Foreign insurer could use local statement reserves under section 954

Plain-English summary

A U.S.-owned controlled foreign corporation sold life insurance, annuity, and certain accident and health products under its home country's insurance rules. It asked to use specified reserves and related asset bases from its foreign regulatory statements when calculating foreign personal holding company income. The IRS found that the company was a qualifying insurance company, its contracts were exempt contracts, and the local regulator's reserving factors appropriately measured income under section 954(i)(4)(B)(ii). The IRS approved the use of foreign statement reserves for life insurance and annuity contracts, noncancellable and guaranteed renewable accident and health contracts, and separate account contracts. The ruling remained subject to revocation if material facts, business circumstances affecting the reserving method, or applicable law changed.

Ruling snapshot

• Question: Could the foreign insurance company use specified home-country statement reserves and related asset bases to compute foreign personal holding company income?
• Outcome: Approved.
• Key authorities: IRC §§ 816, 817, 953, 954, 957, and 989.

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201644010 Third Party Communication: None
Release Date: 10/28/2016 Date of Communication: Not Applicable
Index Number: 954.02-00
Person To Contact:
------------------ -----------------------
--------------------------------------------------------- Telephone Number:
--------------- --------------------
----------------------- Refer Reply To:
---------------------------- CC:INTL:B05
PLR-106587-15
Date:
August 01, 2016

Legend

A = -----------------------
CFC = -------------------------------------------------------------------------------------
Country A = ---------
Parent = ---------------
US Sub = ----------------------------------------------
Corp A = -------------------------------------------------------
Corp B = --------------------------------------------------------
Corp C = ---------------------------------------------
Branch 1 = ------------------
Branch 2 = ----------------------
Regulator = ----------------------------------------
Regulation = ---------------------------
Day X = ------------------

Dear ---------------:

In a letter dated A, you requested a ruling allowing CFC to use certain foreign statement
insurance reserves in computing foreign personal holding company income under
section 954 on the grounds that these insurance reserves are an appropriate means of
measuring income within the meaning of section 954(i)(4)(B)(ii). Specifically, you
requested permission to use (1) the underwriting reserves, loss reserves, policyholders’
dividend reserves, and premiums paid in advance reserves for life insurance and
annuity contracts reported by CFC on its Country A Annual Report; (2) the underwriting
reserves, loss reserves, and premiums paid in advance reserves attributable to its
PLR-106587-15 2

noncancellable and guaranteed renewable accident and health (“A&H”) contracts
reported by CFC on its Country A Annual Report; and (3) the underwriting reserves,
loss reserves, and associated asset bases attributable to CFC’s separate account-type
contracts, as reported on the Country A Annual Report.

The rulings given in this letter are based on facts and representations submitted by
Parent and accompanied by a statement executed under penalty of perjury by an
appropriate party. This office has not verified any of the materials submitted in support
of the request for rulings. Verification of the information, representations, and other data
may be required as part of the audit process.

                                       Facts

Parent is a publicly-traded domestic corporation that is engaged, through its
subsidiaries, in various lines of business, which primarily include life insurance, A&H
insurance, credit insurance, annuities, endowment and retirement and savings products.
Parent directly and indirectly owns all the stock of US Sub. US Sub owns all of the
stock of Corp A. Corp A owns all of the stock of Corp B. Corp B owns all of the stock of
Corp C. Corp C owns all of the stock of CFC. Parent represents that CFC is a
controlled foreign corporations as defined in section 957. CFC currently has two
branches, Branch 1 and Branch 2 (collectively, “Branches”).

CFC is engaged in the life insurance business in Country A and its principal products
are traditional life (both term insurance and permanent insurance), variable whole life
that employ separate account funds, variable universal whole life, variable universal life
savings products with guaranteed death benefits, variable annuities with guaranteed
death and living benefits, fixed annuities, interest sensitive life and annuity products,
A&H insurance, and retirement insurance for both companies and individuals.

Country A regulates any insurance business conducted in Country A through its
insurance laws and regulations. Regulator developed and is responsible for enforcing
insurance laws and regulations in Country A. An insurance company must obtain a
license from the Regulator to conduct an insurance business in Country A.

