Bermuda Insurance Group Seeks Modification of PFIC Regs

September 9,2019

CC:PA:LPD:PR (REG-105474-18)
Courier's Desk
Internal Revenue Service
1111 Constitution Avenue, NW
Washington, DC 20224

Room 5203
Internal Revenue Service
PO Box 7604
Ben Franklin Station
Washington, DC 20044

Re: Insurance Exception to the Passive Foreign Investment Company Rules and Related Rules

Ladies and Gentlemen:

The Association of Bermuda Insurers & Reinsurers (ABIR) represents Bermuda's leading property and casualty insurers and reinsurers. Bermuda is the center of global expertise on underwriting for catastrophe risk transfer products and other specialty insurance and reinsurance. ABIR and Bermuda (reinsurers provide as much as 60% of hurricane reinsurance in some US states, keeping insurance accessible and affordable for Americans. In the past 20 years, ABIR and Bermuda (re)insurers have paid US policyholders and ceding companies more than $208 billion in claim payments. For more information, visit www.abir.bm

We write today providing comments on Internal Revenue Service ("IRS"), Treasury, Notice of Proposed Rulemaking, 26 CFR Part 1, REG-105474-18, RIN 1545-BM69 (the "Notice"), that provides:

proposed regulations under sections 1291, 1297, and 1298 of the Internal Revenue Code ("Code") regarding the determination of ownership in a passive foreign investment company [("PFIC")] within the meaning of section 1297(a) * * * and the treatment of certain income received or accrued by a foreign corporation and assets held by a foreign corporation for purposes of section 1297. The regulations provide guidance regarding when a foreign corporation is a qualifying insurance corporation ("QIC") under section 1297(f) of the Code and the amounts of income and assets that a QIC excludes from passive income and assets pursuant to section 1297(b)(2)(B) ("PFIC insurance exception") for purposes of section 1297(a). The regulations also clarify the application and scope of certain rules that determine whether a United States person that directly or indirectly holds stock in a PFIC is treated as a shareholder of the PFIC, and whether a foreign corporation is a PFIC

(the "Proposed Regulations").

Our comments relate to the exception to the PFIC rules for insurance companies (the "Insurance Exception") generally, and the qualifying insurance corporation ("QIC") rules, specifically as well as the interaction of these rules with other parts of the Proposed Regulations, and are from the perspective of property casualty insurance companies.

However, it is important to note that PFIC characterization does not impact the non-US corporations characterized as PFICs, but impacts the US persons owning stock in the non-US corporations so characterized. Many insurance groups have non-US parent companies, many are publicly traded and many also have significant US operations. US investors investing in legitimate insurance companies should not be harmed as a result of the adoption of overbroad regulations that inappropriately characterize such legitimate insurance companies as investment companies. In addition, such inappropriate characterizations would harm US persons purchasing insurance by causing disruption to the availability and expense of capital for US insurance companies and non-US reinsurance companies with non-US parents.

Executive Summary

We appreciate the challenge in drafting regulations that balance the need to differentiate between investment companies that are characterized as PFICs and legitimate insurance companies eligible for the Insurance Exception to PFIC characterization.

Certain sections of the Proposed Regulations as drafted are, however, overbroad and unclear and if adopted as written would cause many legitimate insurance companies to be characterized as PFICs and many others to be uncertain whether they are PFICS. In addition, the proposed rules as formulated do not appropriately implement the Insurance Exception, nor do they appropriately implement rules with respect to other aspects of sections¹ 1297 and 1298, taking into account the statutory language and legislative history. Given the purpose of the PFIC rules, and of the Insurance Exception, certain sections of the Proposed Regulations require modification so that legitimate insurance companies are not mischaracterized as PFICs. In particular, the Proposed Regulations present the following issues:²

Discussion

I. Overview of the PFIC Statutory Rules

A. Statutory Definition of a PFIC

In general, a non-US corporation will be a PFIC during a given year if: (1) 75% or more of its gross income constitutes "passive income;" (the "75% Test") or (2) 50% or more of its assets produce (or are held for the production of) passive income (the "50% Test"). For the above purposes, passive income is income characterized as foreign personal holding company income as defined under section 954(c), which generally includes interest, dividends, annuities, certain royalties and rents, and other investment income. Under this definition, almost all non-US insurance companies would be characterized as PFICs absent an exception.

B. Overview of the Insurance Exception to the PFIC Rules

The Insurance Exception as modified by "An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018" (commonly referred to as "the Tax Cuts and Jobs Act") (the "TCJA") requires that an insurance company be characterized as a qualifying insurance corporation (the "QIC Test") and that its income be derived in the active conduct of an insurance business³ (the "Active Test").⁴ Any income so derived by a QIC will not be treated as passive for purposes of the 75% Test and 50% Test. In addition, pursuant to the look-through rule of section 1297(c) such income will also be treated as non-passive when the QIC's income and assets are deemed received by and held by any corporation that holds 25% of the value of the QIC's stock directly or indirectly.⁵ As most nonUS insurance companies are part of affiliated groups with a holding company as the ultimate parent, testing for PFIC status is typically done at the holding company level and the insurance company income and assets are treated as non-passive for purposes of the 75% Test and 50% Test at the holding company level. If the holding company is not a PFIC, it is not necessary to test the insurance companies in the group for PFIC status because section 1298(a)(2)(A) limits the attribution of ownership in lower tier subsidiaries of non-US corporations that are not PFICs only to those persons that own at least 50 percent of such corporation.

In order to be a qualifying insurance corporation ("QIC") for a taxable year the following requirements must be met: (i) the corporation would be subject to tax under subchapter L if it were a US domestic corporation; and (ii) its "applicable insurance liabilities" as reported on the corporation's "applicable financial statements"⁶ constitute more than 25% of its total assets (or meet an alternative facts and circumstances test).⁷ For these purposes, "applicable insurance liabilities" include: loss and loss adjustment expenses, and reserves (other than deficiency, contingency, or unearned premium reserves) for life and health insurance risks.⁸

The alternate facts and circumstances test allows a corporation that does not meet the 25% test to otherwise qualify for the exception if: (i) the corporation is predominantly engaged in an insurance business; (ii) at least 10% of its total assets comprise "applicable insurance liabilities;" and (iii) the reason for the failure to meet the 25% test is solely due to run-off or ratings-related circumstances. In order to utilize the exception, however, an election must be made by the US person who would be subject to the PFIC consequences as a result of owning stock in the insurance company.

