Minet Inc. v. R., 98 DTC 6364, [1998] 3 CTC 352 (FCA)

Stone J.A.:

The central issue in this appeal is whether the appellant’s “income” for the taxation years under review must include “commissions” which the respondent contends were earned and received by the appellant while acting as an insurance broker from its Montréal headquarters in arranging insurance with insurers in the United States (“U.S. insurers”) on behalf of various American insureds (“U.S. insureds”).

The learned Tax Court Judge determined that these commissions were income from the appellant’s business under Part I of the Income Tax Act, .S.C. 1970-71-72, c. 63 (the “Act”).

Factual background

The facts of this case are summarized in the reasons for judgment of the Tax Court Judge [1] . It seems to me, however, that it is not so much the facts as found that are important, but whether they establish as a matter of law that the appellant received or enjoyed the commissions which the Minister has assessed as income in its hands. To this end it will be convenient to set out the principal facts and to make reference briefly to the relevant supporting evidence.

During the taxation years in question and for many years prior thereto the appellant conducted most of its insurance brokerage business from its headquarters in Montréal. It had no office or place of business in the United States and was not licensed to act as an insurance broker in any of the states of that country.

The appellant’s business largely consisted of developing and negotiating complex insurance packages on behalf of the U.S. insureds on a subscription or layer basis. The difference between a subscription and a layer basis is explained in paragraph 5 of the appellant’s written argument:

On a so-called “subscription” basis, the Appellant might receive terms, for example, from one insurer in London or United States insurance market for coverage in respect of 20 percent of a particular liability limit. The Appellant would then go into the London and United States markets to find other insurers willing to write the remaining 80 percent of that particular limit. On a so-called “layer” basis, the Appellant would interest different segments of the London and United States insurance markets in various layers of insurance. For example, one insurer, Or a group of insurers on the subscription basis, might quote terms for a first layer of coverage in the amount of $5 million. A second insurer or a group of insurers might quote terms for a second layer of coverage in the amount of $10 million in excess of $5 million, and so on up to the desired amount of coverage.

The evidence at trial indicates that the appellant’s role was that of a so- called “middleman” between the U.S. insureds and the insurers with a view to arranging coverage of insurance risks for the insured on the best obtainable terms. The routine practice, it appears, was for the appellant to obtain several different sets of terms from potential insurers and then to advise the U.S. insureds on the choice of one of them. Upon selecting the potential insurer whose terms were found acceptable, the U.S. insured instructed the appellant to communicate its choice to that insurer. As the appellant - not being a licensed broker - did not act as agent for any of the U.S. insurers, the particular insurer itself bound interim coverage which was confirmed by a “memorandum of insurance” from the appellant to that insurer [2] . The actual policy was issued by the U.S. insurer.

In circumstances that did not involve a U.S. insurer who was prohibited by law from paying a commission to the appellant, the appellant as broker of record would itself bind coverage on behalf of a U.S. insured, and issue an invoice to the U.S. insured for the premium payable. Whenever the appellant so acted, the U.S. insured at the direction of the appellant remitted the premium to the appellant’s New York bank account where it was held until the appellant was required to remit it to the insurer. The appellant then invested the premium in short-term certificates of deposit and retained any interest earned thereon for its own account. The premium that was ultimately remitted to the insurer by the appellant was net of the appellant’s commission.

During the taxation years in issue, a number of U.S. insurers in eleven different states including the State of New York advised the appellant that relevant state insurance laws forbade them from recognizing it as a broker of record and from paying it a commission on insurance coverage which it developed and negotiated [3] . The U.S. insurers took this position because the appellant did not hold an insurance broker’s licence under state law. Not more than 20% of the insurance coverage was placed with U.S. insurers who refused to pay a commission to the appellant.

In these circumstances, the appellant considered that its interest would be best served if it referred the insurance coverage to a duly licensed U.S. broker to formalize the coverage with an insurer and be paid the commission. This option was considered preferable to either obtaining a broker’s licence in the United States or turning away insurance from those U.S. insurers who insisted on the coverage being placed by a licensed broker.

The appellant selected two affiliated U.S. corporations, Minet International Professional Indemnity Brokers Inc. (“MIPI”) and units of Bowes & Company (“Bowes”), to act as broker of record with respect to the insurance coverage in question, as each of them held the requisite broker’s li- cence. The evidence indicates that Bowes was a wholesale broker, whose expertise lay in dealing with other insurance brokers. MIPI was a retail broker whose business was different from that of the appellant. [4] . Neither MIPI nor Bowes owned shares in the appellant, and the appellant did not own shares in either MIPI or Bowes. However, all three companies were controlled by Minet Holding PLC, a United Kingdom corporation.

In situations where the appellant brought MIPI and Bowes into the picture, it conducted its insurance business with its U.S. insureds and insurers (including invoicing the insureds for premiums, depositing the premiums in the New York bank account and investing them in short-term certificates of deposit), in much the same way as it regularly conducted its insurance business with other U.S. insureds and insurers. The departure from its usual practice came at the time the premium had to be remitted to the U.S. insurer. Shortly before the date that the premium was due to be remitted, the appellant transferred it to either MIPI or Bowes. The appellant again kept for its own account the interest earned on the short-term certificates of deposit. The U.S. insurer invoiced either MIPI or Bowes, as appropriate, for the premium due. [5] . MIPI or Bowes, as the case may be, then finalized the transaction by arranging for the policy to be issued showing one of them as the broker of record. They then remitted the premium to the U.S. insurer net of the agreed commission.

