CCA 200844011: Foreign insurance pool premiums were subject to excise tax

Plain-English summary

A foreign-incorporated captive insurer that elected domestic treatment under § 953(d) joined an insurance pool organized in the same foreign country. The captive ceded smaller claims to the pool, assumed a share of other members’ risks, and paid reinsurance premiums that netted against premiums received for assumed risks. Chief Counsel concluded that the pool’s management structure, shared risk, separate books, committees, and mutual member control made it a separate entity rather than a mere contract. Because its business was insurance, it was classified as a corporation, and because it was organized outside the United States, it was a foreign insurer or reinsurer. Section 4371 therefore imposed excise tax on the captive’s reinsurance premiums paid to the pool. The advice did not address any § 4373 exemption.

Ruling snapshot

• Question: Were payments to the foreign insurance pool taxable reinsurance premiums under § 4371?
• Outcome: Advice given. The pool was a separate foreign insurance corporation, so § 4371 applied to the reinsurance premiums.
• Key authorities: IRC §§ 4371, 4372, 4373, 7701; Treas. Reg. §§ 301.7701-1, 301.7701-2, 301.7701-5, 1.801-3(a)(1)

Full text (IRS public release)

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Office of Chief Counsel
Internal Revenue Service
Memorandum
Number: 200844011
Release Date: 10/31/2008
CC:INTL:B05: MKHarris
POSTF-112559-07

UILC: 4371.03-00, 7701.00-00

date: July 21, 2008

 to:   Robert F. Geraghty
       Associate Area Counsel (Seattle)
       (Large & Mid-Size Business)

from: Steven D. Jensen
Senior Counsel, Branch 5
(International)

subject: Application of Section 4371 Excise Tax to Reinsurance Premiums

       This Chief Counsel Advice responds to your request for assistance dated May 11, 2007.
       This advice may not be used or cited as precedent.



       LEGEND


       Taxpayer    =   ------------------------------------
       Parent      =   ------------------
       Pool        =   --------------------------------------
       Contract    =   --------------------------------------------------
       Country X       ------------


       ISSUES

       Whether amounts paid by Taxpayer to an insurance pooling arrangement were
       premiums paid with respect to a policy of insurance, indemnity bond, annuity contract,
       or policy of reinsurance to a foreign insurer or reinsurer that are subject to excise tax
       under section 4371 of the Internal Revenue Code (Hereinafter all section references are
       to the Internal Revenue Code or regulations promulgated under the “Code”)?

POSTF-112559-07 2

CONCLUSIONS

Section 4371 of the Code applies to amounts paid by Taxpayer to Pool because those
amounts were premiums paid with respect to a policy of insurance, indemnity bond,
annuity contract, or policy of reinsurance to a foreign insurer or reinsurer.

FACTS

Parent, a US company, is head of a US consolidated group of corporations. Parent and
its subsidiaries buy insurance covering its US assets, workman’s compensation, and US
commercial liabilities. Parent obtains catastrophic insurance from unrelated insurance
companies covering large claims. Parent buys insurance from Taxpayer, a wholly-
owned subsidiary covering its small claims.

Taxpayer is incorporated in Country X and has filed an election under section 953(d) of
the Code to be treated as a domestic corporation. Taxpayer’s gross receipts primarily
consist of insurance premiums received on policies issued to Parent and its
subsidiaries. Taxpayer is responsible for all claims greater than $100,000 up to the
large claim limits covered by unrelated insurance companies. Taxpayer is a member of
a pooling arrangement (Pool) and cedes insurance on any claims less than $100,000 to
the Pool in accordance with a contract (Contract).

Each year, as a member of the Pool, Taxpayer and other members enter into the
Contract with a management company. The Contract sets out the terms and limitations
of the insurance risks ceded and assumed by the Pool members executing the
document. It also provides for the conduct of Pool business by members and the
Manager, including (1) hiring an actuary to analyze risks for all members and set
premium rates, (2) setting up the operation of committees and (3) establishing
procedures under which new members may be included and certain old members
ousted from the Pool. The Contract is governed and interpreted in accordance with the
laws of Country X. The management company of the Pool is a Country X company.