For purposes of subchapter L, a property casualty company is characterized as an insurance company if more than half of its business during each taxable year is the issuing of insurance or annuity contracts or the reinsuring of risks underwritten by insurance companies.⁹ This definition of a property casualty insurance company was added to the Code for taxable years beginning in 2004. The legislative history of the provision indicates that it was intended to conform the definition of an "insurance company" in the non-life area with the definition provided in the life insurance company area (i.e., section 816(a)).¹⁰

Prior to the enactment of section 831(c), the status of a company as property casualty insurer for US federal income tax purposes was generally defined by regulations and case law under subchapter L of the Code. Generally, under Treasury Regulation section 1.801-3(a)(1), an entity was considered an insurance company other than a life insurance company if its primary and predominant business activity was the issuance or reinsurance of insurance contracts.¹¹ These regulations have not been amended or updated to reflect the enactment of section 831(c). Although the "primary and predominant" test for non-life insurance company status is less precise than the section 831(c) test (i.e., "more than half'), the case law under the "primary and predominant" test, which mainly dealt with life insurers prior to DEFRA, is instructive with respect to judicial concepts of insurance activities.

In determining whether a company was an "insurance company" under the "primary and predominant" test, the courts focused on the nature of the company's income and the business and investment activities of the company, (e.g., solicitation and issuance of policies, investing and managing premiums, the ratio of reserves to total assets and the ratio of premiums to gross income).

The case law under the "primary and predominant" test did not provide a bright line test for determining whether an entity will be deemed an insurance company for US federal income tax purposes. The general standard used in this determination focused upon the "character" of the business actually done. It is important to note that although the courts have stated that the percentage of income generated by the insurance or reinsurance activity, as opposed to pure investment activity (e.g., not related to the investment of necessary insurance reserves) is not determinative of the insurance company characterization issue, it generally was the most important factor in the decided cases.¹²

C. Consequences of PFIC Characterization Apply at Shareholder Level

In general and subject to certain exceptions,¹³ if a non-US corporation is characterized as a PFIC during a given year, each US Person¹⁴ owning shares (directly and in certain cases indirectly) of the non-US corporation would be subject to a penalty tax¹⁵ at the time of the sale at a gain or receipt of an "excess distribution"¹⁶ with respect to the shares of the non-US corporation owned by the US Person.¹⁷

If a US Person owns stock in a non-US corporation that is a PFIC, that stock will continue to be treated as PFIC stock even if the non-US corporation ceases to be a PFIC, in which case an election may be made to "purge" the PFIC taint from such stock, under which a US Person would recognize gain (but not loss) as if the stock were sold at fair market value.¹⁸ Such gain generally should be taxable as an excess distribution as described above.¹⁹

D. Purpose of the PFIC Rules

The PFIC rules were enacted, in 1986, to level the playing field between investors who invested in passive assets in the US and those who invested through non-US corporations. In this regard, the House of Representatives Committee on Ways and Means stated:

The committee does not believe that US persons who invest in passive assets should be able to avoid current taxation just because they invest in those assets indirectly through a foreign corporation.

* * *

Furthermore, the committee does not believe that tax rules should effectively operate to provide US investors tax incentives to make foreign investments.

* * *

US shareholders are currently able to circumvent the foreign investment company provision, avoid current recognition of income, and obtain capital gain treatment for income that would be ordinary income if received directly or received from a domestic investment company.²⁰

E. Banking and Insurance Exceptions — Legislative History

Both the House of Representatives and the Senate proposed bills designed to address the above concerns. Each of these bills was different, although similar, and were combined to become the PFIC rules as enacted in 1986. From the outset, Congress realized that an investment in an active business, including a bona fide bank or insurance company, should not be subject to the PFIC rules. The legislative history to the House Bill indicates that:

The Conference Report states:

An exception to the definition of passive income is provided under the agreement for income derived by bona fide banks and insurance companies, subject to regulatory exceptions. Any foreign bank licensed to conduct a banking business under the laws of the United States or of any State will be generally presumed to be a bona fide bank for this purpose. However, the Secretary has regulatory authority to apply the PFIC provisions to any "bank" where necessary to prevent US individuals from earning what is essentially portfolio investment income in a tax deferred entity. A bona fide insurance company is any foreign insurance company that would be subject to taxation under subchapter L if the company were a domestic insurance company.²²²³

The 1986 Blue Book provides:

The legislative history of TAMRA provides both a description of the PFIC provisions as enacted by the 1986 Act and the provisions as revised by TAMRA. With respect to the Insurance Exception enacted by the 1986 Act, this legislative history provides that:

With respect to the Insurance Exception as revised, the legislative history provides:

As the legislative history demonstrates, Congress wanted to ensure that non-US insurance companies that could avail themselves of the special US federal income tax rules under subchapter L of the Code if they were domestic US insurance companies would not be characterized as PFICs.

Congress displayed two concerns with respect to the Insurance Exception. The first was the possibility for abuse by an overcapitalized non-US insurance company that could earn investment income for the benefit of its shareholders in excess of the needs of its insurance business. This concern is similar to the concern in the cases mentioned above relating to the definition of an insurance company for US federal tax purposes. The second concern was that the Insurance Exception could be abused by a non-US "insurance" company that was not writing business properly characterized as insurance for US federal tax purposes. In connection with the TCJA Congress added the QIC requirement presumably to address the concern with overcapitalization, and the perceived concern previously described as hedge funds disguised as insurance companies.²⁷

These concerns and Congress' approach with respect to excepting insurance companies from PFIC status is completely different than Congress' approach with respect to the exception for banks, where the statutory language makes it clear that only licensed banks (i.e., bricks and mortar depository institutions) should be excepted.

