1. US Tax Update

2. Speakers Karey Dearden, Executive Director, EY
Scott Slater, Director, PwC
P. Bruce Wright, Partner, Sutherland Asbill & Brennan LLP

3. Agenda I. Modifications to the insurance framework
Rent-A-Center
Securitas
Revenue Ruling
II. Validus and the proposed PFIC regulations
III. What’s on the horizon?
Section 831(b) decision
Insurance risk & common notions of insurance
IV. Direct Placement Tax

4. Rent-a-Center v. Commissioner
Opinion issued by the Tax Court on January 14, 2014
Majority found all requisite requirements of insurance to be met:
Risk shifting (dissent disagreed – relied on Humana)
Risk distribution (dissent did not comment)
Insurance risk
Common notions of insurance (dissent disagreed on loanback)
IRS chose not to appeal

5. Rent-a-Center v. Commissioner
Court applied a facts and circumstances test which considered the following key items:
RAC is a public company in “rent to own” business
Owned a Bermuda-based captive, Legacy Insurance Company, Ltd.
IRC Section 953(d) election in place
Captive insured 4-12 subsidiaries in years in question
One subsidiary represented approximately 67% of the risk premiums
“Parental Guaranty”
The parent provided a limited “parental guaranty” relating to a DTA (~$25M) for the BMA “relevant asset test” purposes
Captive owned treasury shares of the parent worth ~$108M

6. Rent-a-Center v. Commissioner
Key facts (cont’d)
Parent paid premiums to Legacy on behalf of subs and used its cost accounting formula to allocate premium expense based on each sub’s exposure units
Standard coverages – WC, AL, GL
Structured as a deductible buy-back program
Independent actuary and third party administrator
Premiums and paid losses were “netted” for settlement purposes

7. Rent-a-Center v. Commissioner
Key Findings
IRS sham argument rejected
Legacy formed for valid non-tax business purposes
Risk clearly shifted to legacy from subs (but not parent)
“Brother-sister” theory accepted
‘Limited’ parental guaranty not a “fatal flaw”
Majority believed guaranty did not prevent risk shifting
Captive was adequately capitalized
$25m relatively small compared to premium levels (>$250m)
Guaranty never used and removed after unnecessary for BMA

8. Rent-a-Center v. Commissioner
Key Findings (cont’d)
New standard for ‘risk distribution’
Majority opinion primarily focused on risks rather than entities
No mention of ‘entity theory’ as set forth in Rev Ruls , and
Court addressed ‘loanbacks’ with respect to treasury shares
Majority - No circular cash flow as shares were not sold
Dissent – Legacy a ‘holding tank for cash’ and loanback along with parental guaranty negated risk shifting

9. Securitas Holdings, Inc. v Commissioner
Key facts
Ultimate parent was Securitas AB (“AB”), a Swedish public company
AB owned Securitas USA Holdings, Inc. (“SHI”), a US affiliate
AB acquired a number of US guard businesses which is consolidated into a few subsidiaries
SHI owned a between 4-11 US subsidiaries for the years at issue
One subsidiary represented ~67% of the total risks
4 US subsidiaries represented ~ 90% of the total risks
SHI also owned Protectors Insurance Company (“Protectors”)
Vermont based captive
Insureds were ‘brother-sister’

10. Securitas Holdings, Inc. v Commissioner
Key facts (cont’d)
Deductible reimbursement policy with SHI affiliates and Protectors
WC, AL, GL, etc.
Protectors entered into a 100% assumption reinsurance arrangement with Securitas Global Reinsurance Limited (“SGRL”), an Irish captive.
Insureds and Protectors were brother-sister to SGRL
SHI provided a “parental guaranty” to Protectors to negate the “insurance” transaction between the SHI subsidiaries and Protectors
No amount ever paid under guaranty
Other stakeholders did not request/require the guaranty

