessment of
changes in insurability) — Expenses of wholly-owned subsidi
ary, created solely to sell excess computer capacity to public,
not deductible as not related to insurance business but to
completely new adventure.
This was an appeal from the trial judgment holding that the
respondent carried on business in Bermuda in 1976 within the
meaning of the Income Tax Act. In 1976, the respondent, a
Canadian life insurance company, appointed agents in Ber-
muda, who obtained a licence to carry on a life insurance
business there. The Bermuda agents were brought to Canada
for indoctrination, head office at London, Ontario changed
certain operating procedures required for entry into the Ber-
muda market and systems were developed for premium billing
and collections. Many residents of Bermuda were solicited as
potential policy holders and were provided with rate quotations.
$100,000 was deposited in a bank account in \ Bermuda. Under
the "Broker's Agency" agreement, the "agents" in Bermuda
were mere independent contractors with no authority to bind
the Company in any way. The first issue was whether the
respondent carried on an insurance business in Bermuda. The
appellant argued that the "profits" or "profits generated" test
enunciated in Smidth should be applied. That test was "where
do the operations take place from which the profits in substance
arise?" The respondent argued that the proper test was to see
whether an insurance business was solicited in Bermuda on its
behalf and whether the life insurance contracts were made in
Bermuda. The Trial Judge had not based his decision on any
one factor, but upon the cumulative effect of applying the
"profits" or "profits generated" test and tests relied upon by
the respondent.
The second issue was whether an amount received from a
wholly-owned subsidiary was deductible. The respondent had
excess computer capacity in 1975 and 1976 which it sold to a
wholly-owned subsidiary for sale by the latter to the public.
The subsidiary's functions were performed by the respondent's
employees, with the respondent's equipment and from the
respondent's premises. The respondent claimed all of the funds
received from its subsidiary as income and all of the expenses
as expenses. The deductions were disallowed on the ground that
the amounts shown as income were operating expenses incurred
on behalf of the subsidiary and, even if income from the sale of
excess computer capacity, the amounts were income from a
business of the respondent other than its life insurance business.
The Trial Judge found that the expenses were incurred by the
respondent on its own behalf for the purpose of the life insur
ance business because the excess capacity was needed by the
respondent to handle the peak demand loads of its life insur
ance business.
Held, the appeal should be allowed in part.
The Trial Judge correctly found that the respondent carried
on business in Bermuda in 1976. The Smidth test was not
applicable because it was developed to determine whether
certain activities resulted in "profits arising or accruing from a
trade ... exercised within the United Kingdom." The question
here (whether the taxpayer carried on business in another
country) is broader than the one considered by the English
courts. It does not follow from the fact that the Income Tax
Act, subsection 138(9) focuses on the generation of gross
investment revenue from property in Canada, that Parliament
thereby intended that the determination of whether a business
was carried on in another country should depend solely on
whether profits in substance arose from the taxpayer's activities
in that country. The phrase "carried on an insurance business
... in a country other than Canada" are words of broad import
and must be construed as such.
In any event, the "profits" or "profits generated" test was
satisfied. Although many things had to be, and were in fact,
done in Canada in order to effect insurance policies on the lives
of Bermuda residents, other acts of overriding importance and
significance had to be done and could only be done in Bermuda
i.e. (I) the delivery of policies before they became binding and
(2) the assessment of any changes in the insurability of the
applicants between the date of their applications and the date
their policies were delivered.
As to the second issue, the respondent engaged in both a life
insurance business and in dealings related to its excess comput
er capacity. The expenses were not related to the life insurance
business but to a completely new adventure. The expenses
claimed were not deductible under Part I in computing the
respondent's income for the year from carrying on its life
insurance business in Canada within the meaning of subsection
209(2).
STATUTES AND REGULATIONS JUDICIALLY
CONSIDERED
Income Tax Act, R.S.C. 1952, c. 148, ss. 138(9) (as am.
by S.C. 1970-71-72, c. 63, s. 1; 1973-74, c. 14, s. 47),
208(1), 209(1),(2),(3), 248(1), 253.
Canadian and British Insurance Companies Act, R.S.C.
1970, c. I-15, s. 2(1).
The Non-Residents Insurance Act, 1967 (Bermuda).
CASES JUDICIALLY CONSIDERED
DISTINGUISHED:
Smidth & Co. v. Greenwood, [1921] 3 K.B. 583 (C.A.);
affd [1922] 1 A.C. 417 (H.L.); Excelsior (The) Life
Insurance Co. y The Queen, [1985] 1 CTC 213; 85 DTC
5164 (F.C.T.D.).