CFC is licensed by the Regulator to sell life insurance and annuity contracts to persons
in Country A and is subject to regulation by Regulator as a life insurance company.
CFC does not carry on business other than life insurance and certain activities that are
incidental to the life insurance business. CFC derives greater than 50 percent of its
aggregate net written premiums from the issuance of life insurance and annuity
contracts covering applicable home country risks. No policyholder, insured, annuitant,
or beneficiary to a life insurance or annuity contract that the CFC issues is a related
person as defined in section 954(d)(3). Parent has represented that CFC would be
subject to tax under Subchapter L if it were a domestic corporation.
PLR-106587-15 3

Branches are each separate and clearly identified units of the insurance business of
CFC that maintain separate books and records. Branches are authorized or licensed by
the applicable insurance regulatory body for their home country to sell insurance to
persons other than related persons (with the meaning of section 954(d)(3)) in such
home country. While each Branch is authorized or licensed by the country in which it is
located, each Branch’s financial position is overseen by Regulator.

CFC issues health and personal accident insurance contracts that are noncancellable or
guaranteed renewable, cancellable, or riders to a life insurance contract. CFC’s
noncancellable and guaranteed renewable A&H policies create a contingent long-term
obligation with an age termination date of age 60 or older, comparable to the obligation
created under a whole-life insurance policy. For Country A tax and insurance regulatory
purposes, CFC (1) treats its noncancellable and guaranteed renewable A&H policies as
life insurance policies; (2) treats its underwriting reserves and loss reserves attributable
to noncancellable and guaranteed renewable A&H policies as life insurance reserves;
and (3) computes the underwriting reserves and loss reserves on such noncancellable
and guaranteed renewable A&H insurance policies using a methodology similar to that
of life insurance policy reserves.

CFC also issues separate account-type variable life insurance and annuity contracts,
which are separately identified and maintained, and are supported by separately
identifiable pools of assets. The assets in the pools are marked to market for local
regulatory reporting purposes and the associated reserve follows movements in the
value of the assets (with very limited exceptions, such as surrender charges). For
Country A tax and insurance regulatory purposes, CFC is required to make asset basis
and reserve-related adjustments to its separate accounts (including premiums received
but not yet allocated to the separate accounts).

As required by Country A’s insurance laws and regulations, CFC files an Annual Report
and financial statements with the Regulator. The Annual Report is audited by an
external accounting firm in addition to the company’s internal auditor. The accounting
records of CFC that form the basis for preparing the Annual Report are subject to
inspection by the Regulator at any time. The Annual Report is made available to the
public. In additional to their use for regulatory purposes, the Annual Report is used for
financial purposes, such as Country A credit rating, by lenders, and the public. Day X is
the official year-end for life insurance companies operating in Country A.

To comply with Country A’s insurance laws, CFC must establish and maintain reserves
for its obligations to holders of its life insurance and annuity contracts and must report
the amount of such reserves on the Country A Annual Report. The reserves at issue in
the ruling request are limited to the underwriting reserves, loss reserves, policyholders’
dividend reserves, and premiums paid in advance reserves that CFC maintains on its
Country A Annual Report for life insurance or annuity contracts.
PLR-106587-15 4

CFC has appointed a qualified actuary that satisfies the requirements put forth by
Regulator to handle the actuarial matters of the insurance undertaking, including the
method of calculating reserves. The actuary has knowledge and experience concerning
actuarial matters for a company in Country A engaged in the insurance business.

The reserve system for Country A includes the following requirements as to
assumptions and method for underwriting reserves, loss reserves, policyholders’
dividend reserves and premiums paid in advance reserves with respect to life insurance
and annuity contracts issued by CFC. Underwriting reserves do not follow a prescribed
methodology and assumptions, but instead follow the general guidelines of Regulation.
Currently, CFC generally holds life insurance reserves determined using the net level
premium method or the Zillmer method. For account value-based products, the account
value is held. CFC also holds loss reserves for outstanding claims (including claims
that have been incurred but not reported) under contracts issued by CFC and calculates
the reserves using the company’s individual loss experience, in accordance with the
rules and regulations prescribed by Regulator. The policyholders’ dividend reserves are
reserves for dividends that have been declared and that have been paid or credited,
and that have not been withdrawn by policyholders. The premiums paid in advance
reserves include any premium that had been paid but whose due date falls in the
following year.