11. Securitas Holdings, Inc. v Commissioner
Findings:
IRS asserted that Protectors was not an insurance company because the parental guaranty and risk was not shifted to SGRL
IRS asserted the concentration of risk in the SHI affiliate results in a lack of risk distribution
In a Tax Court Memorandum decision, the court concluded
the parental guaranty did not negate risk shifting to SGRL from the SHI affiliates
followed the Rent-a-Center decision with respect to risk distribution in commenting who owns the risk is not the critical question; rather the number of risks resulting from thousands of locations, employees and vehicles are key
The option to appeal the case to the 9th Circuit expired January 28, 2015

12. PASS-THROUGH ENTITIES
BROTHER/SISTER TEST
HUMANA INC. v. COMMISSIONER, 881 F.2d 241 (6TH Cir. 1989)
REV. RUL , C.B. 985
12 SUBSIDIARIES EACH WITH 5%-15% OF RISK
REV. RUL , C.B. 4
DEALT WITH SINGLE MEMBER LLC DISREGARDED FOR TAX PURPOSES
POSITION TAKEN THAT IN DETERMINING RISK DISTRIBUTION SINGLE MEMBER IS THE OWNER OF ASSETS IN THE LLC

13. PASS-THROUGH ENTITIES
REV. RUL
X NUMBER
LLC 1
LLC 2
LLC 3
LLC 4
LLC 5
LLC 6
LLC 7
LLC 8
LLC 9
LLC 10
LLC 11
LLC 12
Y INSURER
1 INSURED

14. PASS-THROUGH ENTITIES
STATUS OF SINGLE MEMBER LLC’S REGARDED
ILM – TAXPAYER PERFORMED SERVICES AND DIRECTED PAYMENT BE MADE TO LLC. IRS WANTED TO FILE A LIEN ON ASSETS OF LLC FOR TAXES OWED BY TAXPAYER. IRS DETERMINED IT COULD NOT BECAUSE UNDER STATE LAW TAXPAYER HAD NO RIGHT TO PROPERTY OWNED BY LLC
T.D NOTED EMPLOYEES SHOULD BE TREATED AS EMPLOYEES OF AN LLC FOR EMPLOYMENT TAX PURPOSES PARTICULARLY AS A RESULT OF STATE EMPLOYMENT TAX ISSUES
TECH. ADV. MEMO – IRS DID NOT LOOK THROUGH MULTI-OWNER LLC BASED ON STATE LAW ANALYSIS
SUZANNE J. PIERRE v. COMMISSIONER, 133 T.C. 24 (2009), TAX COURT TOOK THE POSITION THAT TRANSFERS OF INTERESTS IN AN LLC TREATED AS A DISREGARDED ENTITY TREATED AS SUCH RATHER THAN TRANSFER OF UNDERLYING ASSETS FOR GIFT TAX PURPOSES. SEE ALSO ReRI HOLDINGS INC. v. COMMISSIONER, T.C. MEMO (2014)

15. PASS-THROUGH ENTITIES
STATUS OF SINGLE MEMBER LLC’S REGARDED
HEALTHMARK GROUP LTD., GREGORY LENTZ A PARTNER OTHER THAN TAX MATTERS PARTNER v. COMMISSIONER, DOCKET NO , IRS HAD DISREGARDED 8 SUBSIDIARIES FORMED AS SINGLE MEMBER LLC’S AND DENIED DEDUCTION FOR PAYMENT TO SISTER CAPTIVE. MARCH 27, 2015 DECISION ENTERED STIPULATING ENTRY OF JUDGMENT PURSUANT TO WHICH ALL DEDUCTIONS ALLOWED