REFERRED TO: -
Grainger & Son v. Gough, [1896] A.C. 325 (H.L.);
Firestone Tyre & Rubber Co., Ltd. (as agents for Fire-
stone Tire & Rubber Co. of Akron, Ohio, U.S.A.) v.
Lewellan (1957), 37 T.C. I 11 (H.L.).
COUNSEL:
L. P. Chambers, Q.C. and J. Humphrey for
appellant.
David A. Ward, Q.C. and Colin Campbell for
respondent.
SOLICITORS:
Deputy Attorney General of Canada for
appellant.
Davies, Ward & Beck, Toronto, for respon
dent.
The following are the reasons for judgment
rendered in English by
STONE J.A.: This appeal from a judgment of the
Trial Division rendered July 28, 1987 [[1988] 1
F.C. 46] raises an issue whether the respondent,
which carried on a life insurance business in
Canada in the taxation year 1976, also carried on
an insurance business in that year in a country
other than Canada, namely, Bermuda within the
meaning of subsection 138(9) of the Income Tax
Act, R.S.C. 1952, c. 148, as amended [by S.C.
1970-71-72, c. 63, s. 1; 1973-74, c. 14, s. 47] ("the
Act"), and the deductability in the 1976 taxation
year of certain amounts pursuant to Part XII of
the Act. It was heard together with an appeal in
Court File No: A-846-87 between the same parties
from another judgment of the same Trial Judge
rendered on the same day. That appeal is exclu
sively concerned with the deductability in the 1975
taxation year pursuant to Part XII of amounts
received by the respondent from a wholly-owned
subsidiary. I propose to deal with all issues in these
reasons and to file a copy in Court File No:
A-846-87 thereby making them reasons for judg
ment in that appeal to the extent applicable. For
the sake of convenience, I will deal first with the
Bermuda business issue raised in this appeal and
then with the issues under Part XII of the Act
raised in both appeals in respect of both taxation
years.
Bermuda Business Issue
In computing its gross investment income for
the 1976 taxation year, the respondent sought to
take advantage of the election provided for in
subsection 138(9) of the Act,
138... .
(9) Where in a taxation year an insurer (other than a
resident of Canada that does not carry on a life insurance
business) carried on an insurance business in Canada and in a
country other than Canada, there shall be included in comput
ing its income for the year from carrying on that business in
Canada,
(a) if the insurer has, in prescribed manner and in accord
ance with prescribed conditions, made an election under this
subsection in respect of the year, such part of its gross
investment revenue for the year as is gross investment reve
nue from property used by it in the year in, or held by it in
the year in the course of, carrying on that business in
Canada, and
(b) in any other case, such part of its gross investment
revenue for the year as is determined in accordance with
prescribed rules to be applicable to the carrying on by it of
that business in Canada,
and if the insurer has not so elected in respect of the year, the
amounts deductible under paragraphs 3(b), (c) and (d) in
computing its income for the year, the amounts required by
paragraphs 4(b) and (c) to be included in computing such
income, the amounts determined under subparagraphs
(12)(o)(ii) and (iv) for the period ending with the year shall be
determined in accordance with prescribed rules and the aggre
gate of taxable dividends for the purposes of each of para
graphs 138(6)(a), 138(6)(b) and 208(2)(b) shall be determined
in accordance with rules prescribed for the purposes of each of
those paragraphs respectively.
on the basis that in that year, as well as carrying
on a life insurance business in Canada, it also
"carried on an insurance business ... in a country
other than Canada". The denial of this election by
the Minister of National Revenue and consequent
re-assessment of the respondent's income led to the
action being launched in the Trial Division and to
the judgment that is now under attack in the first
appeal.
In 1976, after carrying on an insurance business
in Canada from its office in London, Ontario for
many years, the respondent decided to branch out
to Bermuda. With a view to so doing, it consulted
Bermuda solicitors as to pertinent aspects of Ber-
muda law, studied the potential of the market
there and, in May of that year, appointed Harnett
& Richardson Limited of Hamilton as its Ber-
muda agents with authority to apply for a licence
to allow it to carry on a life insurance business in
that country. That licence was in fact issued on
June 24, 1976. In the meantime, about the same
time, the respondent's Canadian solicitors met
with Bermuda bankers, lawyers and the appointed
agents. Back home in Canada the heads of its
several departments considered changes in its
operating procedures which entry into the Ber-
muda market would require. The forms of policies
and applications were reviewed and adjusted. The
Bermuda agents were brought to Canada for
indoctrination sessions. A system of controls for
premium billings and collections for use in Ber-
muda was developed. Harnett & Richardson solic
ited many residents of Bermuda as potential policy
holders, and provided rate quotations to others
there. A bank account was opened in Bermuda and
the sum of $100,000 deposited therein. Near the
end of the year, in December, one of the respon
dent's marketing executives was dispatched to Ber-
muda to conclude a formal agency agreement with
Messrs. Harnett and Richardson and, at the same
time, handed over to that firm the respondent's
insurance policies being effected on the lives of two
local residents.
