TO Audit Applications Division
D. Schlesinger
Acting Chief
Industry Studies SectionATTENTION B. Kuber
FROM Financial Industries Division
Financial Institutions Section
R.J. Kauffman
957-9769RE: Taxability of Capital Gains realized by a Benevolent or Fraternal Benefit Society or Order (an "Order")
We are writing in reply to your memorandum of October 17, 1986 in which you asked for our comments on a memorandum your section had received from John Lorimer of the Toronto District Office concerning capital gains realized by an Order carrying on a life insurance business.
While subsections 149(3) and (4) of the Act refer to the taxable income of an Order, that taxable income must be computed as if the Order had no income or loss from any source other than from carrying on a life insurance business. Therefore, to support Mr. Lorimer's views, capital gains would have to be income from carrying on a life insurance business. Consistent with the scheme of the Act, it is settled law that capital gains are not income from a business or property. We do not believe that the words "carrying on" expand the scope of the words "income from a life insurance business" to include capital gains derived from dispositions of property used in a life insurance business.
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In Punjab Co-operative Bank, Ltd., Amritsar v. Income Tax Commissioner, Lahore (1949), A.C. 1055 the Privy Council stated:
"... their Lordships do not wish to give any support to the contention that, in order to render taxable profits realized on sales of investments in such a case as that before them, it is necessary to establish that the taxpayer has been carrying on what may be called a separate business either of buying or selling investments or of merely realizing them."
The Privy Council cited the following from Californian Copper Syndicate v. Harris, 5 T.C. 159 at pg. 165:
"... enhanced values obtained from realization or conversion of securities may be so assessable, where what is done is not merely a realization or change of investment, but an act done in what is truly the carrying on, or carrying out, of a business",
and decided the case on whether or not the realization of securities was a normal step in the banking business.
"... If as in the present case, some of the securities of the bank are realized in order to meet withdrawals by depositors, it seems to their Lordships to be quite clear that this is a normal step in carrying on the banking business, or, in other words, that it is an act done in "what is truly the carrying on" of the banking business. This, it appears to their Lordships, is the more appropriate and satisfactory ground for dealing with the question arising in the present case."
This rationale was followed in Colonial Mutual Life Assurance Society Ltd. v. Federal Commissioner of Taxation (1946-47) 73 CLR 604 in which the Australian High Court held that:
"... an insurance company, whether a mutual insurance company or not, is undoubtedly carrying on an insurance business and the investment of its funds is as much a part of that business as the collection of the premiums... In Kinstam, "The Law of Income Tax", 8th Edn., p. 126, it is stated that the buying and selling of investments is a necessity of insurance business; and where an insurance company in the course of its trade realized an investment at a larger price than was paid for it, the difference is to be reckoned among its profits; conversely any loss is to be deducted. This view is in line with that of the Privy Council in the case of a bank in Punjab Co- operative Bank Ltd. v. Income Tax Commissioners. In our opinion, there is no substantial distinction between the business of an insurance company and that of a bank in this respect. The acquisition of an investment with a view to producing the most effective interest yield is an acquisition with a view to producing a yield of composite character, the effective yield comprising the actual interest less any dimunition or plus any increase in the capital value of the securities.
Such an acquisition and subsequent realization is a normal step in carrying on the insurance business, or in other words an act done in what is truly the carrying on of the business of the Society."
The High court also recognized two older cases, Northern Assurance Co. v. Russell 2 Tax Cas. 551 (Ex.Ct. Scot 1889), and Liverpool and London and Globe Insurance Co. v. Bennett 6 Tax Cas. 327 (HL 1913).
While there is not a great deal of Canadian jurisprudence on this point the leading case would appear to be Canada Permanent Mortgage Corporation 71 DTC 5409 (FCTD). Heald, J., in deciding that Canada Permanent's gains on securities were on account of capital distinguished a taxpayer like Canada Permanent from banks and insurance companies, which he felt ordinarily should treat gains on realization of securities on income account. However, Justice Heald did comment that under certain circumstances, even insurance companies may be able to treat realization on change of investments as capital gains, notwithstanding that both the Privy Council in Punjab Bank and the Australian High Court in Colonial Mutual had called into question the decision in Scottish Automobile and General Insurance Co. Ltd. 16 Tax Cas. 382 on which Justice Heald relied for his comment.
Based on the above cases, it would seem that the making and realizing of an investment is an ordinary part of an insurance or banking business, done in the carrying on or carrying out of that business. If the facts in Mr. Lorimer's case are as indicated it would seem that the gains from the sale of investments may be viewed as income from carrying on a life insurance business.
We apologize for the lengthy delay in responding but as you are aware we had requested a legal opinion on this matter. We have now received that opinion which, XXXX In our opinion the onus should be placed on the taxpayer to support a contention that any gains realized are not part of its insurance or banking business.
F. Lee Workman
Chief Financial Institutions Section Financial Industries Division Rulings Directorate Legislative and Intergovernmental Affairs Branch