16. MEDICAL STOP LOSS BACKGROUND RELATED OR UNRELATED BUSINESS
PROGRAMS GENERALLY DESIGNED TO REIMBURSE EMPLOYERS WITH REGARD TO LOSS ASSOCIATED WITH SELF-INSURED PROGRAMS
STATE MINIMUM PER INDIVIDUAL AND AGGREGATE ATTACHMENT POINTS
STRUCTURED GENERALLY TO AVOID “PLAN” STATUS UNDER ERISA PER ADVISORY OPINION 92-02A, REIMBURSEMENT SOLELY TO THE EMPLOYER
RELATED OR UNRELATED BUSINESS
REV. RUL 92-93
REV. RUL 92-94
REV. RUL

17. MEDICAL STOP LOSS BACKGROUND
IRS HAS TAKEN THE POSITION THAT SUCH INSURED BENEFITS ARE EMPLOYEE NOT EMPLOYER RISKS, SEE REV. RUL
EMPLOYER
INSURER
PREMIUM
REINSURES
CAPTIVE
PAY BENEFITS
EMPLOYEES

18. MEDICAL STOP LOSS REV. RUL. 2014-15 FACTS RETIREES RETIREE MEDICAL
EMPLOYER
CONTRIBUTION
VEBA
REINSURES
INSURER
CAPTIVE
RETIREE MEDICAL
BENEFITS
RETIREES

19. MEDICAL STOP LOSS RELATED OR UNRELATED BUSINESS CONSEQUENCES
IS IRS POSITION TO LOOK THROUGH TO EMPLOYEES/RETIREES BASED ON CONTRACTUAL RELATIONSHIP BETWEEN INSURED AND ISSUER OF CERTIFICATE
CONSEQUENCES
ANALYZE YOUR PROGRAM AND DETERMINE WHETHER IT WILL BE ADVERSELY AFFECTED IF MEDICAL STOP LOSS ADDED AND IT IS TREATED AS RELATED BUSINESS
PREMIUMS PAID TO CAPTIVE DEDUCTIBLE BASED ON HUMANA ANALYSIS, SIMILAR SPREAD ON MEDICAL STOP LOSS
PREMIUMS PAID TO CAPTIVE NOT DEDUCTIBLE BASED ON HUMANA UNLESS RENT-A-CENTER/SECURITAS ANALYSIS APPLIES
PREMIUMS PAID, e.g., ONLY FOR PARENT RISK, AND DEDUCTION BASED ON UNRELATED BUSINESS

20. Validus
Facts
Validus is a foreign reinsurer that sells reinsurance policies to direct writers of insurance contracts, including contracts which reinsure US risks.
The policies with US risks are subject to 1 percent US federal excise tax (“FET”).
In 2006, Validus entered into and paid premiums on nine retrocession policies to protect itself against the risks assumed under the initial reinsurance policies that had already been subject to the FET.
The Service asserted that the retrocession premiums were also subject to the FET under section 4371(3). This is the Services’ cascading theory.
Validus paid the FET and sued for a refund in the US District Court for the District of Columbia.
The US District Court for the District of Columbia granted summary judgment for Validus and held that the plain language of section 4371(3) taxes only reinsurance transactions and does not impose an excise tax on retrocession insurance transactions.
The Service appealed.

21. Validus Appellate Court Decision
The US Court of Appeals for the District of Columbia (“Appellate Court”) reviewed the District Court opinion de novo.
The Appellate Court
(i) found both parties’ interpretation of the statute plausible, and concluded the statute “is ambiguous with respect to its application to wholly foreign retrocessions;”
(ii) found nothing to clearly indicate Congress intended the FET to apply to wholly foreign retrocessions’;
(ii) applied the presumption against extraterritoriality to clarify the meaning of the ambiguous statute; and
(iii) stated that applying the FET retrocession at issue “would extend the extraterritorial reach of section 4371 by allowing the tax to compound into perpetuity.”
The Appellate Court affirmed the District Court’s decision, though on narrower grounds, limiting its holding to retrocessions between two foreign entities, rather than to all retrocessions.

