Consolidated-Bathurst Ltd. v. The Queen, 87 DTC 5001, [1987] 1 CTC 55 (FCA)

Stone, J.:—The principal question raised in this appeal concerns the applicability of subsection 245(1) of the Income Tax Act, R.S.C. 1952, c. 148 as amended by S.C. 1970-71-72, c. 63. It is the first of its kind to come before the Court.

Background

The appellant was formed in 1967 as a result of an amalgamation. During the years 1971 to 1975 it operated as a manufacturer of pulp and paper and of packaging in Canada and in other countries. To this end it had some 20 to 30 subsidiaries throughout the world. The shares of these subsidiaries were held by its wholly owned subsidiary St. Maurice Holding Limited ("St. Maurice”) which was formed for the purpose of holding shares in affiliated and subsidiary corporations outside of Canada.

After its formation, the appellant’s insurance requirements and those of the subsidiaries were placed in the insurance market but a high loss record soon made it difficult and expensive to obtain coverage in that way. Nevertheless, insurance coverage was essential in order that the appellant could satisfy conditions of trust deeds securing corporate indebtedness. A scheme was soon developed under which it was thought insurance protection could be achieved in a different way, free of Canadian insurance industry regulations. The scheme took form in 1970 when Overseas Insurance Corporation was incorporated under the laws of Panama with a capitalization of $120,000. It secured a license to carry on an insurance business in Bermuda. In 1974 a second corporation, Overseas Insurance Limited, was incorporated under the laws of Bermuda. The assets of the Panamanian corporation were transferred to the Bermudian corporation which was then licensed to carry on an insurance business in Bermuda. It will be convenient to refer to both corporations simply as "Ol". All of the directors and officers of OI were residents of Bermuda and all of the shares in both corporations were held by St. Maurice. OI was managed pursuant to a contract between St. Maurice and Insurance Managers Limited, a Bermudian corporation owned by the appellant's Canadian insurance brokers. Insurance Managers Limited had a substantial staff and managed some 55 insurance subsidiaries in Bermuda.

The scheme was carried into effect during 1970 and operated throughout the 1971 to 1975 taxation years. The existence of OI represented but one of its essential elements. Other elements involved the appellant in insuring certain risks of its own and of its subsidiaries with Canadian domestic insurers, the reinsuring by those insurers of all but a small percentage of those risks with OI pursuant to the terms of agreements known as Open Facultative Agreements between that insurer and Ol, the securing by OI of stop loss and excess of loss protection by way of reinsurance in the open market and, finally, the protecting of the domestic insurers by indemnity agreements coupled with Ol's bank letters of credit in favour of those insurers secured by Ol's investments and backed up by the appellant's own guarantees. The details of these documents and their significance for this case will become apparent presently. The domestic insurer was Victoria Insurance Company of Canada in 1970, Scottish & York Insurance Co. Limited from 1971 to 1974 inclusive and Elite Insurance Company in 1975.

The groups of risks which the appellant sought to insure under the scheme were of two kinds. The first consisted of the aggregate of deductibles found in primary insurance policies secured by the appellant and the subsidiaries in the insurance market. These deductibles were covered by the primary insurers under so-called "deductibles" policies. Almost all of these risks were reinsured by OI which then protected itself by securing stop loss insurance on the open reinsurance market against claims in excess of its premium funds. The second consisted of miscellaneous risks insured by the appellant and the subsidiaries under "composite" policies. A percentage of these risks was placed with different insurance carriers and with Ol. Initially, 20 per cent of these risks was insured with OI but this was increased to 40 per cent in the second year. Premiums were paid directly to OI for the coverage. Most of these risks were reinsured with underwriters at Lloyd’s. The appellant placed 100 per cent of these risks with those underwriters in the third and fourth years of the program and they, in turn, reinsured most of them with OI. Again, OI protected itself by securing on the open reinsurance market excess of loss insurance against claims exceeding its premium funds. There was evidence that over time risks of persons other than the appellant and the subsidiaries would be accepted by Ol, but no such risks were accepted in the years under review.

