SOURCE: Foreign Insurance Excise Tax - Audit Technique Guide, April 2008, as found at http://www.irs.gov/businesses/small/art ... 63,00.html NOTE: This document is not an official pronouncement of the law or the position of the Service and can not be used, cited, or relied upon as such. This guide is current through the publication date. Since changes may have occurred after the publication date that would affect the accuracy of this document, no guarantees are made concerning the technical accuracy after the publication date.
Chapter 1 - Foreign Insurance Excise Tax
Internal Revenue Code § 4371 requires all of the following three elements for the foreign insurance excise tax to apply. They are:
A policy of insurance,
Insurance of a United States risk, and
Policy issued by a foreign insurer or reinsurer.
Policy of Insurance
A policy of insurance may include a policy of reinsurance, an indemnity bond, or an annuity contract. Generally, a policy is the printed document issued by the insurer presented to the insured which contains the terms of the insurance contract. This document is sometimes referred to as a treaty. When the insurer transfers the same risks to another insurer, reinsurance has occurred and the second insurer is termed the reinsurer.
An indemnity bond is a contract under which the surety party promises to reimburse a third party, called the obligee, for losses it sustained as a result of the failure of the principal party, called the obligor, to perform under its contract with the obligee.
An annuity contract is a contract that provides for periodic payments starting from a certain date and continuing for a fixed period or for the life of the annuitant.
Insurance of a United States Risk
United States risk is defined follows:
For life insurance, sickness and accident insurance, and annuity contracts, the policy or contract must be with respect to the life or hazards to the person of acitizen or resident of the United States.
For casualty insurance or indemnity bonds, the definition depends upon the residency of the insured (in the case of a corporation or partnership, the country in which it is created or organized).
For a United States insured, the policy must cover risks wholly or partly within the United States.
For a foreign insured, the insured must be engaged in a trade or business within the United States and the covered risks must be wholly within the United States. See IRC § 4372.
Policy Issued by a Foreign Insurer or Reinsurer
The policy of insurance must be issued by a foreign insurer or reinsurer. A foreign insurer or reinsurer is defined under I.R.C. § 4372(a) as a nonresident alien individual, a foreign partnership, or a foreign corporation.
Liability for Tax
While the Service generally holds the person making the premium payments liable for the tax, the liability is joint and several. Under I.R.C. § 4374 the tax may be imposed tax on any of the following persons:
The insured, sometimes referred to as the beneficiary,
The policyholder, if that person is someone other than the insured,
The insurance company, or
The broker obtaining the insurance.
Internal Revenue Code § 4372(d) further defines insured to include any of the following:
A domestic corporation or partnership, or an individual resident of the United States, or
A foreign corporation, foreign partnership, or nonresident individual engaged in a trade or business within the United States.
Computation of the Tax Due
The applicable tax rate depends directly on the type of insurance coverage provided in the contract. The table below reflects the rate to be imposed based on the type of coverage in the insurance contract.
Type of Coverage Rate
Casualty insurance or indemnity bonds 4%
Life insurance, sickness and accident policies or annuity contracts 1%
Once the tax rate is determined, it is to be applied to the amount of the premiums paid. The amount of premiums paid is defined in Treas. Reg. § 46.4371-3(b) as ”the consideration paid for assuming and carrying the risk or obligation [of the insured].” This is the gross amount, not the net amount.
Note: As with any other tax, there are many issues which arise from these concepts. These issues are the topics of the remaining chapters in this text.
Chapter 2 - Location of Insured Property for Casualty Insurance and Indemnity Bonds
The old real estate adage, "Location! Location! Location!" applies equally to the foreign insurance excise tax. Location of the risk being insured is one element which is to be considered in order to determine whether the foreign insurance excise tax applies.
Domestic vs. Foreign Insureds
Whether the foreign insurance excise tax applies to a policy of casualty insurance or an indemnity bond will depend upon whether the insured is domestic or foreign. If an insured is foreign entity, the foreign entity must have trade or business in the United States and the risk insured must be located entirely within the United States. On the other hand, if an insured is a domestic entity, the risks insured may be wholly or partly within the United States. Cite: I.R.C. § 4372(d) and Treas. Reg. §§ 46.4371-2(a)(2) and (3).
A domestic insured may be a domestic corporation or partnership, or an individual resident of the United States. To be subject to the foreign insurance excise tax, the domestic insured’s policy must insure against, or with respect to, hazards, risks, losses, or liabilitieswholly or partly within the United States.
Example: Casualty insurance on an aircraft which flies domestic and foreign flights would be taxable. However, if the aircraft flew only foreign flights and never entered U.S. airways, it would not be taxable as the risk is wholly outside the United States.
Internal Revenue Code § 7701(a)(9) defines the term “United States” to include only the States and the District of Columbia. However, the Service relies on the Outer Continental Shelf Lands Act to include the subsoil and the seabed of the outer Continental Shelf as a part of the United States within the scope of § 7701(a)(9). Cite: Rev. Rul. 77-197, 1977-1 C.B. 344, amplified, Rev. Rul. 81-257, 1981-2 C.B. 214.
A foreign insured can be a foreign corporation, foreign partnership, or nonresident individual, which is engaged in a trade or business within the United States. To be taxable, the foreign insured’s policy must insure against, or with respect to, hazards, risks, losses, or liabilities within the United States.
