Date: 19990401
Docket: 96-2202-IT-G
BETWEEN:
THE CANADIAN BAR INSURANCE ASSOCIATION,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
Mogan, J.T.C.C.
[1] The Appellant was incorporated by Letters Patent dated August 17, 1981 under the Canada Corporations Act. The Appellant is known as a non-profit corporation and, specifically, part III of the Letters Patent (Exhibit 1) states the objects to be as follows:
III
The objects of the Corporation are:
(a) to make available insurance plans and similar plans and benefits to members of the legal community in Canada and such other persons as the Board of Directors may determine from time to time,
(b) to negotiate and contract with insurance companies with respect to the insurance plans and benefits referred to in (a) above,
(c) to supervise the provision to certain persons as determined by the Board of Directors from time to time of pension or retirement funds and plans including registered retirement savings plans and registered retirement income funds;
(d) to prepare and distribute informational material relating to the availability of such insurance and registered retirement savings plans and benefits,
(e) to provide the administrative services required in connection with the provision and supervision of said insurance and registered retirement savings plans and benefits, and
(f) to do all such other things as are incidental or conducive to the attainment of the above objects,
In no event shall the purposes of organization and/or operation of the Corporation include profit.
[2] In the nine-year period from 1986 to 1994 inclusive, the Appellant reported a profit for income tax purposes in each of the years 1986, 1987, 1988, 1989, 1993 and 1994. The Appellant reported losses in the years 1990, 1991 and 1992. The Minister of National Revenue issued assessments under the Income Tax Act in respect of the four taxation years 1986, 1987, 1988 and 1994. When issuing those four assessments, the Minister assumed that the Appellant was not organized and operated for purposes other than profit. The Appellant has appealed from those four assessments claiming that it is exempt from tax under the provisions of paragraph 149(1)(l) of the Act which states:
149(1) No tax is payable under this Part on the taxable income of a person for a period when that person was
...
(l) a club, society or association that, in the opinion of the Minister, was not a charity within the meaning assigned by subsection 149.1(1) and that was organized and operated exclusively for social welfare, civic improvement, pleasure or recreation or for any other purpose except profit, no part of the income of which was payable to, or was otherwise available for the personal benefit of, any proprietor, member or shareholder thereof unless the proprietor, member or shareholder was a club, society or association the primary purpose and function of which was the promotion of amateur athletics in Canada;
[3] The parties are in agreement that the Appellant has satisfied all of the conditions in paragraph 149(1)(l) except for the following two conditions which are challenged by the Respondent: (i) whether the Appellant was organized for any purpose except profit; and (ii) whether the Appellant was operated for any purpose except profit. That is the primary issue in the appeals for those four taxation years. There is a second issue concerning the computation of the Appellant's taxable income for 1987 and 1988 but that second issue will have to be decided only if it is determined that the Appellant is not exempt from tax. Following an agreement between counsel, no evidence was led on the second issue. Therefore, in these reasons for judgment, I shall be concerned only with the primary issue.
[4] The only witness to testify at the hearing of these appeals was Charles D. Whelly, a lawyer who was called to the Bar of New Brunswick in 1978. Mr. Whelly was appointed a director of the Appellant in August 1985 and continued as a director until November 30, 1995. In 1987, he became a member of the management board which is like the executive committee of the Appellant. In 1989, he was appointed vice-president of the Appellant. He was appointed acting president at the end of 1990 and held that office until November 30, 1991 when he was appointed president for a two-year term until November 30, 1993. He was a member of the management board from 1987 to November 30, 1995. I was favourably impressed with Mr. Whelly's comprehensive knowledge of the Appellant, its history and its method of operation. He commenced his evidence by reviewing the manner in which The Canadian Bar Association ("CBA") became involved with the insurance needs of lawyers. Some of that information is helpful as background for the primary issue.
[5] Lawyers in different parts of Canada had sponsored insurance programs for many years, back to the 1950s. A sponsored insurance program is a group of insurance products which, within a particular area, are sponsored by a particular group (lawyers, doctors, teachers, accountants, etc.). The insurance products could include sickness and accident, disability, term life, and business expenses during disability. During the 1950s and 1960s within the Canadian legal community, sponsored insurance programs were usually segregated and tended to be operated by a county law association in Ontario or a provincial branch of the CBA or the law society of a particular province. An association of lawyers would negotiate an arrangement with an insurance company to provide the required products.
[6] In the sponsored insurance programs, the association of lawyers never accepted any risk in the sense of paying claims. The arrangement was always with a licensed commercial insurer which accepted the risks. The association of lawyers would negotiate with a commercial insurer to get the required products at the best price through the collective buying power of the association. The Ontario Branch of the CBA established an insurance committee which eventually persuaded the various county law associations to merge their insurance programs so that there was one major program for all lawyers in Ontario. Lawyers in certain other provinces were thinking of merging their programs, and that was the impetus for the development of a national program for lawyers.
