2018-0741041I7 Allocation of net premiums under s. 403(4)

Principal Issues: How should the out of Canada net premiums be allocated under subsection 403(4) of the Income Tax Regulations where the corporation has permanent establishments in several provinces of Canada?

Position: The premiums must be allocated to the PE to which they are reasonably attributable, based on facts of the situation. If the taxpayer's allocation is reasonable, it should be accepted.

Reasons: Subsection 403(4) of the Regulations.

Author: Agarwal, Lata
Section: Regulation 400, 402, 403

                                                                                                                                                 October 24, 2018

Dan O’Neil/John Parker                                                                                                            HEADQUARTERS
PIA Section                                                                                                                               Income Tax Rulings Directorate
Large Business Audit Division                                                                                                  Lata Agarwal, CPA, CMA, MBA
International, Large Business &
  Investigations Branch
                                                                                                                                                 2018-074104

Allocation of outside of Canada net premiums under subsection 403(4) of the Income Tax Regulations

We are writing in response to your email dated January 23, 2018, in which you have requested our view on what would constitute a reasonable attribution of a taxpayer’s “out of Canada net premiums” (“OCNP”) for the purposes of provincial income allocation (“PIA”), under subsection 403(4) of the Income Tax Regulations (the “Regulations”). We apologize for the delay in responding.

Pursuant to your memo, in brief, the taxpayer, a Canadian insurance corporation, is engaged in the underwriting of property, casualty, accident and sickness insurance in Canada and is licensed to conduct an insurance business in XXXXXXXXXX in Canada. The taxpayer has physical offices located in XXXXXXXXXX. The taxpayer also insures risk outside of Canada, but does not have any permanent establishment (“PE”) outside Canada.

The taxpayer files a T2SCH5, Tax Calculation Supplementary – Corporations, as an insurance corporation under section 403 of the Regulations. For the taxation years ending XXXXXXXXXX, the taxpayer has reported PEs in XXXXXXXXXX pursuant to paragraph 400(2)(c) of the Regulations. Although the taxpayer has included the OCNP in its income, it has not reported and allocated them on the T2SCH5s, as required under subsection 403(4) of the Regulations. The details of the insurance policies relating to the OCNP are not available to the auditor.

Initially, the CRA proposed to include and allocate the OCNP on a “reasonably attributable” basis to provinces where the taxpayer has physical offices, in proportion to the net premiums written in these provinces. This would allocate the OCNP to PEs where these policies were being written and/or serviced. However, the taxpayer disputed the CRA’s proposed approach on the basis that it is unreasonable to allocate OCNP to these offices, since a significant amount of the premiums was obtained through brokers/agents who may have offices in the other provinces. In the taxpayer’s view, an allocation on the basis of where the claims on these policies were handled is irrelevant since the allocation under section 403 of the Regulations is based on the net premiums and not the claims. In the taxpayer’s view, its filing position to exclude the OCNP from the T2SCH5 effectively allocates the OCNP to the provinces in proportion to the net premiums written in the provinces, as reported in OSFI P&C 67.10., follows a reasonable attribution basis and is in compliance with the Income Tax Act (the “Act”) and the Regulations.

XXXXXXXXXX

Finally, based on the advice of Industry Specialist Services, in your view, a reasonable attribution under subsection 403(4) of the Regulations would be to allocate the OCNP to the PEs that service the policies (i.e., where claims are handled) or to the head office PE where the underwriting is done. In support of your position, XXXXXXXXXX. In your view, neither the taxpayer’s nor XXXXXXXXXX are reasonable because the taxpayer’s excluding the OCNP ignores the legislative requirement to allocate them and XXXXXXXXXX would arbitrarily allocate the OCNP to all PEs XXXXXXXXXX.

You have also noted that the allocation approach to be applied by the CRA in the current case could be considered precedent setting for the entire insurance industry.

Our comments

Section 403 of the Regulations requires insurance corporations to allocate their taxable income to the applicable PEs using the specific rules provided for this purpose. In this regard, where an insurance corporation has no PE in a foreign country where it provides insurance on property or has a contract for insurance other than on property with a resident of that foreign country, subsection 403(4) of the Regulations requires the insurance corporation to allocate the specific OCNP on a “reasonably attributable” basis. It states:

For the purposes of subsection (1), if in a taxation year an insurance corporation has no permanent establishment in a particular country other than Canada, but provides insurance on property in the particular country or has a contract for insurance, other than on property, with a person resident in the particular country, each net premium for the taxation year in respect of the insurance is deemed to be a net premium in respect of insurance on property situated in, or from contracts with persons resident in, as the case may be, the province in Canada or country other than Canada in which is situated the permanent establishment of the corporation to which the net premium is reasonably attributable in the circumstances. [Emphasis added]

The term “reasonably attributable” is not defined in the Act. Reasonableness is a question of fact and requires the application of a measure of judgment and common sense. (footnote 1) In the case of Home Oil Company Limited v MNR, [1955] SCR 733, the Court held that the words "reasonably attributable" mean “specially or directly related”. Following the above, in our view, the term “reasonably attributable” used in conjunction with the expression “in the circumstances” in the regulation denotes the requirement that in order to attribute the OCNP to a particular PE under subsection 403(4) of the Regulations, a direct causal connection be established between the OCNP and the PE taking in account all the applicable facts of the case. In other words, depending on a taxpayer’s particular circumstances, different factors may contribute to establishing a reasonable allocation under subsection 403(4) of the Regulations.