Example: A foreign entity’s insurance against destruction of a building located within the United States would meet this test for taxability. However, casualty insurance of a building physically located in England would not meet the location test for taxability.
Location of Risk
The location of the risk plays a key role in determining whether a policy is subject to the foreign insurance excise tax. There is a distinct difference as to the location of risk requirement between domestic and foreign insureds. However, determining where the location of the risk is (i.e. within or outside of the United States) is sometimes less clear. Fortunately, there are rulings and cases which provide guidance on some of these issues. The revenue rulings and court cases can be divided into the following categories:
Separation in the coverage of risks
Continental Shelf and territorial waters
Import of products
Export of products
Separation in the Coverage of Risks
The location of the risk being insured is determined on a policy by policy basis. If separate insurance policies are used to insure two or more different risks, the policies are considered separately for application of the location of the risk test. However, if one single policy of a domestic insured covers multiple risks, as long as one risk meets the location test discussed above, the whole policy will be deemed to meet the test. This is true even if the location of some of the risks normally would not be taxable.
Separate Policies - Determining location on a policy by policy basis is brought forth in Revenue Ruling 73-362, 1973-2 C.B. 367. The revenue ruling concerns a domestic aviation company with two separate insurance policies covering its aircraft. The first policy insured the aircraft’s operations exclusively within the United States and the second policy insured the aircraft’s operations exclusively outside the United States. The revenue ruling found that the first policy was subject to tax, while the second was not.
One Policy - Revenue Ruling 73-362 does not address what would happen if one policy covered the aircraft both within and outside of the United States. However, the “wholly or partly within the United States” language of I.R.C. § 4372(d) supports the position that the entire premium of a single policy covering mixed risks would be subject to the excise tax.
The position that the entire premium of a single policy covering mixed risks is subject to the excise tax finds further support in Amtorg Trading Corporation v. United States, 103 F.2d 339, 39-1 USTC ¶ 9454 (2nd Cir. 1939). The Court stated,
Little need be said as to the suggestion [by the taxpayer] that in any event the tax ought to be computed only upon the portion of the premium applicable to the risks while the property was within the territorial waters of the United States. The tax if valid at all is imposed by the terms of the statute on the premiums charged.
Accordingly, for a domestic insured, the tax is to be imposed on the entire premium of a single policy covering multiple risks as long as one or more of the risks meets location of risk test. In other words, there is no allocation of the premiums paid for the taxable and non-taxable portions.
Should a policy subject to tax provide the ability for the policy to be extended to include other risks, then the premiums paid for the extended coverage are also subject to tax. If a separate policy is executed for those risks, and the risks do not meet the location test, then the policy for the extended coverage would not be subject to the tax.
In Revenue Ruling 69-100,1969-1 C.B. 289, a policy covering a shipping vessel against risks wholly or partly within the United States was issued to a domestic company by a foreign insurer. Under the terms of the policy, the taxpayer/insured had the option to extend the policy to cover risks incurred in additional areas outside the United States. The taxpayer subsequently elected to extend the coverage and paid the additional premiums.
The Service held that since the insurer was committed to accept the additional coverage, by virtue of the provision in the original policy, the extended coverage endorsements did not constitute a separate policy. Instead, the extension remained a part of the original policy. Therefore, the risk remained "wholly or partly within the United States" and the additional premiums were subject to tax.
Continental Shelf and Territorial Waters
Taxability of policies for the Continental Shelf and the territorial waters depends upon the activity performed.
Continental Shelf - A foreign insurance policy covering oil drilling operations on the Continental Shelf is subject to the excise tax on foreign insurance. This is so even if the drilling operation is located in international waters, beyond the three-nautical mile boundary of the United States, so long as the drilling operations occur on the Continental Shelf. Cite: Rev. Rul. 56-505, 1956-2 C.B. 891.
Further, the tax may apply to semi-submersible and other floating drilling rigs to the extent they are engaged in oil and gas activities on the Continental Shelf. These activities necessarily require at least a temporary attachment to the seabed. Cite: Rev. Rul. 81-257, 1981-2 C.B. 214
Territorial Waters - In Amtorg Trading Corporation v. United States, the tax was not imposed on a policy which covered transportation of goods from a foreign destination through the territorial waters of the United States. The taxpayer was a domestic company importing products from the Soviet Republic. The products were transported via ocean freight and insured with a foreign company until their arrival at a port within the United States.
The products’ movement through the three-mile portion of United States territorial waters prior to their arrival at the United States port was the only portion of the ocean voyage that was within the United States. A separate domestic insurance policy covered the movement of the products within the United States and Canada.
The Second Circuit Court of Appeals held that such movement through the three-mile territorial waters of the United States was merely a “trifling portion” of the entire voyage and thus, no portion of the premiums paid to the foreign insurer was subject to the Federal Excise Tax (FET).
Coverage Continues Past Port of Entry - Revenue Ruling 57-256, 1957-1 C.B. 416, follows Amtorg but only to the extent the insurance coverage terminates at the point of unloading at the port of entry. If the coverage continues beyond the point of unloading, for instance, to a warehouse within the boundaries of the port of entry, the policy will be subject to the excise tax as the risk is wholly or partly within the United States.
