Rev. Rul. 80-95

ISSUE

Whether the agreement described below, between a domestic corporation and a foreign insurer, is taxable either as an indemnity bond under section 4371(1) of the Internal Revenue Code at the rate of four cents on each dollar, or as a policy of life, sickness or accident insurance under section 4371(2) at the rate of one cent on each dollar.

FACTS

X, a domestic corporation, maintains long-term disability plans under which it is required to make payments to its United States citizen or resident employees and former employees. X entered into a contract with Y, a foreign insurer that is neither authorized to do business nor doing business in the United States. Under the contract, Y agrees to indemnify X for all payments X is obligated to make to its employees and former employees under the disability plans. In consideration, Y receives from X an annual payment that is actuarially computed on the basis of a disability table.

Y is not a party to any of X's employee disability plans and incurs no liability to any individual employee or former employee claiming a disability payment under one of the plans. Further, Y is not responsible for any failure of X to perform its duties under the disability plans, nor is Y responsible for the application or disposition by X of any money received from Y under their contract. The settlement and payment of disability claims is handled entirely by X. Under its contract with X, Y does have the right to audit claims made against a disability plan, and to protest when it feels X has improperly made a payment under a plan.

LAW AND ANALYSIS

Section 4372(c) of the Code defines "indemnity bond" as any instrument by whatever name called whereby an obligation of the nature of an indemnity, fidelity or surety bond is made, continued, or renewed. The term includes any bond for indemnifying any person who shall have become bound or engaged as surety, and any bond for the due execution or performance of any contract, obligation, or requirement, or the duties of any office or position, and to account for money received by virtue thereof, where a premium is charged for the execution of such bond.

Section 4372(e) defines "policy of life, sickness, or accident insurance, or annuity contract" as any policy or other instrument by whatever name called whereby a contract is made, continued, or renewed with respect to life or hazards to the person of a citi or resident of the United States.

The contract between X and Y is an agreement wherein Y's liability to X is contingent upon one of X's employees or former employees becoming disabled. The contract between X and Y is not an indemnity bond subject to the tax imposed by section 4371(1) of the Code. However, the question remains whether the contract is a policy of life, sickness, or accident insurance taxable under section 4371(2).

Although the independent and separate nature of the disability plans means that X's employees or former employees are not parties to the contract between X and Y, this lack of privity is not necessarily determinative as to the nature of that contract.

The character of the risk covered by the contract is "with respect to the life or hazards of the person" as that phrase is used in section 4372(e) of the Code, because (1) the premium is actuarially computed on the basis of a disability table, (2) the contract is directly related to X's disability plans (because the sole basis for a claim by X under its contract with Y is a prior payment by X to an employee or former employee under a disability plan), and (3) Y has the right to audit and protest the payments by X under the disability plans.

Because Y is obliged to indemnify X for losses sustained by X under the disability plans, the risk assumed by Y under the contract is the same as the risk borne by X under the disability plans. The fact that X has passed its risk to Y does not change the nature of the risk. The arrangement is similar to one of reinsurance in which the primary insurer transfers some or all of the risk it has assumed to a second insurance company. Thus the risk insured against under the contract is the risk of injury to employees or former employees of X. Therefore, the contract is a policy of "sickness or accident insurance" within the meaning of section 4372(e) of the Code.

HOLDING

The contract between X and Y is taxable at the rate of one cent on each dollar under section 4371(2) of the Code.