[7] The CBA established a special insurance committee which, over a period of years, negotiated with lawyers' insurance programs across the country to convince them of the merits of pooling the buying power of all lawyers in Canada. By the late 1970s, most of the provincial programs had moved into the national program. By about 1980, the CBA had a sponsored insurance program which was truly national. The special insurance committee of the CBA had representatives from all across Canada but it had no staff and no paid employees. The administrative services which the committee required had been contracted out to Murray Bolger & Associates which carried on business as a benefit plan administrator.
[8] Murray Bolger & Associates provided a number of services for the sponsored insurance program of the CBA. It billed and collected premiums on behalf of the insurer. It marketed the program to persuade the maximum number of lawyers to participate. It provided actuarial advice to the CBA special insurance committee. That committee needed actuarial advice because it comprised only lawyers who did not possess the sophisticated knowledge required to negotiate with the insurance companies who were providing the products. The actuarial advice permitted the lawyers to negotiate appropriate programs with better policy terms and lower premiums than could be found in the open market. The above situation existed until 1981 when a significant change took place.
[9] Around 1980, a lawyer died after allowing his life insurance policy to lapse. His widow sued the insurer and the CBA. The executive of the CBA were surprised that it would be sued because of its insurance related activities and, as a result, the CBA concluded that all insurance related activities should be carried on in a separate organization isolated from the CBA. For that reason, The Canadian Bar Insurance Association (the Appellant herein) was incorporated. About the same time, the CBA special insurance committee had been advised that when its program grew to a sufficient size it should take over the administrative functions which had previously been contracted out. The committee concluded in 1980-1981 that its program had grown to that sufficient size. Upon its incorporation in 1981, the Appellant decided that it would handle all of the administrative functions which had previously been contracted out. As a result of that decision, the Appellant opened an office in Ottawa and hired a director of insurance and a staff of five or six clerical persons.
[10] The Appellant's most important function is negotiating with insurance companies with respect to particular products in the insurance program and the cost of those products. For example, all life insurance in the Appellant's program contains a provision for waiver of premium if a lawyer becomes disabled. That provision adds only about 4% to the cost whereas a separate provision for waiver of premium would add about 15% to the cost of life insurance acquired outside the Appellant's program. The Appellant also negotiates more stable premiums to avoid the insurance industry practice of bouncing premiums up and down in response to experience changes. Because the Appellant has what might be called a captive or special interest market which is attractive to insurance vendors, the Appellant is able to negotiate favourable commission rates with insurance companies and sales representatives for products sold within the Appellant's program. The commissions charged on products within the program are below what would normally be charged on the same products outside the sponsored program.
[11] The Appellant acts as a review board for a lawyer whose claim is rejected by the insurance company. Usually, the Appellant will agree with the insurer but, on occasion, has persuaded the insurance company to change its mind. Since 1981, the Appellant through its administrative office has kept track of who the insured lawyers are and has issued the necessary invoices for premiums. It collects the premiums and turns them over to the insurance company providing the product. The Appellant does not underwrite any risks at all. Only licensed insurance companies underwrite the risks. The Appellant is not in the brokerage business; it does not receive any part of any commission from the sale of insurance to its members. The commissions are paid by the insurance companies to the sales representatives who sell the products. A sales representative is not permitted to sell to a lawyer an insurance product outside the Appellant's program if the same product is a sponsored product within the program.
[12] Exhibit 4 is an organizational chart showing the management of the Appellant since 1992. Prior to 1992, the director of insurance and his staff of five or six were in Ottawa but the Appellant had a marketing director who worked out of Toronto because he was required to travel so much to other cities in Canada. In 1992, the Appellant had its main office in Ottawa and a smaller office in Toronto. It decided to combine both offices in Toronto to be close to the insurance industry and to the professional advisors who would be needed by the Appellant. With regard to Exhibit 4, the Board of Directors is made up of volunteer lawyers from all across Canada. The Management Board and the five committees are each small groups of directors and, accordingly, also volunteers. When the two offices were combined in Toronto in 1992, the director of insurance in Ottawa did not want to move to Toronto and so the Appellant hired a new Executive Director as its most senior employee. It also hired an administrative manager. The marketing director was already in Toronto. From 1992 to the present, those three senior employees listed on Exhibit 4 plus a clerical staff of about 10 have worked in the Appellant's Toronto office.
[13] Prior to December 1992, the Appellant had three basic sources of annual revenue which will be described in greater detail below but which may be summarized as follows:
1. The retained amount; a 5% administration fee which the Appellant retained (from all premiums) for providing administrative services.
2. The remitted amount; an amount which the insurance company remitted to the Appellant each year (depending upon results for the year) pursuant to a retention agreement for the purpose of funding a stabilization reserve.
