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Federal Tax - Insurers. Canada v. Independent Order of Foresters
In Canada v. Independent Order of Foresters (Fed CA, 2026) the Federal Court of Appeal allowed a Crown appeal, this involving the taxation of "life insurance and accident and sickness insurance (accident insurance)" operated by a fraternal benefit society (which themselves are tax-exempt under the ITA).
Here the court considers the taxation of insurers:[4] This appeal is also about the definition of "“Canadian investment fund”", a definition that applies to a Canadian-resident insurer that carries on a life insurance business in Canada and other countries. Such an insurer’s income from carrying on an insurance business is only taxable to the extent it is income from carrying on that business in Canada. To determine that income, the insurer must determine its Canadian investment fund which seeks to distinguish its "“insurance assets”" from its non-insurance assets. An asset is a non-insurance asset only if "“at no time [...] in the year [it] was used or held by the insurer in the course of carrying on an insurance business”". ....
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I. How Part I of the Income Tax Act taxes insurers and how the Order computed its taxable income
[7] The relevant statutory and regulatory provisions as they read for the 2014 taxation year are reproduced in the Appendix to these reasons. Unless the Income Tax Regulations (C.R.C., c. 945) are specified, references are to the provisions of the Income Tax Act.
[8] The provisions of the Income Tax Act and the Regulations that apply to insurers are numerous and highly technical. Experts in the field may read these reasons and lament the omission of certain details or rules. This is intentional. The objective is to resolve the issues before the Court through reasons that are accessible to as many readers as possible, while focusing on the provisions relevant to those issues.
A. The rules that apply to tax insurers
[9] Part I of the Income Tax Act (sections 1 to 180) levies the ordinary income tax on taxpayers: Jinyan Li & Joanne E. Magee, Principles of Canadian Income Tax Law, 11th ed (Toronto: Thomson Reuters, 2023) at 1.3 (Taxnet Pro). Section 2 says that a taxpayer pays this ordinary tax on its "“""taxable income”", that is, its "“""income”" computed in accordance with the rules set out in Division B (sections 3 to 108), minus any deductions and plus any additions provided for in Division C (sections 110 to 114).
[10] Insurers provide financial protection against losses that policy holders may incur from specific events. To do so, insurers charge a fee—called a premium. To have enough money to pay claims in the event of a loss, insurers do two things: 1) they set up reserves, that is, they show a liability in their financial statements that represents funds set aside to cover possible future claims; and 2) they invest their money from the premiums in various financial instruments to generate investment revenue such as interest, and dividends: Massimiliano Maggioni & Giuseppe Turchetti, Fundamentals of the Insurance Business (Cham, Switzerland: Springer, 2024) at 93–95.
[11] Considering how insurers operate, one would expect Part I of the Income Tax Act to: a) require insurers to include in income the premiums and investment revenue they earn; and b) allow insurers to deduct the claims they pay as well as an amount for the reserves they set up. Part I of the Act, together with the Regulations, does just that. But the rules are complex, especially those that relate to the taxation of investment income. To make these reasons easier to understand, it is useful to consider five of the rules that apply to Canadian-resident life insurers.
(1) Rule 1: An insurer that sells life insurance is a life insurer
[12] The first rule is that an insurer carrying on a life insurance business is a life insurer for tax purposes, even if it also carries on another insurance business: definitions of "“life insurer”" and "“life insurance corporation”" in s. 248(1); Jason Swales & Erdem Erinc, Canadian Insurance Taxation, 4th ed (Toronto: LexisNexis, 2015) at 4, 233.
(2) Rule 2: Unless otherwise required, a life insurer computes its income like other taxpayers
[13] The second rule is that a life insurer computes its income in the same way as any other taxpayer unless section 138 says otherwise: s. 138(1)(d).
(3) Rule 3: A multinational Canadian-resident life insurer does not pay tax on foreign insurance income
[14] The third rule is that the income of a Canadian-resident life insurer that carries on an insurance business both in Canada and abroad is limited to its income from carrying on that business in Canada: s. 138(2)(a); Swales and Erinc at 22–23, 29, 97. Put simply, such a Canadian-resident life insurer—hereinafter a "“multinational life insurer”"—is not taxed on income from its foreign insurance business.
(4) Rule 4: A life insurer uses a notional method to compute its Canadian investment income
(a) Overview of the method
[15] The fourth rule is that a multinational life insurer computes its investment income taxable in Canada using a notional amount of investment property that supports its Canadian insurance businesses. This notional method was developed because it is difficult to identify which of the multinational life insurer’s investment assets are connected to its Canadian insurance businesses and, therefore, are generating its Canadian investment income: Regulations Amending the Income Tax Regulations (Taxation of Insurers), S.O.R./2000-413, Can Gaz II, 134:26, 2529, Regulatory Impact Analysis Statement at 2550. The notional method serves to split a multinational life insurer’s investment income between Canada and the other countries in proportion to its insurance business in those jurisdictions: Swales & Erinc at 98.