22. Proposed PFIC Regulations
Background
Proposed regulations were issued on April 23, 2015 pertaining to the insurance exception to the passive foreign investment company (“PFIC”) rules. 
A foreign corporation is a PFIC if either 75 percent or more of its gross income for the taxable year is passive income (“passive income test”), or on average 50 percent or more of its assets produce passive income or are held for the production of passive income (“passive asset test.”)
Passive income is generally defined as income of a kind that would be “foreign personal holding company income” which includes dividends, interest, royalties, rents, annuities, certain property transactions, etc.
An asset is characterized as passive if the asset generates (or is reasonably expected to generate in the foreseeable future) passive income.

23. Proposed PFIC Regulations
Background
The statute provides an exception to the passive income definition for “income derived in the active conduct of an insurance business by a corporation which is predominately engaged in an insurance business and which would be subject to tax as an insurance company if such company were a domestic company.”
The proposed regulations do provide a definition for “active conduct” and “insurance business.”
“Predominately engaged” was not defined given the stricter and more precise definition of a domestic insurance company included in the statute.

24. Proposed PFIC Regulations
Summary of Proposed Regulations
The proposed regulations provide that (i) passive income does not include income earned by a foreign company that would qualify as a domestic insurance company,  if such company were a domestic company, and (ii) the income is derived in an active conduct of an insurance business.
The term “active conduct” means the company’s officers and employees carry out substantial managerial and operational activities. 
A company can be engaged in an active trade or business if incidental activities are carried out by independent contractors; however, in determining whether the officers or employees carry out substantial managerial and operational activities, the activities of the independent contractors are disregarded.  
The term “insurance business” means the business of issuing insurance and annuity contracts and the reinsuring of risks underwritten by insurance companies together with investment activities and administrative services required to support the insurance business.  The investment activities are to produce income to meet the insurance obligations.

25. THE IRC §831(b) ARENA LEGISLATION INITIAL DRAFT BY JOINT COMMITTEE
INCREASED IRC §831(b) LIMIT FROM $1,200,000 TO $2,200,000
REQUIRED NO MORE THAN 20% OF NET WRITTEN PREMIUM ATTRIBUTABLE TO ANY ONE POLICYHOLDER AND PRECLUDED REINSURANCE
NEXT DRAFT
INCREASE ONLY
INCREASE
STUDY TO BE COMPLETED EARLY 2016

26. THE IRC §831(b) ARENA IR 2015-19 IRS COMMENT ON ABUSIVE TAX STRUCTURES
RECOGNIZES VALID CAPTIVES
CRITICIZES POORLY DRAFTED BINDERS AND POLICIES, IMPLAUSIBLE RISKS, EXORBITANT PREMIUMS
WHILE MAINTAINING COMMERCIAL COVERAGES WITH TRADITIONAL INSURERS
UNDERWRITING AND ACTUARIAL SUPPORT “MISSING OR INSUFFICIENT”
HEFTY FEES FOR PROMOTORS
USE OF TRUSTS/ESTATE PLANNING

27. THE IRC §831(b) ARENA
AVRAHAMI v. COMMISSIONER, FEEDBACK INS. CO. v. COMMISSIONER
PREMIUM PAID BY 4 COMPANIES OWNED BY BENYAMIN AND ORNA AVRAHAMI TO FEEDBACK INSURANCE CO. LTD. (FICL), A ST. KITTS/NEVIS ENTITY OWNED BY ORNA, IRC §953(d) ELECTION, PREMIUM WITHIN IRC §831(b) LIMITS
FOR 2009/2010 YEARS AT ISSUE, FICL OFFERED COVERAGES TO THE 4 COMPANIES THAT IRS DESCRIBED AS “BUSINES SINCOME,” “LITIGATION EXPENSE,” “EMPLOYEE FIDELITY,” “LOSS OF KEY EMPLOYEE,” “TAX INDEMNITY,” “BUSINESS RISK,” AND “ADMINISTRATIVE ACTIONS”
NO PAYMENTS/CLAIMS 2009/2010
NO REINSURANCE OUTWARD