3. Investment income; the amount earned from the investment of funds in the stabilization reserves.
Exhibit 5 is a chart with the title "Cash Flow Chart Pre-December 1992" which Mr. Whelly used to describe the three basic sources of annual revenue summarized above. I have already described the administrative services formerly contracted out which the Appellant took over in 1981. Those services continued to expand as more lawyers participated in the Appellant's sponsored insurance programs. Those services are described on the left side of Exhibit 5 in the box with seven items headed by "overhead expenses". The Appellant needed a source of revenue to pay for those services. It collected all of the premiums for insurance in the full service category (life, disability, business expenses, etc.). It negotiated with those insurers for the right to retain 5% of all premiums as compensation for providing administrative services. This 5% of premiums is the first source of revenue summarized above as the "retained amount".
[14] As a convenience for describing the cash flow on Exhibit 5, I will visualize the chart as a map with funds going from left to right as going "east" and funds going from top to bottom as going "south". The reverse directions will of course apply. On Exhibit 5, in the upper left corner, the Appellant sends invoices west to the lawyers and related persons who (as "insured") participate in the Appellant's programs. In exchange, the insured send the premium payments east to the Appellant which then deposits the full payments in a joint account with the insurer. This joint account is the small box marked "A" at the top centre of Exhibit 5. Out of this joint account, (i) the 5% administration fee (i.e. the retained amount) is allocated between the Appellant and the CBA when 4% is paid west to the Appellant and 1% is paid south as a user fee to the CBA; (ii) the negotiated sales commissions and service fees are paid north to the agent; and (iii) the balance of the premium is paid east to the insurer.
[15] The second source of revenue, the remitted amount, is more complicated and arises from what the Appellant calls retention agreements. A retention agreement is between the Appellant and an insurer. Out of the premiums, the insurer has to pay its own expenses and any valid claims which arise. One cannot predict what the claims will be in any given year. Over a period of years, there would be some years when the insurer would receive enough money from premiums to pay all expenses and claims and still have a residue which I will call a surplus; and there would be other years when the premium money would not be enough to pay expenses and claims. In those years when the premium money was more than enough and resulted in a surplus, that surplus would be set aside. In other years when the premium money was not enough to pay expenses and claims, the Appellant would draw an amount from the surplus to subsidize the program. The central idea was that over a long term of years, the persons insured should pay only the true cost of the insurance. In the Appellant's mind, true cost is the total of expenses associated with a particular program plus the claims actually experienced by the legal community in that program.
[16] The main purpose of the retention agreements was premium stabilization over the long term. The Appellant (and prior to 1981 the CBA) wanted stable premiums. The Appellant wanted to avoid fluctuations in premiums, upward and downward, as the insurer would attempt to respond quickly to its own claim and loss experience. In the preceding paragraph, the surplus which I described as "set aside" was in fact the "stabilization reserve". It gets its name from its function which was to stabilize premiums. Prior to 1985, the stabilization reserves were held by the respective insurers but reported (as to amounts) to the CBA and later to the Appellant. In 1983, when those reserves were substantial, the Appellant was concerned as to their disposition if an insurer became insolvent. In 1985, by agreement, each stabilization reserve was transferred from the insurer to the Appellant.
[17] The insurer was required to deliver to the Appellant each year a report (referred to as an "experience report") which showed how much premium money came in, how much went out, where it went and for what expenses or costs. At the end of each year, depending upon the result shown in the experience report, the insurer could be called upon to remit an amount to the Appellant's stabilization reserve or, because the Appellant was actually holding such reserve, the Appellant could be called upon to pay an amount to the insurer. A number of experience reports are bound in Exhibit 3.
[18] The retention agreement for term life begins at page 71 in Exhibit 1. According to Mr. Whelly (Transcript p. 82) the cash flow chart in Exhibit 5 reflects what is described in words in that retention agreement. I will follow Mr. Whelly's use of Exhibit 5. In paragraph 14 above, I referred to the joint account which is the small box marked "A" at the top centre of Exhibit 5, and I described how the balance of the premium is paid east to the insurer. If it were not for the retention agreement, the balance of the premium would simply remain with the insurer. Under the retention agreement, however, the insurer is required to perform certain computations in the experience report. The insurer is entitled to deduct certain expenses, claims, regulatory reserves, taxes, etc. which are described on the right side of Exhibit 5 in the box with six items headed by "Underwriting and Issue Expenses". One of those six items "Other WCL Charges" includes the insurer's profit margin which is a margin negotiated between the Appellant and the insurer.
[19] The experience report for a particular year would determine whether the insurer makes a payment to the Appellant's stabilization reserve or whether the Appellant withdraws an amount from its stabilization reserve to make a payment to the insurer. The formula is shown across the bottom of Exhibit 5. If the net volume of premiums received in a year minus the aggregate of (i) sales commissions, service fees and administrative charges from Box "A"; plus (ii) the insurer's charges from Box "B" was positive, then the insurer would make a payment to the Appellant's stabilization reserve. This is the "remitted amount" described in paragraph 13 above as the second basic source of annual revenue. If the result of that same computation was negative, then the Appellant would withdraw an amount from its stabilization reserve to make a payment to the insurer.
