Menu
Tax Notes logo

Attorney Seeks Tax Result Insurance Exception to Proposed Tax Shelter Reporting Regs

DEC. 2, 2002

Attorney Seeks Tax Result Insurance Exception to Proposed Tax Shelter Reporting Regs

DATED DEC. 2, 2002
DOCUMENT ATTRIBUTES
  • Authors
    Hardy, David R.
  • Institutional Authors
    McDermott, Will & Emery
  • Cross-Reference
    For a summary of REG-103735-00, see Tax Notes, Mar. 6, 2000, p. 1369;

    for the full text, see Doc 2000-6364 (3 original pages) or 2000 TNT

    44-86 Database 'Tax Notes Today 2000', View '(Number'.
  • Code Sections
  • Subject Area/Tax Topics
  • Industry Groups
    Insurance
  • Jurisdictions
  • Language
    English
  • Tax Analysts Document Number
    Doc 2002-27842 (5 original pages)
  • Tax Analysts Electronic Citation
    2003 TNT 3-63
December 2, 2002

 

(REG-103735-00; REG-154117-02;

 

REG-154116-02; REG-154115-02;

 

REG-154429-02; REG-154423-02;

 

REG-154426-02; REG-110311-98)

 

Courier's Desk

 

Internal Revenue Service

 

1111 Constitution Avenue, N.W.

 

Washington, D.C.

 

Re: Proposed Regulations Regarding Tax Shelter Disclosure Statements

 

Dear Sir or Madam:

[1] Enclosed are copies of comments with respect to temporary and proposed regulations on Tax Shelter Disclosure Statements (T.D. 9017).

[2] Please call me at 212-547-5307 if you have any questions. Thank you for your attention to this matter.

Sincerely,

 

 

David R. Hardy

 

McDermott, Will & Emery

 

Washington, DC

 

Enclosures

 

COMMENTS REGARDING THE APPLICATION OF TEMPORARY TREASURY

 

REGULATION SECTION 1.6011-4T

 

 

[3] These comments are submitted on behalf of a managing general agent ("MGA") for several traditional insurance companies. As described in more detail below, MGA is in the business of underwriting tax result insurance. We believe that the proposed and temporary tax shelter regulations which make the existence of such insurance by itself a sufficient basis to require tax shelter disclosure have inappropriately captured the tax result insurance provided by MGA and similar sources, thereby depressing their economically productive activity.

Tax Result Insurance

[4] MGA is one of a half dozen companies who bind tax result insurance utilizing traditional insurance capital. Similar to a private letter ruling, and as explained further below, these products permit real economic transactions to proceed that might otherwise be blocked by the presence of contingent tax risks the uncertainty of which the transaction could not bear. Under these products, taxpayers who are considering or have recently engaged in a transaction with respect to which U.S. income tax risk exists provide due diligence materials to MGA for purposes of determining its willingness to bind insurance. In connection with such insurance, the taxpayer will make a series of representations similar (and sometimes identical) to the representations required were the taxpayer to seek a private letter ruling from the Internal Revenue Service. Based on these representations and MGA's own underwriting process, which includes an examination of factual and legal issues by itself and its outside counsel, MGA may bind an insurance contract. If the taxpayers' insured tax benefits are disallowed following audit by the IRS and normal judicial appeals, MGA is committed to reimburse the taxpayer for the tax incurred.

[5] The tax result insurance product that MGA offers is attractive to taxpayers engaging in various transactions including spin-offs, mergers, insolvency reorganizations, energy products and others where the tax uncertainty may be of sufficient magnitude to substantially erode the economic viability of the transaction. Often, taxpayers seek insurance as a substitute for an IRS ruling which the transactional timing will not permit the attendant delay or in certain areas where rulings are not currently being offered.

[6] MGA does not underwrite listed tax shelter transactions (i.e., those specifically identified in Treasury notices). MGA's reinsurance treaties also specify that the tax risks that MGA may accept must justify a "should" level tax opinion. Given the risks associated with the insurance products they underwrite, MGA and its competitors generally price their coverage in The range of between 5 and 15 percent of the dollar value of the tax exposure covered. If the insurance product were more expensive, no taxpayers would incur the cost. Necessarily, these traditional insurance company carriers are unwilling to underwrite aggressively tax structured transactions with high probability of challenge and disallowance as this would destroy the profitability of the product. High risk transactions of a type normally supported by more-likely-than-not opinions are simply not within the scope of this insurance business activity.

