Recently, the Internal Revenue Service published Letter Ruling 9621001 in which it provided technical advice that premiums paid by one foreign insurer to another with respect to a U.S. risk are subject to the 1,percent excise tax on reinsurance under Section 4371 of the Internal Revenue Code of 1986, as amended (IRC).
Simply stated, the facts were as follows: A U.S. company purchased a product liability policy from a Bermuda insurer and paid the appropriate 4 percent excise tax imposed on direct placements of insurance of U.S. risks with foreign insurers by U.S. insureds, as stated under IRC [sections] 4371(1). The Bermuda company then purchased reinsurance from unrelated foreign reinsurers, and the IRS proposed to tax these transactions at the 1 percent rates under IRC [sections] 4371 (33, which applies to reinsurance of U.S. risks with foreign reinsurers.
Surprisingly, the position is not new; the issue has been raised several times before by representatives of the U.S. Treasury and the IRS, although the position has not been aggressively pursued and has been the subject of legislative proposals.
The principal practical concerns of a cascading application of the excise tax are threefold:
1. Given sufficient successive reinsurance transactions, in theory, all income from the reinsurance could be consumed by tax;
2. The U.S. jurisdiction for the imposition of the tax is unclear under this theory;
3. The theory abrogates certain treaty obligations, assuming the IRS would seek to apply it in the treaty context.
Keeping these points in mind, the IRS reasoning should be analyzed:
Read literally, the statute does not clearly present imposition of a tax on such transactions.
a. IRC [sections] 4371 imposed an excise tax of 1 percent on each premium payment on a policy of reinsurance issued by a "foreign insurer" with respect to the risks of an "insured."
b. IRC [sections] 4372 defines a foreign insurer as an insurer that is a non-resident alien individual, foreign partnership or foreign corporation.
c. IRC [sections] 4372(d) defines an insured to include a domestic corporation that is insured against risks wholly or partly within the United States or a foreign corporation engaged in a U.S. trade or business that is insured against risks wholly within the United States
d. Treasury Regulation [sections] 46.4371-3(b) defines the term premium payment to include consideration paid for assuming risk.
Accordingly, on the face of the statute, the IRS argues that any premium payment made to a foreign insurer with respect to U.S. risk of a U.S. corporation (or a foreign corporation engaged in a U.S. trade or business) is subject to the tax.
The IRS cites the legislative history of the statutory provisions to support its position.
In considering the legislative history, the IRS cites the House Ways & Means Committee Report discussing Section 502 of the Revenue Act of 1942:
"Section 502 of the bill amends the existing provision in full, extending its application to insurance policies of all kinds, as well as to indemnity, fidelity and surety bonds, and to policies of reinsurance. The rate on all contracts of reinsurance and on life and accident policies and annuity contracts is one cent per dollar of premium. . . . It is believed that the revised provision will yield an appreciable amount of revenue, and at the same time eliminate an unwarranted competitive advantage now favoring foreign insurers." (Emphasis added.)
Hearings before the Senate Finance Committee are also cited as follows:
"The amendment . . . imposes a stamp tax on certain insurance policies written by foreign insurance companies. In the main the tax is imposed at the rate of four cents on each dollar, or fractional part thereof, of the premium charged for indemnity . . ., and at the rate of one cent on each dollar, or fractional part thereof, of the premium charged for reinsurance. …