In calculating its taxable income for its 1971 to 1975 taxation years, the appellant deducted as business expenses the whole of the premiums paid for this "deductibles" and "composite" protection. The Minister disagreed and assessed the appellant on the basis that a substantial portion should be disallowed. Further, he assessed interest and exchange gains realized by OI in the taxation years 1972 to 1975 on the basis that they were to be attributed to the appellant for tax purposes. In the Trial Division, Strayer, J. decided against the appellant on the first point and in its favour on the second.* [1] This appeal is brought from that decision.

The Issues

Two issues arise for decision. First, did the learned Trial Judge err in upholding the Minister's assessment disallowing as business expenses portions of insurance premiums paid in the taxation years 1971 to 1975? Second, did the learned Trial Judge err in varying the Minister’s assessment by excluding therefrom the interest and exchange gains earned by OI in the taxation years 1972 to 1975?

I turn now to deal with these issues.

Insurance Expenses

The Minister allowed as business expenses only those portions of the amounts paid as premiums to the domestic insurers for "deductibles" coverage that was not reinsured with OI and premiums paid directly by the appellant for "composite" insurance coverage. In the formal judgment, premiums paid by OI for stop loss and excess of loss insurance together with commissions and taxes relevant to obtaining such reinsurance were also allowed. The remainder of the amounts paid to OI less policy losses was disallowed. Because, in the case of the "deductibles" policies, the domestic insurers retained only seven and one-half per cent of the risks during the years 1971 to 1974 and but two and one-half per cent thereof in 1975, the amounts disallowed are rather substantial.

The position of the appellant is that all of the amounts were paid for insurance protection and as such were properly deducted as insurance expenses. The respondent contends that the plan represented an elaborate scheme of self-insurance through OI! which was not bona fide and that it was in reality a reserve the deduction of which would artificially reduce the appellant's income contrary to subsection 245(1) and paragraph 18(1)(e) of the Act. The respondent argued that the scheme was a sham but the learned trial judge disagreed. It was also his view that the bona fide business purpose which he found to be present could not immunize the appellant from tax liability if the scheme otherwise attracted it. He found at page 147 (D.T.C. 5123) that one of the factors in the decision to set it up was the existence of problems facing the appellant at that time in obtaining insurance or in obtaining it at a reasonable cost. On the other hand, he found at page 148 (5123) that tax advantages were also a motivation. He could not and, indeed, did not find it necessary to say to what extent these and other factors influenced the decision to establish the scheme.

Paragraph 18(1 )(e) and subsection 245(1) of the Act read:

18 (1) In computing the income of a taxpayer from a business or property no deduction shall be made in respect of

(e) an amount transferred or credited to a reserve, contingent account or sinking fund except as expressly permitted by this Part;

245 (1) In computing income for the purposes of this Act, no deduction may be made in respect of a disbursement or expense made or incurred in respect of a transaction or operation that, if allowed, would unduly or artificially reduce the income.

In rejecting the appellant’s basic position that the amounts paid were properly deducted, the learned trial judge had this to say at pages 149-50 (D.T.C. 5125):

To the extent that such risks connected with the plaintiff's property were not insured or reinsured with unrelated companies, those risks remained with OI. All of Ol's assets had their ultimate source in the plaintiff. Its original capitalization of $120,000 came from St. Maurice, the plaintiff's wholly owned subsidiary; its revenues came directly from the plaintiff as insurance premiums, or indirectly from the plaintiff as reinsurance premiums from the plaintiff’s insurers; together with such rebates or commissions as it might earn on insuring or reinsuring the plaintiff's property, and interest earned on surplus funds having their ultimate source in the plaintiff. OI had no other customers among whom to spread the risk, nor any other source of funds from which the plaintiff could be paid for losses within the area of risk retained by OI. Therefore the “insurance program" must be seen as a device for channelling funds from the plaintiff to one of its own instrumentalities over which it had complete control, and to which it would have to look to pay losses on risks retained by Ol. Any funds available in OI would be funds having their origin with the plaintiff. Any surplus OI might enjoy would ultimately be under the control of the plaintiff as the sole shareholder of the sole shareholder of Ol. Any losses which OI did not have assets to cover would have to be borne by the plaintiff. The net result is similar to the establishment of a reserve fund by any institution or corporation from which it would plan to pay for uninsured losses to its property.

