Rev. Proc. 90-36

Rev. Proc. 90-36

SECTION 1. PURPOSE

This revenue procedure provides an administrative procedure whereby certain life insurance companies may expeditiously obtain the consent of the Commissioner to change their method of accounting for ceding commissions to comply with the principles of Rev. Rul. 82-69, 1982-1 C.E. 102, and the Supreme Court decision in Colonial American Life Insurance Co. v. Commissioner, 109 S. Ct. 2408 (June 15, 1989), 1989-33 I.R.B. 5. A taxpayer that complies with this revenue procedure will be treated as having obtained the consent of the Commissioner to change its accounting method.

SEC. 2. BACKGROUND

01 Rev. Rul. 82-69 concerns a reinsuring life insurance company that paid ceding commissions under an indemnity reinsurance agreement. In an indemnity reinsurance agreement, the primary insurer remains directly liable to the policyholders and continues to collect premiums and pay claims. The indemnity reinsurer assumes no direct liability to the policyholders, but agrees to reimburse the primary or direct insurer for a specified percentage of claims and expenses associated with the reinsured risks. In return, the reinsurer receives a specified percentage of the income generated from the policies. In Rev. Rul. 82-69, the taxpayer paid ceding commissions to the direct insurer as consideration for the reinsurance of an existing block of life insurance policies. The stated purpose of these "up-front" ceding commissions was to reimburse the direct insurer for previously incurred expenses associated with selling and maintaining the reinsured policies. The ruling requires the ceding commissions to be treated as the cost of an asset with a useful life extending beyond the close of the tax year, and therefore amortized over the period covered by the agreement.

In the Colonial American case, the Supreme Court addressed the tax treatment of ceding commissions paid by a reinsuring life insurance company to a direct insurer under indemnity reinsurance contracts to reinsure blocks of life insurance policies. The case holds that, for purposes of the Internal Revenue Code, ceding commissions are capital expenditures that must be amortized over the anticipated life of the asset (here the reinsurance agreement), and are not current expenses that may be deducted in the year paid or incurred. The Court concluded that ceding commissions represent payments to acquire an asset (the future stream of income from the reinsured policies) with a life extending beyond the tax year. As a result, the ceding commissions must be treated like commissions involved in assumption reinsurance, which must be treated as a deferred expense and amortized over the reasonably estimated life of the policies. Cf. section 1.817-4(d) of the Income Tax Regulations.

Rev. Rul. 82-69 also provides for the current deductibility of an "annual ceding commission" paid by the reinsurer to reimburse the ceding company for the reinsurer's share of the current expenses in administering the policies. Consequently, if a taxpayer enters into an indemnity reinsurance contract that provides for the payment of an annual ceding commission to reimburse the direct insurer for the taxpayer's proportionate share of the current expenses involved in administering and servicing the reinsured policies, those ceding commissions may be deducted in the year paid or incurred.

If an up-front ceding commission is paid by the taxpayer to acquire an indemnity reinsurance agreement, but all or a portion of the assumed business is retroceded to third parties, the taxpayer is required to amortize only the portion of the ceding commission that is proportionate to the retained business. Thus, the portion of the ceding commission that is attributable to the retroceded portion of the business may be deducted in the year of the retrocession.

02 Under the principles of Rev. Rul. 82-69 and the Colonial American decision, if an indemnity reinsurance agreement provides for the reinsurance of a block of policies with an income producing life extending beyond the tax year, the reinsurer must treat the up-front ceding commission paid for this asset like the ceding commissions involved in assumption reinsurance, which must be capitalized. The principles of section 1.817-4(d)(2) of the regulations (relating to assumption reinsurance transactions) are relevant in determining the amount of the up-front ceding commission that is subject to amortization. Thus, for transactions occurring during tax years beginning after December 31, 1983, the amount of the up-front ceding commission paid by the reinsurer is equal to the excess of the increase in the reinsurer's tax reserve liabilities resulting from the transaction (computed in accordance with section 807 of the Code) over the value of the net assets received. Unlike assumption reinsurance, however, the up-front ceding commission must be amortized over a period reflecting the life of the reinsurance agreement rather than the reasonably estimated life of the reinsured policies.