Although the work of MIPI and Bowes in arranging insurance coverage for the U.S. insureds was slight in comparison to that of the appellant, there was evidence at trial to the effect that they performed an “absolutely essential service” [6] of providing the brokerage licence and provided “the vital link without which the transaction couldn’t have gone ahead”. [7] . That evidence was not contradicted. There was also evidence that these licensed brokers attended to some details in particular kinds of cases and were shown as broker of record on the insurance policies that were ultimately issued.

It is not disputed that MIPI and Bowes reported the commissions received from the U.S. insurers in their respective U.S. tax returns. [8]

The appellant called Thom Rosenthal, a member of the bar of the State of New York, as an expert witness to prove as a fact the relevant law of each of the eleven states in question. Mr. Rosenthal was accepted by the Tax Court Judge as a qualified expert on the relevant laws of each of those states. He was cross-examined by the respondent. The Tax Court Judge referred to the effect of Mr. Rosenthal’s evidence at page 4 of his reasons for judgment, where he stated:

In his affidavit Mr. Rosenthal concluded:

THAT in view of the fact that the Appellant did not hold a New York broker’s license during any of the years 1985 through 1989 inclusive, the provisions of the Insurance Law and Penal Law discussed above operated so as to prohibit the payment of commissions to the Appellant by an insurer providing insurance in New York and to prohibit the sharing of any portion of such commissions with the Appellant paid by an insurer to MIPI or to any other New York-licensed broker;

THAT in consequence, it was reasonable for U.S. insurers to refuse to pay commissions to the Appellant in respect of insurance in New York and for MIPI and all other New York-licensed brokers to refuse to share commissions on such insurance with the Appellant;

THAT had the Appellant initiated an action in the courts of New York against such insurers or such brokers for the payment of the commissions or portions thereof in question, it would have been unsuccessful in establishing any legal entitlement to such amounts;...

The witness testified that the laws of the remaining states were to the same general effect. [9] No evidence to the contrary was adduced at trial.

The judgment below

The Tax Court Judge concluded that the appellant had both “earned” and “received” the commissions and had “derived all of the fruits” of the funds collected from the U.S. insurers in the form of interest. It was significant to him that the appellant, MIPI and Bowes were “related corporations” within the meaning of the Act. In his view, as stated at page 17 of his reasons, the appellant “has acquiesced in the commissions it earned being paid to Bowes and MIPI” which he considered to be different “from a case where, because of a legal constraint, no commissions at all are paid.” The end result, in his opinion, was that the commissions were paid to related corporations and that they accrued to the beneficial ownership of the group, i.e. the parent company, thereby allowing them to remain “in the family”. He considered that the appellant was “instrumental in agreeing in some fashion that the amounts be paid to Bowes and MIPI”, and that this indicated “a degree of control or dominion” over the commissions. It was significant to the Tax Court Judge that, as stated at pages 16-17 of his reasons:

Not all of the funds received by the Appellant were “impressed with a trust” in favour of the insurer. The portion representing the brokerage commission was not. See the above quotation from Exhibit A-14. The amount representing the brokerage commission belonged to the Appellant, 10 [10]

Analysis

I, like my colleague Letourneau J.A., agree that subsection 56(2) of the Act cannot be relied upon in the circumstances of this case. I respectfully adopt what my colleague has written on this aspect of the dispute.

The remaining question is whether the commissions in issue can properly be regarded as the appellant’s income in the taxation years in question. Section 3 of the Act provides that the “income of a taxpayer for a taxation year for the purposes of this Part is his income for the year”, determined by the rules therein set forth. The basic rules for determining income from a business appear in Part 1, Division B, subdivision b, which includes subsection 9(1) of the Act:

9 (1) Subject to this Part, a taxpayer’s income for a taxation year from a business or property is his profit therefrom for the year.

As the Minister conceded at trial, we are not here concerned with tax avoidance. I! [11]

It seems to me that whether an amount is to be regarded as income for tax purposes in any given situation turns most heavily on the evidence in a particular case. While the question under consideration has yet to be defini- tively answered by binding authority in Canada, the decided cases do offer some guidance with respect to whether funds actually received by a taxpayer with some strings attached ought properly to be regarded as income in the hands of that taxpayer.

In Dominion Taxicab Assn. v. Minister of National Revenue, [1954] S.C.R. 82 (S.C.C.), it was determined that the deposits received from the association’s members were not profits derived from its business and as such subject to tax under section 4 of the Income Tax Act, S.C. 1948, c. 52, because the deposits had not become the property of the association. The Court had regard to the substance rather than the form of the transactions. In the words of Cartwright J., for the majority, at page 86:

While the method of book-keeping adopted by the parties is not conclusive either for or against the party sought to be charged with tax, I am of opinion that in the case at bar the appellant rightly treated the $40,500 as a deferred liability to its members, and that unless and until the necessary conditions were fulfilled to give absolute ownership of a deposit to the appellant and to extinguish its liability therefor to the depositing member, such deposit could not properly be regarded as a profit from the appellant’s business.

In Minister of National Revenue v. Atlantic Engine Rebuilders Ltd., [1967] S.C.R. 477 (S.C.C.), the issue was whether a refundable cash deposit was captured as income under section 4 of the Income Tax Act R.S.C. 1952,

c. 148. In determining that it was not, Cartwright J. stated for the majority at pages 479-480:

In Dominion Taxicab Association v. Minister of National Revenue, [1954] S.C.R. 82 at 85, 2 D.L.R. 373, it was said in the judgment of the majority of the Court:

It is well settled that in considering whether a particular transaction brings a party within the terms of the Income Tax Act its substance rather than its form is to be regarded.

