Principal Issues: Whether certain investment income of foreign affiliate in reinsurance business would be recharacterized as active business income.
Position: In the circumstances described it would be.
Reasons: Income is from activities directly related to active business activities of related foreign affiliate and would income from active business if earned by it.
2005-012580
CLHIA Conference - May 26, 2005
Question 4
FAPI and the active business rule under 95(2)(a)
A foreign affiliate of a Canadian corporation (FA1) enters into insurance or reinsurance contracts in the course of carrying on an active business outside Canada in circumstances such that the provisions of paragraph 95(2)(a.2) do not apply. FA1 then reinsures the risk associated with the contracts with a second foreign affiliate of the taxpayer (FA2), for regulatory reasons.
The income derived by FA2 from payments received from FA1 in consideration for reinsuring the contracts of FA1, is deemed to be income from an active business pursuant to subparagraph 95(2)(a)(ii). Thus, the underwriting income of FA2 retains the active business character it would have in the hands of FA1. FA2 also earns investment income from assets that are held by it to support the risks assumed under the contracts ceded by FA1.
Question
Does subparagraph 95(2)(a)(i) apply to deem the income of FA2 derived from investment of assets that are necessary to support risk assumed by FA2 under the contracts that were reinsured by FA2 to be income from an active business?
Agency's Response
To the extent that it can be established that the income of FA2 is attributable to investment of assets that it is required to have on hand, for example by virtue of regulatory requirements, to support the risks assumed under the contracts ceded by FA1, the CRA agrees that such income would be from activities of FA2 that are directly related to the active business activities of FA1 as required by clause 95(2)(a)(i)(A) and would be included in the earnings from an active business of FA1 if it were earned by FA1 as required by clause 95(2)(a)(i)(B). Therefore provided that the other requirements for the application of subparagraph 95(2)(a)(i) are satisfied, that provision would apply to include such income of FA2 in its income from an active business.