[20] There were two limits on any amount which the Appellant might have to pay to the insurer as the result of a negative computation. The overriding limit was that the Appellant could not be required to pay to the insurer any amount greater than it had in its stabilization reserve. The second limit was that the Appellant did not have to pay for any claims or reserves for claims. That was the risk assumed by the insurer. In other words, if there were a negative computation, the Appellant could not be required to pay any amount greater than the expenses (sales commissions, service fees, the 5% administrative charge, underwriting expenses, claims expenses, premium taxes and other WCL charges). The third basic source of annual revenue was investment income earned from the funds in the stabilization reserves.
[21] There was a separate stabilization reserve for each insurance program. For the years 1986 to 1994, the only stabilization reserves were for life, disability and business expenses. Although the Appellant's actuaries kept track of the amount in the stabilization reserve for each program through the years, those reserves were consolidated into one fund. In theory, the Appellant could never be required to put the stabilization reserve with respect to a particular program into a negative balance but the Appellant could voluntarily do so.
[22] As stated above, the primary purpose of the stabilization reserve was to stabilize premiums over the long term. There were also secondary purposes. First, the investment income from the stabilization reserve was often used to subsidize the Appellant's operating expenses when the 5% administration charge was not sufficient to pay those expenses. Second, depending upon the insurer's experience in certain plans, the Appellant was able to negotiate enhanced benefits to lawyers and other insured without any increase in premiums because the insurer was persuaded that it had sufficient protection through the retention agreement (i.e. stabilization reserves) if the cost of the program increased as a result of the enhanced benefits. And third, the Appellant was able to finance the cost of certain studies to determine if a new type of program should be offered to lawyers. The presence of the stabilization reserves and the income earned by those reserves allowed the Appellant to pay for such studies.
[23] Mr. Whelly described an additional way in which the Appellant used the stabilization reserve to achieve a benefit for the insured. By following the term life program, the Appellant with the advice of its actuaries was able to determine in 1986 that the premiums charged were more than necessary to cover the true cost of the insurance. The Appellant then negotiated with the insurer a premium discount of from 10% to 30% depending upon how long the insured had been in the program; the longer the participation, the greater the discount. An insured who had been in the program for a long time received a 30% discount. For 1987, the aggregate premium discounts in the life program were $856,786. See Exhibit 3 at page 539. Without the premium discounts, the life program would have produced a positive margin of $696,496 to the insurer (see page 539); but after deducting the aggregate premium discounts of $856,786, the life program produced a negative margin of $160,290 which the Appellant had to pay from its life stabilization reserve. (Page 539 shows a negative margin of $162,290 which appears to be in error.) It is worth noting that the aggregate premium discounts to the many persons insured in the life program in 1987 was $856,786, an amount much greater than the payment ($160,290) from the Appellant's stabilization reserve to the insurer
[24] Under the retention agreements, the insurer reported on all three programs (term life, disability and business expenses) when preparing its experience reports. The insurer was entitled to offset good experience in one plan against bad experience in another plan for the purpose of determining whether a payment would or would not be made to a stabilization reserve. After the premium discounts were implemented in the life program, it did produce a negative margin for a number of years but the other programs in those years produced positive margins which were more than sufficient to make up the negative margin in the life program. The premium discounts in the life program did not result in any payment to the insurer in 1987 or 1988 but those discounts did require the Appellant to pay an amount to the insurer in 1991.
[25] Exhibit 1 at page 149 is a table which attempts to show how much money was in the stabilization reserve of each program for the years 1981 through to 1994 with an aggregate for each year. The aggregate reserves show a steady growth from $5,273,600 to $24,336,100 for the years from 1981 to 1989. In the next three years 1990, 1991 and 1992, the total drops to $21,982,500; $14,601,900 and $7,857,500, respectively. Mr. Whelly explained that this table was prepared by the Appellant's actuaries who showed only the cash on hand in the reserves without any adjustment for two extraordinary amounts which the Appellant had paid out of the reserves. In 1992, the total is shown as $7,857,500 but in that year the Appellant paid $2,200,000 to Revenue Canada with respect to the assessments under appeal herein and the Appellant also invested $5,000,000 in its wholly-owned subsidiary, Chancery Reinsurance Company ("Chancery"). Those two special payments were pro-rated and charged against the stabilization reserves for the three programs. But for those two special payments, the total for 1992 would be about $14,500,000. Similarly, the totals for 1993 and 1994 would be about $14,800,000 and $15,600,000, respectively.
[26] Having regard to the table at page 149 (Exhibit 1), the stabilization reserve for the disability program had grown so well to 1987 that the Appellant negotiated with the insurer for enhanced benefits under that program. The reserve in that program continued to grow to $9,565,400 at the end of 1989. Over the next five years to 1994, the reserve for the disability program went into a negative balance of $6,727,100 making an aggregate negative reversal of $16,292,500. According to Mr. Whelly, the main reason for the negative reversal was the recession in the national economy in the early 1990s and the dramatic increase in disability claims based on mental depression.