The question of substance in this case appears to me to be whether in stating what its profit was for the year the respondent could truthfully have included the sum in question. To me there seems to be only one answer, that it could not. It knew that it might not be able to retain any part of that sum and that the probabilities were that 96 per cent of it must be returned to the deposits in the near future. The circumstance that the respondent became the legal owner of the moneys deposited with it and that they did not constitute a trust fund in its hands appears to me to be irrelevant; the same may be said of moneys deposited by a customer in a Bank which form part of the Bank’s assets but not of its profits. To treat these deposits as if they were ordinary trading receipts of the respondent would be to disregard all the realities of the situation.

The grounds upon which Thurlow J. based his decision appear to me to be supported by the reasoning of the majority in this Court in Dominion Taxicab Asso- ciation v. Minister of National Revenue, supra, at p. 85, where it is stated that as each deposit was received by the Association and became a part of its assets there arose a corresponding contingent liability equal in amount. This was one of the grounds on which it was held that the deposits formed no part of the profits of the Association. Since that decision there has been no substantial change in the wording of the sections of the Income Tax Act on which the appellant relies.

What appears to me to be decisive is the fact that there is no basis, having regard to the realities of the situation, on which these deposits can properly be treated as ordinary trading receipts of the respondent which it was entitled to include in calculating its profits for the year.

Two decisions of the Exchequer Court of Canada are also deserving of mention. In Robertson Ltd. v. Minister of National Revenue, [1944] Ex. C.R. 170 (Can. Ex. Ct.), Thorson P., at page 182-83, adopted the following test for determining whether an amount received by a taxpayer has the quality of income:

Is his right to it absolute and under no restriction, contractual or otherwise, as to its disposition, use or enjoyment? To put it in another way, can an amount in a taxpayer’s hands be regarded as an item of profit or gain from his business, as long as he holds it subject to specific and unfulfilled conditions and his right to retain it and apply it to his own use has not yet accrued, and may never accrue?

Thorson P. applied the same test in Canadian Fruit Distributors Ltd. v. Minister of National Revenue, [1954] Ex. C.R. 551 (Can. Ex. Ct.), at pages 559-560.

The appellant relies on certain decisions of American courts in support of its submission that the commissions in question are not to be regarded as income in its hands. These are Commissioner of Internal Revenue v. First Security Bank of Utah, N.A., 405 U.S. 394 (U.S. Sup. Ct. 1971) (1972); Proctor & Gamble Co. v. Commissioner of Internal Revenue, 961 F.2d 1255 (U.S. 6th Cir. 1992); and Tower Loan of Mississippi, Inc. v. Commissioner of Internal Revenue, 71 T.C.M. 2581 (U.S. T.C. 1996).

I respectfully agree with the Tax Court Judge that these cases are “distinguishable” not only, in my view, because the factual situations differed but also because the laws under which they were decided also differed. At the same time it is appropriate, in my view, to have some regard to such decisions, particularly to a decision of the United States Supreme Court, to determine whether they contain any principle or other guidance that might assist this Court in the present matter. As was made clear by Rinfret, J. in Equitable Life Assurance Society of the United States v. Larocque, [1942]

S.C.R. 205 (S.C.C.), at page 239, although decisions of the United States Supreme Court are not binding in this country, “they are, it need hardly be stated, entitled to the greatest respect.”

Each of the American cases relied on by the appellant were concerned with the construction of a section of the Internal Revenue Code of the United States which authorized the income tax authorities to allocate the gross income of two or more business entities owned or controlled by the same entity if such was thought necessary in order to reflect the true income of each of them. The common feature of each case was that either a federal, state or foreign law expressly prohibited certain payments to be made to the member of the group whose income the authorities sought to allocate to others in the group. The courts each concluded that as the law prohibited the payments no control could be exercised within the contemplation of the section, and there could accordingly be no allocation.

In First Security, supra, Powell, J. for the majority, enunciated the following principle at page 403:

We know of no decision of this Court wherein a person has been found to have taxable income that he did not receive and that he was prohibited from receiving. In cases dealing with the concept of income, it has been assumed that the person to whom the income was attributed could have received it. The underlying assumption always has been that in order to be taxed for income, a taxpayer must have complete dominion over it. “The income that is subject to a man’s unfettered command and that he is free to enjoy at his own option may be taxed to him as his income, whether he sees fit to enjoy it or not.” Corliss v. Bowers, 281 U.S. 376, 378 (1930).

I have already referred to the grounds upon which the Tax Court Judge decided that the commissions should be regarded as income in the hands of the appellant. One of these is deserving of comment at the outset. It was his view that the commissions were “not impressed with a trust” because an agreement between the appellant and a Canadian insurance company, Exhibit A-14, expressly provided that “[a] 11 premiums collected on behalf of the Company, less the Broker’s commission belong to the Company and must be held in trust in a Bank or Trust Company”. That finding was plainly based on a mistaken view of the evidence. The exhibit relied upon had no bearing whatever on the legal relationship between the appellant and any of the U.S. insurers. It set out the terms of a contract between the appellant and a Canadian insurer. Indeed the respondent concedes at paragraph 16 of her written argument that this agreement “was irrelevant to the issues” because it did not concern the appellant’s U.S. business. In my view, Exhibit A-14 is not evidence that the commissions in question were received with the premiums, or that the commissions belonged to the appellant, or that the premiums were not held in trust.

The record does not contain any clear evidence of the appellant’s precise relationship with the U.S. insurers. While there is no evidence in the form of express agreements between the appellant and U.S. insurers that the premiums were to be held by the appellant in trust, it is evident that the appellant viewed the premiums as trust funds for the U.S. insurers. [12] The record indicates that no part of the premiums were the appellant’s own funds. The appellant accepted that it was under an obligation to pay the full amounts of premium to the U.S. insurers, either directly according to its ordinary practice or through the intermediacy of either MIPI or Bowes.

