2015-0618981E5 Deductibility of run-off insurance premiums

Principal Issues: Can a retired professional deduct run-off insurance premiums from business income in the year the premiums are paid, even if the professional has ceased to carry on business in that year?

Position: Possibly.

Reasons: See below.

Author: Kom, Joel
Section: 9(2), 18(1)(a)

XXXXXXXXXX                          2015-061898
                                                  J. Kom

December 3, 2015

Dear XXXXXXXXXX:

Re: Deductibility of run-off insurance premiums for retired professionals

We are writing in reply to your email of November 19, 2015, wherein you requested our views on the deductibility of certain insurance premiums under the Income Tax Act (the “Act”).

You indicated that certain professionals who carried on a business will, upon retirement, often buy a specific kind of liability insurance to protect against claims from clients. If a client makes a claim against a professional after the professional has retired, and the claim is related to advice or work the professional did pre-retirement, this insurance will cover any damages the professional would otherwise be required to pay to the client. We will refer to this insurance as “Run-off Insurance.”

Your view is that the premiums for Run-off Insurance should be deductible from the professional’s business income in the year the premiums are paid, even though the professional may no longer have a continuing source of income in that year.  Such a deduction would lead to a non-capital loss, assuming no other revenue for that period.

You seek our views on whether the premiums are indeed deductible.

Our Comments

This technical interpretation provides general comments about the provisions of the Act and related legislation.  It does not confirm the income tax treatment of a particular situation but is intended to assist you in making that determination.  The income tax treatment of transactions will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R5, “Advance Income Tax Rulings”.

This issue engages subsection 9(2) and paragraph 18(1)(a) of the Act.  The issue under subsection 9(2) is whether there is a “source” from which to deduct a loss if the taxpayer is no longer carrying on a business.  The issue under paragraph 18(1)(a) is whether the premiums are incurred for the purpose of gaining or producing income from business or property.

The Federal Court of Appeal’s decision in AG (Canada) v Poulin, 1996 DTC 6477 (FCA) (“Poulin”) and subsequent CRA guidance commenting on Poulin are both instructive on this issue.

In Poulin, the taxpayer was a real estate broker.  In 1977, the taxpayer negotiated a real estate transaction that turned out badly for his clients.  The clients successfully sued the taxpayer for fraud and false representation, and in 1987 the taxpayer satisfied the judgment and paid $385,802 in damages, interest, costs and legal fees.  The issue was that in 1984, the taxpayer had completely ceased to carry on business as a broker, and his income in 1987 and the other years in issue came from other activities.  The question was whether the taxpayer could deduct the $385,802 as a business loss in 1987 and then carry over the remaining loss to the other years.

The court’s decision indicated that the fact the taxpayer had ceased to carry on business as a broker in 1987 would not prevent the deduction from satisfying paragraph 18(1)(a), finding that the taxpayer “cannot be considered to have ceased his activities as a broker as long as he was engaged in completing the things he had done in carrying on his profession, even though at that point he was no longer carrying on business and could no longer act on behalf of clients.”

The court further added at paragraph 7 that:

“In order for such a payment [a damage payment related to a wrongful act], which in itself, of course, is not made for the purpose of earning a profit, to be nonetheless considered to meet the requirement in paragraph 18(1)(a) of the Act, it must be seen as the unfortunate consequence of a risk that the taxpayer had to take and assume in order to carry on his trade or profession. And in order for the payment to be seen as such, it is an essential condition, I believe, that it be directly related to an act that was necessary in order to carry on the trade or profession and that it could potentially have been considered to have been performed improperly.”

Therefore, generally speaking, the fact a taxpayer no longer carries on a business will not preclude the taxpayer from deducting Run-off Insurance premiums in the year they are paid, provided the insurance only relates to advice or work the professional did pre-retirement during the ordinary course of the professional’s business operation. The premiums must still conform with the Act’s provisions regarding deductibility in order to ultimately be deductible.

We trust that these comments will be of assistance.

Yours truly,

Michael Cooke, CPA, CA
Manager
Business Income and Capital Transaction Section
Business and Employment Division
Income Tax Rulings Directorate

All rights reserved. Permission is granted to electronically copy and to print in hard copy for internal use only. No part of this information may be reproduced, modified, transmitted or redistributed in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, or stored in a retrieval system for any purpose other than noted above (including sales), without the prior written permission of Canada Revenue Agency, Ottawa, Ontario K1A 0L5.

© Her Majesty the Queen in Right of Canada, 2016

Tous droits réservés. Il est permis de copier sous forme électronique ou d'imprimer pour un usage interne seulement. Toutefois, il est interdit de reproduire, de modifier, de transmettre ou de redistribuer de l'information, sous quelque forme ou par quelque moyen que ce soit, de façon électronique, mécanique, photocopies ou autre, ou par stockage dans des systèmes d'extraction ou pour tout usage autre que ceux susmentionnés (incluant pour fin commerciale), sans l'autorisation écrite préalable de l'Agence du revenu du Canada, Ottawa, Ontario K1A 0L5.

© Sa Majesté la Reine du Chef du Canada, 2016