28. THE IRC §831(b) ARENA
AVRAHAMI v. COMMISSIONER, FEEDBACK INS. CO. v. COMMISSIONER
PARTICIPATED IN A TERRORISM POOL IN EACH OF 2009/2010 ADMINISTERED BY PAN-AMERICAN REINSURANCE CO. PREMIUM CEDED ON FUNDS WITHHELD BASIS. PREMIUM 33% IN 2009 AND 31% IN 2010
ALL BUT ABOUT $6,000 LOANED TO COMPANY BELLY BUTTON CENTER LLC OWNED BY 3 CHILDREN OF AVRAHAMI. NO PRINCIPAL OR INTEREST PAID ON LOANS
IRS ARGUES
NO ECONOMIC SUBSTANCE AND AS SUCH ALL TRANSACTIONS SHOULD BE DISREGARDED
TRANSACTIONS WITH 4 COMPANIES IS NOT INSURANCE
TRIAL HELD

29. Insurance Risk & Common Notions of Insurance TAM 201149021
Facts
Taxpayer filed as a domestic property and casualty insurance company.
Taxpayer entered into contracts with unrelated parties (“protected parties”).
Taxpayer was obligated to pay the excess of (i) the predicted residual value of the protected asset over (ii) the fair market value of the asset at the end of the lease term. The payment was referred to as the “residual value payment.”
A protected party could elect to have the contracts apply to a group of assets.
The contracts covered multiple classes of assets including passenger vehicles, commercial equipment, and commercial real estate that the protected parties leased to third parties.

30. Insurance Risk & Common Notions of Insurance TAM 201149021
Facts (continued)
The length of the contracts differed, and some contracts pertaining to commercial assets could have a length of 10 to 25 years.
The contracts were issued in the commonly accepted form of an insurance contract and had insurance standard policy provisions.
Taxpayer’s obligation to make a residual value payment matured only at the end of the contract term. Fluctuations in the protected asset’s value during the term of the contract did not create a liability unless the decline was permanent.

31. Insurance Risk & Common Notions of Insurance TAM 201149021
Service’s Position
The Service’s overall conclusion was that the substance of the arrangement did not satisfy three of the factors to have an insurance arrangement: (i) lacked insurance risk, (ii) was not insurance in the commonly accepted sense, and (iii) lacked risk distribution.
Insurance risk - The Service concluded the risk was more akin to an investment risk than to an insurance risk.
Common notions of insurance - The Service noted that while the contract may ensure the projected income from market forces, the event which triggers the contract is made at contract termination and such a measurement is not a casualty event.
Risk distribution - The Service took the view all the risks were interdependent; as such, risk distribution was not present.

32. Insurance Risk & Common Notions of Insurance CCA 201511021
Facts
Taxpayer is a multinational enterprise.
Taxpayer has a domestic captive that writes a wide variety of insurance business, e.g., automobile liability, credit guarantee, earthquake damage, retiree medical cost, etc.
Captive began insuring “loss of earnings” arising from foreign currency (“FX”) transactions.
“Loss of earnings” was defined as the percentage increase or decrease in the rate of exchange of the US dollar against the specified foreign currency between the effective and expiration dates multiplied by the coverage limit.

33. Insurance Risk & Common Notions of Insurance CCA 201511021
Facts (continued)
Contracts were issued for 12 months, and each contract started at a different month, e.g., January, February, March, etc.
Contracts were retrospectively rated contracts.
Policy premium was determined using a specific formula and option market data was used in calculating the premium.
The contracts had many features commonly found in insurance policies.
No one insured had more than 15 percent of the premium paid to the captive.
No mention of any parental guarantee, premium loan back, or other aspect that would be inconsistent with a bona fide insurance arrangement.