What I think emerges from the record is that until the point in time at which the premium was due to be transmitted to a U.S. insurer who was prohibited by law from paying a commission to the appellant, the appellant conducted its dealings with a U.S. insured and U.S. insurer in much the same way that it did with any other U.S. insured and U.S. insurer. The appellant’s practice was to invoice the U.S. insureds soon after the U.S. insurers bound coverage, with a view to receiving the premium funds and investing them in short-term certificates of deposit in order to earn interest income, which the appellant retained and reported to the Minister. The usual practice was to deduct a previously agreed to rate of commission from the premium and remit the net amount to the U.S. insurer. When the above mentioned point in time was about to be reached, the appellant departed from this practice by remitting the full premium to either MIPI or Bowes and retaining no portion on account of commission for itself.

The evidence is, I think, tolerably clear that in situations where state law did not prohibit the payment of a commission to the appellant, the appellant considered the commission to be earned when the appellant invoiced the U.S. insured for the premium payable to the U.S. insurer. [13] Although the evidence is not entirely clear it would also seem that some sort of understanding or industry practice was in play between the appellant and the U.S. insurers by which the appellant was entitled to deduct the commission out of the premium it had collected.

Some insight into industry practice prevailing in the United Kingdom and elsewhere with respect to payment of remuneration to a broker or agent by an insurer, may be gathered from H. Cockerell and G. Shaw, Insurance Broking and Agency: The Law and the Practice (London: Witherby & Co. Ltd., 1979) at pages 106-07, where they state:

Insurance brokers and agents are almost always rewarded not by their clients but by the receipt of commission or brokerage from the insurers with whom they place the client’s insurances. This apparent anomaly has met a great deal of criticism in the past but its beginnings are almost coeval with the birth of insurance. It has always been thus and the international aspect of much business flowing into the U.K. broker market would be imperilled were a change made. Thus, an American broker who wishes to have a large risk placed in the London market naturally seeks a proportion of the resultant brokerage as a reward for his introduction. Since U.S., Canadian and almost all other insurance intermediaries are paid on the U.K. basis very considerable difficulties would arise on a change to a fee system....

It follows that the consideration necessary to form a binding contract between the insured and the broker or agent is the acceptance by the former that a percentage, generally of the premium but occasionally of the sum insured or annuity consideration, will be paid by the third parties to that contract, the various insurers with whom the business is or will be placed.

It would seem a fair inference, as the respondent argued, that an agreement of some sort existed between the appellant and each of the U.S. insurers that governed their relationship. [14] The appellant apparently acted for the U.S. insureds in arranging coverage on the basis that the insurers would pay the commission, the rate of which was apparently factored into the premium charged. The U.S. insureds, it appears, were under no obligation to pay a commission. Presumably, payment of the commission was a matter entirely between the appellant and the U.S. insurers. Thus two separate contractual relationships seem to have existed between the parties involved - one between the appellant and the U.S. insured, and the other between the appellant and the U.S. insurer.

Edmund Davies, L.J. commented on the existence of these relationships in Wilson v. Avec Audio-Visual Equipment Ltd., [1974] 1 Lloyd’s Rep. 81 (Eng. C.A.), at page 82:

The plaintiff was undoubtedly authorized to act on behalf of the would-be assured, the defendants, in securing insurance cover for them - an unpaid agent, because (as is commonly known) in such circumstances insurance brokers such as the plaintiff get their remuneration by way of commission from the insurance company with whom they do business. There are really two contracts in existence in such cases as the present. An insurance broker has a contract (one would expect it to be in writing, though no written contract was here produced) between him and the insurance company, securing for him the payment of commission on such business as was procured to the advantage of the insurance company through the broker’s instrumentality. There is also the contract between the plaintiff broker and the defendants whereby the plaintiff is authorized to act as the agent of the defendants in arranging insurance cover for them.

In my view, the receipt of the premiums simpliciter does not in itself determine that the appellant received commissions so as to render them taxable as income in its hands. The premiums paid by the U.S. insureds were clearly not destined to the appellant but rather to the U.S. insurers. They represented the consideration in exchange for which the U.S. insurers agreed to underwrite the risks of the U.S. insureds. In the circumstances of this case they could never, in my view, be regarded as the appellant’s own funds.

It is true, of course, that the appellant customarily deducted its commissions from the premium collected, and that MIPI and Bowes did likewise. It is also true that the appellant normally remitted the balance of the premiums to the U.S. insurer. That practice, however, was not available to the appellant in this case because the U.S. insurers were by law prohibited from paying any commission to the appellant. This central fact was proven by the testimony of expert witness Thorn Rosenthal. Having regard to that fact, I do not see how it can be said that by merely receiving and holding the premiums for a time and earning interest thereon the appellant also received the commissions from the U.S. insurers.

If I am correct in the foregoing analysis, I do not see how as the Tax Court Judge stated the appellant “received” the commissions or acquiesced in their payment to MIPI and Bowes so as to keep them “in the family”, or that the appellant exercised a “degree of control and dominion” over them. The three companies were entirely distinct legal entities. The U.S. state laws simply prohibited U.S. insurers from paying commissions to an unlicensed broker like the appellant. In my view, therefore, the appellant could not and never did become the owner of or have any absolute right to the commissions. Accordingly, the commissions did not constitute income from its business. The relevant foreign laws prevented that from occurring. As we have seen, the case law both in Canada and the United States strongly suggests that an amount is not to be regarded as the income of a taxpayer where he or she has no absolute ownership or dominion over it. This, it seems to me, is the situation in the case at bar.