The Pool operates separately from each member. Various committees oversee the
business operations of the Pool. No single Pool member can prevent the Pool from
acting on its determinations. The Participant’s Committee, with concurrence of the
Manager, has authority to determine all matters relating to the overall operation of the
Pool. Each Participant at the time of admission must meet minimum qualifications to
the satisfaction of the Participant’s Committee. The Participant’s Committee maintains
an Executive Committee, Underwriting Committee, and Audit and Finance Committee.
A Pool member may be terminated by the Manager at the direction of the Participant’s
Committee.
POSTF-112559-07 3

Under the Contract, each member of the Pool transfers its risk for all claims of $100,000
or less to the Pool and agrees to assume a percentage of the risk for those claims of
$100,000 or less arising from the insurance risks of other Pool members. Members of
the Pool are captive insurance companies of unrelated domestic companies. Thus,
Taxpayer pays reinsurance premiums to the Pool, and assumes an equal amount of risk
from the Pool, receiving reinsurance premiums equal in amount to premiums it paid to
the Pool. Under the terms of the Contract, claims arising from policies written by
Taxpayer that were ceded to the Pool are submitted by Taxpayer to the Pool (and,
similarly, to other Pool members). The Pool reviews and approves these claims and
provides a statement of amounts due to Taxpayer. It then bills Taxpayer for its
participating percentage of the total claims submitted by all Pool members, which it has
approved for payment. Thus, Taxpayer either received net income or incurred net loss
depending on the amount of claims it submits to the Pool for payment each quarter in
relation to the amount of claims submitted by other members of the Pool.

The quarterly net income/loss received by Taxpayer as a result of its participation in the
Pool is reported on the Parent consolidated return. This income or loss resulted
primarily from the netting of accrued claims costs, either those ceded or assumed (plus
management fees and extraordinary expenses charged), since the premiums for the
risk assumed and ceded netted to zero each year. Computation of these claims costs is
based on Taxpayer’s participation percentage in the Pool, which has to be determined
actuarially at the “Pool level.”

LAW AND ANALYSIS

Section 4371 of the Code provides for an excise tax on each policy of insurance,
indemnity bond, annuity contract, or policy of reinsurance issued by any foreign insurer
or reinsurer. Section 4371(1) imposes an excise tax of 4 cents on each dollar, or
fractional part thereof, of the premium paid on a policy of casualty insurance or the
indemnity bond, if issued to or for, or in the name of, an insured as defined in section
4372(d). Section 4371(2) provides for an excise tax of 1 cent on each dollar, or
fractional part thereof, of the premium paid on the policy of life, sickness, or accident
insurance, or annuity contract. Section 4371(3) provides for an excise tax of 1 cent on
each dollar, or factional part thereof, of the premium paid on the policy of reinsurance
covering any of the contracts taxable under paragraph (1) or (2).

Section 4372(a) provides that the term “foreign insurer or reinsurer” means an insurer or
reinsurer who is a nonresident alien individual, or foreign partnership, or a foreign
corporation. For purposes of section 4371(3), the term “policy of reinsurance” means
any policy or other instrument by whatever name called whereby a contract of
reinsurance is made continued, or renewed against, or with respect to, any of the
hazards, risks, losses, or liabilities covered by contracts taxable under paragraph (1) or
(2) of section 4371. Section 4372(f). Section 4372(b) provides that the term “policy of
casualty insurance” means any policy (other than life) or other instrument by whatever
name called whereby a contract of insurance is made, continued, or renewed.
POSTF-112559-07 4

Whether an organization is an entity separate from its owners for federal tax purposes is
a matter of federal tax law and does not depend on whether the organization is
recognized as an entity under local law. Treas. Reg. §301.7701-1(a)(1). A joint venture
or other contractual arrangement may create a separate entity for federal tax purposes
if the participants carry on a trade, business, financial operation, or venture and divide
the profits therefrom. Treas. Reg. §301.7701-1(a)(2).

There is no specific factor or set of factors to determine whether parties have entered
into a partnership. In Culbertson, 337 U.S. 733, 742 (1948), the Supreme Court stated:

   [c]onsidering all the facts – the agreement, the conduct of the parties in execution
   of its provisions, their statements, the testimony of disinterested persons, the
   relationship of the parties, their respective abilities and capital contributions, the
   actual control of income and the purpose for which it is used, and any other facts
   throwing light on their true intent – the parties in good faith and acting with a
   business purpose intend to join together in the present conduct of the enterprise.