The establishment of the life of the reinsurance agreement requires a factual determination. If the reinsurance agreement has (either explicitly or implicitly) a determinate life, then that life should be used for amortization purposes. For example, if a reinsurance agreement is written for an indefinite period but contains terms that demonstrate that the agreement has a limited life (such as a provision granting the direct insurer a recapture right after a specified period), this life is used for amortization purposes. If the reinsurance agreement has an indeterminate life, the reasonably estimated life of the underlying policies should be used. See section 1.817-4(d)(2)(iv) of the regulations with respect to the factors that may be considered in determining the reasonably estimated life of the reinsured policies.

The taxpayer may use the straight-line method for purposes of determining a reasonable allowance for amortization. The taxpayer may also use any amortization method that results in an allowance for amortization that is consistent with the anticipated income stream. For this purpose, both future premiums and investment earnings must be taken into account in determining the anticipated income stream from the reinsured policies. The annual allowance for amortization must be calculated from the effective date of the reinsurance agreement.

03 Taxpayers that must change their method of accounting for ceding commissions in order to comply with the principles of Rev. Rul. 82-69 and the Colonial American decision must do so in accordance with section 446(e) of the Code and the regulations thereunder.

04 Section 446(e) of the Code states generally that a taxpayer that changes the method of accounting on the basis of which it regularly computes its income in keeping its books must, before computing taxable income under the new method, secure the consent of the Secretary.

Section 1.446-1(e)(3)(ii) of the regulations states that the Commissioner may prescribe administrative procedures, subject to such limitations, terms, and conditions as deemed necessary to obtain consent, to permit taxpayers to change their accounting practices or methods to an acceptable treatment consistent with applicable regulations. Limitations, terms, and conditions, as may be prescribed in such administrative procedures by the Commissioner, include those necessary to prevent the omission or duplication of items includible in gross income or deductions.

05 If a taxpayer's taxable income for a tax year (year of change) is computed under a method of accounting different from the method used to compute taxable income in the preceding tax year, then section 481(a) of the Code requires that those adjustments necessary to prevent amounts from being duplicated or omitted be taken into account.

06 Rev. Proc. 84-74, 1984-2 C.B. 736, contains procedures under section 1.446-1(e) of the regulations for obtaining the consent of the Commissioner to change a method of accounting for federal income tax purposes. Except as otherwise specifically provided by documents published in the Internal Revenue Bulletin, a change in method of accounting initiated by the taxpayer can be made only under the provisions of Rev. Proc. 84-74.

Section 6.02 of Rev. Proc. 84-74 defines a Category A method of accounting as a method of accounting that is specifically not permitted to be used by the taxpayer by the Code, the regulations, or a decision of the Supreme Court of the United States.

Sections 4.01(1), 4.01(2), 4.01(3), and 4.01(5) of Rev. Proc. 84-74 provide that, subject to certain limited exceptions, a taxpayer may not use that revenue procedure to change a method of accounting if, at the time of the filing the Form 3115, one or more of the following conditions exist: (1) the taxpayer is under examination for the year or years in which the erroneous method of accounting was initiated or in which the taxpayer changed to a method of accounting without the consent of the Commissioner, (2) the method being changed is a Category A method and the taxpayer has been contacted in any manner by the Service for purposes of scheduling an examination (and such examination has not been completed), (3) the taxpayer is under examination by the district director, (4) the taxpayer has a return that is under consideration by an appeals office of the Service, (5) a return of the taxpayer is before any federal court with respect to an income tax issue, or (6) there is pending a criminal investigation or proceeding concerning any issue related to the taxpayer's federal tax liability for any year. These limitations are intended to encourage taxpayers to adopt proper methods of accounting prior to becoming subject to examination.