I would allow the appeal with costs, set aside the judgment of the Tax Court of Canada and remit the matter to the Minister for reconsideration and reassessment on the basis that the commissions in question are not income from the appellant’s business and, therefore, are not taxable as such in the appellant’s hands.

Létourneau J.A.:

I have had the benefit of reading the reasons written by my colleague, Mr. Justice Stone, and unfortunately I am unable to share his views and characterization of the events leading to this case. I will summarize the facts that are necessary for a proper understanding of my position in legally assessing the nature of the involvement of the Appellant in the process generating the commissions that the Respondent seeks to tax.

Facts and Issues

The Tax Court of Canada dismissed with costs an appeal from the reassessments made by the Minister of National Revenue (Ministry) under Part I of the Income Tax Act (Act) in respect of the Appellant’s 1985-1989 taxation years. The Minister had reassessed the Appellant by including in the computation of its income for those years amounts generated by the Appellant as brokerage or commissions. These commissions totalling $7,065,641.00, paid by U.S. insurers, were in the end received by two American companies, Bowes Holdings Inc. (Bowes) and Minet International Professional Indemnity Brokers Inc. (MIPI), which were owned by the Appellant’s parent corporation, Minet Holdings, PLC of the United Kingdom (Minet U.K.). They were remitted to the two U.S. Minet U.K.- owned subsidiaries because the Appellant alleges it was not entitled to receive them under the laws of several U.S. States as it did not hold a broker’s license in these States.

The Appellant corporation is licensed to carry on an insurance brokerage business throughout Canada, but not in any of the States of the U.S. As a result of its expertise in negotiating sophisticated insurance coverage in both the London and U.S. markets, the Appellant attracted many large U.S.based corporate clients. In most cases, the Appellant would itself bind coverage on behalf of U.S. insured, after which it would issue an invoice to the U.S. insured for the premiums due under the relevant insurance policy. The U.S. insured would then transfer the premiums to a New York bank account established by the Appellant. The Appellant would collect and hold premiums on behalf of the insurers. The Appellant would then invest the premiums in short-term certificates of deposit until it was required to remit the premiums to the insurers. The Appellant would then remit the premiums to the insurers net of the commission it was owed and net of any interest income earned on the premiums when they were invested.

However, due to the fact that the Appellant was not licensed to conduct an insurance brokerage business in the U.S., some U.S. insurers declined to pay commissions to it as they feared that such payments would contravene State insurance statutes prohibiting the payment of commissions to unlicensed brokers. These statutes prohibited the payment of commissions to a broker not licensed in the State where the risk was situated. In such situations which amounted to 19 or 20% of its business, the Appellant would have either Bowes or MIPI, two U.S. corporations which were owned by the same parent corporation as the Appellant (Minet U.K.), act as the broker of record as they would be entitled to accept the commissions the Appellant could not. The Appellant selected these two corporations because they were not competitors due to the fact that they were controlled by the same parent as the Appellant. Bowes and MIPI would not attempt to take business from the Appellant. The Appellant was also able to retain control over the brokerage function in a manner which would be impossible if an unrelated company acted as the broker of record. Bowes and MIPI performed nothing more than what was legally beyond the Appellant’s ability to do in the U.S. States in question: act as broker of record, secure binding of the desired coverage, send the premiums to the insurers, effect certain filings, and, of course, receive the commissions the Appellant could not keep. Neither Bowes nor MIPI had the expertise to arrange the insurance coverage on which they were asked to act as the broker of record. In the intercompany accounts of the Minet U.K. group, the Appellant, and not Bowes and MIPI, was shown as having earned the commissions in question.

Finally, by having Bowes and MIPI act as the broker of record in these transactions, the Appellant was able to continue to collect the interest on the premiums payable by the U.S. insured as these related companies did not object to this practice. In these circumstances, U.S. insured still deposited the amounts owed in the Appellant’s account and the Appellant continued its practice of investing them in short-term securities from which it retained the interest payments. When it came time to remit the payments to U.S. insurers, the Appellant kept only the interest and remitted the premiums to either MIPI or Bowes. These corporations then remitted the premiums to the U.S. insurers net of the commissions which they retained for acting as the broker of record. MIPI and Bowes kept these commissions as they were prohibited by law from sharing or rebating them to an unlicensed broker such as the Appellant. MIPI and Bowes included the commissions they received in this manner in the computation of their income for U.S. income tax. The Applicant included the interest payments it received from these commissions in computing its income in the taxation years in question. It did not include the commissions it remitted to Bowes and MIPI. However, it included as deductions all the expenses incurred in arranging the coverage even when Bowes or MIPI acted as the broker of record.

On September 10, 1992, the Minister reassessed the Appellant by adding to its Part I income, as additional commission income from 1985 to 1989, the same commissions which the Appellant had remitted to Bowes and MIPI. The Appellant appealed unsuccessfully to the Tax Court of Canada.

The issue before us is whether the commissions paid to the two U.S. Minet U.K.-owned subsidiaries, who did very little but still necessary work of a processing nature, are income in the hands of the Appellant, also a Minet U.K.-owned subsidiary, who performed in Canada virtually all the brokerage work and deducted all related expenses, but did not retain these commissions which were included in the premiums it received from the insureds.

In other words, this case calls for a characterization at law of the monies, i.e., premiums including commissions, in the hands of the Appellant until they were transferred to the two U.S. subsidiaries.

I hasten to add immediately that there was nothing improper in the Appellant’s conduct of its business. Such conduct, by the admission of the Respondent [1] , involved no scheme or attempt to avoid the payment of taxes or to divert income from Canada into some other jurisdiction. The Appellant, whose knowledge and expertise in the field of insurance as well as access to the European and London markets were solicited by U.S. clients, was confronted with stringent statutory regulations in the various States of the U.S. in which its clients were based. Resort to brokers of record to finalize the transaction on behalf of its clients and payments of the earned commissions to affiliates were steps taken by the Appellant to ensure compliance with the U.S. regulations where needed without jeopardizing the goodwill of its business.