The agency agreement is entitled "Broker's
Agency" and though the respondent is referred to
therein as "Agent", the very first clause makes it
clear that the relationships created by the agree
ment were of "independent contractors". The
Agent's duties are set forth in clause 2:
2. Duties—The Agent, after being properly licensed, is hereby
authorized, and the Agent agrees to solicit applications and to
receive premiums for the Company upon the terms, within the
limits, and in accordance with the instructions, rules and
regulations of the Company.
The Agent, in his dealings with or on behalf of the Company,
agrees to conform to and abide by the instructions, rules and
regulations of the Company, however published or com
municated, and as amended or added to from time to time.
Clause 4 places a number of limits on the agent's
authority:
Limitation of Authority—The Agent agrees that he has no
authority on behalf of the Company to:
(a) Bind the Company in any way;
(b) Interpret a contract of insurance so as to bind the
Company;
(c) Make, alter or discharge any contract;
(d) Extend the time for payment of any premium;
(e) Waive any forfeiture or grant any permit;
(f) Incur any liability on behalf of the Company;
(g) Make or allow the delivery of any policy not issued under a
binding receipt, unless the applicant is at the time in good
health and the first premium has been paid;
(h) Collect a premium on any policy or a payment on any
policy loan except as he may be authorized under this
Agreement;
(i) Give a receipt for any premium or payment except upon the
printed form of receipt furnished by the Company for that
purpose;
(j) Vary any of the conditions contained in any printed form or
receipt;
(k) Institute or defend legal proceedings for any cause in
connection with the transaction of the Company's business;
(I) Publish any advertisement relating in any way to the busi
ness of the Company until a copy of same has been submitted
to and approved by the Company.
Whether or not the respondent carried on an
insurance business in Bermuda in 1976 is a ques
tion of fact and of construction of the statute to be
determined in the light of settled legal principles.
The appellant contends that the correct legal test
to be applied is the one that emerges from a line of
English cases beginning with Grainger & Son v.
Gough, [1896] A.C. 325 (H.L.), as applied in
Smidth & Co. v. Greenwood, [1921] 3 K.B. 583
(C.A.); affd [1922] 1 A.C. 417 (H.L.), and more
recently in Firestone Tyre & Rubber Co., Ltd. (as
Agents for Firestone Tire & Rubber Co. of Akron,
Ohio, U.S.A.) v. Lewellan (1957), 37 T.C. 111
(H.L.). It consists in looking at the place or coun
try in which operations take place from which
profits in substance arise. The application of the
test is well illustrated in Smidth. The House of
Lords was there called upon to decide whether a
firm of Danish manufacturers and dealers in ma
chinery were caught by the language of a British
taxing statute on the basis that by reason of their
activities in the United Kingdom they had "profits
arising or accruing from a trade ... exercised
within the United Kingdom". Those activities were
engaged in from an office in London which had
been put in the charge of a full-time employee who
was required to ascertain the requirements of
intended purchasers, to inspect the sites of any
proposed machinery installations and take samples
of earth, to report to the firm and forward samples
for testing, and to superintend important installa
tions of the firm's products. Negotiations in rela
tion to contracts between the Danish manufactur
ers and their customers in the United Kingdom
were conducted directly from Copenhagen where
the contracts were made and from which the ma
chinery was delivered f.o.b.
At each stage of the case—at trial, before the
Court of Appeal and in the House of Lords—it
was found that the activities in the United King
dom were not reached by the statutory language.
At pages 593-594, Atkin L.J. in the Court of
Appeal enunciated the test upon which the appel
lant now relies:
The question is whether the profits brought into charge are
"profits arising or accruing" to the respondents "from any
trade .... exercised within the United Kingdom" within the
meaning of Sch. D of the Income Tax Act, 1853. The question
is not whether the respondents carry on business in this coun
try. It is whether they exercise a trade in this country so that
profits accrue to them from the trade so exercised.
