On Thursday, July 30, Congressman Richard E. Neal, Chairman of the Subcommittee on Select Revenue Measures, re-introduced a bill in the U.S. House of Representatives that would disallow any deduction to Covered Insurance Companies for Affiliated Nontaxed Reinsurance Premiums paid to affiliated insurance companies that are not subject, directly or indirectly under the Subpart F rules, to U.S. income taxation (2009 Neal Bill). The 2009 Neal Bill has a proposed effective date for taxable years beginning after December 31, 2009.
The 2009 Neal Bill is similar to H.R. 6969, which was introduced by Representative Neal on September 18, 2008 (2008 Neal Bill). Furthermore, on December 11, 2008, Senator Max Baucus, Chairman of the Senate Finance Committee, released for public comment a Senate Finance Committee Staff Discussion Draft identical to the 2008 Neal Bill. Comments were due by February 28, 2009.
As discussed above, the 2009 Neal Bill, as with the 2008 Neal Bill, would disallow deductions for re-insurance premiums paid to affiliates. Although the 2009 Neal Bill is substantially similar to the 2008 Neal Bill, there are some differences. The 2009 Neal Bill excludes from its application premiums that are Subpart F income in the hands of the reinsurer (in addition to premiums subject to regular U.S. federal income tax). The 2009 Neal Bill also modifies the § 832(b)(9)(E) election so that the premiums (and certain investment income attributable to those premiums) subject to the election are deemed to be income effectively connected with a U.S. trade or business. An electing company must agree to waive any applicable treaty benefits. This new provision contrasts with the treatment under the election in the 2008 Neal Bill, which would have treated an electing company as a U.S. corporation. Although for many companies this may not impact their U.S. tax liability, for those companies with foreign source income it is less far-reaching. It would appear that the election may be made separately for each taxable year.
Covered Insurance Company
A Covered Insurance Company is any company subject to the tax imposed by § 831. Thus, for example, a property and casualty insurance company subject to tax in the United States is considered a Covered Insurance Company under the provision. The fact that a company subject to tax under § 831 has no tax liability for the taxable year (for example, due to losses) does not cause the company not to be considered as subject to tax under § 831.
All domestic members of a controlled group of corporations (as defined in § 1563) of which a Covered Insurance Company is a member are treated as one corporation. The excise tax under § 4371 is disregarded for purposes of determining whether a company is a Covered Insurance Company. Thus, for example, a foreign insurer or reinsurer that issues policies, premiums on which are subject to the excise tax under § 4371, and that is not subject to tax under § 831, is not considered a Covered Insurance Company for purposes of this provision.
Affiliated Nontaxed Reinsurance Premiums
An Affiliated Nontaxed Reinsurance Premium is any reinsurance premium paid, directly or indirectly, to an affiliated corporation (other than a controlled foreign corporation as defined under § 957) if, with respect to such affiliated corporation, such premium is neither Subpart F income (as defined under § 952) nor subject to U.S. federal income tax. (The inclusion of a Subpart F income limitation is a change from the 2008 Neal Bill.) Further, for these purposes, a corporation is treated as affiliated with a Covered Insurance Company if both corporations are members of the same controlled group of corporations, as defined in § 1563(a) except that (1) “more than 25 percent” is substituted for “at least 80 percent” each place it appears in § 1563(a)(1), and (2) the determination is made without regard to subsections (a)(4), (b)(2)(C), (b)(2)(D), and (e)(3)(C) of § 1563.
Under a netting rule, the amount that would otherwise be treated as Affiliated Nontaxed Reinsurance Premiums with respect to a Covered Insurance Company is reduced (but not below zero) by the amount of reinsurance premiums paid directly or indirectly to that company by that affiliated corporation during the taxable year. If any treaty between the United States and a foreign country reduces the U.S. income tax imposed on premiums, then to that extent the premium is treated as a premium on which no U.S. income tax is imposed (as under § 163(j)(5)(B)). For purposes of determining whether the premium is subject to U.S. income tax, the excise tax imposed by § 4371 is not taken into account.
Under the 2009 Neal Bill, the amount of the disallowed deduction for premiums paid by the Covered Insurance Company (the Premium Limitation) is determined by comparing a Covered Insurance Company’s reinsurance with a hypothetical average amount of reinsurance obtained by all reinsurers, based on an Industry Fraction of reinsurance. Specifically, the Premium Limitation means, with respect to any Covered Insurance Company for any taxable year, the excess of (1) the product of the gross premiums written by such Covered Insurance Company on insurance contracts during the taxable year multiplied by the Industry Fraction for such taxable year, over (2) the aggregate reinsurance premiums paid by such Covered Insurance Company during the taxable year that are not Affiliated Nontaxed Reinsurance Premiums. This Premium Limitation cannot be less than zero.
The Industry Fraction is used to determine the allowable amount of affiliate reinsurance. The numerator of the Industry Fraction is the industry aggregate reinsurance premiums paid by Covered Insurance Companies to nonaffiliated corporations. The denominator of the Industry Fraction is the aggregate gross premiums written by Covered Insurance Companies. The Industry Fraction for each calendar year is determined, and is to be published, by the Treasury Department on the basis of published aggregate data from annual statements of insurance companies. The determination of the Industry Fraction is made separately for each line of business. Data for the second preceding calendar year are used in determining the Industry Fraction so as to allow time for the publication of aggregate industry data.
In determining the Premium Limitation for a line of its business for a taxable year, a company applies the Industry Fraction published by the Treasury Department for that line of business for the calendar year in which the company’s taxable year begins. Under this rule, the Industry Fraction is multiplied by the company’s gross premiums written for the line of business for the taxable year. Application of the Premium Limitation does not result in the disallowance of any deduction for reinsurance premiums paid to persons that are not affiliated corporations (as defined under the provision). However, the provision operates by determining the deduction amount disallowed after taking into account premiums paid to corporations that are not affiliated. Thus, the provision disallows the deduction for reinsurance premiums paid to an affiliated corporation if the company’s reinsurance premiums paid to corporations that are not affiliated exceed the amount of the company’s premium limitation for that line of business.
Qualified Ceding Commissions
The amount of Qualified Ceding Commissions is added to the Premium Limitation under the deduction disallowance rule of the provision. A Qualified Ceding Commission is determined as a portion of the ceding commissions that are paid to a Covered Insurance Company (and that are included in its income) with respect to the Affiliated Nontaxed Reinsurance Premiums paid by the Covered Insurance Company during the taxable year. This portion is determined by the ratio of (1) the amount of such Affiliated Nontaxed Reinsurance Premiums paid by the company during the taxable year that exceeds the Premium Limitation for that year, to (2) the aggregate amount of Affiliated Nontaxed Reinsurance Premiums paid by the company that year. Thus, under this rule, the Premium Limitation is increased by the amount of certain ceding commissions that are paid to the Covered Insurance Company with respect to otherwise nondeductible Affiliated Nontaxed Reinsurance Premiums. The inclusion of such ceding commissions in the Premium Limitation offsets the potential for earnings stripping through the reinsurance transaction to the extent of the amount so included.
Proposed § 832(b)(9)(E) Election
Proposed § 832(b)(9)(E)(i) provides that in the event that a Specified Affiliated Corporation is paid a premium by a Covered Insurance Company that would (but for that subparagraph) be an Affiliated Nontaxed Reinsurance Premium, then such Specified Affiliated Corporation may make an election to treat its Specified Reinsurance Income as income effectively connected with an insurance trade or business in the United States. This election departs from the 2008 Neal Bill, which provided that such an election would have the effect of treating the electing entity as a domestic corporation for purposes of Subtitle A of the Internal Revenue Code. The explanation to the 2009 Neal Bill, however, clarifies that Specified Reinsurance Income (or loss, if any) of an electing company cannot be taken into account on a U.S. consolidated return.
For these purposes, a Specified Affiliated Corporation means any affiliated corporation that (1) is a foreign corporation that would be taxed under Subchapter L if it were a domestic corporation, (2) waives the benefits of a U.S. tax treaty with respect to Specified Reinsurance Income subject to the § 832(b)(9)(E) election, and (3) meets any other requirements specified by the Secretary. The explanation to the 2009 Neal Bill directs the Treasury Department to strictly ensure that, for purposes of determining net investment income, only those deductible items directly allocable to gross investment income that is allocable to the specified reinsurance premiums are allowed.
Specified Reinsurance Income means, with respect to a Specified Affiliated Corporation, (1) all reinsurance premiums that (but for the § 832(b)(9)(E) election) would be treated as a Affiliated Nontaxed Reinsurance Premium and that are received by such corporation during the taxable year directly or indirectly from a Covered Insurance Company and (2) so much of net investment income (as defined under § 842(b)) for the taxable year as is allocable to reinsurance premiums subject to the § 832(b)(9)(E) election for the current and any prior taxable year.
Once a § 832(b)(9)(E) election is made, the election may be revoked only with the consent of the Secretary. Except as otherwise provided by the Secretary, rules similar to the rules of §§ 953(d)(3) and 362(e) will apply in the case of a corporation making an § 832(b)(9)(E) election. The explanation to proposed § 832(b)(9)(E) claims that the proposed provision does not violate the nondiscrimination articles of most U.S. tax treaties.
Treaty Nondiscrimination Articles Position
Nondiscrimination articles of U.S. tax treaties generally prohibit nationals of one treaty country from being subjected to more burdensome taxation (or any connected requirement) in the other treaty country than are nationals of that other treaty country in the same circumstances. The respective explanations to both the 2008 and 2009 Neal Bills state Representative Neal’s belief that proposed § 832(b)(9) does not violate any nondiscrimination article of any applicable U.S. tax treaty.
A nondiscrimination article, the explanations state, applies only in cases in which persons are in the same circumstances. Because proposed § 832(b)(9) treats similarly situated persons similarly, the explanations reason that the nondiscrimination articles would not apply.
Proposed § 832(b)(9)(G) grants regulatory authority to carry out or to prevent the avoidance of the purposes of this provision. In particular, the Treasury Department is directed to identify, and prevent avoidance of the provision through, transactions that are alternatives to traditional reinsurance, through fronting transactions, conduit and reciprocal transactions, and any economically equivalent transactions. The Treasury is directed, in the explanation to the 2009 Neal Bill, to publish guidance relating to prevention of avoidance of the purposes of the provision as promptly as possible, and is directed to make such guidance effective at a time consonant with the statutory effective date.