Parent represents that: (1) CFC is not engaged in any insurance business outside of
Country A, except through Branches, and does not carry on non-life insurance
business; (2) with regards to A&H policies, the ruling request only applies to
“noncancellable life, health, or accident insurance policies” within the meaning of Treas.
Reg. § 1.801-3(c) or “guaranteed renewable life, health, and accident insurance
policies” within the meaning of Treas. Reg. § 1.801-3(d); and (3) each contract covered
by the rulings requested is a life insurance contract or annuity contract for federal
income tax purposes, without regard to sections 72(s), 101(f), 817(h) and 7702.

The reserves covered by this ruling do not include: (1) deficiency reserves; (2)
contingency reserves; (3) equalization reserves; (4) excess interest reserves for excess
interest credited beyond the end of the taxable year; (5) reserves for administrative
expenses (including guarantees intended to cover future expenses associated with the
payment of claims such as bank fees or inflation risk); (6) reserves for any amount to
protect against a future decline in the value of investment assets; or (7) any reserves for
accrued liabilities.

                                       Law

In general, a United States shareholder of a controlled foreign corporation (“CFC”) must
include in gross income its pro rata share of the CFC’s Subpart F income for each year.
Subpart F income includes, among other types of income, insurance income under
section 953 and foreign base company income under section 954.
PLR-106587-15 5

Section 953(a)(1) defines the term “insurance income” to include any income which is
attributable to issuing or reinsuring of an insurance or annuity contract, and which would
be taxed under Subchapter L if such income were the income of a domestic insurance
company. Section 953(a)(2) provides that section 953 insurance income does not
include “exempt insurance income” derived by a “qualifying insurance company.”
Section 953(b)(3) provides that reserves for any insurance or annuity contract shall be
determined in the same manner as under section 954(i).

Section 953(e)(1) defines exempt insurance income as income derived by a qualifying
insurance company which is attributable to the issuing (or reinsuring) of an exempt
contract by such company and such income is treated as earned by such company in its
home country for purposes of such country’s tax laws. Exempt contracts are defined
under section 953(e)(2) to include insurance or annuity contracts issued by a qualifying
insurance company in connection with the lives or health of residents of a country other
than the U.S. but only if such company derives more than 30 percent of its net written
premiums from otherwise exempt contracts which cover applicable home country risks
and with respect to which no policyholder, insured, annuitant or beneficiary is a related
person within the meaning of section 954(d)(3).

In general, section 953(e)(3) defines a “qualifying insurance company” as any CFC that:
(A) is subject to regulation as an insurance company by its home country, and is
licensed, authorized, or regulated by the applicable insurance regulatory body for its
home country to sell insurance or annuity contracts to persons other than related
persons (within the meaning of section 954(d)(3)) in such home country; (B) derives
more than 50 percent of its aggregate net written premiums from the issuance by such
controlled foreign corporation of contracts covering applicable home country risks of
such corporation and with respect to which no policyholder, insured, annuitant, or
beneficiary is a related person (as defined in section 954(d)(3)); and (C) is engaged in
the insurance business and would be subject to tax under Subchapter L if it were a
domestic corporation.

Section 954(a)(1) defines the term “foreign base company income” to include, among
other types of income, foreign personal holding company income. Section 954(c)(1)
sets forth the types of income that are considered to be foreign personal holding
company income. Section 954(i)(1) provides that for purposes of section 954(c)(1),
foreign personal holding company income does not include “qualified insurance income”
of a “qualifying insurance company”.

Section 954(i)(2) defines the term “qualified insurance income” to mean income of a
qualifying insurance company falling into two categories. First, income received from
unrelated persons and derived from investments made by a qualifying insurance
company or qualifying insurance company branch (collectively referred to as a “QIC”)
either of its reserves allocable to exempt contracts or of 80 percent of its unearned
premiums from exempt contracts (as both are determined in accordance with section
954(i)(4)). Second, income received from unrelated persons and derived from
PLR-106587-15 6

investments made by a QIC of an amount of its assets allocable to exempt contracts
equal to: (1) in the case of property, casualty, or health insurance contracts, one-third of
the premiums earned on those contracts during such year; and (2) in the case of life
insurance or annuity contracts, 10 percent of the reserves described in section
954(i)(2)(A) for such contracts.