II. Discussion of Certain Provisions of the Proposed Regulations and Comments

A. Clarification of Treatment of Insurance Company Assets

1. Overview of the Proposed Regulations Section 1.1297-5 Treatment of Insurance Assets

In general, a non-US insurance company that meets the QIC Test and Active Test will have its income that would otherwise be treated as passive, foreign personal holding company income (under section 954(c)(1) as modified by Proposed Regulation section 1.1297-1(c)), and assets, provided that they are available to satisfy the QIC's liabilities related to its insurance business, treated as non-passive.²⁸ In addition, for purposes of section 1297 and Proposed Regulation section 1,1297-1, a non-US insurance company that meets the QIC Test and Active Test will have its assets (including any assets of non-look-through partnerships) (provided they are used to satisfy its insurance business liabilities) treated as non-passive assets and the income it derives (including any income of non-look-through partnerships) excluded from passive income.²⁹

There are, however, additional special rules for partnership investments (i.e., a partnership that is less than 25% owned) under Proposed Regulation section 1.1297-1(c)(2)(ii) and for look-through partnerships (i.e., a partnership that is owned 25% or more by value) under Proposed Regulation section 1.1297-1(c)(2)(ii) and look-through subsidiaries (i.e., those to which section 1297(c) is applicable) under Proposed Regulation section 1.1297-5(f). In brief, the rules under Proposed Regulation section 1.1297-1(c)(2)(i) provide that look-through partnership investments are treated as passive unless the partnership's income and assets are treated as non-passive when tested at the partnership level. The rules under Proposed Regulation section 1.1297-1(c)(2)(ii) provide that less than 25% owned partnership investments are treated as passive.³⁰

In comparison, the rules under Proposed Regulation section 1.1297-5(f) provide that the income and assets of look-through partnerships and subsidiaries held by a QIC are treated as items of income and assets of the QIC (provided they are reflected on the QIC's applicable financial statement), and presumably are characterized as non-passive provided the QIC has met the Active Test. In addition, because Proposed Regulation section 1.1297-5(f)(1) refers generally to Proposed Regulation section 1.1297-1(c)(2) it is unclear whether this rule also applies to nonlook through partnerships despite the clear reference only to look through partnerships.

2. Comments

Insurance companies enter into a multitude of investments for a variety of sound investment reasons, these include (without limitation) stocks, bonds, derivatives, partnerships, joint ventures, and for certain investments, insurance companies form investment subsidiaries (typically to wall off risk or reporting obligations). Insurance companies conduct asset liability matching and develop investment goals and guidelines. Their investments are limited by regulatory oversight. In addition, the financial accounting rules applicable to GAAP³¹ and IFRS have comprehensive, complex and detailed requirements and guidelines that prescribe the extent to which assets and income of subsidiaries and other investments are required to be reported, or not, on a company's financial statements.

Congress implemented the QIC Test to require insurance companies to have a specified quantum of assets compared to liabilities. As such, all assets and income on an insurance company's applicable financial statement should be characterized as non-passive provided that the insurance company meets the QIC Test and the Active Test (as modified pursuant to comments).

Regulations should not be promulgated that will adversely impact and impair an insurance company in conducting its asset liability matching and investment policies in a manner that is appropriate for its insurance business operations. In addition, regulations should not be promulgated that require an insurance company to modify its accounting treatment from that prescribed by GAAP and/or IFRS.

An insurance company should not be penalized for following the requirements of GAAP and IFRS financial reporting standards. Proposed Regulation 1.1297-5(f)(2) should be modified so that the income and assets of a look through partnership and a look through subsidiary that are reported on an insurance company's applicable financial statement, and taken into account for the QIC Test, are characterized as non-passive for purposes of the 50% Test and 75% Test. Congress chose to require that GAAP or IFRS is the preferred methodology for determining applicable insurance liabilities and the GAAP or IFRS determination of when an investment requires consolidation should be respected. In this regard, Proposed Regulation section 1.1297-5(f)(2) should provide that:

an item of passive income or passive asset in the hands of an entity other than a QIC (subsidiary entity) shall be treated as an item of income or an asset used in the active conduct of an insurance business by a foreign corporation treated as a QIC for purposes of paragraphs (c) and (e) of this section to the extent that the applicable financial statement used to test the QIC status of the foreign corporation includes the assets and liabilities of the subsidiary entity, whether the income and assets of the subsidiary entity are directly included or whether the value of the investment in the subsidiary entity is included. Any such amount included to test for QIC status should reduce the amount of income and assets treated as passive in the hands of the subsidiary entity for purposes of section 1297(c) and Proposed Regulation sections 1.1297-2(b)(2) and 1.1297-1(c)(2)(i)).

Finally, the Proposed Regulations should clarify that the cross reference in Proposed Regulation section 1.1297-5(f) to Proposed Regulation section 1.1297-1(c)(2) is only a cross reference to Proposed Regulation section 1.1297-1(c)(2)(i), as the section 1.1297-5(f) rules are only intended to apply to look through partnerships and not to less than 25% owned partnerships.

B. Modification of the Active Test

1. Overview of the Proposed Regulations Active Test Requirements

The Proposed Regulations provide a facts and circumstances analysis for determining if a QIC is engaged in the active conduct of an insurance business.³² They specifically require that a QIC's officers and employees carry out substantial managerial and operational activity.³³ However, the Proposed Regulations also allow a QIC to include activities of officers and employees of another entity in the same control group³⁴ as the QIC.³⁵ The QIC must exercise regular oversight and supervision over the services and pay the compensation of the officers and employees providing the services or reimburse the service-providing entity for such compensation.