Import of Products
Tax is applied based upon who the insured is. The chart below summarizes the application of the tax to products imported into the United States for shipments between the United States and certain of its possessions. Cite: Revenue Ruling 57-257, 1957-1 C.B. 417.
Chart - Revenue Ruling 57-257:
Shipment Insured Subject To FET?
From Puerto Rico or Virgin Islands to United States. Foreign corporation, foreign partnership, or nonresident individual Not taxable because not wholly within the United States.
From Puerto Rico or Virgin Islands to United States. Domestic corporation, partnership or individual Not taxable unless coverage continues past the point of unloading at the U.S. port, in which case the insured risk would be partly within the United States.
The above chart also applies to imports for foreign locations other than possessions of the United States. In essence, for purposes of the foreign insurance excise tax, Puerto Rico and the Virgin Islands are treated as if they are foreign countries. Generally, policies on imports are taxable only when:
Purchased by a domestic insured, and
Coverage of the policy continues past the point of unloading at the United States port.
Export of Products
Foreign insurance covering goods which are in export transit from the United States to anywhere outside the United States are not subject to the foreign insurance excise tax. Cites: United States v. International Business Machines Corp., 517 U.S. 843, 96-1 USTC, ¶ 70,059 (1996) (“IBM”), and the Export Clause of the United States Constitution (U.S. Const., Art. I, § 9, cl. 5).
Under IBM, no portion of any premiums paid to a foreign insurer to cover goods in export transit from the United States will be subject to the excise tax. This is so even though a portion of the foreign insurance premium paid may include coverage for risks incurred partially within the United States. For instance, coverage may include the period during which the products are being transported or are temporarily stored at an intermediate freight forwarder.
It is important to note that this ruling applies only to goods being exported from the United States. Additionally, the ruling applies only to the extent the insurance covers the export transit of such goods. Accordingly, if a single policy covers risks incurred during export transit, as well as risks incurred in the U.S. prior to export transit, an allocation of the premiums paid for such policy may be made. (It is important to note that this is the only exception to the general rule that no allocation will be made of premiums paid under a single policy.)
Chapter 3 - Identifying the Parties to an Insurance Contract
The Internal Revenue Code provides a broad definition of who is potentially liable for the excise tax on foreign insurance. Generally, liability is imposed on the last domestic entity which pays the insurance premiums to a taxable foreign insurer. In order to determine the party responsible for filing the Form 720 and remitting the tax, all of parties to the insurance contract should be identified.
Scope of Liability
Section 4374 of the Internal Revenue Code imposes liability for the foreign insurance excise tax on the following persons:
any person who makes, signs, issues, or sells any of the documents and instruments subject to the tax, or for whose use or benefit the same are made, signed, issued, or sold. The United States or any agency or instrumentality thereof shall not be liable for the tax. (Emphasis added.)
The broad scope of the liability for the foreign insurance excise tax under § 4374 makes it possible for more than one person to be liable for the tax. However, it should be noted that taxpayers have attempted to narrow the liability to only those persons making the premium payment and have cited to Treas. Reg. § 46.4374-1(a) in support of their position. In 2002, this regulation was amended to make clear that there is no such limitation to the liability imposed under § 4374.
Thus, while the Service will generally seek payment of the excise tax from the U.S. person making the premium payment, the Service may, in its discretion, seek payment from other persons, as described in the next section. The Service’s ability to seek payment of the excise tax from other persons may be particularly useful where payment of the premiums is made by a non-U.S. person on behalf of a U.S. insured, or if the U.S. person making the payment has failed to pay the excise tax and the statute of limitations has expired with respect to such person.
Joint and Several Liability
The liability for the foreign insurance excise tax is joint and several and under § 4374, may be imposed on any of the following persons:
The insured, sometimes referred to as the beneficiary,
The policyholder, if that person is someone other than the insured,
The insurance company, and
The broker obtaining the insurance.
The insured or beneficiary is the party to the insurance contract to whom, or on behalf of whom, the insurer agrees to pay benefits and is usually named in the policy. In the case of life insurance, the insured is the person on whose life an insurance policy is issued and the beneficiary is the person or entity to whom benefits are paid.
A policyholder is defined as the person who has the insurance policy in his possession or under his control, typically the party who purchased the policy. A common example of when the policyholder and the insured/beneficiary will not be the same person occurs with debts secured by a piece of property where the debtor will be required by the lien holder to purchase casualty insurance on the secured property in the debtor’s name. Such is the case with homeowners insurance required by the bank holding the mortgage. You, as the debtor, are the policyholder and the bank is the beneficiary.
An insurance company is a company whose primary and predominant business activity during the taxable year is the issuance of insurance or annuity contracts. An insurance company can also act as a reinsurer by reinsuring risks underwritten by another insurer.
A broker is an intermediary who negotiates insurance contracts on behalf of the insured or the insurer. Brokers generally receive their commissions from the insurer.
Effect of Contractual Agreements
The parties to an insurance contract are free to decide among themselves, contractually or otherwise, as to who will file the excise tax return and pay the tax. However, should the excise tax not be paid, the Service is not bound by any such agreement. The Service may then pursue any of the parties to the insurance contract as discussed above for payment.