Section 816(a) defines the term “life insurance company” as an insurance company that
is engaged in the business of issuing life insurance and annuity contracts (either
separately or combined with accident and health insurance), or noncancellable
contracts of health and accident insurance, if (1) its life insurance reserves plus (2)
unearned premiums, and unpaid losses (whether or not ascertained), on noncancellable
life, accident, or health policies not included in life insurance reserves, comprise more
than 50 percent of its total reserves. For purposes of the preceding sentence,
“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.

Section 816(b)(1) defines the term “life insurance reserve” as amounts (A) computed or
estimated on the basis of recognized mortality or morbidity tables and assumed rates of
interest, and (B) that are set aside to mature or liquidate, either by payment or
reinsurance, future unaccrued claims arising from life insurance, annuity, and
noncancellable accident and health insurance contracts (including life insurance or
annuity contracts combined with noncancellable accident and health insurance)
involving, at the time with respect to which the reserve is computed, life, accident, or
health contingencies.

Section 817 generally provides special rules for certain variable contracts for purposes
of Part I of Subchapter L of the Code. Section 817(d) defines a variable contract as any
contract that (1) provides for the allocation of all or part of the amounts received under
the contract to an account which, pursuant to state law, is segregated from the general
asset accounts of the company, and (2) provides for the payment of annuities, is a life
insurance contract, or provides funding for insurance on retired lives.

If a contract satisfies the variable contract requirements, and the separate account that
funds the variable contract is treated as a segregated asset account, section 817
requires that certain adjustments be made to the insurance company’s asset basis and
insurance tax reserves with respect to the segregated asset account. Section 817(a)
provides that, with respect to any variable contract, reserves are adjusted (1) by
subtracting an amount equal to the sum of the amounts added from time to time (for the
taxable year) to the reserves separately accounted for by reason of appreciation in
value of assets (whether or not the assets have been disposed of) and (2) by adding
thereto an amount equal to the sum of the amounts subtracted from time to time
(for the taxable year) from such reserves by reason of depreciation in value of assets.
PLR-106587-15 7

Under section 817(b), the basis of each asset in a segregated asset account is
increased or decreased by the amount of appreciation or depreciation, respectively, to
the extent the reserves or other items referred to in section 817(a) are adjusted. The
asset basis and insurance tax reserve adjustments offset any realized gain/loss
attributable to such marked assets at the insurance company level.

Section 954(i)(3) imposes separate contract treatment for “separate account-type
contracts,” a term which includes contracts not meeting the requirements of section 817.
Section 954(i)(3)(A) provides that, for purposes of applying section 954(i) and with
respect to any separate account-type contract (including any variable contract not
meeting the requirements of section 817), income credited under such contract is
allocable only to such contract. Income not allocable to a separate account-type
contract is allocated ratably among contracts.

Section 954(i)(4)(B)(i) generally provides that in the case of life insurance and annuity
contracts, a QIC’s reserves allocable to exempt contracts are equal to the greater of (1)
the net surrender value of the contract or (2) the reserve determined under section
954(i)(5). Section 954(i)(4)(B)(ii), however, provides:

  The amount of the reserves under section 954(i)(4)(B)(i) shall be the
  foreign statement reserve for the contract (less any catastrophe,
  deficiency, equalization, or similar reserves), if, pursuant to a ruling
  request submitted by the taxpayer or as provided in published guidance,
  the Secretary determines that the factors taken into account in
  determining the foreign statement reserve provide an appropriate means
  of measuring income.