We have the guidance of the House of Lords on this subject
in Grainger v. Gough ([1896] A.C. 325, 336). Lord Herschell,
after pointing out that there is a difference between trading in a
country and trading with a country, says: "How does a wine
merchant exercise his trade? I take it, by making or buying
wine and selling it again with a view to profit." Similarly a
manufacturer of machinery exercises his trade by making the
machinery and selling it again, with a view to a profit. There
are indications in the case cited and other cases that it is
sufficient to consider only where it is that the sale contracts are
made which result in a profit. It is obviously a very important
element in the inquiry, and, if it is the only element, the
assessments are clearly bad. The contracts in this case were
made abroad. But I am not prepared to hold that this test is
decisive. I can imagine cases where the contract of resale is
made abroad, and yet the manufacture of the goods, some
negotiation of the terms, and complete execution of the con
tract take place here under such circumstances that the trade
was in truth exercised here. I think that the question is, Where
do the operations take place from which the profits in substance
arise? To my mind there is no evidence in the present case of
any other place than Denmark. No doubt operations of impor
tance take place here, orders are solicited, and the successful
adapting of the goods bought for the purposes of the buyer's
business is supervised here. But in the words of Lord Watson in
the case cited, ([1896] A.C. 340): "There may, in my opinion,
be transactions by or on behalf of a foreign merchant in this
country so intimately connected with his business abroad that
without them it could not be successfully carried on, which are
nevertheless insufficient to constitute an exercise of his trade
here within the meaning of Sch. D," and he instances the case
of the purchase of goods here for the purpose of salt abroad.
Sully v. Attorney-General (5 H. & N. 711) a case to which I
shall have to refer on the second point. In the words of Lord
Herschell ([1896] A.C. 325, 336): "What is done there," that
is, soliciting orders, "is only ancillary to the exercise of his
trade in the country where he buys or makes, stores, and sells
his goods." On this part of the case I think that the learned
judge came to the right conclusion in law.
The respondent resists the application of this
test and maintains that the Trial Judge was right
in concluding as he did having regard to the
activities engaged in in Bermuda, to definitions
contained in both the Canadian and Bermuda
legislation,' and to the overall scheme of the Act.
According to the respondent, a proper way of
testing whether an insurance business was carried
on in Bermuda in 1976 would be to see whether
that sort of business was solicited there on its
behalf and also whether the life insurance con
tracts were made there. It is apparent that the
learned Judge did not rest his conclusion on any
single factor but, as he himself put it at page 62 of
his reasons for judgment, upon "the cumulative
effect" of applying the "profits" or "profits gene
rated" test and tests relied upon by the respondent,
for at the latter page of his reasons for judgment
(pages 62-63), he said this:
' Subsection 248(1) of the Act defined "business" as
248. (1) In this Act,
"business" includes a profession, calling, trade, manufacture
or undertaking of any kind whatever and includes an
adventure or concern in the nature of trade but does not
include an office or employment;
while, by section 253, a person is deemed to be carrying on
business in Canada in the following circumstances:
253. Where, in a taxation year, a non-resident person
(a) produced, grew, mined, created, manufactured, fab
ricated, improved, packed, preserved or constructed, in
whole or in part, anything in Canada whether or not he
exported that thing without selling it prior to exportation,
or
(b) solicited orders or offered anything for sale in Canada
through an agent or servant whether the contract or
transaction was to be completed inside or outside Canada
or partly in and partly outside Canada,
he shall be deemed, for the purposes of this act, to have been
carrying on business in Canada in the year.
The term "business of insurance" is defined in subsection 2(1)
of the Canadian and British Insurance Companies Act, R.S.C.
1970, c. I-15, as amended, as
... the making of any contract of insurance, and includes
any act or acts of inducement to enter into such a contract,
and any act or acts relating to the performance thereof, or
the rendering of any service in connection therewith;
(Continued on next page)
The contracts of insurance issued in 1976 were made in Ber-
muda, a vital part of the company's business, its sales opera
tions, was conducted in Bermuda through its agent, and the
inducement to have residents of Bermuda enter into life insur
ance contracts clearly fell within the common, and also legisla-
tively defined, meaning of carrying on the insurance business.
Those circumstances, combined with the other activities carried
on by the plaintiffs agent in Bermuda, to which I have already
made reference, have satisfied me that in 1976 the plaintiff did
carry on its business in Bermuda.