In order to meet the Active Test, a QIC must also satisfy an active conduct percentage requirement, as follows: the expenses related to the payment of the officers and employees providing the substantial managerial and operational activity (and that are related to the production or acquisition of premiums and investment income on assets held to meet obligations under the insurance, annuity, or reinsurance contracts issued or entered into by the QIC) must equal or exceed 50% of all production or acquisition expenses for the taxable year (not taking into account ceding commissions).³⁶

2. Comments

i. Employee Requirement

As a general matter, it is inappropriate to require a QIC to have its own employees in order to utilize the Insurance Exception to avoid PFIC characterization. The employee requirement does not take into account the manner in which many bona fide insurance companies operate. Requiring QICs to meet such a requirement is inconsistent with Congressional intent to except bona fide insurance companies from PFIC characterization and does nothing to ferret out companies lacking risk transfer in their products or that are overcapitalized. Moreover, in general, other types of companies are not required to have employees in order to avoid PFIC characterization.³⁷

The employee requirement does not take into account the business reality of insurance company operations, including how insurance companies in the US are operated. In today's global economy, corporate groups operate in a variety of different business models for sound business reasons. As a practical matter, the nature of the insurance business does not require an insurance company to have its own employees. In fact, there are specific types of insurance companies, including US companies, that by definition have no employees and others that have by long tradition operated through management companies, insurance agents or managing general agents ("MGAs"), and third party administrators ("TPAs"). For example, reciprocal insurance companies, by definition, have no employees. Instead, they are operated by attomeys-in-fact. Other US insurance companies rely heavily on MGAs and/or third party administrators.³⁸ Captive insurance companies traditionally have also been operated using management companies. Those companies are recognized as bona fide insurance companies that are taxable under Subchapter L of the Code if they are US domestic companies. Certainly Congress did not intend for such companies, or companies with similar structures, to be PFICs simply because they were not US domestic companies.

Indeed, in 2015, Treasury and the IRS issued proposed regulations ("the 2015 Proposed Regulations") to clarify the application of the Insurance Exception as it was formulated at that time. Those regulations, which were withdrawn by the Proposed Regulations, also include an employee requirement in order for a non-US insurance company to be treated as engaged in the active conduct of an insurance business for purposes of the Insurance Exception. It is noteworthy that Congress chose not to include an employee requirement when it amended the Insurance Exception in the TCJA, despite the fact that the 2015 Proposed Regulations had been issued more than two years previously.

Small or new insurance companies may not have the economic wherewithal to employ all of the various experts needed to operate an insurance company. Such companies, as well as more seasoned and larger companies, may hire independent agents or MGAs to produce business on an ongoing basis, outside accountants to conduct their audits, outside actuaries to provide underwriting and pricing expertise, third party modelers to develop risk models, TP As to handle claims and various other outside service providers with supporting expertise. Such experts provide operational support to the insurance company under the policies established by the company's Board of Directors and are generally subject to oversight by one or more officers of the insurance company. A US investor in a non-US insurance company that performs all of the activities of an insurance business by employing outside experts should not be treated differently from an investor in a non-US insurance company that performs all of the same activities through employees.

There are two Code sections that seem relevant to determining what it means to be in the active conduct of a trade or business: section 367 (which is cross referenced in the proposed banking exception regulations) and section 904. Under section 367(a)(3), a corporation actively conducts a trade or business only if its officers and employees carry out substantial managerial and operational activities.³⁹ In this regard, the section 367 regulations set forth a blanket rule that a business that has no employees and relies exclusively upon independent contractors does not engage in substantial managerial and operational activities, and therefore, cannot ever satisfy the "active conduct" test of section 367(a). The employee requirement in the Proposed Regulations seems to be drawn from the section 367(a) rules.

However, despite use of the term "active conduct" in section 1297, which mirrors the language of section 367(a)(3), (as well as the language of section 904 discussed below), the use of the section 367 test for active business is inappropriate. The concerns addressed by the section 367 regulations are different from the concerns expressed in the legislative history to the Insurance Exception. The section 367(a)(3) active business exception is concerned with a different issue, ensuring that appreciated assets are being transferred outside of the US taxing jurisdiction for sound business reasons and not for tax avoidance. A strict employee requirement seems to make sense for such an anti-abuse rule. On the other hand, as noted above, the legislative history indicates that Congress's focus with regard to the Insurance Exception was to prevent its application to entities with excessive passive assets to escape the PFIC rules. Hence, the concern in the context of the Insurance Exception appears to be focused on overcapitalized companies and with companies where risk is not transferred. An employee requirement does not address that concern.

As noted above, the section 1297 "active conduct of an insurance business" language also mirrors language found in section 904. In the section 904 context, the active conduct of an insurance business test is an objective test that examines the type of income earned by the non-US company rather than the level of activity generating the income. Section 904, which provides rules for limitations on foreign tax credits, provides, in part, that the term "financial service income" means any income which is received or accrued by any person "predominantly engaged in the active conduct of a banking, insurance, financing or similar business."⁴⁰ If a person meets this test, all of its income would be characterized as "general category" income rather than "passive category" income for purposes of the limitations on foreign tax credits,⁴¹ which generally is the more favorable characterization. The section 904 Treasury Regulations provide that for these purposes, an insurance company is predominantly engaged in the active insurance business for any year if for that year at least 80 percent of the entity's gross income is characterized as "active financing income."⁴² Accordingly, for purposes of section 904(d)(2)(D), the focus is entirely on income; there is no requirement for an insurance company to be actively run by its management and/or employees to be predominantly engaged in an active insurance business. Given that the rules under section 904 are aimed at determining when a non-US company is engaged in an active insurance business, it would make more sense to turn to those rules, rather than the section 367(a) rules, for purposes of defining the active conduct of an insurance business for PFIC purposes.

Proposed Regulation section 1.1297-5(c) should be modified to provide that the active conduct of an insurance business is a facts and circumstances test that is focused primarily on premium income and the assumption of underwriting risk, rather than on expenses related to direct or related employees.⁴³

ii. Active Conduct Percentage

The Proposed Regulations compound the issues associated with the employee requirement by requiring an insurance company to satisfy the active conduct percentage in order to be considered to be in the active conduct of an insurance business. Like the employee requirement, this requirement does not take into account the business reality of insurance company operations and puts an undue burden on insurance companies that companies in other industries do not have to bear in order for their income and assets to be characterized as non-passive for purposes of the PFIC rules.