Section 954(i)(4)(B)(ii) was originally enacted by section 614 of the Job Creation and
Worker Assistance Act of 2002. Under the Protecting Americans from Tax Hikes
(PATH) Act of 2015 (P.L. 114-113, 12/18/2015), section 954(i) was permanently
extended and made effective for taxable years of foreign corporations beginning after
December 31, 2014, and for taxable years of U.S. shareholders with or within which
such taxable years of such foreign corporations end. In its Technical Explanation to the
PATH Act, the staff of the Joint Committee on Taxation explains section 954(i)(4)(B)(ii)
as follows:

  The provision does, however, permit a taxpayer in certain circumstances, subject
  to approval by the IRS through the ruling process or in published guidance, to
  establish that the reserve for such contracts is the amount taken into account in
  determining the foreign statement reserve for the contract (reduced by
  catastrophe, equalization, or deficiency reserve or any similar reserve). IRS
  approval is to be based on whether the method, the interest rate, the mortality
  and morbidity assumptions, and any other factors taken into account in
  determining foreign statement reserves (taken together or separately) provide an
  appropriate means of measuring income for Federal income tax purposes.

PLR-106587-15 8

Joint Comm. on Taxation, Technical Explanation of the Revenue Provisions of the
Protecting Americans from Tax Hikes Act of 2015, House Amendment #2 to the Senate
Amendment to H.R. 2029 (Rules Committee Print 114-40) (JCX-144-15 (December 17,
2015)).

                                    Analysis

CFC is subject to regulation as a life insurance company by Country A. CFC is licensed,
authorized, and regulated by the Regulator, which is the insurance regulatory body for
Country A, to sell life insurance and annuity contracts to persons other than related
persons within the meaning of section 954(d)(3)) in Country A. Parent has represented
that CFC derives more than 50 percent of its aggregate net written premiums from the
issuance by CFC and Branches of life insurance and annuity contracts covering
applicable home country risks and with respect to which no policyholder, insured,
annuitant, or beneficiary is a related person (as defined in section 954(d)(3)). Parent
has also represented that CFC is engaged in the life insurance business and would be
subject to tax under Subchapter L if they were domestic corporations. Branches are
qualified business units (within the meaning of section 989(a)) of CFC. Each Branch is
authorized or licensed by the applicable insurance regulatory body for its home country
to sell insurance to persons other than related persons (within the meaning of section
954(d)(3)) in such home country. Premiums received by Branches are treated as
earned by each Branch in its home country for purposes of such country’s tax laws.
Accordingly, CFC is a QIC under section 953(e)(3) and the Branches are qualifying
insurance company branches under section 953(e)(4).

CFC issues life insurance and annuity contracts in connection with the lives and health
of residents of Country A, a country other than the United States. The Branches issue
life insurance and annuity contracts in connection with the lives and health of resident of
their respective home country. CFC derives more than 30 percent of its net written
premiums from contracts that cover Country A risks with respect to which no
policyholder, insured, annuitant, or beneficiary is a related person within the meaning of
section 954(d)(3). Each Branch also derives more than 30 percent of its net written
premiums from contracts that cover home country risks with respect to which no
policyholder, insured, annuitant, or beneficiary is a related person within the meaning of
section 954(d)(3). Life insurance and annuity contracts issued by CFC (including
Branches) are therefore exempt contracts within the meaning of section 953(e)(2).

CFC must establish, maintain, and calculate its underwriting reserves, loss reserves,
policyholders’ dividend reserves, and premiums paid in advance reserves in accordance
with the insurance laws and regulations prescribed by the Regulator. The Regulator
generally requires a life insurance company to determine the amount of its underwriting
reserves, loss reserves, policyholders’ dividend reserves, and premiums paid in
advance reserves based on guidance provided by the Regulator. CFC must set forth its
underwriting reserves, loss reserves, policyholders’ dividend reserves, and premiums
PLR-106587-15 9

paid in advance reserves on the Country A Annual Report, which must be filed annually
with the Regulator. These reserves are the measure of the legal obligations to
policyholders on the financial statement used for regulatory purposes by life insurance
companies doing business in Country A (whether U.S.-owned, locally owned, or owned
by companies headquartered in other foreign countries). The Regulator requires CFC
to hold its underwriting reserves, loss reserves, policyholders’ dividend reserves, and
premiums paid in advance reserves for the fulfillment of claims owed to policyholders
and beneficiaries. The reserves are not catastrophe, deficiency, equalization, or similar
reserves. Under the rules prescribed by the Regulator for determining reserves
required to be calculated for purposes of the Country A Annual Report, the method,
interest rate, the mortality and morbidity assumptions and other factors taken into
account provide an appropriate means of measuring income within the meaning of
section 954(i)(4)(B)(ii).