I should deal first with the approach which I
conceive should be taken in deciding whether the
respondent carried on an insurance business in
Bermuda in 1976 within the meaning of subsection
138(9) of the Act. Here I must confess to some
doubt that the "profits" or "profits generated" test
enunciated by Atkin L.J. in Smidth is the one to
be applied. As the Trial Judge observed, that test
was developed to determine whether certain activi
ties engaged in within the United Kingdom result
ed in "profits arising or accruing from a trade ...
exercised within the United Kingdom". Moreover,
Atkin L.J. himself took care to observe that the
question was not whether "the respondents carry
on business in this country". I agree with the
learned Trial Judge that under the subsection this
latter question is indeed broader than the one
which had to be answered by the English courts
upon the United Kingdom legislation.
According to the appellant, the whold object of
subsection 138(9) is to identify and isolate an
insurer's "gross investment revenue from property
used by it ... , or held by it ... in the course of,
carrying on that business in Canada" and hence,
by necessary implication to eliminate from taxa
tion in Canada revenue from property used or held
by it in carrying on an insurance business outside
of Canada. From this it is argued that under the
subsection the question is reduced to discovering
whether the profits sought to be held arose out of a
trade which was exercised in Bermuda, making the
"profits" or "profits generated" test relevant and
(Continued from previous page)
The Non-Residents Insurance Act, 1967 (Bermuda) defines an
"insurance business" to include "making out or executing
policies of insurance".
applicable. I do not think it follows from the fact
that, in one respect, the statute focuses on the
generation of gross investment revenue from prop
erty in Canada, Parliament thereby intended that
the determination of whether a business was car
ried on in the same year in a country other than
Canada should depend solely on whether profits in
substance arose from the taxpayer's activities in
that country. Indeed, I am inclined to the view
that the phrase "carried on an insurance business
... in a country other than Canada" is not to be
limited by considerations that may or may not be
determinative of whether such a business was car
ried on in Canada. These are words of broad
import and must be construed as such. I am
generally of the view that the learned Trial Judge
was right in the conclusion he arrived at on this
aspect of the case.
Against the possibility that I may be wrong in
the view I should now consider whether the
respondent's activities in Bermuda in 1976 satisfy
the "profits" or "profits generated" test laid down
in the cases. Counsel for the appellant submits that
those activities were, as he put it, but "prelimi-
nary" or "preparatory" or, to use the words of
Lord Herschell quoted by Atkin L.J., merely
"ancillary" to the carrying on of a business and
did not amount in themselves to the doing of such.
That, he says, is particularly so with respect to the
solicitation of insurance business through agents
there, such activities later maturing into the
making of insurance contracts on lives of individu
als residing in Bermuda. Activities of substance
(i.e. those bearing on the making of decisions that
gave rise to revenue or to the reasonable expecta
tion of same), he contends, all occurred at the
respondent's head office in Canada, and these he
catalogues as follows:
(a) deciding whether or not to accept and underwrite the risks;
(b) deciding what rates to charge following an assessment of a
particular risk;
(c) preparing and issuing policies for delivery to Bermuda
applicants;
(d) deciding on whether or not to pay claims submitted;
(e) controlling the appellant's financial affairs and sending
funds to Bermuda to be disbursed to claimants;
(f) otherwise closely controlling the appellant's financial
inflows and outflows, both with respect to its policies and
with respect to the investments made by it from the
premiums collected by it in Bermuda.
Additionally, counsel took issue with some of
the Trial Judge's findings regarded by him as
relevant to his determination that the respondent
had indeed carried on an insurance business in
Bermuda in 1976. These were that the agents:
(a) arranged for medical examination of applicants for insur
ance policies;
(b) bound the respondent to interim insurance coverage;
(c) - performed "persistency ratings" of applicants for insur
ance;
(d) satisfied themselves that the applicants were, at the date of
delivery of the insurance policies to them, in continued
apparent good health; and
(e) completed the contracts of insurance by delivery of the
policies to them.
I can find no material error in any of these
findings. A review of the record suggests that an
obligation did rest upon the agents under the terms
of their appointment or approved practice to
arrange medical examinations and to be satisfied
at the time of delivery of the policies . in Bermuda
that the applicants continued in apparent good
health. I do not think it at all material that the
need for medical examinations on the two lives
insured were apparently waived. Such evidence as
does exist in the record is rather clear to the effect
that the agents did satisfy themselves as to the
continued good health of the applicants when they
delivered the policies to them in Bermuda on
December 30, 1976. It seems clear too, even from
the conditions of the policies themselves, that they
were only to come into effect upon delivery. Thus,
among the "General Provisions and Conditions"
(Appeal Book, Common Appendix, Vol. 1, at page
179) it is explicitedly provided:
The contracts shall not come into force unless
(2) this policy has been delivered to the policy owner, his agent
or assign, or the beneficiary and
(3) no change shall, subsequent to the completion of the said
application, have taken place in the insurability of the Life
Insured ....