The Decision Under Appeal

The learned Tax Court Judge concluded that these commissions ought to be included in computing the Appellant’s income. This conclusion was based on the following findings, some of which the Appellant challenges on appeal:

(1) The Appellant, not Bowes or MIPI, earned the commissions;

(2) The Appellant in all cases received the full amounts from the insureds, i.e., not only the amount destined to be the brokerage commission but also the amount intended to be remitted to the insurer as premium. It invested all of the monies in term deposits and collected the income thereon. This was either the custom or in certain cases was provided for by specific arrangements with insurers. Neither the insurer nor Bowes and MIPI, in those cases where they were involved, objected to this. The Appellant received the total funds and while the funds remained in its hands the Appellant derived all of the fruits therefrom, in the form of interest on the term deposit investments;

(3) Not all of the funds received by the Appellant were “impressed with a trust” in favour of the insurer. The portion representing the brokerage commission was not. (See the quotation from Exhibit A-14 on the next page.) The amount representing the brokerage commission belonged to the Appellant;

(4) Bowes and MIPI and the Appellant are related corporations within the meaning of the Act. In substance, the Appellant has acquiesced in the commissions it earned being paid to Bowes and MIPI. That clearly differs from a case where, because of a legal constraint, no commissions at all are paid;

(5) The commissions were paid to related corporations with the result that the commissions earned in some form or other by the Appellant accrued to the beneficial owner of the group, i.e., the parent com- pany. As counsel for the Respondent points out, the money “remained in the family”. Although, after the funds left the Appellant and were not returned to the Appellant, the Appellant was certainly instrumental in agreeing in some fashion that the amounts be paid to Bowes and MIPI. The acquiescence or instructions from the Appellant as to where the brokerage commissions were to be paid certainly indicates a degree of control or dominion over those funds;

(6) The Appellant, although not actually retaining the brokerage commissions, benefited in two ways. Future business and good business relationships and contacts were maintained. Moreover, as mentioned above, the Appellant and/or its officers or employees were recognized by the parent as being responsible for earning the commissions.

Exhibit A-14 to which the learned judge referred in his third finding is a copy of a sample of a brokerage agreement between the Appellant and a Canadian insurance company (Wellington Guarantee). Section I of that agreement deals with the collection of premiums and reads:

1. Premium Collection

The Broker is responsible for all premium collection for the Company. If the Broker cannot collect a premium due the Company, the Broker must notify the branch office of the Company nearest the Broker in writing before the premium due date. All premiums collected on behalf of the Company, less the Broker's commission, belong to the Company and must be held in trust in a Bank or Trust Company. Interest on the Trust Funds is the property of the Broker.

[emphasis added]

Ruling on the Appellant’s objection to the application of subsection 56(2) of the Act

Before I address the main issue, I ought to dispose of an objection taken under reserve and made by counsel for the Appellant to an attempt by the Respondent to justify the dismissal of the appeal on the basis of subsection 56(2) of the Act.

Subsection 56(2) provides that payments made to some other person at the direction or with the concurrence of the taxpayer are to be included in a taxpayer’s income where such payments are for the benefit of the taxpayer or as a benefit that the taxpayer desires to have conferred on that other person.

This provision has been known as a tax-avoidance provision but our Court has decided that the generality of its terms is such that its application is not confined to clear cases of tax-avoidance [2] .

It should be mentioned that subsection 56(2) was not the basis of the reassessment of the Appellant’s income for the years in question. Nor was its application to the facts of this case argued and pleaded before the learned Tax Court Judge.

The Respondent made its bed totally outside the ambit of subsection 56(2) when it reassessed the Appellant, but now feels that a resort to it is needed for better comfort. It submits that all the facts are on the record and can justify this late application by us of the subsection.

It is true that there are authorities on the books to support the position of the Respondent, one of the latest being the decision of the Supreme Court of Canada in Athey v. Leonati>. [3] The following excerpt from the decision at pages 58-59, I believe, summarizes well the governing principle:

The general rule is that an appellant may not raise a point that was not pleaded, or argued in the trial court, unless all the relevant evidence is in the record: John Sopinka and Mark A. Gelowitz, The conduct of an Appeal (1993), at p. 51. In this case, all relevant evidence was part of the record. In fact, all the requisite findings of fact had been made. The point raised by the appellant was purely a question of law.

52 Most importantly, the respondents did not suffer prejudice, since they would not have proceeded any differently even if the appellant had expressly relied on McGhee v. National Coal Board and Bonnington Castings v. Wardlaw, supra, from the very beginning. The defence theory was that the disc herniation was not causally related in any way to the injuries suffered in the motor vehicle accidents. The respondents could not have made any more emphatic defence than this. This was a case where “had the question been raised at the proper time, no further light could have been thrown upon it”: Lamb v. Kincaid (1907), 38 S.C.R. 516, at p. 539, per Duff, J. (as he then was). Given that the appellant’s arguments raised an issue of law which did not require any further evidence (or indeed any further findings of fact) and which would not have caused any prejudice to the respondents, it was an error for the Court of Appeal to refuse to consider the argument.

It is clear that the overriding consideration remains the lack of prejudice to the other party evidenced by the fact that all relevant evidence or material facts necessary to the application of the legal provision are on the record.

