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WASHINGTON, April 23 — Three trade associations have issued a public comment to the U.S. Department of the Treasury Internal Revenue Service. The comment was written on April 20, 2022, and posted on April 21, 2022:

The comment was co-signed by David F. Pearce Jr., vice president and director of tax policy at the American Property Casualty Insurance Association; Jonathan Rodgers, director of financial and tax policy at the National Association of Mutual Insurance Companies and Joseph B. Sieverling, senior vice president and director of financial services at the Reinsurance Association of America.

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To: Lily Batchelder, Esq., Assistant Secretary for Tax Policy, Department of Treasury, 1500 Pennsylvania Avenue, NW, Washington, DC 20220

Charles Rettig, Esq., Commissioner, Internal Revenue Service, 1111 Constitution Avenue NW, Washington, DC 20224

RE: Guidance on Related Party Insurance Income (IRS REG-118250-20)

Dear Secretary Batchelder and Commissioner Rettig:

We are writing today on behalf of the American Property Casualty Insurance Association (“APCIA”), the National Association of Mutual Insurance Companies, and the Reinsurance Association of America (the “Trades”). The Trades collectively represent the great majority of insurance companies issuing property and casualty (non-life) insurance throughout the United States.

On January 25, the IRS released proposed regulations altering the rules for the determination and inclusion of related person insurance income (“RPII”) under Code Section 953(c). At the same time, the IRS issued proposed rules regarding the aggregate treatment of domestic partnerships and S corporations that own stock in passive foreign investment companies (“PFICs”). This comment letter focuses upon the impact of the proposed RPII regulation on property/casualty insurance and reinsurance companies.

The proposed regulation has applied a special rule meant for captive insurers to commercial insurers and reinsurers, contrary to the intent of the statute. The proposed regulation creates a new concept of a “related insured” that significantly expands the definition of RPII and causes routine, non-tax motivated, ordinary insurance transactions to be treated as RPII. In contrast, under current rules, a U.S. shareholder in a commercial insurer or reinsurer does not recognize RPII income, because of the de minimis exceptions provided in Section 953(c). The broader definition requires information about related persons and their affiliates not available to commercial insurers and reinsurers in the ordinary course of business. The new concept is an inappropriate expansion of the RPII definition, especially in cases where the insurer is publicly traded.

INSURANCE IS A GLOBAL BUSINESS

Insurance companies provide coverage for a wide range of risks, some more predictable, like automobile and homeowner lines; some more volatile, such as medical malpractice; and some infrequent but severe, such as catastrophic coverage for hurricanes, earthquakes and wildfires. To offer coverage at reasonable rates and operate efficiently with a low risk of insolvency, insurers diversify their risks by line of business and geographically, often on a global basis.

Risk diversification is essential to professional risk management, and is accomplished in two ways: within a group, insurers use affiliate reinsurance to transfer risks to a group reinsurer that pools risks of different types and from different geographic areas to attain sufficient diversification; insurers and reinsurers also transfer risks to reinsurers outside their corporate group to limit liability on specific risks, stabilize loss experience, and protect against catastrophes. Third party reinsurers include both domestic companies and foreign reinsurers selling directly to U.S. insurers or through U.S. subsidiaries.

Transferring risk globally benefits consumers by enabling the U.S. to recover more quickly from catastrophes and reducing the impact of major catastrophes upon the U.S. economy. In summary, global transfer of risks increases U.S. insurance capacity and enables companies to offer coverage at more reasonable costs.

ANALYSIS

Under Code Sec. 952(a), “insurance income” is included in Subpart F income. Code Sec. 953(c)(2), which creates a special rule for captive insurance companies, defines related person insurance income as any insurance income attributable to a policy of insurance or reinsurance with respect to which the person (directly or indirectly) insured is a U.S. shareholder in the foreign corporation or a related person to such shareholder. For purposes of the RPII rules, a U.S. shareholder may own any amount of stock, no matter how small, a standard that creates a wide net for related persons. A U.S. shareholder is required to include his pro rata share of RPII income in his income annually. RPII income imputed to the U.S. shareholder may be substantially different from actual dividends paid or accrued during the year.

The new definition of “related insured” in Prop. Reg.Sec. 1.953-3(b)(1)(ii) adds two new categories (C) and (D) to the entities included in the definition:

(A)A U.S. shareholder of the foreign corporation,

(B) A person (individual, partnership, corporation) that is related to a U.S. shareholder,

(C) A pass-through entity if a related insured (other than a pass-through entity) owns stock in the foreign corporation indirectly,

(D)A person (other than a publicly traded corporation or publicly traded partnership) that is more than 50% owned by the U.S. shareholder of the foreign corporation.

1. THE PROPOSED REGULATION INAPPROPRIATELY EXTENDS TO COMMERCIAL REINSURANCE TRANSACTIONS TREATMENT INTENDED ONLY FOR CAPTIVE INSURANCE COMPANIES

For most insurance groups, foreign as well as domestic, the expanded reach of new Subsection D draws into RPII income routine transactions between affiliates. Insurance groups, both foreign and domestic, routinely engage in affiliate reinsurance, so that there will be diversification of risk by line of business and geographically. Affiliates in different jurisdictions are typically 100% owned by the holding company, so that the 50% ownership threshold of Subsection D would be met if the holding company is more than 50% owned (directly or indirectly) by U.S. persons. If routine affiliate reinsurance is treated as RPII, a substantial amount would likely be treated as taxable to U.S. shareholders that, in reality, has little or no relationship to the U.S. shareholder. The new definition of a “related insured” equates routine commercial reinsurance transactions which do not involve tax avoidance motives with those of the captives that were the target of Section 953(c).