Inherent in the active conduct percentage is the requirement that an insurance company have employees or utilize the employees of related entities. Accordingly, for all of the reasons discussed above, it is not an appropriate test for determining if a company is engaged in the active conduct of an insurance business. Moreover, the ratio itself is flawed because insurance companies often incur significant expenses in connection with the production of premium and investment income that are paid to non-employees.

Many US and non-US insurance companies rely on independent agents to produce their business. They also may accept business from independent brokers representing insureds seeking to buy coverage. The commissions and fees paid to such independent agents and brokers often represent a significant expense for the insurance company. Those expenses could be enough, when combined with other expenses, to cause a QIC to fail to satisfy the active conduct percentage. As noted above, insurance companies also hire a number of other service providers that support them in their operations, such as risk modelers, accountants, actuaries and TP As. A QIC should not be required to act in a way that a similarly situated US domestic insurance company would not in order to avoid PFIC characterization.

Fees paid to investment advisors also can skew a QIC's active conduct percentage. QICs with large books of business and significant loss reserves have substantial assets to invest. P&C insurance companies typically do not conduct all of their investment management activities internally, because it is not economically efficient or prudent to handle day-to-day asset management internally. With a large book of business, fees paid for such services will be substantial and may outweigh amounts paid to officers and employees. In addition, such amounts vary annually. A QIC should not be forced to give bonuses to officers and employees, or to not act prudently with respect to investments to mitigate PFIC exposure.

The active conduct percentage requirement should be removed from Proposed Regulations section 1.1297-5(c). Otherwise, many non-US insurance companies that have long been viewed as legitimate companies engaged in the active conduct of insurance business may not be able to meet it. Even if the active conduct percentage were modified, it simply is not an appropriate measure of whether an insurance company is engaged in the active conduct of an insurance business. Any test of active conduct of an insurance business should be a facts and circumstances test that is focused primarily on premium income and the assumption of underwriting risk rather than on direct or related employees.

C. Applicable Insurance Liabilities and the Definition of Loss and LAE

1. Overview of the Proposed Regulations

For purposes of applying the QIC test, the Proposed Regulations provide that "applicable insurance liabilities" for P&C companies, include only "occurred losses" and unpaid expenses of investigating and adjusting unpaid losses.⁴⁴ "Occurred losses" although not defined are described as those losses for which a company "has become liable but has not paid" by the end of the accounting period, and include unpaid claims for death benefits, annuity contracts, and health insurance benefits.

2. Comments

"Occurred losses" is not defined in the Proposed Regulations or in any provision of the Code or the regulations, nor is it used for insurance regulatory or accounting purposes. Section 832(b) and the regulations thereunder have defined terms for losses with well-established meanings, as do the statements governing insurance regulatory and financial accounting. By using a term that is not recognized in the insurance industry, the regulations add uncertainty to the understanding of die term "applicable financial liabilities" rather than clarifying that term.

Use of a new undefined category of losses not recorded as such on financial statements appears at odds with the statutory language which relies on applicable financial statements as the source for "applicable insurance liabilities."⁴⁵ It appears that Congress wanted to simplify the review of whether a company met the Insurance Exception. In requiring applicable insurance liabilities to be on an applicable financial statement, it seems Congress believed the amount of applicable insurance liabilities should be clearly stated on the applicable financial statement such that one need look no further. The adoption of a rule that requires review beyond the face of a company's financial statements appears at odds with this apparent statutory goal.

The terms used to define "applicable insurance liabilities" should have recognized meanings for insurance regulatory and tax purposes and relate to items on financial statements.

Moreover, the Proposed Regulations do not explain how "occurred losses" are to be determined other than to specify that they must be amounts for which the insurance company "has become liable" and which are unpaid as of "the end of the last annual reporting period ending with or within the taxable year. . . ." The Proposed Regulations do not provide any guidance with regard to when an insurance company "has become liable" for "occurred losses." It is unclear whether "occurred losses" are intended to be estimates or must be amounts that have been finally determined, but not paid.⁴⁶

Applicable insurance liabilities for property casualty companies, at the least, should include actuarial estimates of all unpaid losses, including actuarial estimates of IBNR (incurred but not reported) losses, consistent with the determination of losses under the Code and the regulations thereunder and under financial accounting principles for insurance.⁴⁷ Further, Treasury should consider a definition of losses that would take into account special rules for certain lines of business.⁴⁸

Finally, the Proposed Regulations exclude unpaid loss adjustment expenses with respect to paid losses. It is unclear what the basis for such exclusion would be. The statutory language does not distinguish between loss adjustment expenses with respect to paid losses and loss adjustment expenses with respect to unpaid losses. Even if paid losses and paid loss adjustment expenses are excluded from the definition of applicable insurance liabilities, the basis for excluding such amounts would not apply to any unpaid loss adjustment expenses whether they related to unpaid losses or to paid losses. Unpaid loss adjustment expenses related to paid losses should be included in the definition of applicable insurance liabilities.

D. Interaction of Sections 1297(c) and 1298(b)(7)

1. Overview of the Proposed Regulations Interaction Rule

The Proposed Regulations section 1.1297-2(b)(2)(iii) treat the special characterization rule of section 1298(b)(7) with respect to US domestic companies as taking precedence over the section 1297(c) look-through rule when both rules would apply simultaneously, because the characterization rule of section 1298(b)(7) is the more specific rule in the circumstances when the tested non-US corporation owns a domestic US corporation.

Section 1297(c) provides a look-through rule under which a non-US corporation shall be treated as if it "received directly its proportionate share of the income . . ." and as if it "held its proportionate share of the assets . . ." of any other corporation in which it owns at least 25 percent of the value of the stock. This rule applies to both US and non-US subsidiaries and operates to treat active assets (and passive assets) held by subsidiaries as active in the hands of the non-US parent corporation for purposes of the 50% Test and 75% Test.

On the other hand, section 1298(b)(7) only applies to US subsidiaries and provides that if a non-US corporation is subject to the accumulated earnings tax and owns at least 25% of the value of the stock of a US domestic corporation, the stock held by the US domestic corporation in a US domestic C corporation (that is not a RIC or a REIT) will be treated as a non-passive asset, and income with respect to such stock will be treated as non-passive for purposes of the 50% Test and 75% Test.