Nor was it established by the evidence that this was only an incidental consequence of an arrangement required by the plaintiff for obtaining insurance from third parties. For example, the evidence indicates that the premiums paid to Scottish and York, the Canadian insurer, were the same as it would have charged to any insured whether or not the insured had a captive insurance company to act as reinsurer. By the same token this suggests that there was no market advantage in having a captive reinsurer. Similarly, although it was said that one of the reasons for establishing a captive insurer was to obtain access to reinsurance markets not available otherwise than to a captive insurance company, in fact the evidence indicates that the reinsurance obtained was available to any insurance company whether a captive or not. Therefore the use of the captive insurance company in part to cover risks not otherwise reinsured was not merely incidental to an arrangement for obtaining from third parties reinsurance not otherwise available.

Therefore I conclude that the so-called “premiums" paid by the plaintiff in respect of risks for which its instrumentality, OI, assumed the responsibility, were disbursements which would artificially reduce the income of the plaintiff and are therefore not deductible from its income, pursuant to subsection 245(1). In fact such disbursements were in effect amounts transferred to a reserve fund and are therefore not deductible by virtue of paragraph 18(1 )(e) of the Income Tax Act.

The learned trial judge relied on cases dealing with the meaning of artificiality in the context of the predecessor of subsection 245(1) including a decision of the Exchequer Court of Canada in Shulman v. M.N.R., [1961] Ex. C.R. 410; [1961] C.T.C. 385 (affirmed without reasons by the Supreme Court of Canada, 72 D.T.C. 1166), where Ritchie, D.J. said at page 425 (C.T.C. 399- 400):

In the context found here, “artificially" means “unnatural", — “opposed to natural” or “not in accordance with normality".

I construe subsection (1) as though it read:

In computing income for the purpose of this Act no deduction that if allowed would unduly or artificially reduce the income may be made in respect of a disbursement or expense made or incurred in respect of a transaction or operation.

In considering the application of section 137(1) to any deduction from income, however, regard must be had to the nature of the transaction in respect of which the deduction has been made. Any artificiality arising in the course of a transaction may taint an expenditure relating to it and preclude the expenditure from being deductible in computing taxable income.

The decisions of the Trial Division in Don Fell Limited et al. v. The Queen, [1981] C.T.C. 363; 81 D.T.C. 5282 and Sigma Explorations Ltd. v. The Queen, [1975] F.C. 624; [1975] C.T.C. 215 were also relied upon. He was neither persuaded by the appellant's arguments based upon the parties to undoubtedly binding and enforceable legal transactions being separate legal entities nor by the lack of a principal/agent relationship between the appellant and OI. It was his view, at page 149 (D.T.C. 5124), that it is permissible to pierce the corporate veil on occasion . .. .” In that connection he referred to the majority decision of the Supreme Court of Canada in Covert et al. v. Minister of Finance of the Province of Nova Scotia et al., [1980] 2 S.C.R. 774; [1980] C.T.C. 437 where at page 796 (C.T.C. 449) the Court felt compelled to "examine the realities of the situation” and concluded that a subsidiary company “was bound hand and foot to the parent company and had to do whatever its parent said". That case was exceptional on its facts. Nevertheless, the learned trial judge at page 149 (D.T.C. 5124) inferred that OI had to do whatever St. Maurice and the appellant said. In my view, evidence supporting this inference is somewhat scant. The respondent relies on a general investment guideline directed to OI by the appellant but, taken alone, I would regard it as nothing more than the legitimate interest of an ultimate investor in the financial success of its affiliate.

In attacking the decision under appeal the appellant repeats submissions made at trial, all of which were directed toward showing that the operation of the scheme had not "artificially" reduced income in any of the years in question but rather that it was a legitimate program which was designed to secure the appellant’s insurance requirements. Accordingly, it argues that no portion of the premiums should have been disallowed as business expenses even though tax savings had resulted. The respondent likens the scheme to a train operating on a single track between two fixed points. Each year as annual coverage expired and new coverage was required the scheme took over and, like the train, was set upon a preordained course. The appellant, it is said, had locked itself into a program that amounted in reality to a reserve for payment of future losses. The indemnities, letters of credit and guarantees could only mean that the appellant and St. Maurice had obliged themselves to make good any short-fall between insurance claims presented and funds available in Ol to meet them. The fact that the scheme had been dressed up in the guise of an insurance program, argues the respondent, did not make it such.