Identifying the Foreign Insurer
Section 4372(a) of the Internal Revenue Code defines a “foreign insurer or reinsurer” as follows:
For purposes of section 4371, the term “foreign insurer or reinsurer” means an insurer or reinsurer who is a nonresident alien individual, or a foreign partnership, or a foreign corporation. The term includes a nonresident alien individual, foreign partnership, or foreign corporation which shall become bound by an obligation of the nature of an indemnity bond. The term does not include a foreign government, or municipal or other corporation exercising the taxing power.
Thus, a foreign insurer is an insurer or reinsurer who is a nonresident alien individual, or a foreign partnership or a foreign corporation.
Foreign Entity Owned by a Domestic Entity
If an insurer appears to be a foreign entity but is wholly owned by a domestic corporation, it is important to ascertain the nature of the relationship between the insurer and the domestic corporation. The focus is on whether the insurer is merely a foreign branch or division of a domestic corporation, or a subsidiary of a domestic corporation. Field Service Advice 199952018 (September 27, 1999) provides an analysis of these two situations.
Foreign Branch or Division - An unincorporated foreign branch or division is not considered an entity separate and distinct from its domestic owner and therefore, will not be considered a “foreign insurer.” Accordingly, premiums paid to a foreign branch or division of a domestic entity will not be subject to the excise tax.
Foreign Subsidiary - If a foreign entity is a subsidiary of a domestic corporation, federal income tax law regards it as a distinct and separate entity. An example would be a subsidiary incorporated in a foreign country. Consequently, a foreign subsidiary of a domestic corporation will generally be considered to be a foreign insurer and the premiums paid to it will be subject to excise tax.
Domestic Entity Owned by a Foreign Entity
The same relationship analysis explained above should be applied where the insurer appears to be a domestic entity but is wholly owned by a foreign entity. Thus, if the domestic entity is a branch or division of a foreign corporation or other entity, premiums paid to such domestic entity will generally be subject to excise tax. (It should be noted there is an exemption under section 4373 for premiums which constitute effectively connected income under I.R.C. section 882(a), unless such income is exempt from income tax pursuant to a tax treaty with the United States.) If the domestic entity is a subsidiary of a foreign corporation, premiums paid to such domestic entity will not be subject to the excise tax.
Identifying the Insured
The insured for casualty and indemnity bonds is defined under IRC § 4372(d) as:
a domestic corporation or partnership, or an individual resident of the United States, against, or with respect to, hazards, risks, losses, or liabilities wholly or partly within the United States, or
a foreign corporation, foreign partnership, or nonresident individual, engaged in a trade or business within the United States, against or with respect to, hazards, risks, losses, or liabilities within the United States.
Determining whether an individual or entity falls under either of the above definitions for an insured is generally straightforward. However, as the economy becomes more global, the occurrence of a single policy with multiple insureds, which are both domestic and foreign, becomes commonplace. This requires a more involved analysis of the following two items:
The structure of the global company, such as whether the company has branches, divisions, or subsidiaries in foreign countries, and
Coverage of the single policy.
Structure of the Global Company - If a single foreign policy covers both domestic and foreign offices, and such offices are separate entities, the portion of the premium allocable to the foreign offices will not be subject to the excise tax. However, if the foreign office is engaged in a trade or business within the United States and all of its insured risks are located wholly within the United States, it would be subject to excise tax. Premiums allocable to domestic offices are taxable, whether all or part of the insured risks are located within the United States.
Coverage of the Single Policy - Generally, the parent company will allocate to each office a portion of the premium payment. This may be reflected by a book entry or paid by intercompany fund transfer. If no allocation or billing is made amongst the domestic and foreign offices, then arguably, the entire premium is subject to the excise tax if the single policy is issued to a domestic parent (the same argument cannot be made if the single policy is issued to a foreign parent). The theory behind this position is that the domestic parent company is the insured, and the policy covers the insured’s risks which are partly within and without the United States.
Chapter 4 - Taxable Premiums
Cede - To transfer liability in connection with a risk, or a portion of it, from the original insurer to a reinsurer.
Reinsurance - A first insurer passes all or a portion of the risks insured to a second insurer who is called the reinsurer.
Settlement Statement - A periodic statement prepared by the ceding insurance company and provided to the reinsurer which reflects the amount of premiums due.
The foreign insurance excise tax is applied to the amount of premiums paid per IRC § 4371. Although the definition sounds straightforward, determining the amount of premiums paid can, at times, be difficult. As you will see in this chapter and out in the field, there are reductions to the amount of premiums paid which decrease the amount of tax due. Whether these reductions are allowable is the topic covered in this chapter.
The excise tax is based on the gross amount of premiums paid to the foreign insurer or reinsurer for an insurance policy, annuity contract or indemnity bond. This amount includes any additional assessments, charge, or call, paid pursuant to the agreement of the parties. The whole amount is taxed whether payable in one lump sum or installments. Cite: Treas. Reg. § 46.4371-3(b).
In situations involving a domestic insured obtaining insurance from a foreign insurer, the application of the above definition is straightforward. For example, the full amount of the premium paid to the foreign insurer is the amount subject to the tax. However, the determination of the amount of premiums paid becomes complex if return premiums or reinsurance is involved.