While it appears that no "persistency ratings"
were carried out by the agents in Bermuda along
the lines applied by the respondent in Canada,
there was evidence to the effect that the agents did
carry out some sort of persistency rating on the
Bermuda policy holders. Finally, while the evi
dence also supports the conclusion that interim
insurance was not actually arranged in 1976 it
nevertheless is to the effect that this came about
because of failure on the part of the agents to
collect the premiums at the time the insurance
applications were submitted due to a misunder
standing on their part that such was a necessary
precondition to interim insurance becoming effec
tive. There appears no doubt, however, that the
agents did possess authority to arrange interim
insurance and that, but for this misunderstanding,
they would have done so in 1976.
If the respondent's activities in Bermuda had
consisted only of soliciting orders there for accept
ance in Canada it might be arguable on the basis
of certain utterances in Grainger & Son v. Gough
that, to use the phraseology of Lord Herschell,
what was done in Bermuda was only "ancillary" to
the carrying on of a business in Canada. Although,
as the appellant has demonstrated, many things
had to be and were in fact done in Canada in order
to bring insurance policies on the lives of residents
of Bermuda into existence, it remains that other
acts of overriding importance and significance had
to be done and could only be done in Bermuda.
The initial solicitation of business was but one of
these. There must be added to it the other activi
ties of the agents identified in the judgment below,
the absence of at least two of which would have
meant that no policies could have come into force
in Bermuda. I have in mind the requirement that
policies be delivered there in order for them to be
legally effective and the further requirement that
the agents, in effect, make a subjective but funda
mentally important assessment prior to such deliv
ery that no change had occurred in the insurability
of the lives of the applicants between the date of
their applications and the date the policies were
delivered to them. Had these activities not trans
pired in Bermuda, no life insurance policies would
have issued there from which profits could gener
ate. All in all I am satisfied that the "profits" or
"profits generated" test, if it is applicable at all, is
satisfied. The respondent further submits from the
scheme of the Act that one can only conclude the
licensing of the insurer to carrying on business in
Bermuda under its domestic legislation and the
actual issuance of life insurance policies there
constituted a carrying on of business within the
meaning of subsection 138(9). I do not find it
necessary to examine the merits of this contention
in order to be satisfied, as I am, that the respon
dent did in fact carry on an insurance business in
Bermuda in 1976 in the sense of the subsection.
Data Services Issue
The second issue in this appeal, and the sole
issue in the second appeal, arises as a consequence
of the fact, found by the Trial Judge, that in the
1975 and 1976 taxation years the respondent had
excess computer capacity that was needed to meet
peak demands of its life insurance business but not
otherwise. These services consisted of preparing
cheques or accounting statements or data process
ing and some programming—whatever can be
done on a computer. Because the respondent's
business was subject to the provisions of the
Canadian and British Insurance Companies Act,
R.S.C. 1970, c. I-15, it was prohibited from selling
this excess capacity directly to the public for a fee.
In the taxation years in question subsection
208(1) of the Act, found in Part XII thereof,
levied on the "taxable Canadian life investment
income" a 15% tax. This income was defined in
subsection 209(3) as the excess of the life insurer's
"net Canadian life investment income" over the
aggregate of certain defined amounts. A life insur
er's "net Canadian life investment income" was its
"gross Canadian life investment income", under
subsection 209(1), minus certain specified
amounts. In the 1975 and 1976 taxation years
paragraph 209(2)(d) of the Act provided as
follows:
209... .
(2) A life insurer's net Canadian life investment income for a
taxation year is its gross Canadian life investment income for
the year minus the aggregate of
(d) 50% of the aggregate of each amount deductible under
Part I in computing the insurer's income for the year from
carrying on its life insurance business in Canada, except to
the extent that such amount
(i) is included in any of the amounts determined in respect
of the insurer for the year under paragraph (a), (b) or (c),
(ii) is deductible under subsection 138(3) in computing its
income for the year from carrying on its life insurance
business in Canada,
(iii) was paid or payable by the insurer under a life
insurance policy before the end of the year,
(iv) was an outlay or expenses laid out or incurred by it
for the purpose of earning income from its group life
insurance business, or
(v) was payable by the insurer to a province as a tax in
respect of premiums collected by it in the year under life
insurance policies.