Section 5.06(1)(d) of Rev. Proc. 84-74 provides that if there is a change in method of accounting from a Category A method that results in a positive net adjustment under section 481(a) of the Code, then the adjustment period shall not exceed 3 tax years.

07 With respect to actions taken by taxpayers, or determinations made by the Service, on or after June 15, 1989 (the date of the Colonial American decision), a method of accounting for the treatment of ceding commissions that is inconsistent with the principles of Rev. Rul. 82-69 and the Colonial American decision is a Category A method of accounting (as defined in section 6.02 of Rev. Proc. 84- 74).

08 Under this revenue procedure, however, as a matter of administrative convenience, if a life insurance company applies to change its method of accounting for ceding commissions, then it may obtain less stringent treatment than the limitations, terms, and conditions that usually apply for a change from a Category A method. This treatment applies only with respect to the types of taxpayers and the specific changes in method that are within the scope of this revenue procedure. No inference should be drawn from the treatment provided by this revenue procedure as to the procedures that the Service may adopt in other situations in which a change from a Category A method of accounting is required as the result of a Supreme Court decision.

09 Taxpayers' actions taken to change their method of accounting for ceding commissions to comply with the provisions of Rev. Proc. 82-69, on or after December 5, 1988 (the date certiorari was granted in Colonial American) but before June 15, 1989, are subject to the rules, of section 14 of this revenue procedure. This section imposes conditions designed to put the taxpayer in the same position as if it had not acted to change its method of accounting until June 15, 1989.

SEC. 3. SCOPE

This revenue procedure must be used by life insurance companies to change their method of accounting for ceding commissions to comply with the principles of Rev. Rul. 82-69 and the Colonial American decision for their first tax year ending after June 15, 1989, as set forth below. In general, this revenue procedure applies (i) to taxpayers that as of June 15, 1989 were not under examination by the Service, as described more fully in section 3.01, and (ii) to taxpayers that were under examination on that date if the taxpayer's treatment of ceding commissions was not a "pending issue" as of June 15, 1989, as described more fully in section 3.02. Taxpayers eligible to use this revenue procedure to effect a change in method of accounting must treat the tax year that includes June 15, 1989 as the year of change, as described more fully in section 5.

01 This revenue procedure applies to any life insurance company that, as of June 15, 1989, had not been contacted by a representative of the Service for purposes of scheduling an examination and was not otherwise described in sections 4.01(1), 4.01(2), 4.01(3), or 4.01(5) of Rev. Proc. 84-74 on that date, provided the taxpayer complies with the general procedures for implementing the change set forth in section 5 of this revenue procedure. Thus, if a any time after June 15, 1989, but prior of June 15, 1989. See section 5 regarding the general procedures for implementing the change, including section 5.05 with regard to the additional procedures for notifying the Service representative(s) or counsel for the Government and obtaining a statement verifying that the taxpayer's treatment of ceding commissions on indemnity reinsurance was not a pending issue.

SEC. 4. SPECIAL RULES RELATING TO PENDING ISSUE

A taxpayer's treatment of ceding commissions on indemnity reinsurance is considered to have been a pending issue as of June 15, 1989, only if on or before that date the Service had sent the taxpayer written notification indicating that an adjustment was being proposed to the treatment of ceding commissions on a return that was under examination (e.g., by Form 5701, Notice of Proposed Adjustment). Thus, if on or before June 15, 1989, the examining officer had merely notified the taxpayer orally that its indemnity reinsurance transactions were being examined but had not proposed any adjustments in writing to the taxpayer's treatment of ceding commissions on indemnity reinsurance, the taxpayer's treatment of ceding commissions was not a pending issue. Similarly, if on or before June 15, 1989, the examining officer had formally requested relevant documents but had not yet notified the taxpayer in writing of a proposed adjustment in the treatment of ceding commissions, the taxpayer's treatment of ceding commissions was not a pending issue.