The only allowable reductions to gross premiums are for the following:
Policy cancellations and overcharges, and
An allowable reduction in the amount of taxable gross premiums is for return premiums. Return premiums are funds which are returned or credited to the account which are fixed by contract and do not depend only on the experience of the company itself. This term includes experience-rated refunds which are refunds due to an overcharge as calculated at a later date.
Experience-rated refunds are based on a comparison of the actual loss experience, usually of either the policyholder or the insurer, and the premiums produced by the covered risk during a given period of time. The refunds are determined by a formula set forth within the insurance contract and are generated when the premiums paid exceed the losses paid for a particular period of time. Experience rating may be either prospective, based on the loss experience of a prior period, or retrospective, based on the loss experience of the period being covered.
An example of this type of contract may be found in workers compensation insurance. In basic terms, at the end of each contract period, the amount of claims actually filed is compared to the amount of claims which were expected to be filed for the period. The difference is entered into a complicated computation which is used to determine the amount refunded back to the insured.
Policy Cancellations and Overcharges
Amounts which are refunded or credited due to an overcharge or cancellation of a policy fall within the definition of return premiums. When the amount of a premium overcharge is refunded, the insured is due a refund of the tax already paid on those premiums. This is an allowable reduction to the amount of gross premiums. The same finding holds true when premiums are refunded due to a cancellation of a policy.
Note that the foreign insurer may not actually send a check to the domestic insured. Instead, the two parties may find it easier to net the refund on the next premium payment. In this case, the agent will determine that the taxpayer is not receiving a double benefit by filing a claim for the tax on the refunded premiums and computing the tax on the net amount on the subsequent premium payment.
An insurance company will have various contracts for which premium payments are paid to the same foreign insurer. Imbedded within the total premium payment are premiums for which the domestic insurer is merely acting as an agent for another domestic entity. In that case, the other domestic entity may have paid the excise tax and filed a Form 720 itself.
However, the taxed premiums are forwarded from the original entity to the domestic insurer who then pays the taxed premiums to the foreign insurer. Since the foreign insurance excise tax is already paid by another entity, these taxed premiums may be used to reduce the amount of gross premiums used in the computation of the excise tax due by the domestic insurance company.
It is not uncommon for reinsurance agreements to be structured in such a manner that a very small amount of cash is actually transferred between the parties. In these cases, the agreement typically provides that the ceding insurance company will withhold a significant percentage of the ceded premiums on behalf of the foreign reinsurer. In this case, the tax is still computed on the amount of gross premiums as required by the reinsurance agreement.
The agreement may also provide that certain reductions or setoffs, will be made against the ceded premiums owed to the foreign reinsurer for various agreed expenses. A periodic statement, called a settlement statement or a bordereau, is usually prepared by the ceding insurance company and provided to the foreign reinsurer. The settlement statement reflects the premiums due and the reductions made resulting in the net premium paid.
Reductions to the amount of the ceded premiums and include ceding commissions, agent commissions, premium taxes, license taxes, fees, administrative and overhead expenses. These expenses are incurred by the domestic insurer in writing the insurance contract. Setoffs can also include losses or loss adjustment expenses. Cite: Rev. Rul. 79-138, 1979-1 C.B. 359.
There is no reduction to the amount of taxable gross premiums for setoffs. Where ceded premiums are being withheld by the domestic insurance company and used to offset the reinsurer's liabilities, the full amount of gross premiums before the reductions is subject to tax.
Some taxpayers have taken the position that the tax applies only to the net amount of the ceded premiums remaining after the setoffs for the reinsurer's liabilities are taken. In essence, the taxpayers contend that the definition of "premiums paid" encompasses a netting concept. Even more aggressive is the argument made by some taxpayers that the tax applies only if and when the withheld funds are physically transferred to the foreign reinsurer. This is an incorrect position.
Cash vs. Accrual Method of Accounting
In determining when premiums are paid, and thus subject to the tax, the accrual method of accounting, not the cash-basis method of accounting applies. Revenue Ruling 77-453, 1977-2 C.B. 237, and G.C.M. 37,201 (July 26, 1977) support an interpretation of the term "amounts paid for reinsurance" under IRC § 832(b)(4) as including amounts accrued as well as amounts actually paid. Ceded premiums are considered paid to the reinsurer when all events have occurred that fix the reinsurer's right to the premiums and the amount of such premiums is reasonably ascertainable.
Sources of Information
Premiums ceded to a foreign reinsurer may be reflected in the domestic insurer's National Association of Insurance Commissioners (NAIC) Annual Financial Statements on Schedules F and S. Additionally, information relating to premiums ceded to a foreign reinsurer is reflected on settlement statements or similar documents prepared by either the domestic/ceding insurance company or the foreign reinsurer on a periodic basis.
When reviewing the settlement statements, note that the actual amount transferred to the foreign reinsurer is typically net of expenses, which is less than the gross amount subject to the tax. The insurance contract, along with the settlement statement, in many cases will provide the amount of gross premiums due.
Chapter 5 - Exemptions
There are a number of statutory and non-statutory exemptions to the foreign insurance excise tax. The statutory exemptions are set forth under I.R.C. §§ 4373 and 953. The non-statutory exemptions are based on either a tax treaty with the United States or the Export Clause of the United States Constitution.