[27] In May 1991, the insurer gave notice to the Appellant of its intent to discontinue the disability program effective December 1, 1991. To avoid the termination of the disability program, the Appellant posted with the insurer a contingency reserve equal to 25% of the annual premiums on the two disability programs. That contingency reserve was paid to the insurer from the stabilization reserves. It was a voluntary payment but, according to Mr. Whelly, consistent with the purpose of the stabilization reserves to maintain stable premiums and benefits. There was another voluntary payment to the insurer to subsidize the premium discount program. And then there was a contractual payment to the insurer under the retention agreement in accordance with the formula set out at the bottom of Exhibit 5. These payments are reflected at page 149 of Exhibit 1 where the amounts in the "total" column decline after 1989.
[28] In paragraph 25 above, I have summarized Mr. Whelly's explanation as to how the 1994 total of $9,255,500 on page 149 of Exhibit 1 should really be adjusted to $15,600,000 after taking into account the two special payments to Revenue Canada and Chancery. That adjusted total of $15,600,00 is only $2,600,000 higher than the total of $13,029,000 at the end of 1985. In other words, although the total reached $24,000,000 in 1989, the nine-year experience from 1986 to 1994 showed a net increase of only $2,600,000 in the total column. In Mr. Whelly's view, this is the way the stabilization reserves were intended to operate. Over the same nine-year period, the premium revenue on these three programs increased from $9,500,000 in 1986 to $22,500,000 in 1994.
[29] The operation of the retention agreements as shown in Exhibit 5 came to an end on December 1, 1992. In June 1992, Chancery was incorporated in Barbados as a wholly-owned subsidiary of the Appellant. The paid-up capital of Chancery was $5,000,000 paid by the Appellant out of its stabilization reserves as described in paragraph 25 above. Effective December 1, 1992, Chancery agreed with the insurer of the three programs (life, disability and business expenses) to reinsure the risk of the Appellant's programs. The old retention agreements came to an end and new retention agreements were signed effective December 1, 1992. Mr. Whelly said that the new agreements were more like reporting agreements because they could not result in any payments between the Appellant and the insurer.
[30] Exhibit 6 is a chart showing the cash flow after the new structure was put in place on December 1, 1992. The cash flow starts out the same as in Exhibit 5 with respect to the Appellant issuing the invoices; receiving the premiums; depositing the premiums in the joint account and receiving back the 5% administrative charge. The agents are paid out of the joint account, and the balance of the premium is paid to the insurer which then pays the expenses described on the right side of Exhibit 6 in the box with seven items headed by "Underwriting and Issue Expenses". At year end, the insurer produces a report still called an experience report but it does not trigger any payment between the Appellant and the insurer as in Exhibit 5. Any profit or loss remains with the insurer. The big difference is the involvement with Chancery.
[31] The insurer reinsures its risk under the Appellant's sponsored programs with Chancery on what is referred to as a "modified co-insurance basis". The insurer has 10% of the risk and Chancery has 90% of the risk. If there are any profits, the insurer keeps 10% of the profits and Chancery receives 90% of the profits. The coinsurance is "modified" in the sense that the insurer keep all the premium money until the end of the year when it completes its calculations. At that time, any profit is divided 90-10.
[32] According to Mr. Whelly's answers in cross-examination, Chancery enters into real reinsurance contracts with arm's length parties and uses some of its paid-up capital to purchase such contracts. Chancery is a "for profit" corporation in Barbados and has some retained earnings. Since Chancery arrived on the scene on December 1, 1992 and all the old retention agreements were terminated, there are no more "remitted amounts" (see paragraph 13 above) flowing from the insurer to the three stabilization reserves. The consolidated stabilization reserves are frozen at the level of about $10,000,000 (since December 1992) and, according to Mr. Whelly, the investment income earned from that $10,000,000 fund is used to subsidize the Appellant's administrative expenses.
[33] Exhibit 7 shows the amounts of income or (loss) reported by the Appellant for income tax purposes for the nine years ended November 30, 1986 to 1994 inclusive. Those amounts are as follows:
1986 $163,717
1987 2,577,277
1988 1,549,925
1989 4,968,767
1990 (869,884)
1991 (6,361,566)
1992 (1,932,215)
1993 40,707
1994 556,791
Total (income minus losses) $693,519
During the first seven years, the accumulated income for the positive years and the accumulated losses for the negative years were almost in balance at the end of 1992.
[34] I am required to determine whether the Appellant is exempt from tax under paragraph 149(1)(l) of the Act (set out in paragraph 2 above). It is implicit in the opening words of subsection 149(1) that a person described in that subsection may very well have income and taxable income but no tax to pay if certain conditions are met. If the simple act of earning income from any source disqualified a person from relying on the exemption, then the exemption itself would be redundant and meaningless. The exemption has meaning only if a qualified person has income which can be exempt from tax. Specifically, a "club, society or association" within the meaning of paragraph 149(1)(l) may have income but that income will be exempt from tax if the club, society or association satisfies the conditions in that paragraph. The only two conditions in paragraph 149(1)(l) which are in dispute are whether the Appellant was organized for any purpose except profit and whether the Appellant was operated for any purpose except profit.