Proposed Revisions to Regulations

[7] On October 17, 2002, under Treasury Decision 9017, Treasury released proposed and temporary regulations to be effective as of January 1, 2003. In an effort to increase the amount of reporting for aggressive transactions, Treasury has changed a prior structure of reporting under which a specific list of transactions must report, or other transactions having two of the five tax shelter distinguishing characteristics. Under the newly-issued proposed and temporary rules, transactions having any one of the six new identifying characteristics would be required to report as a tax shelter. Under section (b)(4) of Reg. § 1.6011-4T one of the identifying tax shelter characteristics is "transactions with contractual protection" which is defined as:

 

a transaction for which the taxpayer has obtained or been provided with contractual protection against the possibility that part or all of the intended tax consequences from the transaction will not be sustained, including, but not limited to, rescission rights, the right to a full or partial refund of fees paid to any person, fees that are contingent on the taxpayer's realization of tax benefits from the transaction, insurance protection with respect to the tax treatment of the transaction, or a tax indemnity or similar agreement (other than a customary indemnity provided by a principal to the transaction that did not participate in the promotion or offering of the transaction to the taxpayer). Notwithstanding the foregoing, a transaction will not be considered to have contractual protection solely because the issuer of a debt instrument agrees to pay additional interest to compensate the holder of such debt instrument for withholding tax imposed on interest paid on the debt instrument, or because the requirement to pay such additional interest entitles the issuer to redeem the debt instrument.1

 

[8] Under the foregoing language, the existence of insurance protection with respect to the tax treatment of a transaction requires the taxpayer to disclose his participation in a reportable tax shelter transaction. This rule applies without regard to whether insurance is provided by an independent third party or by a party that participated in the promotion or offering of the product by the tax shelter promoter or a related person or conduit. Exceptions to this rule provide for (i) customary tax indemnities between principals in an acquisition transaction (not involving a "promoted transaction") and (ii) debt instruments that provide a withholding tax gross-up or a withholding tax call. For tax result insurance providers, such as MGA, the literal force of this language appears to require any company obtaining their insurance to report its insured transaction as a tax shelter.

Inappropriate Application

[9] We believe the application of the tax shelter disclosure regulations to transactions solely due to the existence of third party insurance protection is inappropriate for several reasons.

1. Tax Motivation

[10] Some would assert that the willingness of a taxpayer to seek insurance protection demonstrably establishes their motive of tax reduction. We believe that this proposition states far too much, however. In any transaction, there are tax risks and uncertainties that taxpayers appropriately seek to mitigate. Thus, for example, in every spin-off transaction, the transaction would not be tax-free if it did not promote some significant commercial objective. Yet without an Internal Revenue Service private letter ruling, the risk of taxation on the distributing corporation and its shareholders creates a contingent tax liability that might equal or exceed the commercial benefit to be achieved. Where transaction timing or specific ruling guidelines do not permit recourse to the private letter ruling process, tax result insurance has been available to permit genuine business transactions to proceed without concern for specific, though hard to quantify, tax contingencies.

[11] That taxpayers seek to identify and minimize tax risks that otherwise detract from the viability of proposed transactions is not per se indicative of the absence of economic substance, the absence of business purpose the taxpayer's intention to enter into a sham transaction, or the taxpayer's intention to enter into an uneconomic aggressively structured tax shelter transaction. We think the motives of taxpayers in seeking commercial insurance are roughly equivalent to the motives of taxpayers seeking private letter rulings.

2. Relationship to the Promoter

[12] As shown in the New York State Bar Association Tax Section comments on prior versions of the tax shelter regulations (Robert H. Scarborough letter of November 16, 2000), many practitioners assumed that the contractual protection of concern was that offered or funded by the tax shelter promoter, its affiliates or conduits, so the tax shelter promoter's offer to restore fees for loss of tax benefits would clearly be included in this provision. The right granted to a taxpayer to "put" its investment to an affiliate of the tax shelter promoter for its original cost upon the disallowance of tax benefits would similarly be captured. The New York State Bar Association Tax Section report suggested that this ambiguity be clarified in the old regulations. However, the new proposed and temporary regulations literally apply to any insurance product, even where there is no relationship between the provider or procurer of the insurance and the tax shelter promoter.