It seems to me that the applicability of subsection 245(1) must be examined from two distinct points of view: first, in the circumstances of the 1971 to 1974 period with its indemnities, letters of credit and guarantees and, then, in the absence any such indemnity or guarantee in the 1975 taxation year. Those elements were not incorporated in the original scheme though they seemed to have been contemplated. They were introduced during the 1972 taxation year. The effect of the indemnities was to protect both Victoria Insurance Company of Canada and Scottish & York Insurance Co. Limited from exposure to loss for any coverage ceded by either of them to OI pursuant to the Open Facultative Agreement. By their terms St. Maurice bound itself both to Victoria Insurance Company of Canada and to its sister com- pany, Scottish & York Insurance Co. Limited, as an “‘eligible person” therein defined, as follows:

In consideration of the benefits to ST. MAURICE HOLDINGS LIMITED from operations of its wholly owned subsidiary OVERSEAS INSURANCE CORPORATION, "OVERSEAS , ST. MAURICE HOLDINGS LIMITED shall indemnify and hold harmless any eligible party, as hereinafter defined, against all current liability, loss and expense, including but not limited to reasonable attorneys’ fees, that such eligible party may incur by reason of the failure of OVERSEAS to perform any or all of its obligations to such eligible party with respect to transactions between such eligible party and ST. MAURICE HOLDINGS LIMITED and/or CONSOLIDATED-BATHURST LIMITED, or any of their subsidiary companies, or in defending or prosecuting any suit, action or other proceeding brought in connection therewith or in obtaining or attempting to obtain a release from liability in respect thereof.

ST. MAURICE HOLDINGS LIMITED covenants that it will reimburse such eligible party on demand for, or pay over to such eligible party, all sums of money which such eligible party shall pay or become legally liable to pay by reason of any of the foregoing, and will make such payment to such eligible party as soon as such eligible party shall become liable therefor, whether or not such eligible party shall have paid out such sums or any part thereof.

The obligation of ST. MAURICE HOLDINGS LIMITED to indemnify any such “eligible party” hereunder shall constitute for as long as any obligation is outstanding from OVERSEAS to such “eligible party .

Then, from time to time throughout the 1971-1974 years Ol arranged bank letters of credit in favour of Victoria Insurance Company of Canada and Scottish & York Insurance Co. Limited against which either company could on demand draw up to specified limits on terms similar if not completely identical to the following which appeared in the 1972 letter of credit:

The amount so drawn is to be payable upon presentation of a certificate by Scottish & York Insurance Co. Ltd. and/or Victoria Insurance Co. of Canada, stating that Overseas Insurance Corporation is in default of its current obligations towards Scottish & York Insurance Co. Ltd. and/or Victoria Insurance Co. of Canada, written demand for which was mailed to Overseas Insurance Corporation with copy to St. Maurice Holdings Ltd. not less than 30 days prior to presentation of this certificate.

These instruments were each secured by Ol's time deposits in Bermuda. The evidence was that they were required by Scottish & York Insurance Co. Limited and Victoria Insurance Company of Canada because OI was not a Canadian licensed insurer as required by the Superintendent of Insurance. Finally, the appellant furnished the bank with its own guarantees as further security for the letters of credit. These guarantees each read in part:

IN CONSIDERATION of the (Bank) dealing with Overseas Insurance Corporation herein referred to as the Customer, the undersigned hereby guarantee(s) payment to said Bank of all present and future debts and liabilities direct or indirect or otherwise, now or at any time and from time to time hereafter due or owing to said Bank from or by the Customer, arising from a demand having been made under Letter of Credit. . . .

When, in 1975, the Elite Insurance Company entered the picture as the domestic insurer neither an indemnity nor a guarantee supporting the letter of credit was required. Again, that letter of credit was provided directly by Ol.