34. Insurance Risk & Common Notions of Insurance CCA 201511021
Service’s Position
The Service concluded the arrangement was not insurance because the contracts lacked insurance risk, are not insurance in the commonly accepted sense, and lacked risk distribution.
Insurance risk
The Service stated one should take into account such things as
(i) the ordinary activities of a business enterprise,
(ii) the typical activities and obligations of running a business,
(iii) whether an action that might be covered by a policy is in control of the insured within a business context,
(iv) whether the economic risk involved is a market risk that is part of the business environment,
(v) whether the insured is required by law or regulation to pay for the covered claim, and
(vi) whether the action in question is willful or inevitable.

35. Insurance Risk & Common Notions of Insurance CCA 201511021
Service’s Position
Common notions of insurance
The Service used similar arguments as were used in the residual value ruling to conclude the contracts were not insurance in the commonly accepted sense. Namely, (i) all products sold by insurance companies are not insurance contracts for US federal income tax purposes, (ii) a “casualty event” is required to damage or impair an asset or income to have an insurance contract, and (iii) that a contract termination date does not provide the type of event that gives rise to a casualty event.
Risk Distribution
  The Service noted a number of contracts were sold, but under the principles of Revenue Ruling , risk distribution did not occur.

36. Direct Placement Tax
Direct placement tax is imposed on an insured when directly procuring coverage from a non-admitted insurer (i.e. captive)
Payable based on rates, varying by states, on the net written premiums paid to the captive
Note, some states do not impose any direct placement tax
Direct placement tax is also known as self-procurement tax.
Direct placement tax arises when an insured directly procures coverage from a non-admitted insurer. As a captive domiciled in one state is treated as non-admitted in another state, an insured is potentially liable for paying direct placement tax based on net written premium paid to the captive.
Payable based on rates, varying by state, applicable to amount of premium allocated to each state.
Some states do not impose any direct placement tax
The insured parent or affiliate will be obligated to remit direct placement taxes to the state.

37. Direct Placement Tax - Illinois
Effective January 1, 2015, S.B imposes direct placement tax of up to 4.6% on insurance contracts independently procured from a non-admitted insurer by industrial insureds.
Industrial insureds are defined as those who,
Procure the insurance of Class 2 (casualty, fidelity, surety), or Class 3 (fire and marine) risks by use of services of a full-time employee who is a qualified risk manager’
Procures insurance from an unauthorized insurer without services of an intermediary insurance producer, and;
Is an exempt commercial purchaser whose home state (generally the principal place of business) is Illinois.
Effective January 1, 2015, S.B imposes direct placement tax of up to 4.6% on insurance contracts independently procured from a non-admitted insurer by industrial insureds.
Industrial insureds are defined as,
• Procures the insurance of Class 2 (casualty, fidelity, surety), or Class 3 (fire and marine) risks by use of services of a full-time employee who is a qualified risk manager
• Procures insurance from an unauthorized insurer without services of an intermediary insurance producer, and
• Is an exempt commercial purchaser whose home state (generally the principal place of business) is Illinois.
Through the addition of S.B. 3324, potential is created for companies with an Illinois home state insuring risks through non-admitted captive insurers to be subject to this new tax. As such, these companies would be subject to reporting responsibilities pertaining to these transactions to the Surplus Line Association of Illinois.
Illinois enacted a direct placement tax on non-admitted insurance companies in However, there is a strong movement in Illinois to repeal or narrow the tax.

38. Direct Placement Tax - Tennessee
Legislatively amended its direct placement tax on non-admitted insurance
Previously Tennessee had only imposed direct placement taxes on limited lines of business such as marine insurance
Section of the Tennessee Code Annotated expands its direct placement tax beyond marine insurance to industrial insureds, as similarly defined.
Tennessee has now legislatively expanded its direct placement tax on non-admitted insurance. Previously, the state has only imposed direct placement taxes on limited lines of business such as marine insurance.
Section of the Tennessee Code Annotated addresses the amendment by expanding its direct placement tax beyond marine insurance to industrial insureds, as similarly defined.

39. Questions
Questions?