By arrangement with the Superintendent of In
surance appointed under the above-mentioned
statute, the respondent was permitted to provide
the excess capacity to a wholly-owned subsidiary
for sale by it to the public. A subsidiary was soon
incorporated under the name Lonlife Data Ser
vices Limited. It had no employees and owned no
data processing equipment or premises from which
to conduct such a business. Its functions were
performed by the respondent's employees, from the
respondent's premises and with the respondent's
equipment. According to the Trial Judge's finding
(at page 64 of his reasons for judgment) the
subsidiary (referred to by him as "L.D.S.") "paid
the plaintiff [respondent] for this capacity an
annual amount calculated as a percentage of cer
tain actual and fictional expenses incurred by the
plaintiff [respondent] in the operation of the com
puter" and also that "[B]y the direction of the
Superintendent of Insurance the plaintiff, in this
arrangement with L.D.S., was not permitted to
make a profit or suffer a loss as determined by the
methods of accounting prescribed for life insur
ance companies".
The manner in which the matter was dealt with
by the respondent in carrying out the directive of
the Superintendent of Insurance so as to produce
neither a profit nor a loss in the respondent's life
insurance business as well as the manner in which
it was dealt with for income tax purposes in the
1975 and 1976 taxation years is explained by the
Trial Judge at pages 64-65 of his reasons for
judgment:
For its 1975 and 1976 taxation years, the plaintiff carried on
this arrangement with its subsidiary and, for the purposes of its
insurance accounting requirements, made neither a profit nor
sustained a loss. In its annual statements for those years, which
it was required to submit to the Superintendent of Insurance,
the revenues and expenses associated with the intercompany
computer business were shown as net amounts which sometimes
offset one another in individual categories, and the net totals of
each category, which offset each other completely. This was as
required and to the satisfaction of the Superintendent of
Insurance.
In filing its income tax returns for the same years, however,
the plaintiff did not report the revenues and expenses in the
same manner as it did for the Superintendent of Insurance.
Indeed it reported all of the funds received from L.D.S. as
income and all of the expenses, which it considered as deduct
ible expenses, as expenses.
This had the result of increasing the plaintiffs income as well
as its expenses. It also gave rise to the result which formed the
basis for the defendant reassessing the plaintiff for those two
years. The reassessment was for additional tax in each year
under Part XII of the Income Tax Act by reason of the
defendant reducing the expenses deductibe in computing the
amounts on which the Part XII tax was applicable.
Part XII of the Act, now repealed [S.C. 1977-78, c. 1, s. 9],
contained special provisions for the taxation of investment
income of a life insurer arising in the course of its Canadian life
insurance business. Subsection 209(2) [as am. by S.C. 1974-75-
76, c. 26, s. 117] also provided for the deduction of expenses
incurred in carrying on its life insurance business. Fifty percent
of any expense so incured [sic] was allowed as a deduction and
the resultant taxable income was taxed at the rate of 15%. By
adding 50% of the gross expenses associated with its income
from L.D.S. to 50% of each of the other expenses incurred in
carrying on its life insurance business, the plaintiff reduced its
taxable income from its life insurance business by an equivalent
amount and its tax by 15% of that amount.
It is convenient to recite at this point paragraph
46 of the respondent's written argument (the con
tents of which are not disputed) so as to better
understand how the matter was treated by the
respondent in computing its income for tax pur
poses in the two years in question:
46. In computing its income for its 1975 and 1976 taxation
years for purposes of the Act, the Respondent reconciled its net
income as shown in its statement prepared for the Superintend
ent of Insurance with net income for tax purposes on the form
T2S(1) in its 1975 and 1976 tax returns. This was done by
making the following adjustments:
(a) showing amount received from Lonlife as revenue,
(b) increasing the various expense accounts by amounts in the
aggregate, equal to the amount received from Lonlife,
(c) adding back to income all depreciation (as increased in the
manner referred to above) charged in its accounts for
financial statement purposes,
(d) claiming capital cost allowance to the extent permitted
under the Act and Regulations, and
(e) adding back to income the notional or fictional amount of
head office rent which had also been increased as set out
above...
The deductions were disallowed by the appellant
on the ground that the amounts so shown as
income were not income of the respondent but
were operating expenses incurred by the respon
dent on behalf of the subsidiary for which the
respondent was reimbursed and, secondly, that
even if the amounts received by the respondent
from its subsidiary were income from the sale of
excess computer capacity, the amounts were
income from a business of the respondent other
than the respondent's life insurance business and
the amount shown as expenses (50% of the total of
which were claimed as deductions) were not
deductible under the provisions of subsection
209(2) of the Act because they were incurred for
the purpose of earning income from the sale of
excess computer capacity and not for the purpose
of carrying on its "life insurance business".