The legislative history of Section 953(c) makes it clear that the special rule was intended to apply to captive insurance companies; it makes no mention of application of the RPII rule to commercial insurance companies. The Conference Report on the 1986 Act/1 provides,

“Generally, a captive insurance company is considered to be a company organized by one or more persons primarily to provide insurance protection to its owners or persons related to its owners. The new rule will limit the unintended tax advantages presently received by U.S. taxpayers that jointly own, with a number of other persons, offshore captive insurers.

One of the major U.S. tax benefits presently claimed by certain offshore captives is exemption from current taxation under subpart F.”

By applying a rule intended to prevent tax avoidance by captive insurance companies to commercial insurance and reinsurance companies, the proposed regulation is inconsistent with the intent of the statute. The extension of Section 953(c) to commercial reinsurance is unwarranted. It is essential that any new rule make a clear distinction between captives and commercial insurance companies.

2 THE PROPOSED REGULATION PRECLUDES RELIANCE UPON LONG STANDING EXCEPTIONS

The exceptions on which foreign insurers and their shareholders have long relied appear to be significantly limited under the proposed regulation. The de minimis stock exception of Code Section 953(c)(3)(A) provides that insurance income will not be RPII if at all times during the taxable year less than 20% of the total combined voting power of all classes of stock and less than 20% of the total value of the corporation is owned (directly or indirectly) by persons who are insured under an insurance policy issued by the corporation or a related person to the foreign

1 Tax Reform Act of 1986, Conference Report, H.R. 3838, September 18, 1986. page II-616 to II-626. H.R. 3838 became P.L. 99-514.

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corporation. The de minimis income exception of Code Section 953(c)(3)(B) provides that insurance income will not be RPII if RPII income on a gross basis is less than 20% of gross insurance income. It would appear that the de minimis stock ownership exception would become unavailable and the de minimis income exception would be much less likely to apply to any foreign insurance company assuming risk from a related insured that meets the definition under Prop. Reg. Section 1.953(b)(1)(ii)(D).

Prop. Reg. Section 1.953-3(b)(1)(ii)(D) provides an exception to the definition of a “related insured” for a person “other than a publicly traded corporation or publicly traded partnership.” The exception for publicly traded entities is welcome, but needs clarification. International insurance groups typically have a holding company that is publicly traded with insurance companies in various countries held beneath the top tier holding company. Read literally, the exception would cover only the holding company and leave the insurance subsidiaries subject to the RPII rules. A preferred interpretation would be to treat a publicly traded corporation and affiliates of a publicly traded corporations as excluded under the publicly traded exception. In the alternative, the regulation might provide that for purposes of Section 1.953-3(b)(1)(v), stock owned by a non-U.S. publicly traded corporation should not be treated as owned by a U.S. person.

3. THE PROPOSED REGULATION REQUIRES INFORMATION NOT AVAILABLE IN THE ORDINARY COURSE OF BUSINESS

U.S. shareholders of foreign insurance and reinsurance companies include many different types of investors from mutual funds, investment funds, and other insurance companies to manufacturers, pharmaceutical companies, and individual investors. U.S. shareholders could also include U.S. owners of foreign entities that are the direct shareholders of a foreign insurance group. Although the foreign insurer may know the location of the U.S. shareholder, it has no information about the extent of the shareholder’s U.S. and non-U.S. business activities. Furthermore, a foreign insurer that is a subsidiary of a publicly traded company will have a constantly changing shareholder base and will not be able to determine with certainty all of its U.S. shareholders at a particular point in time.

The proposed RPII definition of “related insured” requires information far more granular than that ordinarily collected by reinsurers. Altering current information collection practices would be unreasonably expensive and would deter policyholders from buying coverage from insurers that attempted to comply. In reality, it is impossible for the foreign insurer to make the determination required by the proposed definition of a “related insured.”

RECOMMENDATIONS

1. RAA recommends that the new concept of a “related insured” in Prop. Reg.Sec. 1.9533(b)(1)(ii) should not be adopted because it treats routine affiliate reinsurance transactions entered into by commercial insurers to satisfy risk diversification standards as abusive, and inappropriately extends RPII treatment to ordinary, non-tax motivated reinsurance transactions.

2. The de minimus exceptions designed to relieve commercial insurers from the RPII rules for captives should be made available to commercial insurers. The definition of “related insured” should not end commercial insurers long-standing reliance upon these exceptions.

Further, to clarify the exception for publicly traded insurers, in Prop. Reg. Section 1.9533(b)(1)(ii)(D) should state that it applies to a publicly traded corporation and its affiliates, not merely to the one entity that is publicly traded.

3. In addition, the proposed regulation would require commercial insurers, who provide essential coverage to U.S. businesses and homeowners, to collect detailed information impossible to obtain under ordinary business practices. At a minimum, the proposed regulation should be revised so that it applies only to the captive insurance companies that are the intended target of Code Sec. 953(c)(2).

If you have questions, please contact David Pearce ([email protected] or 202-8287114), Jonathan Rodgers ([email protected] or 317-876-4206), or Joseph Sieverling ([email protected] or 202-783-8312).

Sincerely,

____________________________ ____________________________

David F. Pearce Jr., Vice President and Director of Tax Policy, American Property Casualty Insurance National Association

Jonathan Rodgers, Director of Financial and Tax Policy, National Association of Mutual Insurance Companies

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Joseph B. Sieverling, Senior Vice President and Director of Financial Services, Reinsurance Association of America

TARGETED NEWS SERVICE (founded 2004) features non-partisan ‘edited journalism’ news briefs and information for news organizations, public policy groups and individuals; as well as ‘gathered’ public policy information, including news releases, reports, speeches. For more information contact MYRON STRUCK, editor, [email protected], Springfield, Virginia; 703/304-1897; https://targetednews.com