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Insurance Groups Seek Changes to Definitions Under FTC Regs

FEB. 18, 2020

Insurance Groups Seek Changes to Definitions Under FTC Regs

DATED FEB. 18, 2020
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February 18, 2020

Jeffrey L. Parry
Senior Counsel
CC:PA:LPD:PR (REG-105495-19), Room 5203
Internal Revenue Service
P.O. Box 7604
Ben Franklin Station
Washington, DC 20044

Re: Definition of “Financial Services Entity” and “Financial Services Group” for Insurance Companies

Dear Mr. Parry:

On behalf of the member companies of the American Property Casualty Insurance Association, Reinsurance Association of America, and the National Association of Mutual Insurance Companies (the Trades), we welcome additional guidance1 from the Internal Revenue Service and the Treasury Department for taxpayers regarding the application of foreign tax credit rules. The Trades collectively represent the great majority of insurance and reinsurance companies underwriting property and casualty insurance throughout the United States.

The Trades respectfully submit the following comments with regard to the definition of a “financial services entity” (an “FSE”) and a “financial services group” (an “FSG”) under section 1.904-4(e)(2) of the Proposed Regulations in their application to taxpayers in the insurance industry. Without amendment, United States taxpayers with foreign insurance company affiliates would potentially bear adverse tax consequences without sound tax policy reasons for a separate treatment of foreign tax credits compared to non-insurance company taxpayers.

Executive Summary

Under current foreign tax credit rules applicable to United States taxpayers with foreign affiliates that accrue or receive income predominantly through the active conduct of an insurance business, the definitions of FSE and FSG provide that such income should be treated as general category income for foreign tax credit limitation purposes under section 904.2

In contrast, the definition of an FSE under the Proposed Regulations appears to result, at least in part, in investment income of foreign insurance companies to be treated as passive category income for foreign tax credit limitation purposes under section 904. This can result in unused foreign tax credits that, ultimately, increase the overall tax liability of the United States taxpayer.

Additionally, the definition of an FSG under the Proposed Regulations does not reference insurance income or the active conduct of an insurance business. In this form, no FSG would likely exist, resulting in income of foreign affiliates being considered on a company-by-company basis for foreign tax credit limitation purposes under section 904. Again, this can result in unused foreign tax credits that, ultimately, increase the overall tax liability of the United States taxpayer.

Respectfully, we recommend the following:

1. The definition of an FSE under the Proposed Regulations should be expanded to include entities that (a) if domestic, are subject to tax under subchapter L of the Code, or (b) if foreign and regulated under the insurance laws of the country in which they operate, would be subject to subchapter L if such entity were to be domestic; and

2. When considering whether the affiliated group, as a whole, would be considered to be predominantly engaged in the active conduct of an insurance business, the definition of an FSG under the Proposed Regulations should be expanded to include (a) income of an FSE as defined above and adjusted for income from assets not used predominantly in the active conduct of an insurance business, and (b) income of affiliated entities that provide insurance and investment management services to an FSE.

Analysis

Current Rules

In relevant part, Regulation section 1.904-4(e)(3)(i) defines an FSE to be an entity that is predominantly engaged in the active conduct of a banking, insurance, financing, or similar business (active financing business) for any taxable year. The determination is made on an entity-by-entity basis.

An insurance company is predominantly engaged in the active financing business for any year if for that year at least 80 percent of its gross income is (1) insurance income as defined in section 953(a) (including related party insurance income) and (2) income from the investment of its unearned premiums or reserves ordinary and necessary to the proper conduct of the insurance business, income from providing services as an insurance underwriter, income from insurance brokerage or agency services, and income from loss adjuster and surveyor services.

An FSG is defined under section 904(d)(2)(C)(ii) as any affiliated group (within the affiliated group definition of section 1504(a) without regard to life insurance or foreign corporations) which, when considered as a whole, is predominantly engaged in the active conduct of a banking, insurance, financing, or similar business. In this determination, only income of members of a group that are United States corporations or controlled foreign corporations (“CFC”) in which such the United States corporations hold at least 80% of the total voting power and value of the stock of the CFC is included.

A relevant consequence of meeting the current definition is that financial services income (generally, income received or accrued by an entity predominantly engaged in the active conduct of insurance income) is treated as general category income for foreign tax credit limitation purposes under section 904. Importantly, investment income of foreign affiliates, as well as foreign-source income of members of the United States consolidated group, is general category income under the current rules.

Proposed Definition of an FSE

Under the Proposed Regulations, section 1.904-4(e)(2)(i)(A) states that a financial services entity means, in relevant part, a corporation that is predominantly engaged in the active conduct of an insurance business within the meaning of paragraphs (e)(2)(i)(A)(1) through (4) of the Proposed Regulation section for any taxation year.

Section 1.904-4(e)(2)(i)(A)(1) of the Proposed Regulations appears to relate only to banking, financing and similar business, i.e., not to insurance businesses.