[13] In the case of commercial tax result insurance provided by MGA and others, MGA has no relationship to any tax shelter promoter. Moreover, neither MGA nor its principal competitors in offering tax result insurance are affiliated with any promoters of tax shelter products. In the majority of times, the opportunities for tax result insurance underwriting is sourced through the traditional insurance brokerage community. Such brokers frequently offer the submission to MGA as well as its competitors, who give competitive pricing indications in an effort to win the assignment. The insurance product is in almost all cases transaction specific and is not a part of any program of transactions.

3. Relationship to Aggressive Tax Transactions

[14] The last element to demonstrate that MGA's insurance is not related to aggressive tax shelter products has to do with the pricing of their insurance protection and the insurance capital which they represent. As is evident from the economics of the operation described above, MGA cannot offer a commercially viable insurance product at 5-15 percent of tax dollar exposure if the aggregate payout on all policies it underwrites exceed this amount. For this reason among others, MGA avoids not only the listed tax shelter transactions but also non-listed transactions which it and its underwriting counsel regard as having an unacceptably high risk. This independent underwriting may serve as a check for taxpayers on the soundness of a proposed transaction and discourage entry into a transaction that is not suitable for insurance. We believe that MGA is in the business of facilitating commercial transactions which have significant tax risk and not in the business of facilitating tax oriented transactions. Indeed, neither MGA nor the taxpayer has any outside incentive to enter into an insurance contract. MGA derives no fees, commissions, or other income from the consummation of the transaction other than those associated with the negotiated premiums (as well as reimbursement for its costs incurred in utilizing experienced tax counsel such as our firm to assist it in its underwriting evaluation) and has no role in structuring the insured transaction.

Alternative Approach

[15] We believe the reference to insurance protection in the proposed regulation should be modified. In subsection (b)(4), following the words "insurance protection with respect to tax treatment of the transaction" add the words "(other than insurance provided by, funded by or otherwise obtained directly or indirectly from a person that is engaged in the insurance business generally and that did not participate in the promotion or offering of the transaction to the taxpayer)." We believe that tax insurance from the tax shelter promoter or an affiliated company claiming to be in the insurance business has risks similar to contingent pricing fee rebates or the other contractual protections identified in the regulation language. However, where the insurance provider is unrelated to the promoter, representing conventional insurance capital and pricing in a competitive environment, the insurance contract does not have tax shelter characteristics. For reasons set forth above, tax result insurance provides an invaluable service to the business community by facilitating closure of transactions which otherwise might have been aborted due to the magnitude of a tax exposure, regardless of the low probability of adverse tax consequences being realized. As such, we think it would be wrong to impose a chilling effect on the consummation of legitimate business transactions which are facilitated by tax result insurance, as well as on the productive businesses of these insurance providers, when they are clearly not involved in the industry which the U.S. Treasury properly seeks to monitor.

[16] Thank you for the opportunity to provide these comments. If you have any questions regarding the foregoing or if you would like to speak further about these issues, please feel free to call me at (212) 547-5307.

David R. Hardy

 

McDermott, Will & Emery

 

New York, New York

 

FOOTNOTE

 

 

1Emphasis added.

 

END OF FOOTNOTE
DOCUMENT ATTRIBUTES
  • Authors
    Hardy, David R.
  • Institutional Authors
    McDermott, Will & Emery
  • Cross-Reference
    For a summary of REG-103735-00, see Tax Notes, Mar. 6, 2000, p. 1369;

    for the full text, see Doc 2000-6364 (3 original pages) or 2000 TNT

    44-86 Database 'Tax Notes Today 2000', View '(Number'.
  • Code Sections
  • Subject Area/Tax Topics
  • Industry Groups
    Insurance
  • Jurisdictions
  • Language
    English
  • Tax Analysts Document Number
    Doc 2002-27842 (5 original pages)
  • Tax Analysts Electronic Citation
    2003 TNT 3-63
Copy RID