FOREIGN INSURANCE EXCISE TAX

1
FOREIGN INSURANCE EXCISE TAX

• RECENT IRS RULINGS AND FET LITIGATION PROJECT

2
BASICS ABOUT THE FET

• IRS Code Sec. 4371 assesses 4 of gross premiums
  paid on direct insurance of U.S. p/c risk 1 on
  life, accident or health policy or annuity 1on
  reinsurance of U.S. risks
• Tax treaties might waive the first leg but the
  majority include an anti-conduit clause. U.K.
  treaty includes a conduit arrangement clause
  and
• Responsible entity could be insured, insurer,
  reinsurer or broker.

3
RECENT IRS INTERPRETATION AND ACTIVITY

• Rev. Rul. 2008-15 IRS announced that the FET
  applied not only to a U.S. foreign transaction,
  but to the second transaction between foreign
  reinsurer and foreign retro (cascade theory)
• Subsequent tax seminars and Audit Guide IRS has
  stated they believe the tax is also applicable to
  subsequent retrocessions (Chapter 7) regardless
  of a U.S. nexus
• Audit Guide IRS claims that in determining when
  premiums are paid, the accrual rather than
  cash-basis method of accounting applies (Chapter
  4)

4
RECENT IRS INTERPRETATION AND ACTIVITY (CONTD)

• Announcement 2008-18 IRS has established a
  Voluntary Compliance Initiative (deadline to join
  was January 31, 2009)
• IRS has assembled a FET audit team, notices have
  been sent to captives in the Caribbean and
  Bermuda, foreign subs of U.S. companies, at least
  one German company, and even those who
  participated in the VCI (no current intent to
  audit brokers)
• Audits are broader than just the cascading tax.

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FOUR IRS SCENARIOS

• 1direct to non Treaty insurer

• 2Cession to non Treaty Reinsurer(s)

• Foreign insurer issues casualty policy covering
  U.S. risk 4 tax
• Reinsured with a non-exempt foreign reinsurer
  1 tax.

• U.S. insurer cedes to non-exempt foreign
  reinsurer A 1 tax
• Foreign reinsurer A cedes to non-exempt foreign
  reinsurer B 1 tax.

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Rev. Rul. 2008-15, Situation 1Insurance Excise
Tax Cascade Theory
B Foreign Insurance Company
100
30
A US Insured
C Foreign Reinsurance Company
Tax Due 4 x 100 4.00 (A-B) 1 x 30
0.30 (B-C)
7
FOUR IRS SCENARIOS (CONTD)

• 3-CESSION TO TREATY WAIVER W/ANTI-CONDUIT

• 4-Cession to Treaty waiver w/UK Conduit

• Same fact scenario as 1 except reinsurer is
  exempt and treaty has standard anti-conduit
  clause
• No 4 tax on first leg but because of the cession
  to non-exempt reinsurer in violation of
  anti-conduit, treaty exemption was terminated
  4 plus 1 tax.

• Same fact scenario as 1 except reinsurer is
  exempt under unique UK conduit arrangement
  clause
• First leg exempt because not entered into as part
  of a conduit arrangement, second leg 1 tax.

8
Rev. Rul. 2008-15, Situation 3Treaty Waiver of
FET with Anti-Conduit Rule
B Foreign Insurance Company (FET Waiver)
30
100
C Foreign Reinsurance Company (no FET waiver)
A US Insured
Tax 4 x 30 1.20 (A-B) 1 x 30 0.30
(B-C) Total 1.50
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POTENTIAL LIABILITY

• Potential loss or termination of the treaty
  waiver on the first leg of the transaction,
  resulting in multiple taxes on the transaction
• Audits, even for VCI participants, aimed at
  uncovering non-payment of the second leg tax
  even for reinsurers covered by treaty waivers
• Extension of typical three year statute of
  limitations for excise tax violations to six
  years and
• Interest equal to the federal short term interest
  rate plus 3 and other potential penalties.

10
INDUSTRY LITIGATION PROJECT

• Steering Committee intends to finance litigation
  but need a plaintiff
• Anticipate that run-off companies will be
  audited, some believe that a run-off company
  would be best plaintiff, e.g., limited of
  transactions (liability for past 3-6 years), no
  future liability, less expensive and
  cleaner/simpler fact pattern
• Contact Brad Kading (ABIR), Joe Sieverling (RAA)
  or Brenda Viehe-Naess (Washington Advocates
  Group).