There are two statutory exemptions under the Internal Revenue Code which specifically exempt premiums paid to foreign insurers from the excise tax on foreign insurance. These statutory exemptions are discussed in detail in this lesson. They include:
Internal Revenue Code Section 4373
Internal Revenue Code Section 953(c) and (d)
Internal Revenue Code Section 4373
The exemption provided under § 4373(1) applies to premiums which are subject to the United States income tax. Section 4373(1) states that the tax imposed by § 4371 shall not apply to:
Any amount which is effectively connected with the conduct of a trade or business within the United States unless such amount is exempt from the application of section 882(a) pursuant to a treaty obligation of the United States.
This typically arises in the case of premiums paid to a foreign insurer engaged in the business of insurance within the United States and is thus, taxable under § 882(a).
The exemption under § 4373(2) applies to indemnity bonds insuring certain obligations of the United States. This exemption is rarely found in the field. It provides that the tax imposed by § 4371 shall not apply to:
Any indemnity bond required to be filed by any person to secure payment of any pension, allowance, allotment, relief, or insurance by the United States, or to secure a duplicate for, or the payment of, any bond, note, certificate of indebtedness, war-saving certificate, warrant or check, issued by the United States.
Internal Revenue Code Section 953(c) and (d)
Internal Revenue Code § 951 imposes an income tax on the "Subpart F" income attributable to a controlled foreign corporation ("CFC") of certain United States shareholders. Subpart F income includes insurance income such as from premium payments received by the CFC.
Subpart F insurance income under § 953(a) is not income which is effectively connected with the conduct of a trade or business within the United States. Thus, it is not specifically exempt from the excise tax imposed under § 4373. However, such income and/or premium payments may be exempt from the excise tax if an election is made by the foreign insurer under §§ 953(c) or (d). The excise tax exemption available under such election is consistent with the statutory language for exemptions set forth in § 4373.
Section 953(c) Election - A § 953(c) election is applicable to a CFC which is a captive insurance company. Internal Revenue Code § 953(c)(3)(C) provides an election to treat subpart F income, which is related person insurance income, as income effectively connected with the conduct of a trade or business in the United States. Section 953(c)(3)(D)(ii) exempts income subject to the section 953(c) election from the tax imposed by section 4371.
Related person insurance income is defined under I.R.C. § 953(c)(2) as “any insurance income … attributable to a policy of insurance or reinsurance with respect to which the person (directly or indirectly) insured is a United States shareholder in the foreign corporation or a related person to such shareholder”. Therefore, only related person insurance income is exempt from the foreign insurance excise tax. All unrelated insurance income is subject to the foreign insurance excise tax. Due to these restrictions, there are few § 953(c) elections.
Section 953(d) Election - Similarly, § 953(d) permits a CFC, meeting the reduced stock ownership threshold and other requirements set forth in § 953(d)(1), to make an election to be treated as a domestic corporation. Unlike a § 953(c) election, under a § 953(d) election, all income of the foreign insurer, including insurance premium income, is treated as the income of a domestic corporation.
Such an election causes the excise tax to be inapplicable since the tax applies only to policies insured with a foreign insurer. After the CFC makes the election, they are treated as a domestic insurer. It does not matter from whom the insurance premium income is from. All income is treated as the income of a domestic corporation. Revenue Procedure 2003-47, I.R.B. 2003-28 (June 20, 2003) provides rules and procedures pertaining to an election under § 953(d).
Important Note: Although a captive may hold a § 953(d) election and premium income to the captive is exempt from the foreign insurance excise tax, the activities of the captive concerning reinsurance premiums paid to other parties should be reviewed to determine if the cascading tax issue is present. Reference Chapter 7, Cascading, for more information on the cascading tax issue.
Exemptions from the tax under § 4371 may be established based upon tax treaties between the United States and a treaty country. Policies issued by a foreign insurer that is a resident of a treaty country may be exempt from the tax. There are two types of treaty exemptions; qualified and unqualified. (Appendix A notes a listing of the countries with each type of exemption.)
Qualified exemptions are the most common type of treaty exemption. Countries with current qualified treaty exemptions with the United States are:
Treaty Country Effective Date Treaty Country Effective Date
Cypress 1-1-86 Japan 1-1-05
Finland 1-1-91 Luxembourg 1-1-01
France 2-1-96 Mexico 1-1-94
Germany 1-1-90 Netherlands 1-1-94
India 1-1-91 Spain 1-1-96
Ireland 1-1-98 Sweden 1-1-98
Israel 1-1-95 Switzerland 1-1-98
Italy 1-1-85 United Kingdom 1-1-04*
* The United Kingdom insurer or reinsurer may elect to have the full provisions of the prior treaty apply for an additional 12 months. Should the United Kingdom insurer or reinsurer make this election, the provisions of the qualified treaty will take effect on January 1, 2005. The extension is allowed if the provisions of the prior treaty provide greater relief to the United Kingdom insurer or reinsurer than the new treaty.
The new UK treaty provisions are discussed in full at the end of the Qualified Treaty section of this Chapter.
Qualified Exemption Requirements - In order for a foreign insurer to be entitled to a qualified excise tax exemption, the following are required:
Compliance with the anti-conduit provision, and
A valid closing agreement (or proof that the residency and Limitations on Benefits requirements have been satisfied).