[35] The years under appeal are 1986, 1987, 1988 and 1994. The table in paragraph 33 above shows that the Appellant reported income for tax purposes in each of the years under appeal but the Appellant claimed to be exempt under paragraph 149(1)(l). The primary issue in this case is the purpose for which the Appellant was organized and operated and whether that purpose was for profit. The Appellant argues that there is no restriction on the range of permitted purposes which would entitle it to rely on the exemption so long as earning a profit was not one of those purposes. Accordingly, the Appellant acknowledges that its particular activity is in an area populated by commercial enterprises (i.e. insurance companies) but the Appellant argues that that fact does not disqualify it from the exemption if its purpose was not profit-making. The Appellant claims that its non-profit purpose was to facilitate certain insurance products being made available to the Canadian legal community at reasonable and stable rates. This is consistent with paragraph (a) of the Appellant's corporate objects quoted in paragraph 1 above.
[36] The Respondent argues that it is not possible to separate the Appellant's claimed non-profit purpose (to facilitate the availability of certain insurance products at reasonable and stable rates) from the need to make a profit because premium stability could not be achieved, given the essential participation of insurance companies, unless the Appellant received part of the profits from the insurance companies. The Respondent also argues that the Appellant could not receive a share of the insurer's profit without sharing the risk. In the Respondent's submission, the potential payment from the Appellant to the insurer under the retention agreement and the insurer's restrictions on the Appellant's use of the stabilization reserves are evidence of the Appellant's sharing of the risk.
[37] For the reasons set out below, I have concluded that the Appellant had a non-profit purpose in the years under appeal and was entitled to the exemption under paragraph 149(1)(l). I do not ordinarily place much weight on the objects clause of a corporation's charter but it is a place to start. Article III of the Appellant's Letters Patent quoted in paragraph 1 above concludes with these words:
In no event shall the purposes of organization and/or operation of the Corporation include profit.
When determining purpose or object or motive, the conduct of a corporation is more important than a declared object in its charter.
[38] The Appellant's by-law no. 1 (a lengthy general by-law) provides for two classes of members: (a) active members who are designated by the council of the CBA together with certain officers of the CBA; and (b) general members who are the persons who from time to time constitute the members in good-standing of the CBA. I note that membership in the Appellant is not tied in any way to those members of the legal community in Canada who purchase one or more insurance products through the facilities of the Appellant. Under Article IV of the Appellant's Letters Patent, the following provision prohibits any members of the Appellant from receiving any benefit upon its dissolution or winding up:
... In the event of dissolution or winding-up of the Corporation, those assets which the Corporation is properly entitled to distribute that remain after the discharge by the Corporation of its liabilities shall be distributed to The Canada Bar Association.
The CBA itself is a non-profit organization. On the question of whether the Appellant was organized for any purpose except profit, its Letters Patent and general by-law support its claim and there was no evidence to the contrary.
[39] On the question of whether the Appellant was operated for any purpose except profit, it is necessary to take a broad view of everything which the Appellant did and why it was done. Mr. Whelly stated clearly that the Appellant was operated to facilitate insurance products being made available to members of the Canadian legal community at reasonable and stable rates. He was more precise in stating that the Appellant's goal was to deliver insurance products at cost if possible. Mr. Whelly described a number of the Appellant's activities and explained how each activity was aimed at cost recovery. His evidence in this area was not challenged on cross-examination although counsel for the Respondent later argued that profit must have been a purpose of the Appellant if it was to achieve its declared goals of stable premiums and cost recovery.
[40] The Appellant's profit and loss results seem to support the Appellant's declared non-profit purpose. Those results are in Exhibit 7 and summarized in paragraph 33 above. It is a fact that over the seven-year period 1986 to 1992, the profits and losses were in balance. And in the nine-year period 1986 to 1994, profits exceed losses by only $693,519 when the Appellant's annual operating expenses in 1994 exceeded $1,000,000. Those excess profits of $693,519 over a nine-year period are even less significant when measured against gross premium revenue of about $20,000,000 in 1994. See Exhibit 1, page 155.
[41] There is no doubt that the Appellant engages in a high level of commercial activity. It invoices and collects premiums. It negotiates lower commission rates for vending agents. It enters into complicated retention agreements with insurers. And in the period 1985 to 1992, it would receive an amount or pay an amount each year depending upon the result in the insurer's experience report. The formula for receiving or paying is summarized in Exhibit 5 and explained in paragraph 19 above. That high level of commercial activity, by itself, does not prove that the Appellant operated for profit.
