CCA 1350008: IRS declines to rule on a captive insurer's reinsurance pool arrangement

Plain-English summary

Chief Counsel considered a foreign insurance company that elected to be taxed as a domestic corporation and participated in a reinsurance pool. The company requested rulings that it qualified as an insurance company under IRC § 831 and that premiums paid by its two insured affiliates were deductible under IRC § 162. The IRS declined to rule because the submission did not provide enough information to determine whether the pool shifted and distributed risk, whether the contracts covered insurance risks rather than investment or business risks, or whether the premiums reflected an arm's-length transaction. The memorandum also noted that a ruling, if issued, would have applied only for the specified year because the insurance-company test is annual and the contracts covered one-year risks.

Ruling snapshot

• Question: Did the captive company qualify as an insurance company, and were the premiums paid by its affiliates deductible insurance premiums?
• Outcome: Advice given. The IRS was unable to rule because the submitted information was insufficient.
• Key authorities: IRC §§ 162, 816, 831, and 953(d); Rev. Proc. 2012-1, §§ 7.07(2)(a), 10.06, and 15.10(1)(c)

Full text (IRS public release)

       Office of Chief Counsel
       Internal Revenue Service
       Memorandum
       Number: 201350008
       Release Date: 12/13/2013
       CC:FIP:B04:DRemus                            Third Party Communication: None
       PLR-132436-12                                Date of Communication: Not Applicable

UILC: 831.07-00, 162.00-00

date: June 13, 2013

 to:   Mary Coleman
       Examination Director, Central Area
       (Small Business/Self-Employed)

from: Donald J. Drees, Jr.
Senior Technician Reviewer, Branch 4
(Financial Institutions & Products)

subject: Notification of No-Rule Decision on Letter Ruling Request

       LEGEND


       Company                  =    ------------------------------------------------------------------------------
                                     ---------------------------------------------------
       Foreign Jurisdiction     =    ------------

       Date                     =    -----------------------------

       Address                  =    ----------------------------------------------------------------

       Insured Affiliate 1      =    ------------------------------------------------------------------------------
                                     ----------------------------------------
       Insured Affiliate 2      =    ------------------------------------------------------------------------------
                                     --------------------------------------------

       ISSUES

       Pursuant to section 7.07(2)(a) of Rev. Proc. 2012-1, 2012-1 I.R.B. 1, 30, this is to notify
       you that we were unable to rule on a letter ruling request submitted by Company
       regarding section 831 of the Internal Revenue Code (the “Code”).

PLR-132436-12 2

FACTS

Company was incorporated in Foreign Jurisdiction on Date and is licensed as an
insurance company by the insurance regulators of Foreign Jurisdiction. Company made
a permanent election under section 953(d) of the Code to be taxed as a domestic
corporation for federal tax purposes and it annually files a Form 1120-PC tax return.
Company’s U.S. address is Address.

Company directly issued purported insurance contracts with a one year coverage period
to Insured Affiliate 1 and Insured Affiliate 2 (collectively, the “Insured Affiliates”).
Company joined a reinsurance pool (the “Pool”) consisting of several other unrelated
purported insurance companies. Under the reinsurance agreements Company ceded to
the Pool a substantial portion of its direct written premiums and risks and assumed from
the Pool a roughly equal amount of premiums and risks. The agreements contained
language providing for experience refunds and experience loss carryforwards, which
were to be paid back with interest.

Company sought two rulings:

1. That Company would be treated as an insurance company under section 831 of
   the Code for federal tax purposes.

2. That the purported insurance premiums paid to Company by Insured Affiliates
   would be deductible as “insurance premiums” under section 162 of the Code for
   federal tax purposes.

LAW AND ANALYSIS

Section 831(a) of the Code provides that taxes, computed as provided in section 11, are
imposed for each taxable year on the taxable income of each insurance company other
than a life insurance company. Section 831(c) provides that, for purposes of section
831, the term “insurance company” has the meaning given to such term by section
816(a). Under section 816(a), the term “insurance company” means “any company
more than half of the business of which during the taxable year is the issuing of
insurance or annuity contracts or the reinsuring of risks underwritten by insurance
companies.”

Neither the Code nor the Income Tax Regulations define the terms “insurance” or
“insurance contract” in the context of property and casualty insurance. The Supreme
Court of the United States has explained that in order for an arrangement to constitute
insurance for federal tax purposes, both risk shifting and risk distribution must be
present. Helvering v. Le Gierse, 312 U.S. 531 (1941). The risk transferred must be risk
of economic loss. Allied Fidelity Corp. v. Commissioner, 572 F.2d 1190, 1193 (7th Cir.
1978). The risk must contemplate the fortuitous occurrence of a stated contingency,
PLR-132436-12 3

Commissioner v. Treganowan, 183 F.2d 288, 290-291 (2d Cir. 1950), and must not be
merely an investment or business risk. Rev. Rul. 2007-47, 2007-2 C.B. 127. In
addition, the arrangement must constitute insurance in the commonly accepted sense.
See, e.g., Ocean Drilling & Exploration Co. v. United States, 988 F.2d 1135, 1153 (Fed.
Cir. 1993); AMERCO, Inc. v. Commissioner, 979 F.2d 162 (9th Cir. 1992).

Our review of the materials that Company submitted in connection with its letter ruling
request led us to identify three areas of concern:

  1. Whether the pooling arrangement actually provided risk shifting and risk
     distribution. In particular, we were concerned that the reinsurance agreements
     between Company and the Pool contained provisions whose net effect might be
     to negate risk shifting and risk distribution.

  2. Whether some or all of the purported insurance contracts were insurance for
     federal tax purposes, as opposed to, for example, contracts covering investment
     or business risks.

  3. Whether the premiums paid by Insured Affiliates to Company reflected an arms-
     length transaction between the parties.

The Company did not provide sufficient information for us to address these concerns.
Accordingly, we are unable to rule pursuant to sections 10.06 and 15.10(1)(c) of Rev.
Proc. 2012-1.

Had we been able to rule, the letter ruling would have been controlling for only the year
specified in the letter ruling because section 831(c) imposes an annual test and the
specific contracts involved covered risks for only a one year period.

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) 622-3970 if you have any further questions.

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