However, the Appellant submits, rightly so in my view, that such is not the case in the present instance. It was never alerted to the possible application of subsection 56(2). It was not told specifically the assumptions upon which the Minister would have based his reassessment under that subsection. Consequently, it never explored the matter on discovery. It did not examine or cross-examine witnesses with that perspective in mind. It did not introduce evidence to establish, for example, that it did not either in fact or in law desire to confer benefits on its affiliated subsidiaries or benefit itself from such payments to these subsidiaries.

Counsel for the Respondent argued that he could not see what additional evidence could have been adduced on the matter. He may be right. The Appellant might or might not have been able to establish a factual base to prevent the application of subsection 56(2). I do not know, but it is certainly not for us to speculate at this late stage as to what the Appellant’s conduct could or might have been had the issue been properly raised at the outset and debated in the pleadings.

With due respect, speculation as to whether sufficient additional and probative evidence could have been adduced or not is not the proper issue now confronting us. The real issue is one of fairness to the taxpayer, especially as the burden is on him to disprove, on a balance of probabilities, the assumptions upon which the Minister normally proceeds to reassess under subsection 56(2) [4] .

The Appellant was deprived of such opportunity throughout the process and particularly at the evidentiary stage.

In my view, the Respondent is seeking through the application of subsection 56(2) not the mere addition of blankets or pillows to improve the comfort of its bed, but in fact a change in the structure of the bed itself. It would be unfair to the Appellant to now allow such a change. Therefore, I would maintain the objection and rule that subsection 56(2) cannot be applied in the circumstances of this case.

Analysis and Decision

Whether the Appellant earned and received the commissions

The learned Tax Court Judge found that the Appellant earned the commissions in dispute. I think such a finding was not only entirely supported by the evidence, but also legally sound.

There is no dispute, as the evidence reveals, that all the negotiating work was done by the Appellant who alone had the required knowledge and expertise [5] and that MIPI and Bowes, because they were licensed brokers in the U.S., acted as brokers of record for the purpose of legally collecting from the insurers the income generated by the work and expertise of the Appellant.

In his testimony, Mr. Middleton, the principal officer of the Appellant, recognized in the following terms the modest contribution of MIPI and Bowes [6] ;

We do not and have never denied the amount of actual work that would be undertaken by the entities was modest and so they couldn’t claim that they had in fact produced to the Minet Group a piece of business of their own volition which had generated this sort of level of income.

Indeed, when acting as brokers of record, MIPI and Bowes internally received, as management accounting allocation, a modest fee of $5,000 per transaction by the Minet Group to reflect the limited extent of the work they had done [7]

The substantial commissions generated by the work of the Appellant were earned when the Appellant invoiced its clients for payment of the pre- mium. This was confirmed by the principal officer of the Appellant in his testimony [8] :

Q So, I suppose on an accrual basis, as soon as the Appellant invoices its client, the commission is considered as earned even though not yet received?

A. Yes, that is the case...

Q Then, when the placing of the risk is complete, an invoice is then issued to the client?

A. Yes.

Q. Reflecting the period for the firm order that was given?

A. Correct.

Q. At this point the Appellant recognizes the commission as earned?

A. The applicable commissions are recognized as earned at that point, yes.

The U.S. insureds were invoiced by the Appellant out of the Montreal office [9] and they were instructed to, and did, deposit the funds in the Appellant’s bank account in New York [10] . A copy of the client invoice was sent every time to the Appellant’s accounts department [11] . Payment of the commissions by insurers was effected by the Appellant or, in some cases, its affiliated subsidiaries retaining a portion of the gross premium received by the Appellant from the insureds [12] .

This brief review of the evidence shows factually that the commissions were payable and effectively paid for the work done by the Appellant, that it is the Appellant who collected them by invoicing the insureds and collecting the premiums on behalf of the insurers and that they were put in the Appellant’s bank account.

In William Wrigley Jr. Co. v. Manitoba (Provincial Treasurer))^ [13] , Taschereau J. stated:

Primarily, to “earn” income or profit is, I should say, to expend the effort or exertion which creates the value to be exchanged.

According to the Shorter Oxford English Dictionary, to “earn” means to obtain or deserve as the reward of labour [14] . There is no doubt that, in fact, the Appellant, to use the expression of Taschereau J., has expended the effort or exertion which created the value to be exchanged.

However, counsel for the Appellant very ably, and, in my view, rightly so, submitted that the earning of income requires at law that the reward of labour be either received or receivable. I accept the Appellant’s submission that, in the present instance, the commissions were not “receivables” under section 9 of the Act because the Appellant did not have a clearly legal, though not necessarily immediate, right to receive them [15] . The fact is that the U.S. insurers were prohibited by statute from paying the commissions to an unlicensed broker. The Appellant has also referred us to some decisions of U.S. courts and in particular to this excerpt of the U.S. Supreme Court in Commissioner of Internal Revenue v. First Security Bank of Utah, N.A.^: [16]

We know of no decision of this Court wherein a person has been found to have taxable income that he did not receive and that he was prohibited from receiving.

I stress that the Appellant who was operating its business in Canada was not prohibited in Canada from receiving these commissions. In any event, it is accepted law both in U.S. and Canadian law that monies illegally received by a taxpayer are nonetheless taxable income in that taxpayer’s hands [17] . The question then is: were the commissions effectively received by the Appellant, whether illegally or not?

Counsel for the Appellant contends that the commissions were never received by the Appellant because the Appellant held the premiums it received from the insureds in trust for the insurers.