[42] In The Gull Bay Development Corporation v. The Queen, 84 DTC 6040 (Federal Court Trial Division), the corporation was incorporated by the Gull Bay Indian Reserve to promote the economic and social welfare of the members of the Reserve. Some members of the Reserve were employed by the corporation to carry on a logging operation. In 1975, the Minister of National Revenue assessed tax on the corporation's profit from its logging operation. The corporation claimed it was exempt under paragraph 149(1)(l). When allowing the corporation's appeal, Walsh J. stated as page 6048:
The real issue in the present case appears to he that the corporation was not set up, as its Letters Patent indicate, to carry on a commercial activity although it is no doubt true that the motive for forming the corporation may have been that it was desirable to provide employment and training to otherwise unemployed Indians on the Reserve by engaging in a commercial activity which would not only provide such employment but raise funds to be used for the very worthy social and charitable activities required on the Reserve. ...
The social and welfare activities of Plaintiff are not a cloak to avoid payment of taxation on a commercial enterprise but are the real objectives of the Corporation.
... The Corporation is operated "exclusively" for the purpose set out in Section 149(1)(l) pursuant to its charter, even though it may raise funds for this purpose by its commercial lumbering enterprise.
[43] In Gull Bay, the profit was earned from a competitive logging operation and it was not fortuitous, but the corporation was nevertheless held to have a non-profit purpose. The Appellant's situation is quite different. It does not compete with insurers or brokers but acts on behalf of a restricted class of consumers. If the competitive logging operation in Gull Bay did not cause the corporation to lose its tax-exempt status, then the Appellant's non-competitive activities in the commercial area of insurance ought not to be regarded as proof of a profit purpose.
[44] When issuing the assessments under appeal, the Minister may have been influenced by the size of the reserves. For example, the aggregate of the three stabilization reserves was $24,336,100 in 1989 and that may have been just prior to an audit by Revenue Canada. See Exhibit 1, page 149. Counsel for the Appellant characterized those reserves as being in substance over-paid premiums. That may be too simplistic but the fact is that the Appellant used its large stabilization reserves to enhance benefits either directly or indirectly. All of the reserves were used to stabilize the disability program when it began a period of significant negative results from 1990 to 1994. The life reserve was used to obtain premium discounts starting in 1987 as described in paragraph 23 above. And the income earned from investing the funds in the reserves was used to subsidize the Appellant's operating expenses.
[45] In a perfect world, the cost of insurance could be determined each year like the cost of a manufactured product but the world is not perfect, and it is in the nature of insuring a specific risk that the cost of such insurance can be determined only over a period of many years. Therefore, it is not possible to fix an annual premium on a pure cost recovery basis. It seems to me that the Appellant has done the next best thing if its goal is to achieve reasonable and stable premiums because (i) it negotiated a fixed margin of profit with the insurer; and (ii) it required the insurer to remit any excess profit (the "remitted amount") so that the Appellant could accumulate such remitted amounts in a reserve to stabilize premiums and, if the reserve grew too big, the Appellant could obtain enhanced benefits for the insured without increasing premiums.
[46] If I accept the uncontradicted evidence of Mr. Whelly and documents like the retention agreements and the tables at pages 149 and 155 of Exhibit 1, a big stabilization reserve proves the difficulty in measuring the cost of an insured risk in advance and on an annual basis. The fact that a particular reserve could grow very big like the life reserve does not prove that the Appellant was operated for profit. The stabilization reserves were really a tool by which the Appellant obtained reasonable and stable premiums. Although the stabilization reserves were big in an objective sense, they maintained a relatively stable relationship with the size of the programs measured in premium income. See Exhibit 1, page 155.
[47] In considering the Appellant's activities in the commercial world, I have focused on the retained amount (the 5% of premiums) and the remitted amount (payments under the retention agreements 1985-1992). When I consider the Appellant's third source of revenue which is income earned from investing the funds in the stabilization reserves, there is even less reason to regard that third source as evidence of a profit purpose. In L.I.U.N.A. Local 527 Members' Training Trust Fund v. The Queen, 92 DTC 2365, the trust fund was established with a grant from the union's existing training and recreation fund. Both the union and the Ottawa Construction Association contributed to the trust fund at a fixed rate per employee per hour worked. In reassessing the trust fund for the years 1985, 1986 and 1987, the Minister refused to accept the trust fund's claim for exemption under paragraph 149(1)(l) of the Income Tax Act. The problem seemed to arise from the fact that, in the years under appeal, the trust fund had accumulated money not used for training purposes in the amounts of $600,000 to $900,000. The question was whether investment income earned on the use of those monies was subject to income tax. In allowing the appeal of the trust fund, my colleague Bowman J. concluded that the fund was a purpose trust and that it was an association within the meaning of paragraph 149(1)(l). With respect to the question of whether it was exempt from tax, Bowman J. stated at page 2380:
For an organization to be operated for the purpose of earning a profit so as to disqualify it for the exemption under paragraph 149(1)(l) it would be necessary that it do more than merely earn passive investment income. The earning of such income would need to be both an operating motivation of the fund and a focus of its activity. The evidence does not support this conclusion. On the evidence the earning of the interest income was not the purpose — primary or secondary — for which the fund was operated. The earning of interest was simply an incident of the only purpose for which the fund was operated, the training of the members of the union; it was a means to an end and not an end in itself.