Despite the Culbertson finding that a partnership is not defined by reference to any
specific factors, the courts generally look at factors. Usually, the most important factor
is evidence that the participants in an arrangement intended to join together to make
and share profits as co-proprietors. Madison Gas & Electric Co. v. Commissioner, 72
T.C. 521 (1979), aff’d 633 F. 2d 512 (7th Cir. 1980).

The term “partnership” includes a joint venture. Subsequent to Culbertson, the Tax
Court identified a number of factors bearing on the issue of whether an arrangement
rises to the level of a joint venture. In Luna v. Commissioner, 42 T.C. 1067 (1964), the
Tax Court suggested eight factors, none of which is conclusive, that bear on the issue of
who is a partner in a partnership. These factors include (1) the agreement of the parties
and their conduct in executing its terms, (2) the parties’ contributions to the venture, (3)
the parties’ control over income and capital and their right to make withdrawals, (4)
whether each party was a principal and co-proprietor sharing a mutual proprietary
interest in the net profits and having an obligation to share losses (or whether one party
was the agent or employee of the other), (5) whether the business was conducted in the
joint names of the parties, (6)whether the parties filed federal partnership returns, (7)
whether separate books of account were maintained for the venture, and (8) whether
the parties exercised mutual control over and assumed mutual responsibility for the
enterprise.

Section 7701(a)(2) defines the term “corporation” to include insurance companies.
Insurance companies other than life are taxed under the provisions of § 831. Section
831(c) provides that for purposes of 831, the term “insurance company” has the
meaning given to such term by 816(a). Section 816(a) (formerly 801) and the
regulations under former section 801 are relied upon for purposes of defining insurance
companies other than life. Section 816(a) defines an insurance company as a company
POSTF-112559-07 5

for which more than half of the business during the taxable years is the issuing of
insurance or annuity contracts or the reinsuring of risk underwritten by insurance
companies.

Treas. Reg. §1.801-3(a)(1) provides that, while the name, charter powers, and
subjection to State insurance laws are significant in determining the business which a
company is authorized and intends to carry on, it is the character of the business
actually done in the taxable year which determines whether a company is taxable as an
insurance company under the provisions of the Subchapter L of the Code (sections 801-
846). Accordingly, by its terms, the definition of an insurance company in Treas. Reg.
§1.801-3(a)(1) requires an entity that is engaged in the insurance business to be treated
as an insurance company, regardless of the entity’s legal form.

Rev. Rul. 83-132, 1983-2 C.B. 270, states that a noncorporate business entity that is
primarily engaged in the business of issuing insurance contracts is an insurance
company as defined Treas. Reg. § 1.801-3(a)(1), and therefore is taxable as a
corporation under section 7702(a)(3). Rev. Rul. 83-132 considers the tax classification
of a noncorporate entity that is engaged in the business of issuing insurance contracts
through an insurance exchange. The insurance exchange was created by the state
under the state statute which permitted noncorporate insurers, including partnerships
and individuals, to operate on the insurance exchange. The insurers operating on the
exchange are subject to the basic accounting rules imposed on all insurers under state
law. Rev.Rul. 83-132 holds that the insurance exchange is a business entity primarily
engaged in the business of underwriting and issuing insurance contracts. Accordingly,
the noncorporate entity meets the definition of an insurance company under section
7701(a)(3). Thus, it is immaterial whether an organization is a partnership,
proprietorship, or any other noncorporate form under state law, if an entity is primarily
engaged in underwriting insurance risks.

A business entity (including an entity that is disregarded as separate from its owner
under §301.7701-2(c)) is domestic if it is created or organized as any type of entity
(including, but not limited to, a corporation, unincorporated associated, general
partnership, limited partnership, and limited liability company) in the United States, or
under the law of the United States or any State. Treas. Reg. §301.7701-5. A business
entity (including an entity that is disregarded as separate from its owner under sec.
301.7701-2(c)) is foreign if it is not domestic. Treas. Reg. §301.7701-5.