For example, using the guidance in OSFI Advisory 2007-01-R1 XXXXXXXXXX, ultimately it is a question of fact as to which tasks constitute the core functions in a particular case such that without them the earning process in respect of the specific OCNP would not be complete, and their performance by a particular PE(s) would justify the attribution of the OCNP to that PE(s), as reasonable. Consequently, in our view, a determination in this regard could consider more than one approach. In this regard, our comments in TI E9807035, which addressed the application of paragraph 402(4)(g) of the Regulations and suggested a proportional allocation to each PE which provided the ancillary services, could be relevant:

A determination of the proper allocation of income will depend upon a complete analysis of all the facts, including the specific terms of the client contracts, the nature of the services provided and the relevance of the particular services provided by each permanent establishment to the taxpayer's overall operation.
…

In allocating the gross revenue from its services, the taxpayer must determine the place where the duties which generate those revenues are performed. In our view, the services which generate the taxpayer's gross revenues are a composite of the services rendered by the portfolio managers and the ancillary services. Consequently, it is reasonable to assume that some portion of the gross revenues earned by the taxpayer are derived from the ancillary services. Accordingly, the taxpayer should attribute a portion of its gross revenues to each permanent establishment in recognition of the value of the ancillary services provided by that establishment.

Our above view is consistent with CRA’s previous TIs XXXXXXXXXX, which dealt with subsection 403(3), and, in general, opined that the determination of a PE for the reasonable attribution purposes involves consideration of various factors such as the location of origin and servicing of the policies involved and the location which negotiated the contract of reinsurance and on whose books the liability for the risk is recorded (which may be the company's head office in most cases). Also, since the criterion described in subsection 403(3) for the allocation of the “in Canada net premiums from the non-PE provinces” is essentially the same as in subsection (4), we recommend a consistent approach be developed in consultation with the Provinces for the purposes of administering both subsections.

However, where a taxpayer has made an allocation under subsection 403(4) and the taxpayer’s approach is reasonable, the CRA should not require the taxpayer to use a different method of allocation. Our above view is expressed in TI 2012-0470361I7 which states:

We agree with the position taken by LPD that, where there is no specific rule provided by 402(4) after the modifications required by 402(4.1), the taxpayer would have to allocate the gross revenue on this sale on the basis of where it is reasonably attributable as required by subparagraph 402(3)(a)(i). Where the taxpayer has chosen to allocate the gross revenue in accordance with the normal rules found in paragraphs 402(4)(a) and (d), this would appear to be a reasonable approach; however the taxpayer would not be required to do so. The taxpayer could allocate gross revenue using any method that leads to a reasonable allocation.

Accordingly, we would expect the taxpayers to choose a method of allocation that is reasonable and to apply it consistently every year unless the circumstances change. Further, the taxpayer must provide sufficient information to be able to show that its method of allocation is reasonable.

In the current case, we agree with you that the taxpayer has not allocated the OCNP in accordance with subsection 403(4) of the Regulations. In such situations, it is our view that since subsection 403(4) requires a connection between the PE(s) and the earning process of the particular premiums in question, in order for the CRA to propose an allocation on a particular basis, the CRA must be satisfied that the basis being proposed is reasonable, even where the taxpayer has not provided sufficient information for allocating on a reasonable basis.

In the above regard, in our view, the method of allocation proposed by you (i.e., the allocation of the OCNP based on where the policies are underwritten) appears to be a reasonable method. Similarly, allocation of the OCNP on some other basis, such as where the contracts are negotiated or serviced, using factors discussed in OSFI Advisory 2007-01-R1, may also be reasonable depending on the particular circumstances.

It is also our view that the allocation of the OCNP to PEs based solely on the allocation of the net premiums from the policies insuring property in Canada or from the contracts with persons resident in Canada, pursuant to subsections 403(1) to (3) of the Regulations, would not be a reasonable allocation where those PEs are not directly connected with the OCNP. In our view, the purpose of paragraph 400(2)(c) of the Regulations is to enable the rules in section 403 to allocate the taxable income of the insurance corporation to any province where the corporation is registered or licensed to do business. We do not agree that purpose of paragraph 400(2)(c) is to allocate taxable income based solely on the allocation of net premiums pursuant to subsection 403(1). Subsection 403(4) – like subsection 403(3) – requires the taxpayer to allocate the OCNP on a reasonable basis. Therefore, in our view, the intent of subsection 403(4) is to take the OCNP into account. Had the intent been to allocate based on the allocation of net premiums in subsection 403(1), it would have been much simpler to just have subsection 403(4) exclude the OCNP from net premiums.

We hope that these comments will be of assistance. Should you need any further clarification, please call Lata Agarwal at 613-670-9021 or me at 613-670-9031.

Unless exempted, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency’s electronic library. After a 90-day waiting period, a severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. You may request an extension of this 90-day period. The severing process removes all content that is not subject to disclosure, including information that could reveal the identity of the taxpayer. The taxpayer may ask for a version that has been severed using the Privacy Act criteria, which does not remove taxpayer identity. You can request this by e-mailing us at: ITRACCESSG@cra-arc.gc.ca. A copy will be sent to you for delivery to the taxpayer.

Terry Young, CPA, CA
Manager, Administrative Law Section
International Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

FOOTNOTES

Note to reader:  Because of our system requirements, the footnotes contained in the original document are shown below instead:

1  (TCC) Tsiantoulas v The Queen, [1995] 1 CTC 2401

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, 2019

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, 2019