I am in respectful agreement with the conclusion of the learned trial judge in so far as it concerns the taxation years 1971 to 1974 inclusive. The effect in those years of the appellant’s guarantees, it seems to me, was to place the appellant in a position where it could have been required to absorb a loss it had purported to insure. OI was then in its infancy and its Capitalization was relatively small. True, it had reinsurance protection for its premium accounts and neither expected to be nor in fact was called upon to make good under its guarantees. I do not see that that matters at all. The effect of the guarantee arrangements was that in the event something unforeseen had occurred such as would have prevented OI from meeting claims presented by the domestic insurers pursuant to the Open Facultative Agreement, the appellant itself would have had to absorb any resulting loss otherwise covered by the terms of its insurance contracts. According to the evidence, guarantees of this kind had some prevalence in the industry as between insurer and reinsurer but not as between insured and reinsurer. It only stands to reason. I should have thought that an insurer's request for such a guarantee might, in ordinary circumstances, quite properly be met with incredulity and, I suspect, with a firm and swift rejection by his insured. Similarly, even though no guarantee was given in respect of the “composite" policies, the appellant would also have had to absorb any loss thereunder for coverage retained by OI because OI might not have had sufficient funds available. In respect of risks retained by OI, I do not see how the arrangement which operated throughout the 1971 to 1974 taxation years can be viewed as providing bona fide insurance protection under which risk shifted and was distributed so as to render eligible for deduction as business expenses amounts paid by the appellant as premiums thereunder. As no such protection was purchased in those years, the deduction of such amounts resulted in an artificial reduction of the appellant's income.

The respondent urges that these payments constituted a “reserve" within paragraph 18(1)(e) of the Act and the learned trial judge agreed. There seems to me, however, no necessity of characterizing the payments in that or any other particular way. It is sufficient to say that they cannot be regarded as insurance premiums deductible against income. This follows because in the circumstances they were abnormal payments whose deduction would “artificially" reduce income within the test of artificiality set forth in the Shulman case. A contract of insurance is a contract to indemnify an insured for losses incurred to the full extent provided in the contract according to its terms and conditions. In my view, an arrangement or condition whereby an insured may be required to absorb any portion of the loss for which indemnity is so provided does not result in bona fide insurance protection. Moneys paid as premiums therefor may not be deducted from income as business expenses.* [2]

I have not overlooked additional arguments put forward by the appellant although I cannot accept them. Reliance is placed on the decision of this Court in Spur Oil Ltd. v. The Queen, [1982] 2 F.C. 113; [1981] C.T.C. 336 and particularly at page 125 (C.T.C. 343) concerning the treatment accorded the word “artificial" found in subsection 137(1) of the Income Tax Act as it then stood. That case did not involve an insurance scheme. Additionally, while binding and enforceable legal obligations were incurred, the transaction did not, as here, relieve the performance of a fundamental obligation had the need to do so arisen. Further, the appellant argues that the “foreign accrual property income" rules in section 95 of the Act as amended in 1972 and effective in 1976 and subsequent years, must be taken as expressing parliamentary intention that amounts paid as premiums in the years under review are not to be regarded as contravening subsection 245(1). Under those rules, it was said, the income of an offshore captive insurer is deemed to be the income of its Canadian parent. I do not gain assistance from this argument for it seems to me that whether the scheme is proscribed by subsection 245(1) must depend on the interpretation to be given its language regardless of the presence in some of those years of newly adopted rules awaiting legal effect.

But what of the 1975 taxation year? Should the result be any different? The situation differed from the earlier years in that neither an indemnity nor a guarantee was required. By 1975 Ol had been in operation for some years and had built up substantial assets. The evidence rather suggests that the strength of its financial position in that year made it unnecessary to require either a guarantee or an indemnity. Indeed, in its memorandum of fact and law the respondent appears to say as much by stating that “by 1975 sufficient funds had been transferred either directly or indirectly by the appellant to OI . .. that no indemnification was required". Moreover, OI had developed its own investments and continued to protect its premium funds against reinsurance claims under stop loss or excess of loss reinsurance in the open market.