SEC. 5. APPLICATION

01 CONSENT. If a taxpayer properly complies with the provisions of this revenue procedure (i) in accordance with section 1.446- 1(e)(3)(ii) of the regulations, the 180-day time period for filing an application is extended to the due date (including extensions) of the taxpayer's federal income tax return for the first tax year ending after June 15, 1989, and (ii) consent is hereby granted to the taxpayer to effect the change in method for the tax year which includes June 15, 1989. If the return for the year of change has already been filed, see section 5.03.

02 METHOD OF IMPLEMENTING THE CHANGE. A taxpayer applying for a change in method under this revenue procedure must complete and file a current Form 3115 in duplicate. The original must be attached to the taxpayer's timely filed (including extensions) original federal income tax return for the first tax year ending after June 15, 1989. The duplicate of the completed Form 3115 shall be filed with the Commissioner of Internal Revenue, Office of Assistant Chief Counsel (Financial Institutions and Products), CC:FI&P:4, P.0. Box 7616, Ben Franklin Station, Washington, D.C., 20044, no later than the time the original of the Form 3115 is filed as described above. In order to assist in the processing and proper handling of these applications, reference to this revenue procedure shall be made a part of the Form 3115 by either typing or legibly printing the following statement at the top of page 1 of the Form 3115: "FILED UNDER REV. PROC. 90-36." No user fee is required for an application filed under this revenue procedure.

03 RETURN FOR THE YEAR OF CHANGE ALREADY FILED. If on or before August 1, 1990, any taxpayer eligible to change its method of accounting under this revenue procedure files its federal income tax return for the first tax year ending after June 15, 1989, consent is hereby granted to the taxpayer to effect the change in method by filing an amended return for the tax year that included June 15, 1989, provided the taxpayer otherwise complies with the requirements of section 5.02 and the amended return is filed by September 17, 1990.

04 CONTACTED FOR EXAMINATION BEFORE FORM 3115 IS FILED. If any taxpayer described in section 3.01 is contacted by the Service for purposes of scheduling an examination at any time after June 15, 1989, but prior to the due date (including extensions) of the taxpayer's tax return for the first year ending after June 15, 1989, the taxpayer must provide the district director a written statement indicating that the taxpayer is changing its method of accounting for ceding commissions under this revenue procedure. This statement must be provided by the later of (i) 90 days after the taxpayer has been contacted by the Service for purposes of scheduling an examination, or (ii) September 30, 1990. In addition, the taxpayer must provide the district director a duplicate of the completed Form 3115 filed with the taxpayer's federal income tax return for the year of change. This duplicate must be provided by the later of the date the above statement is filed or the date the Form 3115 is filed.

05 SUPPORTING STATEMENT REQUIRED. A taxpayer qualifying to use this revenue procedure under section 3.02 may change its method of accounting under this revenue procedure only if on or before September 30, 1990, the taxpayer notifies the Service representative(s) or counsel for the Government with jurisdiction over its tax returns that the taxpayer is changing its method of accounting for ceding commissions under this revenue procedure. The taxpayer must also request that the Service representative(s) or counsel for the Government with jurisdiction over its return(s) provide a written statement concurring that on or before June 15, 1989, there was no pending issue concerning the taxpayer's treatment of ceding commissions on indemnity reinsurance. A copy of this supporting statement must be filed with the completed Form 3115 attached to the return for the tax year of change. The taxpayer must also provide the Service representative(s) or counsel for the Government a duplicate of the Form 3115 filed with the taxpayer's federal income tax return for the tax year of change. If the taxpayer fails to comply with these requirements, then the treatment of ceding commissions on returns under examination or otherwise described in sections 4.01(1), 4.01(2) or 4.01(3) (without regard to section 4.02) of Rev. Proc. 84-74 shall be subject to adjustment in the earliest open year in the manner provided in section 11 of this revenue procedure.

06 YEAR OF CHANGE. The year of change for any change in method of accounting for ceding commissions which is made in accordance with this section 5 is the first tax year ending after June 15, 1989.