CFC issues noncancellable and guaranteed renewable A&H contracts and riders to life
insurance contracts as part of its life insurance business. For Country A tax and
insurance regulatory purposes, CFC computes the underwriting reserves, loss reserves,
and premiums paid in advance reserves on these policies using a methodology similar
to that used to compute life insurance reserves. The treatment of noncancellable and
guaranteed renewable A&H contracts as life insurance contracts, the reserves for which
are computed as life insurance reserves, is consistent with the treatment of such
reserves for standard actuarial, local regulatory, local tax, and U.S. GAAP purposes.
Under the rules prescribed by the Regulator for determining reserves required to be
calculated for purposes of the Country A Annual Report, the method, interest rate, the
mortality and morbidity assumptions and other factors taken into account provide an
appropriate means of measuring income within the meaning of section 954(i)(4)(B)(ii).
For Country A insurance regulatory purposes, CFC is required (1) to mark to market its
portfolio investment assets held pursuant to its separate account-type contracts, (2) to
adjust the bases of its marked portfolio investment assets to fair market value, and (3)
to adjust its underwriting reserves and loss reserves in order to offset any realized gain
or loss attributable to the marked assets. The asset basis and reserve-related
adjustments prevent CFC from reporting distortions in the amount and timing of its
income on its Country A Annual Report to the Regulator. This method clearly reflects
income as does the rules provided by section 817 for domestic insurance companies
taxed under subchapter L. Under the rules prescribed by the Regulator for determining
reserves required to be calculated for purposes of the Country A Annual Report, the
method, interest rate, the mortality and morbidity assumptions and other factors taken
into account provide an appropriate means of measuring income within the meaning of
section 954(i)(4)(B)(ii).

                                     Ruling

Based on the information submitted and the representations made, we rule as follows:
PLR-106587-15 10

(1) Under the facts set forth above, the foreign statement underwriting reserves, loss
reserves, policyholders’ dividend reserves, and premiums paid in advance reserves
maintained by CFC with respect to its exempt life insurance or annuity contracts are an
appropriate means of measuring income within the meaning of section 954(i)(4)(B)(ii)
and may be used in determining the foreign personal holding company income of CFC
under section 954(i).

(2) Under the facts set forth above, the foreign statement underwriting reserves, loss
reserves, and premiums paid in advance reserves maintained by CFC for its
noncancellable and guaranteed renewable accident and health contracts are an
appropriate means of measuring income within the meaning of section 954(i)(4)(B)(ii)
and may be used in determining the foreign personal holding company income of CFC
under section 954(i).

(3) Under the facts set forth above, the foreign statement underwriting reserves, loss
reserves, and associated asset bases attributable to CFC’s separate account contracts
are an appropriate means of measuring income within the meaning of section
954(i)(4)(B)(ii) and may be used in determining the foreign personal holding company
income of CFC under section 954(i).

                                      Caveats

We express no opinion on any provisions of the Code or regulations not specifically
covered by the above ruling. This ruling will be subject to revocation if any of the
following circumstances occurs: (1) a change in the material facts on which this ruling
was based; (2) a material change in the business circumstances of CFC which would
impact its reserving method; or (3) a change in the applicable law or foreign rules
relating to the current reserving method of CFC.

                              Procedural Statements

This ruling is directed only to CFC. Section 6110(k)(3) provides that it may not be used
or cited as precedent.

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax consequences of any aspect of any transaction or item discussed or referenced in
this letter.

In accordance with the power of attorney on file with this office, a copy of this letter is
being sent to your authorized representative.
PLR-106587-15 11

A copy of this letter must be attached to any income tax return to which it is relevant.
Alternatively, taxpayers filing their returns electronically may satisfy this requirement by
attaching a statement to their return that provides the date and control number of the
letter ruling.

                               Sincerely,


                               Mark E. Erwin
                               Branch Chief, Branch 5
                               Office of Associate Chief Counsel (International)

cc: