On April 2, 2009, Congressmen Richard Neal (D-Mass) and Pat Tiberi (R-Ohio) introduced H.R. 1944, which would permanently extend the Subpart F exemption for “active financing income.” (The active-financing provisions allow certain active income from overseas business operations of financial services companies to be exempt from current U.S. federal taxation.) Specifically, § 1(b) of the bill would repeal § 953(e)(10) of the U.S. Internal Revenue Code (Code).
Code § 953(e)(10) currently provides for the temporary application of § 953(e) and § 954(i) (and indirectly the flush language in § 954(e)) (the Insurance Active Financing Provisions) to certain controlled foreign corporations (CFCs) engaged in the business of insurance. The Insurance Active Financing Provisions were first enacted in the Tax and Trade Relief Extension Act of 1998 (TTREA), for taxable years beginning only during the calendar year 1999. These temporary provisions have been extended repeatedly over the last 10 years: the Tax Relief Extension Act of 1999, for two additional years; the Job Creation and Worker Assistance Act of 2002, for five additional years; the Tax Increase Prevention and Reconciliation Act of 2005, for two additional taxable years; and, finally, the Tax Extenders and Alternative Minimum Tax Relief Act of 2008, for one additional taxable years. The provisions currently are set to expire with respect to taxable years of foreign corporations beginning after December 31, 2009.
The repeal of § 953(e)(10) would make § 953(e) and § 954(i) permanent fixtures of the Code. (Note that President Obama’s proposed 2010 budget plans to extend these provisions for only one additional year.)
Current § 953(e)
For taxable years beginning after December 31, 1998, and before January 1, 2010, § 953(a)(2) excludes from the definition of Subpart F insurance income any “exempt insurance income” (EII) as defined under § 953(e). EII is defined as income derived by a “qualifying insurance company” (QIC) that (1) is attributable to the issuing (or reinsuring) of an “exempt contract” (Exempt Contract) by such a company or by a “qualifying insurance company branch” (QIC Branch) of such a company, and (2) is treated as earned by such company or branch in its home country for purposes of such country’s tax laws.
For an insurance or reinsurance contract of a QIC or a QIC Branch to qualify as an Exempt Contract, the contract must insure only non-U.S. risks and more than 30% of the QIC’s or the QIC Branch’s net written premiums must be attributable to unrelated “same-country” risks. If the contract insures risks other than “same-country” risks, the QIC or QIC Branch must conduct substantial activities in its place of organization/operation.
For a CFC to qualify as a QIC, the corporation must be subject to insurance regulations in its country of organization, must have more than 50% of its net written premiums (including premiums received by all branches of the QIC) attributable to unrelated “same-country” risks, must be engaged in the insurance business, and must be a company that would be subject to tax under Subchapter L of the Code if it were a U.S. corporation. (For a branch to qualify as a QIC Branch, the branch must be a “qualified business unit” within the meaning of § 989(a), be subject to insurance regulations in its country of operation, and be a branch of a QIC.)
Current § 954(i)
Code § 954(i) provides that the “foreign personal holding company income” of a CFC does not include “qualified insurance income” (QII) of a QIC. QII means income of a QIC equal to the sum of two amounts: (i) the unrelated investment income attributable to Exempt Contracts and (ii) the unrelated investment income attributable to a portion of its required surplus. (These two amounts parallel two former exceptions to § 954(c): former § 954(c)(3)(B) and former § 954(c)(3)(C).)
The first permitted amount of QII is investment income received by a QIC or a QIC Branch on its reserves allocable to Exempt Contracts or, in the case of property and casualty insurance business, on 80% of its unearned premiums from Exempt Contracts.
The second permitted amount of QII is investment income received from an unrelated person by a QIC or QIC Branch and derived from investments made by the QIC or QIC Branch 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 its premiums earned on such insurance contracts during the taxable year (as defined in § 832(b)(4)) and (2) in the case of life insurance or annuity contracts, 10% of the life insurance reserves for such contracts. The House Report on the TTREA provided that in no case does this exception apply to investment income with respect to “excess surplus.”
When § 953(e) was enacted by the Tax and Trade Relief Extension Act of 1998, several other Subpart F provisions in the Code were not updated to take into account the new statutory framework, creating uncertainty about the proper application of those provisions. Consequently, five provisions should be amended in conjunction with any permanent change to § 953: (1) § 952(c)(1)(B)(vii) (certain losses attributable to former “same-country” exception that can be treated as Subpart F losses); (2) § 953(c)(3)(B) (20% gross income “related person insurance income” exception that “turns off” the former “same-country” exception); (3) § 956(c)(2)(E) (an exception from a § 956 inclusion for an amount equal to reserves relating to former “same-country” exceptions); (4) § 957(b) (definition of certain foreign insurance companies treated as CFCs); and (5) § 964(d) (permitting certain QIC Branches to be treated as separate CFCs for purposes of benefiting from the exempt insurance company exception).
Reversion to Pre-1999 Code
In the event that H.R. 1944 does not become law as proposed above, § 953(e) and § 954(i) are set to expire for taxable years of foreign corporations beginning after December 31, 2009. Upon such expiration, the pre-1999 version of § 953(a) again would become the relevant exception to the inclusion of Subpart F insurance income. This pre-1999 version generally provides that only underwriting income attributable to risks located in the country of incorporation of the CFC are exempt from treatment as Subpart F income. There would be no specific Subpart F exceptions excluding any investment income (other than that attributable to “same-country” underwriting income) of an offshore insurance business. While other Subpart F exceptions or limits might apply (for example, the high-tax exception or the current earnings and profits limitation), the expiration of § 953(e) and § 954(i) would significantly increase the amount of offshore insurance (underwriting and investment) income reported by U.S. corporations.