2. Comments

The legislative history of the enactment of sections 1297(c) and 1298(b)(7) does not support the Proposed Regulations' rule for coordinating sections 1298(b)(7) and 1297(c).

The legislative history of the enactment of section 1298(b)(7) indicates that it was specifically enacted to deal with the situation in which US individual shareholders hold US stock investments through a non-US holding company as opposed to through a US holding company, and to put such investors on par. The legislative history clearly contemplates the use of section 1298(b)(7) only in circumstances when income and assets would be deemed passive if section 1297(c) was applied. In this regard, the legislative history of section 1298(b)(7) states:

if a foreign investment company intends to use this rule to avoid the PFIC provisions, it will be subject to the accumulated earnings tax and, thus, the shareholders of that company will be subject to tax treatment essentially equivalent to that of shareholders of a PFIC.⁴⁹

Neither the statute nor the legislative history indicates that section 1298(b)(7) was intended to take precedence over section 1297(c) and both of these provisions are discussed alongside one another in the legislative history to the enactment of section 1298(b)(7),⁵⁰ which was enacted after section 1297(c); it would not have been necessary to enact section 1298(b)(7) other than for circumstances in which the US domestic company's assets and income were characterized as passive. This intent is consistent with the comments in the legislative history quoted above and below. The legislative history of section 1298(b)(7) states:

[t]hese PFIC look-through rules are in addition to the Act's rule that treats assets held by, and income received by, certain 25% owned corporations as being held by, and received by those corporations' shareholders.⁵¹

This clearly indicates that the section 1298(b)(7) rule was only intended to be used when a nonUS corporation would otherwise be treated as an investment company, and conversely would not be used by a non-US corporation that would otherwise not be a PFIC after application of the section 1297(c) rule.

Additionally, The legislative history of section 1297(c) states:

[t]he conferees do not intend that foreign corporations owning the stock of subsidiaries engaged in active businesses be classified as PFICs. To this end the agreement attributes a proportionate part of assets and income of a 25% owned corporation to the corporate shareholder in determining whether the corporate shareholder is a PFIC. [Emphasis added].⁵²

The word "foreign" is used only in connection with the non-US corporation testing for PFIC status. There is no language in the statute or in the legislative history that suggests the application of section 1297(c) was intended to be limited, or that section 1297(c) should not apply to any and all 25% owned subsidiaries whether US or non-US. In fact, the intention is clear in the legislative history that non-US corporations owning subsidiaries engaged in active businesses should not be classified as PFICs. Treasury is authorized to issue regulations that may be necessary or appropriate to carry out the purposes of the PFIC rules.⁵³ A rule that limits the application of 1297(c) so that the income and assets of a US domestic corporation with an active business are not treated as received and held by the non-US corporation testing for PFIC status, but instead treats only the stock held by such subsidiary as a non-passive asset, is at odds with the purposes of the PFIC rules and Congressional intent.

E. Exclusion of Qualifying Domestic Insurance Corporations for Purposes of Indirect Ownership in Lower Tier PFICs Under Section 1298(a)(2) — Proposed Regulation Sections 1.1297-5(b)(2) and 1.1297-5(e)(2)

1. Overview of Section 1298(a)(2) and Proposed Regulation Sections 1.1297-5(b)(2) and 1.1297-5(e)(2)

Section 1298(a)(2) provides an indirect ownership rule for testing to determine whether a US person indirectly owns stock of a PFIC that is a subsidiary of the parent company (a "lower tier PFIC") in which the US person owns shares. Pursuant to section 1298(a)(2) a person is not treated as indirectly owning shares in a lower tier PFIC as long as the person does not own 50% or more of the value of the parent company and the parent company is not characterized as a PFIC. Based on this rule, a US person that owns shares in a non-US holding company that is a parent of a multinational group of corporations is treated as owning, a holding company whose value and income is based on the results of the entire group, unless the person owns a significant portion (i.e., 50%) of the parent corporation. If the parent corporation is a PFIC, or if the parent corporation is a controlled foreign corporation ("CFC") and the person is a US shareholder, the 50% limitation does not apply.

Proposed Regulation sections 1.1297-5(b)(2) and 1.1297-5(e)(2) provide that the income and assets of a qualifying US domestic insurance corporation are treated as non-passive for purposes of determining whether a non-US corporation is treated as a PFIC. The preamble to the Proposed Regulations indicates that a qualifying US domestic insurance company (a "QDIC") is a US domestic corporation that is subject to tax as an insurance company under subchapter L and is subject to US federal income tax on its net income. Presumably, this rule is based on the fact that it would be inappropriate to treat a US domestic insurance company as having passive income and assets while treating a non-US insurance company as having non-passive income and assets when the foundation for the non-US corporation's status as non-passive is that it "would be subject to tax under subchapter L if such corporation were a domestic corporation."⁵⁴

However, Proposed Regulation sections 1.1297-5(b)(2) and 1.1297-5(e)(2) additionally provide that for purposes of section 1298(a)(2) and determining if a US person indirectly owns stock in a lower tier PFIC, the rule that treats the income and assets of a QDIC as non-passive will not apply.

2. Comments

It is unclear whether the provisions in Proposed Regulation sections 1.1297-5(b)(2) and 1.1297-5(e)(2) that indicate that the QDIC rule does not apply for purposes of section 1298(a)(2) is intended to cause the US domestic insurance company's income and assets to be not included in both the numerator and denominator for purposes of the 50% Test and 75% Test or whether the income and assets of US domestic insurance companies are to be treated as passive for this purpose. Given the purpose of the PFIC rules it would appear inappropriate to characterize a US domestic insurance company as having passive income and assets, and is clearly not what Congress intended in enacting the PFIC rules, including the QIC rules, especially given that the determination of QIC status is based on whether the non-US corporation would be subject to tax under subchapter L if such corporation were a domestic corporation.