Anti-conduit Provision - Tax treaties with a qualified exemption contain an anti-conduit provision which eliminates the excise tax exemption to the extent the foreign insurer reinsures the risks with a person/entity not itself entitled to an excise tax exemption under a treaty with the United States.
In other words, if an insurer located in a qualified treaty country reinsured with a reinsurer located in a non-treaty country, the exemption provided under the treaty with the qualified treaty insurer is lost to the extent of the amount reinsured. The amount of premium payment which was reinsured becomes subject to excise tax. The anti-conduit provision prohibits the qualified treaty country insurer from acting as a front for non-exempt country insurers.
Example: Foreign Insurer A, domiciled in France, accepts premiums for casualty insurance on United States risks from Domestic Company B in the amount of $ 1,000,000. Foreign Insurer A reinsures $ 600,000 of the premiums with Foreign Insurer C located in Bermuda. Foreign Insurer C does not have a valid section 953(d) election and is considered to be a taxable entity for foreign insurance excise tax. The remaining $ 400,000 in premiums remain with Foreign Insurer A. When Foreign Insurer A reinsured with Foreign Insurer C, the provisions of the qualified tax treaty between the United States and France were violated for the amount of premiums reinsured. This results in the $ 600,000 of reinsured premiums becoming subject to the 4% excise tax for the transaction between Foreign Insurer A and Domestic Company B. In addition, the reinsured premiums paid from Foreign Insurer A to Foreign Insurer C are subject to the 1% tax on reinsurance as cascading tax. Cascading tax is discussed further in Chapter 7.
Closing Agreement - The second requirement which must be met, is that the foreign insurer must satisfy the residency and Limitations on Benefits requirements as provided in the treaty. Because of the complexity of these requirements, procedures to obtain a closing agreement are located in Rev. Proc. 2003-78, I.R.B. 2003-45 (October 10, 2003), have been implemented. A closing agreement helps to facilitate the administration of the tax treaty exemptions by ensuring that the residency and Limitations on Benefits provisions have been complied with before a closing agreement is entered into with a foreign insurer.
As part of the closing agreement procedures, the foreign insurer is required to maintain records including items of insurance and reinsurance subject to the treaty exemption. Such records must be maintained for six years and be made available to the Service upon the Service’s written request. A letter of credit is also required and serves as a source of payment in the event the foreign insurer violates the anti-conduit provision or otherwise owes excise tax.
The closing agreement procedures set forth in the revenue ruling is not a legal prerequisite for the treaty exemption. However, in practically all cases, a foreign insurer entitled to an excise tax exemption will have followed these procedures. A closing agreement is the only practical means of providing a U.S. insurer/beneficiary with assurance that the premiums are not subject to the tax.
Special Provisions of the Qualified Treaty between the United States and the United Kingdom – The qualified treaty with the United Kingdom has an additional caveat to the anti-conduit position found on the other tax treaties providing qualified exemptions. In the case of a foreign insurer or reinsurer domiciled in the United Kingdom and meeting all other treaty provisions, the anti-conduit provision of the treaty will not be violated if the United Kingdom insurer reinsures premiums to an entity not exempt for the foreign insurance excise tax unless the United Kingdom insurer acts as a conduit to reduce the amount of tax due.
Example: Foreign Insurer A, domiciled in the United Kingdom and meeting all other provisions of the income tax treaty between the United States and the United Kingdom, accepts premiums for casualty insurance on United States risks from entities in Domestic Affiliated Group B in the amount of $ 1,000,000. Foreign Insurer A reinsures $ 1,000,000 of the premiums with Captive C located in Bermuda. Captive C is owned by the parent company of Domestic Affiliated Group B and does not hold a section 953(d) election. Before the implementation of this insurance arrangement with Foreign Insurer A, Domestic Affiliated Group B paid its insurance premiums directly to Captive C and paid the 4% excise tax on the transaction. After implementation, Domestic Affiliated Group B stopped paying any excise tax on foreign insurance and claimed exemption from the tax based on the tax treaty between the United States and the United Kingdom.
In this case, Foreign Insurer A is acting as a conduit to reduce the amount of excise tax paid on the insurance premium transactions. Therefore, the provisions of the tax treaty between the United States and the United Kingdom have been violated and the premium payments from Domestic Affiliated Group B to Foreign Insurer A are taxable at the 4% casualty insurance rate. In addition, the 1% reinsurance tax is imposed on the transaction of reinsurance between Foreign Insurer A and Captive C as cascading tax. Cascading tax is discussed further in Chapter 7.
Requirements for domestic entity to treat exemption as valid for Qualified Treaties - A person otherwise required to file a return and pay the excise tax may consider the policy exempt from the insurance excise tax under an income tax treaty if:
The premiums are paid to an insurer or reinsurer that is a resident, for treaty purposes, of a country with which the United States has a treaty containing an excise tax exemption and,
Prior to filing the return for the taxable period, such person has knowledge that there was in effect for such taxable period a closing agreement between the Internal Revenue Service and the foreign insurer or reinsurer. Cite: Rev. Proc. 2003-78.