The Appellant filed three documents in support of its claim that the monies were held in trust: a sample of a Broker’s Agreement [18] , a Producer’s Agreement [19] and an Agency Agreement [20] . I need say at the outset that none of these agreements are relevant to the Appellant’s business. The first one involves an agreement with a Canadian insurer while the Appellant was dealing with U.S.-based insurers. The second refers to an insurer that was not involved in any of the business dealings that the Appellant has chosen to file as examples. In addition, there is no evidence before us that it was a sample of a relevant agreement with a U.S. insurer. The third relates to the kind of agreements signed by MIPI in the course of its own business. In fact, the Appellant has filed no copies of the agreements that they would have had with their U.S. clients if ever they had anything of the kind in writing. In my view, the answer to the question whether the Appellant effectively received the commissions is to be found primarily in the testimony of the principal officer of the Appellant and the correspondance of the Appellant with its affiliated subsidiaries although these samples of agreements also assist in shedding some light on the status of the commissions paid for the work done by the Appellant.

It is clear from the testimony of the principal officer of the Appellant that the Appellant’s bank account in New York was not a trust account, but that, in order to retain the trust of their clients, the Appellant operated it as such to ensure that the balance of the account would at all times be sufficient to reimburse insurers of their premiums [21] :

Q. Has the balance of the account plus the term deposits ever to your knowledge dipped below the total amount of premiums that were due to insurers?

A. I’ll say not to my knowledge. I would almost certainly say absolutely not because that would have been a major issue as far as we were concerned. We would have been out of trust.

Q. To your knowledge then the bank account was indeed and in fact operated as a trust account?

A. It wasn’t a trust account in the sense there was a trust deed but we certainly — for all intents and purposes it was operated as and treated as a trust account.

The Appellant took the monies received from the insureds out of their bank account and reinvested them in certificates of deposit until the amount of the premiums, net of the commissions, were due to the insurers, at which time the amounts so invested were deposited back by the Appellant into its bank account. It kept the substantial amount of interests thus produced ($971,208 in 1985, $949,343 in 1986, $707,894 in 1987, $502,770 in 1988 and $856,836 in 1989). At least in those cases where the U.S. insurers did not require that the commissions be assigned to a U.S. licensed broker of record, the Appellant used part of the commissions earned to cover its operating expenses. The principal officer of the Appellant described in the following terms the control it assumed over the premiums and commissions received from the insureds [22]

Q. How does it do that, just mechanically?

A. As far as our U.S. business was concerned, the money would go into Marine Midland Bank. We would only withdraw from Marine Midland Bank, apart from the purposes of investing the money in short-term instruments as I mentioned before, we would only withdraw from that bank account monies needed to pay the insurers and monies representing our own earned commissions that we would then bring back into Canada to cover our operating expenses.

Q.The term deposits were taken from this account and deposited back into that account?

A. That is correct.

Q. That’s the arrangement you had with Marine Midland Bank?

A. That is so.

Obviously, the sums received by the Appellants, especially the commissions which formed part of the gross premiums received by the Appellant, were not legally held in trust. Although not relevant to the facts of this case, the Broker’s agreement filed by the Appellant and to which the Tax Court judge referred nonetheless confirms that the broker’s commissions, which are part of the premiums collected on behalf of the insurers, are not held in trust for the obvious reason that these commissions have been earned by and belong to the Appellant from the date of their invoices to the insureds. To put it another way, funds which belonged to the Appellant were not and cannot be impressed with a trust for another.

Clearly, the Appellant, in fact and at law, earned the commissions paid by the insurers and received them as evidenced both by the fact that they were paid at its request in its bank account and by the measure of control it exerted over and the benefits it obtained from these sums.

Whether the commissions received by the Appellant were income in its hands

Monies received or receipts are not income in a taxpayer’s hands until and unless the taxpayer’s “right to them is absolute and under no restriction, contractual or otherwise, as to their disposition, use or enjoyment” [23] .

Relying upon such precedent, counsel for the Appellant submitted that the commissions did not have for the Appellant the character of income because the Appellant merely had temporary custody of these commissions which were remitted to MIPI and Bowes who acted as brokers of record. He also claimed that the Appellant did not have over these sums the possession, dominion or control necessary to constitute receipt.

As I have mentioned earlier, the Appellant exercised a substantial amount of control over the commissions it generated, earned and received for its work. Evidence of further control by the Appellant over these commissions can be found in the letters of remittance of these sums to its affiliated subsidiaries. In these letters, the Appellant would, for example, instruct Bowes and Company Inc. of Chicago, who acted as the broker of record, to keep a very small percentage (1 or 2%) of the commissions and give the balance of the commissions to Bowes and Associates who had no involvement in the business transaction [24] . Furthermore, in its financial statements produced in conformity with the Canada Business Corporations Act, the Appellant described as income in its hands from the time the client was invoiced the commissions earned:

The commissions earned are recognized as income when the client is invoiced, which is generally at the inception date of the policies [25] .

It is a mistatement of the facts and the law for the Appellant to now assert, as it does, that it merely acted as an agent of MIPI and Bowes in producing and earning these commissions. In my view, the evidence clearly reveals that the Appellant was the principal and that MIPI and Bowes acted as mere conduits in collecting the income earned by the Appellant in these instances where it was believed that U.S. law prohibited payment to the Appellant. As the principal officer of the Appellant recognized in his testimony, it is the Appellant’s expertise which was the foundation of the whole business [26] and it is this business which earned the income. The Appellant earned and received the commissions and, as the facts reveal, assigned them to Bowes or MIPI in order to show the compliance with U.S. State insurance regulations required by some, but not all, of the U.S. insurers with whom the Appellant did business.

In my view, the findings of fact of the Tax Court Judge were amply supported by the evidence and he made no error of law when he came to the conclusion that the commissions totalling $7,065,641 were income in the hands of the Appellant. For these reasons, I would dismiss the appeal with costs.

Appeal allowed.