[16] Simply put, the notional method requires a multinational life insurer to designate investment property (e.g. shares, real estate and bonds) the income from which will be taxed in Canada. The value of investment property that must be designated is equal to the Canadian reserve liabilities of its life insurance business, its accident and sickness insurance business, and its other insurance businesses. However, if the multinational life insurer’s Canadian investment fund (a term described in more detail below) exceeds its total Canadian reserve liabilities, the multinational life insurer must designate property equal to the excess in respect of one of its insurance businesses.
[17] For each taxation year, the multinational life insurer includes in its income from its insurance businesses the total income generated by the investment property it designated: s. 138(9).
[18] Those keen to learn about how the method works can read paragraphs [19] to [23] below. Others can skip to paragraph [24].
(b) How the notional method works in detail
[19] To be more specific, the notional method requires the multinational life insurer to find two numbers that together represent its "“Canadian investment fund”". These numbers are:. The total amount of the multinational life insurer’s liabilities and reserves in respect of each of its Canadian insurance businesses (Canadian reserve liabilities) net of Canadian policy loans and outstanding premiums: subparagraph (a)(i) of the definition of "“Canadian investment fund”" in s. 2400(1) of the Regulations, and definition of "“Canadian reserve liabilities”" in subsection 2400(1) of the Regulations; and
. An amount based on the multinational life insurer’s net assets (other than non-insurance assets) multiplied by the percentage that its Canadian liabilities represent of its weighted total liabilities: elements I, J, M and N of clause (a)(ii)(B) of the definition of "“Canadian investment fund”" in s. 2400(1) of the Regulations. [20] The multinational life insurer must then compute the average of its opening and closing Canadian investment fund balances for the year—the "“mean Canadian investment fund”": s. 2412 of the Regulations.
[21] Once its mean Canadian investment fund has been determined, the multinational life insurer must identify investment property—such as shares, real property and bonds—in respect of each insurance business. For its Canadian life insurance business, it must designate investment property with a value equal to its average ("“mean”") Canadian reserve liabilities in respect of that business minus its average policy loans and Canadian outstanding premiums in respect of that business: definition of "“designated insurance property”" in subsection 138(12) of the Act and paragraph 2401(2)(a) of the Regulations. The multinational life insurer must do a similar designation in respect of its accident insurance business and other insurance businesses: s. 138(12) of the Act and ss. 2401(2)(b), (c) of the Regulations.
[22] However, if the multinational insurer’s mean Canadian investment fund is greater than the value of the investment property that it has designated in respect of its insurance businesses, the insurer must designate the excess in respect of one of these businesses: s. 2401(2)(d) of the Regulations. Of note, the Income Tax Act and the Regulations do not specify the insurance business in respect of which the excess must be designated. The multinational life insurer can choose.
[23] Finally, subsection 138(9) of the Income Tax Act requires the multinational life insurer to include in its income from carrying on insurance businesses in Canada the total income (called "“gross investment revenue”") generated for the year by the investment property that it designated (referred to collectively as the "“designated insurance property”"): ss. 138(2), 138(9)(a), 138(12).
(5) Rule 5: The life insurer must compute its life insurance income and income from other sources separately
[24] The fifth and last rule that governs the computation of a life insurer’s income under Part I is one that applies to all taxpayers: a life insurer must compute its income or loss from various sources as though each source were its only source of income and limit its deductions to those that are connected to that source: s. 4. So, if a life insurer carries on two insurance businesses—say life and accident—it must compute the income or loss from each business separately. Once this is done, the life insurer must add the income or losses from the two businesses together and the total amount becomes its "“income”" under Part I: s. 3.
[25] It is important to know that life insurance and accident insurance operate differently. Policyholders keep their life insurance policies for a long time, sometimes for decades, before making a claim. As a result, life insurers have more opportunities to invest both the policy premiums and the reserves they hold to meet their future obligations to policyholders. By contrast, accident insurers operate on a shorter-term basis, often on year-to-year policies with claims that are paid out quickly and frequently. As a result, premiums are priced according to the year’s expected claims, and there is little time for sizeable reserves to accumulate: Maggioni & Turchetti at 93–94.
[26] The Income Tax Act and the Regulations take these differences into account. For instance, the reserve for life insurance is calculated differently from the reserve for accident insurance: ss. 138(3), 20(7)(c) of the Act and applicable Regulations; Swales & Erinc at 79–96. At para 27 the court usefully sets out a graphic illustration of how a "multinational life insurer computes its income", and at para 28 an "(i)llustration of how a multinational life insurer computes its taxable income".
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