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Wyden’s Offshore Reinsurance Bill Aims to Combat Tax Loophole


August 2015

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Synopsis

On June 25, 2015, Senator Ron Wyden (D-OR) introduced legislation to combat what has been called a tax loophole for hedge funds’ use of offshore reinsurers. The Offshore Reinsurance Tax Fairness Act restricts hedge funds’ ability to use offshore reinsurance arrangements to avoid passive foreign investment company (PFIC) rules. Senator Wyden has sought to close the perceived loophole for years and this current bill attempts to ensure that only legitimate insurers will be exempt from PFIC rules.

Issue

The PFIC rules prevent U.S. taxpayers from deferring U.S. tax on passive income by making investments through a foreign corporation. An exception to the PFIC rules provides an exemption to a foreign insurance company. However, Senator Wyden’s bill requires a foreign insurer to qualify for the exemption through a test that measures the percentage of a corporation’s insurance liabilities under three scenarios:

  1. If the foreign corporation has insurance liabilities that comprise more than 25% of its total assets, it is treated as a “qualifying insurance corporation” and entitled to the exemption from the PFIC rules under section 1297(b)(2)(B) of the Code.
  2. If the foreign corporation has insurance liabilities that are 10% to 25% of its total assets, and the corporation is predominantly engaged in an insurance business, a shareholder of the company can elect a “facts and circumstances” test to prove it should qualify for the PFIC exemption.
  3. If the foreign corporation has insurance liabilities that are less than 10% of its total assets, it cannot qualify for the PFIC exemption.


The bill does not provide any indication of how it would resolve certain ambiguities, such as the fact that many reinsurers that insure low frequency, catastrophic risks such as earthquakes or terrorism would not meet the 25% test. In addition, it is not clear which facts and circumstances would be relevant in proving a foreign corporation would qualify for the exemption. Further, since the bill will require the cooperation of foreign companies in obtaining information to apply the tests, these companies may be reluctant to share financial information with shareholders.

What Does CohnReznick Think?

In general, the bill ignores the reality of the reinsurance business and is overly broad. For example, it has been proposed that, in order meet the “facts and circumstances test” in the proposed legislation, an insurance company must have its own employees involved in the insurance business and cannot rely on contractors from affiliates. This requirement has drawn criticism due to the current state of operations of reinsurance companies. In addition, it is unlikely that Congress will be able to either prioritize standalone tax legislation or come to an agreement to pass the bill or enter into conference and debate its provisions. The IRS will continue to scrutinize these transactions.

Contact

For more information, please contact James Wall, Principal, at james.wall@cohnreznick.com or 646-254-7460, or Jonathan Babu, Senior Manager, at jonathan.babu@ccohnreznick.com or 301-664-8111.

To learn more about CohnReznick’s Tax Practice, please visit our webpage.


Any advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues. Nor is it sufficient to avoid tax-related penalties. This has been prepared for information purposes and general guidance only and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick LLP, its members, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.

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