IRS Rules that Federal Excise Tax Does Not Generally Apply to Wholly Foreign Reinsurance and Retrocession Agreements

SUMMARY

cior Ruling”), which described certain situations in which the excise tax would apply to foreign to foreign reinsurance and retrocession agreements.2 The Service reconsidered the position taken in the Prior Ruling in light of the recent decision of the United States Court of Appeals for the District of Columbia Circuit (the “D.C. Circuit”) in Validus Reinsurance, Ltd. v. United States. 3

DISCUSSION

Section 4371 of the Code imposes an excise tax on “each policy of insurance . . . or policy of reinsurance issued by any foreign insurer or reinsurer.”4 Pursuant to Treasury Regulations under Section 4371, the excise tax generally applies to policies issued with respect to U.S. risks, including to U.S. persons and foreign persons engaged in a trade or business in the United States, and that insure against hazards, risks, or liabilities within the United States.5 Generally, the person paying the premium to the foreign insurer or reinsurer bears the responsibility for paying the tax; if the tax is not paid by such person, however, then the issuer of the insurance or reinsurance policy may also be liable for payment.6 The Prior Ruling held that the excise tax generally applies to premiums paid on reinsurance and retrocession agreements from one foreign insurer or reinsurer to a foreign reinsurer, except in cases where treatybased exemptions would apply. Under the Prior Ruling, the excise tax could apply to successive retrocession agreements between foreign reinsurers with respect to the same risk – a so-called “cascading” tax.

In Validus, the Service assessed the excise tax on retrocession contracts between Validus Reinsurance, Ltd., a Bermuda reinsurer, and other foreign reinsurers.7 Validus paid the tax and sued for a refund.8 The D.C. Circuit upheld the decision of the District Court for the District of Columbia, holding that Section 4371 of the Code does not apply to retrocession contracts between foreign reinsurers.9 The decision was based on an ambiguity in the statute, which was not clear whether it applies to retrocession contracts, and the presumption against extraterritoriality – the notion that, absent a clear indication to the contrary, legislation applies only within the United States.10

Now, seven months after the D.C. Circuit decision in Validus, the Service has released the Ruling revoking the Prior Ruling and announcing that the Service generally will no longer seek to impose the excise tax on reinsurance or retrocession agreements between two foreign insurers or reinsurers. The Ruling does provide, however, that the Service will continue to impose the excise tax in other situations that are not considered wholly foreign for U.S. tax purposes, such as reinsurance issued by one foreign reinsurer to another that has elected to be treated as a U.S. reinsurer, or in situations where the ceding company is exempt from the excise tax on underlying premiums because the premiums are effectively connected to its U.S. trade or business. The Ruling also provides that the Service will continue to enforce those provisions of certain treaties that deny an exemption from the excise tax that would otherwise be available under the treaty in cases where the foreign reinsurer further reinsures the risk to other reinsurers not entitled to similar treaty benefits.

Interestingly, the Ruling is broader than the decision in Validus in that Validus only dealt with retrocession agreements between foreign reinsurers, while the Ruling exempts both reinsurance and retrocession agreements between foreign insurers and reinsurers.

IMPLICATIONS

Foreign insurers or reinsurers that have paid the excise tax on reinsurance or retrocession agreements issued to or by foreign insurers or reinsurers should consider applying for a refund, if they have not already done so.