Tax considerations determine the structure of paper backed by life insurance settlements (“LIS”). From an offshore perspective, double taxation treaties (“DTTs”) exist between the United States of America (“US”) and a number of offshore jurisdictions. From an onshore perspective, in addition to domestic US taxation rules, which are generally beyond the scope of this paper, it is important to consider the Internal Revenue Service (“IRS”) rulings relating to LIS. One of the IRS rulings includes references to non-US persons and accordingly may impact DTT protections from which investors in LIS funds benefit.

The use of DTTs

A number of offshore jurisdictions offer the possibility of domiciling a fund which would raise finance from investors in the US and outside of the US, by issuing securities. The return for investors, both with respect to the principal amount and coupon of the investment, would be secured by an underlying pool of LIS assets, acquired using part or all of the proceeds of the securities issue. The securities could take the form of debt, in which case investors would receive interest payments relative to their noteholding, or equity, in which case investors would receive distributions relative to their fractional ownership of the offshore fund.

In each case, the purpose of a DTT is to identify and permit the payment stream to an investor from the offshore fund to be delivered without a need for the paying agent to withhold amounts for income tax liability in the jurisdiction of the offshore fund. Under the US-Ireland DTT, for example, the benefits of the DTT are only accessible to qualifying persons. An Irish fund complying with the provisions of section 110 of Ireland’s Taxes Consolidation Act 1997 would be a “qualifying fund.” Interest paid by a qualifying fund does not give rise to Irish income tax liability if the recipient is not a resident of Ireland and is resident in either the EU or a DTT jurisdiction. Accordingly, an Irish paying agent would not need to withhold amounts relating to Irish income tax liability on behalf of a US owner of the fund’s securities.

Revenue Rulings 2009-13 and 2009-14

Revenue Ruling 2009-13 and Revenue Ruling 2009-14 provided guidance on the federal tax consequences of the sale, surrender or maturity of life insurance contracts. Revenue Ruling 2009-13 contains three holdings, one relating to surrender of policies and two relating to sales. The latter two holdings will be applied adversely with respect to sales of policies which occur from August 26, 2009 onwards. In light of this, the industry has seen a marked increase in life settlement sales (apparently this is also the case with respect to surrenders). Presumably this will have resulted in significantly increased paper workload for carriers. Consequently, this may cause a backlog in applications to transfer the legal ownership of policies which extends beyond August 26, 2009. It is unclear whether the IRS will impose a tax liability upon a seller of a policy in a situation where documentation transferring beneficial ownership of a policy was executed prior to August 26, 2009, but the transfer of legal ownership was not completed until after August 26, 2009.

Revenue Ruling 2009-14 relates to the maturity and/or sale of term policies without cash surrender benefits. The third situation examined in this ruling relates to the amount and characterization of income recognized by a foreign corporation that is not engaged in a trade or business within the US (including the trade or business of purchasing, or taking assignments of, life insurance contracts) upon the receipt of death benefits. The ruling holds that such benefits constitute ordinary US source income. Gains realized would be taxable at 30% under Section 881(a)(1) of the Internal Revenue Code (i.e. fixed or determinable annual or periodic income – “FDAP”). The position relating to income from a sale of policies by the foreign corporation to a third party was not addressed by the IRS in Revenue Ruling 2009-14. The life insurance carrier, payment agent or other administrator could therefore fall within the IRS’s US withholding agent rules and become responsible for withholding an amount to represent the deduction from the taxable gain realized by an offshore fund. The amount of the gain may not be verifiable by the administrator. Moreover, the applicable DTT may contain exemptions relating to FDAP, of which the administrator may need to be aware. A further complication may arise where the beneficial owner of the death benefit is a tax neutral US vehicle wholly owned by the offshore fund.


There are a number of possible finance-raising structures involving an offshore qualifying fund in a DTT jurisdiction, where payments to investors are funded by death benefits accruing from the underlying LIS portfolio. Such portfolio may be beneficially owned by a US tax transparent subsidiary of the offshore fund and administered by US service providers. Best practice guidelines will need to be developed to deal with US withholding requirements in light of relevant DTT protections applying to FDAP. Revenue Ruling 2009-14 should be supplemented to include gains upon sales of policies by foreign corporations. In addition, it is unclear whether Revenue Ruling 2009-13 requires completion and return of change of ownership forms prior to August 26, 2009.

This article was originally published in the August 2009 Life Settlements Review