SEC. 6. SECTION 481(a) ADJUSTMENT

01 SECTION 481(a) ADJUSTMENT. An adjustment (the "section 481(a) adjustment") is required to prevent items from being omitted or duplicated solely by reason of a change in method of accounting. In a situation in which the taxpayer has been treating ceding commissions as currently deductible expenses, the section 481(a) adjustment required by reason of the change in accounting method is the amount that would be the unamortized balance of the ceding commissions as of the beginning of the year of change, if the method to which the taxpayer is changing had always been used. Thus, the section 481(a) adjustment (which is positive) takes into account all of the reinsurance agreements entered into by the taxpayer prior to the year of change for which the taxpayer would, as of the beginning of the year of change, have an unamortized balance of ceding commissions, if the method of amortization to which the taxpayer is changing had originally been applied to such commissions.

02 ADJUSTMENT PERIOD. If the entire amount of the section 481(a) adjustment is attributable to the tax year immediately preceding the year of change, then the total adjustment must be taken into account in computing taxable income for the year of change. Otherwise, the section 481(a) adjustment must be taken into account in computing taxable income ratably over a period equal to the lesser of (i) the number of tax years the taxpayer has used the method being changed, or (ii) 3 tax years.

03 ACCELERATION OF ADJUSTMENT. If, during the adjustment period, the aggregate amount of unamortized ceding commissions as of the last day of any tax year is reduced by more than 66 2/3 percent of the aggregate amount of unamortized ceding commissions at the beginning of the year of change, the balance of the section 481(a) adjustment not previously taken into account must be included in income in the year the aggregate amount of unamortized ceding commissions is so reduced.

04 CEASING TO ENGAGE IN THE TRADE OR BUSINESS. If, during the adjustment period, the taxpayer ceases to engage in the trade or business giving rise to the adjustment, the balance of the section 481(a) adjustment not previously taken into account must be included in income in the year that the taxpayer ceases to engage in the trade or business. See section 5.09 of Rev. Proc. 84-74 for guidance as to when a taxpayer is treated as ceasing to engage in a trade or business.

05 NET OPERATING LOSSES. No limitations on net operating loss and tax credit carryovers apply with respect to any section 481(a) adjustment taken into account as a result of a change in method under this revenue procedure. See section 5.15(3) of Rev. Proc. 84-74.

06 CONSOLIDATED RETURNS. If the taxpayer is a member of an affiliated group and more than one member of the group is requesting to change its method of accounting for ceding commissions under this revenue procedure, the section 481(a) adjustment must be computed and separately stated for each taxpayer.

SEC. 7. ESTIMATED TAXES

For purposes of any required quarterly installments and extension payments made on or before August 1, 1990, no penalty shall be assessed for underpayment of estimated taxes under section 6655 of the Code or for late payment of tax under section 6651 of the Code on account of an underpayment or late payment that results from the treatment of ceding commissions on indemnity reinsurance as being currently deductible.

SEC. 8. RECORDS

The taxpayer must maintain adequate records so that the Service may, upon examination, verify the data relating to the change in method of accounting.

SEC. 9. COMPLIANCE WITH CONDITIONS

A taxpayer that attempts to make an accounting method change under this revenue procedure without complying with all the conditions of this revenue procedure has initiated the change without obtaining the consent of the Commissioner.

SEC. 10. ADDITIONAL PROCEDURAL REQUIREMENTS

The signature of the person preparing the request for the change in method of accounting must appear in the space provided on Form 3115. The Form 3115 also must be signed by or on behalf of the taxpayer requesting the change. See the signature requirements set forth in the General Instructions attached to Form 3115 regarding those who are to sign. For example, an officer must sign on behalf of a corporation. If for the year of change the taxpayer is a member of an affiliated group that has elected to file a consolidated federal income tax return, a Form 3115 submitted on behalf of the taxpayer must be signed by a duly authorized officer of the common parent. (See section 1.1502-77 of the regulations.)

