AFL-CIO Backs Insurance Activity Definition Under Reinsurance Regs

On behalf of the American Federation of Labor and Congress of Industrial Organizations (the "AFL-CIO"), I am writing to provide comments to the Treasury Department ("Treasury") and the Internal Revenue Service ("IRS") on the proposed regulations regarding when a foreign insurance company's income is excluded from the definition of passive income under section 1297(b)(2)(B) of the Internal Revenue Code. The AFL-CIO is the umbrella federation of U.S. labor unions, including 56 unions, representing 12.5 million union members.

We strongly support the Treasury and IRS proposal that will close the hedge fund reinsurance tax loophole that permits wealthy hedge fund managers and their high-net-worth individual investors to defer and reduce their U.S. tax obligations. In our view, these foreign reinsurance companies that hedge funds have created in offshore tax havens lack any meaningful economic substance and do not appear to have any significant business purpose other than the creation of a tax benefit.

By investing through a foreign reinsurance company in a tax haven country, individual investors in hedge funds are able to convert ordinary income -- which is taxed at the maximum federal rate of 39.6 percent -- into assets which are taxed at the federal capital gains rate of 20 percent when those appreciated assets are eventually sold. This abusive conversion of ordinary income into capital gains and the potentially indefinite deferral of tax liability is simply unconscionable and must be stopped.

For this reason, we support the IRS and Treasury proposed definition of the insurance business as "the business activity of issuing insurance and annuity contracts and the reinsuring of risks underwritten by insurance companies, together with investment activities and administrative services that are required to support or are substantially related to insurance contracts issued or reinsured by the foreign insurance company." This definition should be adopted as soon as possible.

To distinguish legitimate foreign reinsurance companies from abusive tax avoidance strategies, we support the three-pronged test proposed by former Rep. David Camp. In order to qualify as an insurance company under the Camp proposal, more than 50 percent of a company's gross receipts must consist of insurance premiums, and their insurance liabilities would be equal to 35 percent of total assets. The company also would need to be subject to tax as an insurer if it were a U.S. business.

We thank you for taking the AFL-CIO's views into consideration regarding this matter. If the AFL-CIO can be of further assistance, please contact Brandon Rees at (202) 637-5152 or brees@aflcio.org.