In support of his opinion that the appeal should
be allowed and the tax assessments for the years in
question be referred back to the Minister for reas
sessment on the basis that amounts received from
the subsidiary did not reduce expenses incurred by
the respondent deductible under Part XII of the
Act, the Trial Judge reached the following
conclusions:
1. The amounts received by the respondent from
the subsidiary as payment for the excess com
puter capacity was properly characterized as
income of the respondent; the "no profit/no
loss" arrangement carried out in accordance
with the directive of the Superintendent of In
surance was irrelevant to the issue; the reduc
tion of the respondent's overall costs represent
ed additional income or profits in his hands in a
business sense and, likewise, the respondent had
a reasonable expectation of making a profit
from the arrangement with the result that the
revenue received from the subsidiary could be
properly characterized as income;
2. The expenses were incurred by the respondent
to earn that income were incurred on its own
behalf and not on behalf of the subsidiary;
practically all of the expenses which went to
make up the respondent's annual charge to the
subsidiary would have been incurred by the
respondent without the existence of the
arrangement with the subsidiary and, accord
ingly, were incurred by the respondent in its
own right and not on behalf of the subsidiary;
there was no suggestion in the evidence [at page
68]:
... that the salaries of the plaintiffs staff would have been
reduced or that the number of employees of the plaintiff would
have been reduced if the plaintiff had not entered into the
arrangement with L.D.S. Similarly the computer equipment
would have required the same amount to maintain and repair it
and would have depreciated to the same extent. What was
charged by the plaintiff to L.D.S. for the provision of the excess
computer capacity was an annual fee calculated in accordance
with the guidelines of the Superintendent of Insurance and by
reference to percentages of certain costs of the plaintiff allowed
as costs under the provisions of the Canadian and British
Insurance Companies Act. The expenses were incurred by the
plaintiff in its own right and not on behalf of L.D.S. Indeed the
rent and depreciation amounts which were allocated and made
up some $60,000 of the 1976 charge to L.D.S. were not
incurred by the plaintiff at all and therefore could not possibly
be considered as reimbursed expenses because there was no
outlay by the plaintiff and therefore nothing to be reimbursed.
3. Though the question was "most troublesome",
as the expenses in question were incurred by the
respondent on its own behalf and not on behalf
of the subsidiary and for the purpose of carry
ing on the life insurance business, they were
deductible under paragraph 209(2)(d) of the
Act; the excess capacity was needed by the
respondent to handle the peak demand loads of
its life insurance business; the decision of the
Trial Division in Excelsior (The) Life Insurance
Co y The Queen, [1985] 1 CTC 213; 85 DTC
5164 (F.C.T.D.) was applicable.
As I am in respectful disagreement with the
Trial Judge on the third point I need not address
the first two. I cannot agree with the respondent's
submission that the amounts claimed as expenses
were incurred in carrying on its life insurance
business in that they were associated with the
operation of its computer, the full capacity of
which was found by the Trial Judge to be required
so as to service peak period demands. In reality,
the respondent engaged in both a life insurance
business and, additionally, in dealings related to
this excess computer capacity. Not being content
to see that capacity lie unused during non-peak
periods, the respondent chose, instead, to turn it to
account in the manner found by the Trial Judge.
In this way the respondent, in my view, stepped
across the boundary between its life insurance
business and an entirely new and different adven
ture, a fact which, indeed, both the respondent and
the Superintendent of Insurance apparently well
understood by the "no profit/no loss" arrange
ment. In my view, the expenses were not related to
the life insurance business but to this new adven
ture. The question before the Trial Judge was one
of law, namely, whether the expenses claimed were
"deductible under Part I in computing the
[respondent's] income for the year from carrying
on its life insurance business in Canada" within
the meaning of subsection 209(2) found in Part
XII of the Act. In my opinion they were not. In so
concluding I could derive no assistance from the
Trial Division's decision in Excelsior Life. As the
appellant submits, all that was decided there was
that the management expenses applicable to
"segregated fund" were nevertheless incurred for
the purpose of gaining or producing income. The
precise question before us in the case at bar was
not raised for decision in that case.
In the result, I would
1. allow the first appeal in part without costs and
would vary the judgment therein rendered July 28,
1987 (Court File No. A-847-87) by deleting para
graph 2 thereof. In all other respects I would
confirm the judgment therein;
2. allow the second appeal with costs both here
and in the Trial Division and would set aside the
judgment therein rendered July 28, 1987 (Court
File No. A-846-87).
HEALD J.A.: I concur.
DESJARDINS J.A.: I concur.
You are being directed to the most recent version of the statute which may not be the version considered at the time of the judgment.