In addition, there is no statutory authority for creating any exception to section 1298(a)(2) other than as specified in the statute (i.e., for 50% ownership and CFCs), nor is there statutory authority for creating a special insurance company penalty provision. No such rule applies to any other type of a business. For example, a non-US holding company with a US manufacturing business could own one or more non-US investment company subsidiaries, they could be the only non-US entities that the parent company owned and the manufacturing business would not be ignored or treated as passive for purposes of determining a US person's ownership in the parent's lower tier PFICs. There is no logical reason to treat an insurance company group so radically different than every other industry and no statutory authority to do so. If Congress believes it is necessary to curtail such potential activity, Congress may do so.

US investors that own stock in non-US holding companies, that own US and non-US entities, including insurance companies, own stock in a combined group of entities and such investors investment returns will be based on the combined group of entities. Such US investors should not be characterized as owning shares in a lower tier PFIC because (i) their investment is in an insurance group, instead of some other type of business, or (ii) the nature of the business written by the non-US insurance operations is of a type that does not generate reserves. In addition, they should not be characterized as owning stock of a PFIC, or a lower tier PFIC, because the income and assets of a US domestic, federal taxpaying, insurance company are characterized as passive.

Additionally, although Treasury was given authority to prescribe regulations as may be necessary or appropriate to carry out the purposes of the PFIC rules, there is no indication that Congress intended to treat an investment in a non-US parent corporation as a bifurcated investment or as an investment in a number of lower tier entities except when a person owns 50% or more of the value of the stock of the non-US parent corporation, the CFC rules⁵⁵ apply or the person owns stock tracking the lower tier PFIC,⁵⁶ and there is no indication that Congress intended to treat US domestic insurance company federal taxpayers less favorably than non-US insurance companies meeting the requirements of the Insurance Exception. The legislative history states:

The conferees do not intend that foreign corporations owning the stock of subsidiaries engaged in active businesses be classified as PFICs. [Emphasis added].⁵⁷

As can be seen, the intention is that subsidiaries (both US and non-US) owned by the non-US corporation testing for PFIC status be taken into account and that active businesses (both US and non-US) be taken into account; the word "foreign" is only used with respect to the tested corporation.⁵⁸ The Senate Report, which the Conference Agreement generally follows states:

The committee does not intend that holding companies formed to own active operating subsidiaries be treated as PFICs. The bill avoids this result by providing look-through rules for characterizing amounts *** received from foreign or domestic subsidiaries.⁵⁹ [Emphasis added]

The provisions in Proposed Regulation sections 1.1297-5(b)(2) and 1.1297-5(e)(2) that indicate that the QDIC rule does not apply for purposes of section 1298(a)(2) should be removed.

F. Exclusion of Certain US Domestic Corporations for Purposes of Indirect Ownership in Lower Tier PFICs Under Section 1298(a)(2) — Proposed Regulation Section 1.1298-4(e)

1. Overview of Proposed Regulation Section 1.1298-4(e)

Proposed Regulation Section 1.1298-4(e) operates in much the same way as Proposed Regulation sections 1.1297-5(b)(2) and 1.1297-5(e)(2), discussed above, and provides that for purposes of section 1298(a)(2) and determining if a US person indirectly owns stock in a lower tier PFIC that section 1298(b)(7) does not apply.

2. Comments

It is unclear whether the provisions in Proposed Regulation section 1.1298-4(e) that indicate that section 1298(b)(7) does not apply for purposes of section 1298(a)(2) is intended to cause the US domestic stock held by US domestic companies to be excluded from both the numerator and denominator for purposes of the 50% Test and 75% Test or whether US domestic stock held by US domestic companies is to be treated as passive for this purpose. Although given the purpose of the PFIC rules, and the purpose of section 1298(b)(7) as stated in the legislative history (discussed above), if section 1298(b)(7) was only used as intended (in circumstances where section 1297(c) would bring up passive income and assets), it might be appropriate to characterize the US domestic stock held by such US domestic company as excluded for purposes of section 1298(a)(2) and determining if the non-US parent corporation was a PFIC for such purposes. Congress, however, did not provide for such an exclusion, and the legislative history does not indicate such an intention. Given the stated purpose of section 1298(b)(7) in the legislative history (to equalize US and non-US investments in passive assets), it is not appropriate to treat stock held by a US domestic company that is characterized as non-passive as a result of section 1298(b)(7) as passive for purposes of section 1298(a)(2).

As noted above, there is no statutory authority for creating an exception to section 1298(a)(2) other than as specified in the statute (i.e., for 50% ownership and CFCs). Presumably Congress knew what they were doing when they enacted section 1298(b)(7) and they did not provide for an exception to section 1298(a)(2), and although Treasury was given authority to prescribe regulations as may be necessary or appropriate to carry out die purposes of the PFIC rules, there is no indication that Congress intended to treat an investment in a non-US parent corporation as a bifurcated investment or as an investment in a number of lower tier entities except when a person owned 50% or more of the value of the stock of the non-US parent corporation or the CFC rules applied.

Proposed Regulation Section 1.1298-4(e) should be removed.

G. Disparate Treatment for Insurance Companies Related to the Section 954 Passive Income Exceptions

1. Overview of the Proposed Regulations

The Proposed Regulations make clear that passive income for purposes of determining whether a non-US corporation is a PFIC does not include income excepted from the definition of foreign personal holding company income under sections 954(c)(2)(A) (active rents and royalties), 954(c)(2)(B) (export financing), 954(c)(2)(C) (dealers), and 954(h) (active banking and, financing), but does include income excepted under Code sections 954(c)(3) (income from related persons) and 954(i) (active insurance).⁶⁰ The preamble to the Proposed Regulations describes why these last two exceptions were treated differently and with respect to the related person exception points to specific legislative history. However, with respect to the section 954(i) exception, Treasury refers to the fact that the QIC rule was recently implemented and given this statutory change determined that Code section 954(i) should not apply.

