Recently, the Federal Court of Appeal addressed the nature of a government instrumentality. This classification, expressed in various ways in the Income Tax Act, is important because, broadly, governments generally do not tax each other. This is notable in various paragraphs of section 149 of the Act, and is a longstanding exception to the imposition of non-resident withholding tax on interest and features also in bilateral tax treaty provisions concerning interest. The lynch-pin however is the qualification of the taxpayer as some sort of instrumentality or manifestation of government, performing public functions that are commonly associated with the roles and responsibilities of governments even if targeted and not comprehensive.
The Federal Court of Appeal decided in Lawyers’ Professional Indemnity Company v. The Queen, 2020 FCA 90, that this taxpayer, the common commercial name of which is “LawPRO”, is not a government instrumentality and therefore is taxable on its income. It is not the inclination of this blog to comment on “live” cases – it remains to be seen whether an application for leave to appeal this decision to the Supreme Court of Canada will ensue – in ways that would amount to arguing the points in issue. I strongly believe that counsel should have the opportunity to shape their case as they determine and according to the legal principles and facts as they present them. It is very easy, from the sidelines, to intervene through public commentaries for which authors are not accountable in the controversy. Nevertheless, the case is important for the legal profession in Ontario and perhaps more broadly, and it can be imagined that if undisturbed this decision could affect the cost of legal services by increasing the cost of professional indemnity insurance.
Taking some but not many liberties with the facts, LawPRO is a wholly owned subsidiary of the Law Society of Ontario, a delegate by bespoke legislative authority of the Province of Ontario constituted to regulate the provision of legal services in Ontario. The public purpose of the Law Society is stated expansively by the Court: “The Law Society was founded by an Act of the Legislative Assembly to serve the people of Ontario and to defend and maintain constitutional principles such as the cause of justice and the rule of law: An act for the better regulating of the practice of law, S.U.C. 1797 (George III), c. 13.” Lawyers and law firms practicing law in Ontario are subject to comprehensive regulation by the Law Society according to that regulatory authority. Within this regulatory framework and in the interest of protecting the public served by lawyers, lawyers and law firms are required to maintain levels of professional insurance and are required to obtain that insurance coverage from LawPRO. Coverage for “excess liability” can be obtained by commercial carriers, but the basic coverage is mandated via and exclusively provided by the Law Society in this way. Professional insurance is a badge, an attribute of professional qualification. Both the Law Society and, until now LawPRO, have operated and presented themselves as not for profit organizations performing a governmental role. The Law Society and LawPRO are funded by those they regulate and serve, lawyers and law firms, who pay membership fees and insurance premia.
The Federal Court of Appeal disagrees in LawPRO’s case. Relying on a close and tight construction of the statutory provisions on which LawPRO seemingly relied to situate itself in the Canadian tax firmament as not taxable, the Court found that the relevant statutory language in section 149 is neither expansive nor elastic enough to accommodate LawPRO. The essence of this case is an exercise in statutory construction, with deference to statutory text and context. The result is that LawPRO is taxable on its income if this decision stands. The focus is very much on the meaning of the words used in the Act, in the aspect of section 149 on which LawPRO seemingly relied to frame its ostensible non-taxable status, even allowing for its close connection to the Province of Ontario via the Law Society. One wonders for example what the outcome would have been and how easily it would have been reached if the Province, directly or via the Law Society without the intervention of an separate legal entity, had regulated and insured lawyers and law firms and how pertinent that might be to a contextual analysis.
This is not inconsequential. Without discussing or debating how insurance enterprises operate, it is common ground that insurance companies have two main operating functions: they provide liability coverage, that is they compensate those suffering insured losses, and to do that they invest their capital – notably premia from indemnifying losses via insurance – to earn a return, i.e., “income” including capital appreciation, to provide the necessary financial reserves out of which losses are indemnified.
Interestingly, at almost the same time that this case was decided and the judgment published, administrative guidance was provided by the Canada Revenue Agency addressing “[w]hat criteria should be considered when determining whether a particular entity is a public institution.” This is found in Document Number 2020-0846931E5 (E). As is not uncommon, the CRA offers general guidance explaining in sum that “[t]he determination is a question of fact.” No doubt facts are important to any evidence-based analysis of tax law, but statutory context considering those facts is intrinsically a legal analysis.
The CRA concludes its analysis this way:
Whether a particular entity is one described in paragraphs 149(1)(d) to (d.6) would be determined with reference to the ownership of the shares or capital of the corporation as well as the existence of any right by a person other than Her Majesty in right of Canada, a province or a Canadian municipality to acquire such shares or capital.
In the context of a corporation without share capital, the determination of the ownership necessitates a review of all the relevant documents such as articles of incorporation, by-laws and agreements relating to the operation and control of the corporation and its assets. We consider that the following factors would be relevant in making such determination:
the identity of members,
the structure of the corporation,
who exercises control over the financing, operation and direction of the corporation,
who has the right to elect or change the board of directors or to reverse its decision,
who can contribute capital and receive a distribution of capital,
details regarding asset distribution on winding-up or dissolution and
whether a person other than her Majesty in right of Canada, a province or a Canadian municipality has any right to acquire any capital of the corporation.
It will be interesting to monitor the progress of the LawPRO case.
Click here for the decision in Lawyers’ Professional Indemnity Company v. The Queen, 2020 FCA 90.
Click here for Canada Revenue Agency (CRA) Document Number 2020-0846931E5 (E).