Valid and revoked closing agreements are maintained in Washington, D.C. To confirm if a particular foreign insurer has a closing agreement and/or is listed as a resident insurer/reinsurer of a particular treaty country, contact the Foreign Insurance EIS with the name and country of domicile of the foreign insurer or reinsurer in question.
Unqualified exemptions have only one requirement for the premium payment to be exempt from the excise tax on foreign insurance. The foreign insurer or reinsurer is required to be a resident of the treaty country either during the last three months of the calendar year preceding the calendar year in which the taxable period occurs, or during the taxable period.
Countries with tax treaties containing an unqualified excise tax exemption include:
United Kingdom, (through December 31, 2003*), Hungary, Romania and The Soviet countries of Armenia, Azerbaijan, Belarus, Georgia, Kazakhstan, Kyrgyz Republic, Moldova, Tajikistan, Turkmenistan, Ukraine, and Uzbekistan. Russia entered into a separate treaty with the U.S. in 1992, which currently does not contain an insurance premium tax exemption.
* The United Kingdom insurer may elect to have the full treaty provisions apply for an additional period of 12 months. If this election is made, the treaty provisions will apply through December 31, 2004. The extension is allowed if the provisions of the prior treaty provide greater relief to the United Kingdom insurer or reinsurer than the new treaty.
No Anti-conduit Provision - Tax treaties with unqualified exemptions do not contain an anti-conduit provision. Therefore, the foreign insurer or reinsurer may reinsure with a taxable reinsurer and not lose the exempt status of the payment from the domestic entity to the unqualified foreign insurer.
Requirements for Domestic Entity to Treat Exemption as Valid for Unqualified Treaties – As with qualified treaty exemptions, a closing agreement may be entered into by a foreign insurer or reinsurer located in an unqualified treaty country. The closing agreement assists in ensuring that the residency provisions of the unqualified treaty have been complied with before a closing agreement is entered into with a foreign insurer.
If there is no closing agreement, the person relying on the excise tax exemption provided by a tax treaty with an unqualified exemption must have a copy of the certification of residency by the taxing authority of the treaty country. Further, the person required to remit the excise tax may not consider the policy exempt if prior to filing the return for the taxable period, such person has knowledge that the foreign insurer or reinsurer was not a resident of the treaty country during the taxable period. Cite: Rev. Proc. 84-82
Filing Requirements for Treaty-Based Exemptions
Internal Revenue Code § 6114 provides the general rule on the disclosure of treaty-based returns. In particular, § 6114 provides as follows:
In general. Each taxpayer who, with respect to any tax imposed by this title, takes the position that a treaty of the United States overrules (or otherwise modifies) an internal revenue law of the United States shall disclose (in such manner as the Secretary may prescribe) such position -
on the return of tax for such tax (or any statement attached to such return), or
if no return of tax is required to be filed, in such form as the Secretary may prescribe.
Waiver authority. The Secretary may waive the requirements of subsection (a) with respect to classes of cases for which the Secretary determines that the waiver will not impede the assessment and collection of tax.
Under Treas. Reg. § 301.6114-1(c)(1)(vii), the Secretary has waived the disclosure requirement for treaty-based excise tax exemptions with respect to insureds and insurance brokers. In other words, only the insurer is required to file a treaty-based disclosure under § 6114. This is filed on Form 8833, Treaty Based Position Disclosure Under Section 6114 or 7701(b).
However, if the insurer files an annual Form 720 with the required § 6114 disclosure no later than the date on which the return is due for the first quarter after the end of the calendar year, it will not have to file disclosures for that year. Also, if the insurer has entered into a closing agreement with the Service which exempts the insurer from excise tax, the insurer will then be exempt from the § 6114 disclosure requirement noted above.
It should be noted that in the case of reinsurance, the insurance company reinsuring a policy covering United States risks is considered the insured as contemplated under Treas. Reg. § 301.6114-1(c)(1)(vii)(A). As such, the requirement to file a treaty-based disclosure under § 6114 falls not on the reinsured company but instead, on the foreign reinsurer.
Exemption for Exported Products
The Export Clause of the United States Constitution provides that “No Tax or Duty shall be laid on Articles exported from any State.” Therefore, the tax can not be applied to insurance premiums covering the export transit of goods from the United States. Cite: United States v. International Business Machines Corp., 517 U.S. 843, 96-1 USTC ¶ 70,059 (1996).
For a qualified or an unqualified treaty exemption, a copy of the closing agreement is to be requested from an insured or broker claiming a treaty exemption on premiums paid to a foreign insurer. If a taxpayer is unable to provide a closing agreement, or does not hold a closing agreement with the United States, an information document request should be issued to verify that the foreign insurer satisfies the residency requirements of the treaty.
In addition, for qualified treaty exemptions, the information document request should request that the taxpayer verify that the foreign insurer satisfies the Limitations on Benefits section of the applicable tax treaty. In either case, information is to be obtained as to whether any portion of the premiums paid to the foreign insurer were reinsured with a taxable reinsurer. This information may affect the exemption status of the premiums paid to the foreign insurer or reinsurer under the treaty and may give rise to cascading tax on the reinsurance premiums paid to the subsequent foreign reinsurer. Cascading tax is discussed further in this Guide.
Continued at http://www.irs.gov/businesses/small/art ... 63,00.html