Section 1.904-4(e)(2)(i)(A)(2) of the Proposed Regulations defines a corporation to be predominantly engaged in the active conduct of an insurance business if it is an insurance company meeting the requirements of section 953(e)(3)(A) and (C), provided that the company's foreign personal holding company income does not exceed the amount that would be derived in the active conduct of an insurance business under section 954(i) if all of the insurance and annuity contracts issued or reinsured by the company had qualified as exempt contracts under section 953(e)(2).

Generally, a foreign insurance company with $1 or more of subpart F income (that would otherwise be foreign personal holding company income) would fail to meet the definition above. This is because the investment income that would otherwise be foreign personal holding company income would be required to be recharacterized as qualifying insurance income under section 954(i) and be excluded from being treated as foreign personal holding company income under the hypothetical construct of the definition that requires all of the insurance and annuity contracts issued or reinsured by the company to be treated as exempt contracts. Thus, the threshold set in the hypothetical construct of the definition would be zero.

Accordingly, a foreign insurance company could only satisfy the definition to be an FSE under the Proposed Regulations in the unlikely “real world” scenario that all of its insurance and annuity contracts were, in fact, exempt contracts under section 953(e)(2).

Section 1.904-4(e)(2)(i)(A)(3) of the Proposed Regulations defines a corporation to be predominantly engaged in the active conduct of an insurance business if it is engaged in the active conduct of an insurance business under section 1297(b)(2)(B), without regard to whether the corporation is a foreign corporation.

Generally, a corporation satisfies the test under section 1297(b)(2)(B) if the amount of its applicable insurance liabilities exceeds 25 percent of its total assets. This determination is made on the basis of the liabilities and assets reported on the corporation's applicable financial statement for the last year ending with or within the taxable year.

This would be a factual determination but, prima facie, a non-insurance company that, nevertheless, provided intercompany services to a foreign insurance company would fail this test on a stand-alone basis, as could a foreign insurance company that is capitalized, for valid regulatory or creditworthiness reasons, above the amount that would be determined under section 1297(b)(2)(B).

Absent potential benefit from an FSG rule or the benefit of other recharacterization rules (such as the high-tax kickout under section 904(d)(2)(B)(iii)), failure to meet the definition of an FSE would likely result in the income of a foreign affiliate, whether a regulated insurance company or not, to be treated as partly general category income and partly passive category income. This could result in unused foreign tax credits and, ultimately, an increase in the aggregate tax liability on such income.

Accordingly, we recommend expanding the definition of an FSE under the Proposed Regulations to include entities that, if domestic, are subject to tax under subchapter L of the Code and, if foreign and regulated under the insurance laws of the country in which they operate, would be subject to subchapter L if they were domestic entities. Thus, the test of whether a corporation is an FSE would be by reference to the entity and its regulation, not by reference to the income it accrues or receives.

Proposed Definition of an FSG

Section 1.904-4(e)(2)(ii) of the Proposed Regulations defines a corporation to be a member of an FSG if, among other requirements, the affiliated group as a whole meets the requirements of section 954(h)(2)(B)(i), i.e., more than 70 percent of the gross income of the CFC is derived directly from the active and regular conduct of a lending or finance business from transactions with customers which are not related persons. The definition does not reference income from the active conduct of an insurance business under section 954(i). Further, the definition does not include income of affiliated entities that, nevertheless, provide insurance-related intercompany services to foreign insurance companies.

Without reference to the income from the active conduct of an insurance business by an FSE or to affiliated entities of an FSE that provide intercompany services, affiliated companies would only satisfy the definition of an FSG if they were also engaged in the active and regular conduct of a lending or finance business. This is unlikely to be the case as a practical and regulatory matter. Thus, all affiliated entities would need to be considered individually and on a stand-alone basis, resulting in the potentially adverse consequence for foreign tax credit limitation purposes under section 904 outlined elsewhere in this letter.

Accordingly, in determining whether an affiliated group as a whole meets the requirements of an FSG, we recommend expanding the definition of an FSG to include:

1. The gross income of FSEs within the affiliated group, adjusted for income from assets not used predominantly in the active conduct of an insurance business under an appropriate measure (such as by reference to section 954(i) or section 1297(b)(2)(B)); and

2. The gross income received or accrued by affiliated entities from the provision of insurance and investment management to an FSE.

We appreciate the opportunity to comment. Please do not hesitate to contact David Pearce (david.pearce@apci.org or 202-828-7114), Jonathan Rodgers (jrodgers@namic.org or 317-876-4206), and/or Joseph Sieverling (sieverling@reinsurance.org or 202-783-8312) if you have any questions or would like to discuss our comments in more detail.

Respectfully submitted,

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

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

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

FOOTNOTES

1Guidance Related to the Allocation and Apportionment of Deductions and Foreign Taxes, Financial Services Income, Foreign Tax Redeterminations, Foreign Tax Credit Disallowance Under section 965(g), and Consolidated Groups, 84 FR 69124 (“Proposed Regulations”).

2Unless otherwise indicated, all “section” references herein are to the Internal Revenue Code of 1986, as amended (the “Code”), and all “Treas. Reg. §” references are to the Treasury Regulations promulgated thereunder (the “Regulations”).

END FOOTNOTES

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