The learned trial judge, at page 151 (D.T.C. 5126), did not consider the presence of the indemnities and guarantees “essential to a finding that at no time during the years in question was the risk shifted away from the plaintiff or its instrumentalities". In so concluding he was influenced by decisions of courts in the United States dealing with the nature of insurance in the context of a taxing statute (Helvering v. Le Gierse, 312 U.S. 531 (1941)) and particularly with the deductibility from income of amounts paid as premiums whose ultimate destination was a captive insurance subsidiary (Carnation Company v. Commissioner of Internal Revenue, 640 F. 2d 1010 (9th Cir. 1981) and Stearns-Roger Corp., Inc. v. United States, 577 F. Supp. 833 (D. Colo. 1984)). In examining these cases I must not forget what was said by Estey, J. in Stubart Investments Limited v. The Queen, [1984] 1 S.C.R. 536 at 555; [1984] C.T.C. 294 at 304 to the effect that the Internal Revenue Code and its predecessors “did not include an anti-tax avoidance provision in the nature of section 137. . . ."

According to these decisions, insurance involves risk shifting and risk distributing. I agree. That view was central to the Carnation and Stearns-Roger decisions and was the view taken by the Supreme Court of the United States in the Le Gierse case. The Carnation case involved a deduction of premium paid by the parent to a domestic insurer, the ceding of most of the cover to an offshore captive and payment of a correspondingly high percentage of the premium. The United States Court of Appeals for the 9th Circuit concluded that as there had been no shifting and distributing of risk no insurance resulted and, accordingly, that the amount paid as premium could not be deducted from income pursuant to the Internal Revenue Code. In the Stearns-Roger case the parent paid an amount as premium to its U.S. captive insurance company but its deduction from income was disallowed on the basis that the parent and the subsidiary belonged to the same "economic family’. In coming to his conclusion, the learned trial judge made the following observations at page 150 (D.T.C. 5125):

In the present case, with respect to losses not insured with third parties, the plaintiff was obliged to look to its own instrumentality, Ol, for any funds it might require to replace the losses on such property. If the money were not there — money which incidentally had come from the plaintiff directly or indirectly — then the plaintiff would not be recompensed for its loss, at least unless it provided the funds to this subsidiary of its subsidiary with which to reimburse itself. Therefore, the risk had not been shifted or distributed.

and he added at pages 151-52 (D.T.C. 5126):

While in Canadian jurisprudence we have not apparently embraced the term "economic family” it appears to me we should reach the same conclusion, that in a case such as the present one the risk has not been shifted to anyone other than an instrumentality of the insured, an instrumentality which draws all of its assets directly or indirectly from the insured and whose only source of more funds for paying insurance losses, should its assets not be sufficient, would be the insured itself. Without resorting to familial metaphors, I can conclude that such does not involve a true shifting of the risk and therefore the payment of "premiums” to such captive "insurer” would artificially reduce the income of the "insured”.

I should note here that unlike the case at bar neither of these U.S. cases involved reinsurance of any part of the risks beyond the captive itself. Besides, in the Carnation case the requirement of the domestic insurer that the parent subscribe to additional capital was seen by the Court at page 1013 as "key" to the arrangement by which the parent could insure its risks. That factor is entirely missing in the present case for the taxation year 1975 for in that year neither an increase in Ol's capitalization nor a guarantee was sought or given.

Moreover, the concept of "economic family” has been neither authoritatively established nor universally accepted. In this Court for the first time the appellant relies on a decision of the High Court of the Netherlands rendered August 21, 1985 (Court Roll No. 22929). The parties are not identified by name. As I understand, a domestic business concern placed its insurance requirements and those of its other companies with an offshore subsidiary incorporated under the laws of the Netherlands Antilles. It was assessed to tax liability on the basis that risks were not covered by insurance and that no business relationship existed between the parent and the offshore subsidiary. The Court disagreed, saying at page 26 of the certified translation handed to this Court:

For the rest, the argument is based on the view that with companies belonging to one group for the purpose of corporation tax, no attention should be paid to the transfer of risks to a company belonging to the group by means of premium payment, since in this case, these risks remain inside the concern

This view is not correct. If and in so far as in a group relationship a premium is charged for the transferred risk, based on normal business practice — and therefore is not influenced by the relationship itself within that concern —, allowance should be made for the premium payment when corporation tax is levied.

