March 1, 2011 by David Gambrill, Editor
Clients involved in cross-border commercial insurance transactions are being audited and billed retroactively for the Canada’s 10% federal excise tax, because the Canada Revenue Agency (CRA) has taken a fresh look at old legislation that applies to tax on unlicensed insurance placements.
Canadian commercial insurance brokers note the section of the Excise Tax in question is designed to promote the use of licensed Canadian brokers and carriers in situations in which U.S. or other foreign companies seek insurance coverage for their Canadian operations.
But the CRA’s new emphasis on ensuring the Canadian broker is the lead broker in any cross-border commercial insurance transactions – transactions involving both licensed Canadian brokers and unlicensed U.S. brokers – may in fact have the opposite effect, Canadian commercial brokers note. It may cause unlicensed brokers to steer business to U.S. carriers in an effort to avoid paying the 10% Canadian Excise Tax.
It may also complicate cross-border insurance transactions, since Canadian brokers may require procedures to be followed that are unnecessary elsewhere in order to keep commercial insurance clients from having to pay the federal Excise Tax.
“This legislation [The Excise Tax Act] goes back to the MacKenzie King era, so its not new legislation,” says Michael Boire, president of the Toronto Insurance Conference, which represents Canadian commercial insurance brokers across the country. “In my opinion, the intent of the legislation in the 1930s was to make sure that Canadian businesses were insuring through licensed Canadian brokers and licensed Canadian carriers, so that a company in Montreal, Toronto, Vancouver was not insuring through a New York broker and a New York insurance carrier. They (clients) were to go through a Canadian broker and a Canadian carrier and provide jobs to the industry and really to ensure the insurance purchase is in Canada. If you use an unlicensed broker or an unlicensed carrier, a 10% federal excise tax applies and then there are various provincial penalties that apply.”
Provincial penalties for the use of unlicensed insurance vary by province. They range anywhere from 3 or 4% of the unlicensed insurance premium in Ontario, all the way up to 50% of the unlicensed insurance premium in Alberta.
Up until about a year ago, the CRA did not charge the 10% federal excise tax if the insurance carrier or broker in a cross-border transaction was licensed in Canada, and if the broker did some form of work in the cross-border insurance purchase – i.e. a negotiation of renewal terms, providing binders of insurance, certificates of insurance, analyzing, collecting, remitting, providing claims service, etc.
But now the CRA has started to take a literal interpretation of Section 4.4 of the Excise Tax Act, which states: “Where a contract of insurance is entered into or renewed through more than one broker or agent, or where payment of the premium or any part of the premium thereon is effected through more than one broker or agent, the contract shall, for the purposes of this Part, be deemed to have been entered into or renewed, as the case may be, through the broker or agent directly retained or instructed by the insured and not through any other broker or agent. [Emphasis added.]”
In other words, a licensed Canadian broker must now be ‘directly retained and instructed’ by the client. To see how this works, take the following fictitious example:
Bruce Springsteen Commercial Brokers Inc., an unlicensed broker based in the U.S.A., is looking for commercial insurance coverage on behalf of a U.S.-based client, a business that just opened up a new operation in Vancouver, B.C. Springsteen Brokers contacts Bryan Adams Insurance Brokers Inc., a licensed commercial broker in Canada, to help find an insurance carrier for their client. Adams gathers a list of quotes and suggests the best deal is to insure through the licensed Canadian carrier Jann Arden Insurance Inc. in Alberta. On behalf of its client, Springsteen gives instructions to Adams to go ahead and bind the coverage. In the eyes of the CRA, since the licensed Canadian broker Adams
received its instructions from the unlicensed U.S. broker Springsteen, the 10% federal Excise Tax applies. Had Adams received its instructions directly from Springsteen’s U.S. client instead, the transaction would be exempt from the Excise Tax.
This shift in interpretation has already cost clients of Canadian brokers big money. “The big concern is that the clients here in Canada are all of a sudden being assessed a 10% surcharge on their insurance,” said Boire. “And since the CRA can go back four years, and depending on the premiums paid, that could turn into a fairly lofty amount.”
Thus, if a client is paying $100,000 in premium, they could be on the hook for $10,000 in retroactive tax for a single year, Boire notes. And if the CRA goes back four years, “they’re getting a bill for $40,000 that they didn’t budget for and that they didn’t anticipate. That’s creating a bit of angst between the client and not only the Canadian broker, but whoever the foreign broker is as well.”
Ironically, the legislation, which is supposed to promote business through licensed Canadian brokers and insurers, may in fact drive business away from Canada. In the above example, if the licensed Canadian carrier, Jann Arden Insurance Inc., has a U.S. affiliate, the unlicensed U.S. broker Springsteen may choose to place the insurance with Arden’s U.S. affiliate instead, thus remaining the broker of record and negating the possibility of the client paying the 10% tax surcharge by placing the coverage in Canada. “A U.S. broker may say: ‘I don’t need to place [the insurance] with you in Canada if I’m still going to get the 10% surcharge,” as Boire puts it. “‘ I might just keep it all down here in the United States.'”
Brenda Rose of Firstbrook Cassie Anderson is one of a number of broker representatives negotiating with the CRA on this issue. She says the CRA’s current interpretation of the legislation is perfectly legitimate, but the legislation itself is outmoded and does not reflect the day-to-day reality of cross-border insurance placements, which often require Canadian and U.S. brokers to talk to one another about coverage. This is particularly true of complex deals in which the coverage with the licensed Canadian carrier is predicated on the financial capacity of its U.S. counterpart. This means brokers and underwriters on both sides of the border will be in constant touch with one another.
“The business reality is that where there is a customer outside of Canada, but they have a global program, they will have one broker from whom the instructions are often disseminated and that, according to the CRA, disqualifies an otherwise compliant placement,” says Rose. “So this is problematic: a) because nobody has been interpreting it this way up until now, and b) because it creates extra work in the process. If you’ve told the client, ‘Okay, you’ve given your broker in Zurich your instructions, but by the way in Canada we’re special, and you need to advise us specifically and separately,’ it creates a boondoggle. It creates more work and room for errors. This legislation was drafted years and years ago, before this type of placement was contemplated.”
Commercial brokers are now lobbying officials in both Industry Canada and the Finance Department of Canada to change the legislation.
In the meantime, the TIC has issued a bulletin advising brokers on how to stay onside of the tax law. It notes the CRA is looking for evidence of a specific
appointment of a broker licensed in Canada (a broker of record letter);
ongoing and direct communication between the insurance purchaser and the Canadian broker, and negotiations with and instruction of the insurer by the Canadian broker.