SEC. 11. TREATMENT OF LIFE INSURANCE COMPANIES WITH PENDING ISSUE

If a life insurance company is ineligible to use this revenue procedure because there was a pending issue concerning the treatment of ceding commissions on indemnity reinsurance on or before June 15, 1989, then the change in method of accounting shall be imposed by the Service under authority of section 446(b) and section 481 of the Code in accordance with the procedures that generally apply when an issue is raised concerning the use of a Category A method of accounting pursuant to an examination of the taxpayer's returns.

SEC. 12. ACCOUNTING METHOD CHANGES BY NON-LIFE COMPANIES

The provisions of this revenue procedure are applicable only to life insurance companies as defined in section 816(a) of the Code. With respect to non-life companies engaged in reinsuring life insurance policies, the Service will not treat a method of accounting for ceding commissions that is inconsistent with the principles of Colonial American decision as a Category A method of accounting. Thus, an insurance company taxable under section 831(a) (a non-life company) that has reinsured life insurance business may request to change its method of accounting with respect to the treatment of the related ceding commissions to be consistent with the principles of the Colonial American decision by filing a Form 3115 in accordance with the procedures and rules of Rev. Proc. 84-74.

SEC. 13. EXCLUSIVE APPLICATION

If a life insurance company does not implement the change in method of accounting for ceding commissions to comply with the principles of Rev. Rul. 82-69 and the Colonial American decision in the manner provided by section 5 above, the company must use Rev. Proc. 84-74 to change the method of accounting. With respect to any application filed by a life insurance company under Rev. Proc. 84-74 prior to January 1, 1992, however, under the authority of section 1.446-1(e)(3)(ii) of the regulations, the Service will require as a condition for its consent that the taxpayer implement the change in method of accounting for the treatment of ceding commissions in the year of change provided under this revenue procedure. Thus, a taxpayer that files an application under Rev. Proc. 84-74 prior to January 1, 1992 to request the change in method will generally be required to file an amended return to implement the change. For applications filed after December 31, 1991, the Service will process these applications in accordance with the general procedures then in effect for obtaining the consent of Commissioner to change a method of accounting for federal income tax purposes.

SEC. 14. APPLICATIONS FOR METHOD CHANGE FILED AFTER DATE CERTIORARI WAS GRANTED

With respect to any application on Form 3115 filed on or after December 5, 1988 (the date certiorari was granted in Colonial American) but before June 15, 1989, in order to comply with Rev. Rul. 82-69, the Service will impose the conditions outlined in this section, which are necessary in order to provide treatment that is substantially equivalent to the treatment of taxpayers that change their method of accounting pursuant to section 5. If the taxpayer's treatment of ceding commissions was a pending issue at the time the Form 3115 was filed, then both the year of change and spread period shall be imposed by the Service under the authority of section 1.446- 1(e)(3)(ii) of the regulations in accordance with the procedures that generally apply when an issue is raised concerning the use of a Category A method of accounting pursuant to an examination of the taxpayer's returns. If the taxpayer's treatment of ceding commissions was not a pending issue at the time the Form 3115 was filed, then the year of change is the applicable year in which the Form 3115 is filed and the spread period will be determined under section 6.02 of this revenue procedure (i.e., not more than 3 years).

SEC. 15. EFFECTIVE DATE

This revenue procedure is effective June 15, 1990, the date in which notice of its publication in the Internal Revenue Bulletin was given to the public.

SEC. 16. INQUIRIES

Inquiries in regard to this revenue procedure should refer to its number and be addressed to the Commissioner of Internal Revenue, Attention: Office of Assistant Chief Counsel (Financial Institutions and Products), CC:FI&P:4, P.O. Box 760-4, Ben Franklin Station, Washington, D.C. 20044.

DRAFTING INFORMATION

The principal author of this revenue procedure is Gary E. Geisler of the Office of the Assistant Chief Counsel, Financial Institutions & Products. For further information regarding this revenue procedure contact Mr. Geisler on (202) 566-6456 (not a toll- free call).