While care must be taken in the treatment to be given this case decided under foreign laws with which we are not familiar, it may be seen as rejecting the "economic family” concept. As I see it, adoption of that concept would amount to a wholesale disregard of separate corporate existence regardless of the circumstances in a particular case. I find that to be unacceptable.

In the present case, whether risk shifted and was distributed is a question of law. I am unable to say that in the 1975 taxation year risk did not shift and was not distributed. Unlike in the four preceding years, the domestic insurer as the fronting company could not look to the insured to absorb losses covered by the scheme in the event OI defaulted. True, that insurer held a letter of credit from OI but it was not guaranteed by the appellant. This may suggest that OI occupied a far more mature and solid financial position in 1975 than may have been the case in the preceding years. As was noted by the learned trial judge, the appellant’s holdings were vast. In my view, the arm’s length insurance transactions in 1975 created binding and enforceable legal obligations. Moreover, a shifting and distributing of risk occurred for the following additional reasons. First, the coverage arranged in that year was extremely large e.g. in the case of the "deductibles” alone, the limit of coverage was $750,000 per loss, accident or disaster. Second, the risks were numerous and were of a similar kind. Third, there is nothing in the record suggesting the likelihood that OI would have been faced at the same time with paying similar losses incurred by more than one of the insured entities, for it appears the risks were not interdependent.

The predecessor of subsection 245(1) was subsection 137(1).* [3] It was the subject of certain observations by a majority of the Supreme Court of Canada in the Stubart case some of which are relied upon by the respondent. No issue actually arose in that case as to the application of that subsection; it was concerned with income attribution rather than expense deduction. Nevertheless, at page 579 (C.T.C. 316), Estey, J. set out as the first of several guidelines to the interpretation of the Act that the absence of a bona fide business purpose for a given transaction may render applicable the general tax avoidance provisions (then subsection 137(1), now subsection 245(1)) "depending upon all the circumstances of the case”. The learned trial judge found such a purpose to be present in this case. Earlier, at page 576 (C.T.C. 315), Estey, J. laid down what I understand to be a general approach to be taken to interpreting the Act in the context of a scheme which must be determined as falling on one side or other of the tax line. He said:

It seems more appropriate to turn to an interpretation test which would provide a means of applying the Act so as to affect only the conduct of a taxpayer which has the designed effect of defeating the expressed intention of Parliament. In short, the tax statute, by this interpretative technique, is extended to reach conduct of the taxpayer which clearly falls within “the object and spirit” of the taxing provisions. Such an approach would promote rather than interfere with the administration of the Income Tax Act, supra, in both its aspects without interference with the granting and withdrawal, according to the economic climate, of tax incentives. The desired objective is a simple rule which will provide uniformity of application of the Act across the community, and at the same time, reduce the attraction of elaborate and intricate tax avoidance plans, and reduce the rewards to those best able to afford the services of the tax technicians.

I am unable to say that any such conduct was present in the 1975 taxation year. The complexion of OI had changed considerably from the earlier years when doubt as to its ability to pay claims was such that the elaborate set of indemnities, letters of credit and guarantees already was required lest the scheme abort. That neither an indemnity nor a guarantee was required in 1975 rather testifies to Ol’s financial strength and independence as an insurer in that year. As I have stated, there was in that year a genuine transfer of risk and distribution thereof among the insurers and reinsurers. Accordingly, in my view, expenses laid out in that year as insurance premiums did not work an artificial reduction of the appellant’s income contrary to subsection 245(1).

Income Attribution

I am persuaded that the learned trial judge did not err in referring the matter back to the Minister for reassessment on the basis that the interest and exchange gains earned by OI in the taxation years 1972 to 1975 inclusive could not be attributed to the appellant. The cross-appeal should be dismissed for the reasons given below.

Disposition

I would dismiss the appeal with respect to the taxation years 1971 to 1974 but would allow it with respect to the taxation year 1975 and would refer the matter back to the Minister for reassessment on the basis that the premium expenses claimed as deductions in that year did not artificially reduce the income of the appellant contrary to subsection 245(1). I would dismiss the cross-appeal with costs. As success in the main appeal has been divided, I do not think it is a case for costs to either party.

Appeal allowed in part.