[48] I have no hesitation in accepting the decision of this Court in L.I.U.N.A. and applying it to the Appellant's third basic source of annual revenue. That particular source of revenue is on all fours with the income earned in the L.I.U.N.A. case and, if the Appellant had no other source of revenue, I should think that the L.I.U.N.A. case would be conclusive in the Appellant's favour. This case is complicated, however, by the fact that the Appellant has the other two sources of annual revenue identified as the retained amount and the remitted amount.
[49] With respect to the 5% retained amount, I have accepted the Appellant's evidence and argument that, on an annual basis, the retained amount is not adequate to cover the Appellant's annual operating expenses, and the shortfall must be made up from the stabilization reserves. With respect to the remitted amount and its accumulation in the stabilization reserves, although that amount arises out of the Appellant's involvement in the insurer's business, I find that the growth of the stabilization reserves was caused (i) by the impossibility of measuring on a year-by-year basis the cost of insuring a particular risk; and (ii) by the need of the insurer to err on the side of caution when establishing the rate of premium for a particular insurance product. If I may adapt the words of Walsh J. in Gull Bay, the Appellant's attempt to provide insurance products at cost to the legal community in Canada is not a cloak to avoid payment of tax on a commercial enterprise but is the real purpose of the Appellant. In other words, the accumulation of remitted amounts in the stabilization reserves was only incidental to the Appellant's true object of providing insurance products at cost.
[50] Counsel for both parties made reference to the decision of the Supreme Court of Canada in The Regional Assessment Commissioner and the Municipal Clerk of the Corporation of the Town of Hearst v. Caisse populaire de Hearst Limitée, [1983] 1 S.C.R. 57. The Caisse populaire ("CP") was assessed for business tax under the Ontario Assessment Act with respect to property it occupied in connection with its operations. The assessment notice described CP as a banker but CP was successful in having the assessment set aside in the lower courts. In particular, the trial judge found as a fact that the preponderant purpose of CP was "to provide loans to members for provident or productive purposes at a low cost". The Supreme Court of Canada dismissed an appeal by the Town. When delivering judgment for the Court, McIntyre J. commented on the "commercial activity" test cited in the Ontario Court of Appeal and then stated at page 70:
...Many community and charitable organizations, relying from time to time on what would be termed commercial activity to raise funds for the fulfilment of their objectives, could be classed as businesses by such a test. To attach primary importance to the commercial aspect of an operation in question will offer, in my opinion, no sure or helpful guide. In my view, the commercial activity test is too indefinite to allow consistent application. I agree that, in deciding whether or not any activity may be classed as a business under the provisions of s. 7(1)(b) of The Assessment Act, all relevant factors regarding an operation must be considered and weighed. However, they must be considered and weighed in order to determine not whether in some general sense the operation is of a commercial nature or has certain commercial attributes, but whether it has as its preponderant purpose the making of a profit. If it has, it is a business; if it has not, it is not a business.
[51] The Supreme Court of Canada has said that "commercial activity", by itself, is not a helpful guide for purposes of the Ontario Assessment Act. If the preponderant purpose test as accepted by the Supreme Court in Hearst has any application in cases arising under paragraph 149(1)(l), I would have no hesitation in finding that the Appellant's preponderant purpose was to facilitate the availability of certain insurance products at cost to the legal community in Canada. Because the Appellant's preponderant purpose was the availability of certain insurance products at cost, it did not have a profit purpose at all.
[52] I view the incorporation of Chancery, the Barbados subsidiary, as a red herring in this appeal. Its incorporation was prompted by two factors. First, the disappearance of the stabilization reserve for the disability program and the insurer's notice of intent to discontinue that program caused the Appellant to look for a reinsurable vehicle to permit the program to continue. And second, Chancery's access to the reinsurance market would help the Appellant to obtain reasonable and stable premiums. Quite apart from those two factors, Chancery is a separate legal entity distinct from the Appellant.
[53] Returning briefly to the stabilization reserves, it could be said that the Appellant is parking money in those reserves for future use in bad (i.e. negative) years. The large reserves do not reflect a profit purpose but a service to members purpose. A person (individual or corporate) with a profit purpose will usually want to use any profit as some method of personal gain by the payment of dividends or salaries or by the increased value of issued shares. The Appellant did not use the stabilization reserves in any of those ways. When it could do so, the Appellant decreased the premium costs or increased the benefits to members. These were genuine services to members which partly justified the Appellant's characterization of the stabilization reserves as overpaid premiums.
[54] In my opinion, the Appellant was neither organized nor operated for a profit purpose. Accordingly, the appeal on the primary issue is allowed with costs. Counsel for both parties agreed not to present evidence on the second issue pending a decision on the primary issue. I will withhold signing the formal judgment for 30 days in case either party should want to make submissions with respect to the second issue.
Signed at Regina, Saskatchewan, this 1st day of April, 1999.
"M.A. Mogan"
J.T.C.C.