The Contract, which is governed by and interpreted in accordance with the laws of
Country X, provides for the conduct of an insurance Pool and the terms and limitations
of the insurance risks ceded and assumed by the Pool members. The Contract sets
forth the duties of the Pool members and Manager, including hiring an actuary to
analyze risks for all members and set premium rates, setting up the operation of
committees, and establishing procedures under which new members may be included
and old members removed from the Pool. The Pool spreads the risk of loss for claims
under $100,000 among members of the Pool and permits the members to share
POSTF-112559-07 6

management fees for the operation of the Pool. In addition, separate books of account
were maintained by the Pool. Finally, the members of the Pool exercised mutual control
over the operations and management of the Pool through the Participant’s committee.

Each member of the Pool enters into the Contract which sets out the terms and
limitations of the insurance risks ceded and assumed by the Pool members. The Pool
reinsures a portion of the insurance risk of each member and receives a reinsurance
premium. The reinsurance premium is determined by an actuarial firm appointed by the
Manager. Concurrently, the Pool member assumes an equal amount of risk from the
Pool, receiving reinsurance premiums equal in amount to premiums it paid to the Pool.
The Pool, through its Manager and Committees, assesses the risk it assumes and those
it reinsures with other member insurers processes, approves and pays claims, and
audits reserves.

The Pool operates separately from each member. Various committees oversee the
business operations of the Pool. No single Pool member can prevent the Pool from
acting on its determinations. The Participant’s Committee, with concurrence of the
Manager, has authority to determine all matters relating to the overall operation of the
Pool. Each Participant at the time of admission must meet minimum qualifications to
the satisfaction of the Participant’s Committee. The Participant’s Committee maintains
an Executive Committee, Underwriting Committee and Audit and Finance Committee.
A Pool member may be terminated by the Manager at the direction of the Participant’s
Committee.

The activities carried on by the Pool demonstrate that the pooling arrangement is more
than a contractual arrangement between individual members. Instead, the Pool is a
separate entity under Treas. Reg. §301.7701-1(a)(1). The Pool activities are indicative
of business activities characteristic of insurance companies. Thus, based on the
determination that the Pool is a separate entity under Treas. Reg. §301.7701-1(a)(1),
the Pool is an insurance company for purposes of Subchapter L of the Code. Insurance
companies are corporations for federal tax purposes. Section 7701(a)(3) and Treas.
Reg. §301.7701-2(b)(4). Therefore, the Pool is treated as a corporation for federal
income tax purposes. Because the Pool was not created or organized in the United
States or under the law of the United States or any state, it is a foreign corporation.
Section 7701(a)(5) and Treas. Reg. §301.7701-5. The Pool is thus an insurance
company that is a foreign corporation and consequently it is a foreign insurer or
reinsurer under Section 4372(a).

As described above, Taxpayer is a Country X insurance company that is treated as a
domestic corporation for purposes of the Code. Taxpayer’s gross receipts consist of
premiums from insurance policies written by Taxpayer to provide insurance coverage
for assets, workman’s compensation and commercial general liability insurance for
affiliated corporations. Taxpayer entered into the Contract with Pool that requires
Taxpayer to pay reinsurance premiums to the Pool in exchange for the Pool reinsuring a
portion of the insurance risk of Taxpayer from policies issued to affiliated corporations.
POSTF-112559-07 7

Based on the fact that the Pool provided Taxpayer with a policy of reinsurance covering
hazards, risks, losses or liabilities wholly or partly within the United States and the
determination that the Pool is a foreign insurance company, the excise tax of section
4371 applies to reinsurance premiums paid by Taxpayer to the Pool. This Chief
Counsel Advice does not address any exemptions under section 4373 to the excise tax
imposed by section 4371.

This writing may contain privileged information. Any unauthorized disclosure of this
writing may undermine our ability to protect the privileged information. If disclosure is
determined to be necessary, please contact this office for our views.

Please call (202) 622-3870 if you have any further questions.

                                    Steven Musher
                                    Associate Chief Counsel
                                    (International)



                               By: _____________________________
                                   Steven D. Jensen
                                   Senior Counsel, Branch 5
                                   (International)

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