2. Comments

Given that the section 954(i) active insurance exception requires significant home country insurance, and is a very specific and narrow exception, this exception to section 954(c) should apply. In enacting the QIC requirement in the TCJA, Congress was focused on the overcapitalization and hedge fund concern noted above; this is not typically an issue with companies that would meet the section 954(i) active insurance exception. It is inappropriate to treat insurance companies differently than all the other businesses that have exceptions to 954(c) enumerated in section 954. Further, the statute and legislative history⁶¹ indicate that it was intended that section 954(c) should apply except as specifically modified in the PFIC provisions. The modifications discussed in the legislative history are the banking exception in the PFIC rules (i.e., section 1297(b)(2)(A)) and the Insurance Exception. Congress did not indicate that the statutory exceptions in section 954 to section 954(c) should be disregarded and accordingly they should be taken into account when determining what is passive income for purposes of section 1297; in particular there is not a good reason to allow use of the section 954(h) banking exception and not the section 954(i) active insurance exception.

The section 954(i) active insurance exception to section 954(c) should be taken into account for purposes of determining passive income under section 1297.

H. Alternative Facts and Circumstances Test — Rating Related and the Meaning of "Minimum Credit Rating Required to be Secure to Write New Insurance Business"

1. Overview of Proposed Regulation section 1.1297-4(d)

As noted above, the alternate facts and circumstances test allows a corporation that does not meet the 25% test to otherwise qualify as a QIC if: (i) the corporation is predominantly engaged in an insurance business; (ii) at least 10% of its total assets comprise "applicable insurance liabilities;" and (iii) the reason for the failure to meet the 25% test is solely due to run-off or ratings-related circumstances. In order to utilize the exception, an election must be made by the US person who would be subject to the PFIC consequences and who owns stock in the insurance company.

An important aspect of utilizing the alternative facts and circumstances test is that the non-US corporation has rating related or run-off related circumstances that cause the failure to meet the 25% test (the "rating related test"). Proposed Regulation section 1.1297-4(d)(4) provides guidance on the circumstances in which the rating related test is met, and indicates that only if a generally recognized credit rating agency imposes specific capital and surplus requirements, and the non-US insurance company complies with these requirements in order to maintain "the minimum credit rating required for the foreign corporation to be classified as secure to write new insurance business for the current year," has the non-US insurance company met the rating related test.

2. Comments

The standard: "minimum credit rating required for the foreign corporation to be classified as secure to write new insurance business for the current year," proposed by Treasury should be modified. The standard should be tied to the credit rating needed by the insurance company to be able to write the business in its approved business plan in the marketplace in which it operates. As the preamble to the Proposed Regulations notes the required rating may differ based on the line(s) of business written. It may also differ based on the geographical market in which the company writes its business and/or the source of the risk. For example, an insurance company writing US business and one writing Asian business may require different ratings, one writing both types of business would require the higher of the two ratings. Market conditions may impact the rating needed in order to effectively write business at an appropriate price. Further, the terminology "to be classified as secure" is not rating agency terminology and is thus not meaningful in this context.

The standard: "minimum credit rating required for the foreign corporation to be classified as secure to write new insurance business for the current year," should be replaced with: "the credit rating needed for the current year by the foreign corporation to be able to write the business in its regulatory or board approved business plan."

In addition, Treasury should consider collateralized reinsurers as holding the capital that they hold as a rating related circumstance, because the reason they are fully collateralized is so that they do not have to be rated. They are required by the marketplace to be fully collateralized in order to write the business that they write, which is typically catastrophic risks. They also typically have small amount of investment income compared to premium income because of market requirements and are typically invested in very conservative, preservation of principal investments. Collateralized reinsurers represent an increasing share of worldwide reinsurance capacity and have become the primary source of retrocessional coverage for reinsurance companies. These insurers are also typically required by insurance law to be fully collateralized. Because they write catastrophe coverage which by nature deals with infrequent events, it generally will be extremely difficult to meet the 25% test, and even the 10% test to achieve QIC status.

The regulations should provide that collateralized insurers that are regulated by law and provide full collateralization of insurance limits be treated as meeting a ratings-related circumstance. If Treasury believes an additional quantitative requirement should be imposed on such companies, a de minimis investment income to premium earned test or a hypothetical ratings capital requirement test can be developed.

I. Alternative Facts and Circumstances Test — Election Process

1. Overview of Proposed Regulation section 1.1297-4(d)(5)

As noted above, in order to utilize the alternative facts and circumstances test, an election must be made by the US person who would be subject to the PFIC consequences and who owns stock in the insurance company. Proposed Regulation section 1.1297-4(d)(5) provides rules for making the election. The Proposed Regulation requires that the non-US insurance company must directly provide a statement to the US person making the election or that the non-US insurance company makes a publicly available statement, in each case indicating that the non-US insurance company has satisfied the requirements for the election to be made, provided the electing person does not know or have reason to know such statement is incorrect. The Proposed Regulations also require that the election be made on Form 8621 and filed with the elector's US federal income tax return with the statement provided by the non-US insurance company, or the information in the publicly available statement.

2. Comments

The process provided by the Proposed Regulations should be modified as follows. Electing persons (that do not own more than 50% of the non-US parent corporation) should be allowed to make the election(s) at the non-US parent corporation level, provided that as a result of the election(s) the non-US parent corporation will not be characterized as a PFIC. The non-US parent of the corporation should be permitted to provide a collective statement encompassing all of its lower tier insurance subsidiaries that meet the requirements for the election to be made instead of each lower tier insurance corporation having to provide such statement. This would be consistent with how public statements are made by insurance groups. The election at the non-US parent corporation would be made for all applicable subsidiaries and each would be listed on the electing statement. In addition, it is imperative that shareholders of publicly traded corporations⁶² and shareholders with small holdings in non-publicly traded insurance groups be deemed to make the election, provided that the non-US parent corporation has publicly provided the required statement. A small holding for this purposes should not be defined at a level below 10%, not taking into account any ownership attribution rules, aside from indirect ownership.

J. Treatment of Effectively Connected Income and Related Assets

1. Proposed Regulations are Silent

The Proposed Regulations do not address the treatment of the effectively connected income ("ECI") of a non-US corporation engaged in a US trade or business, the treatment of income attributable to a US permanent establishment ("PE income") or the assets held to generate such income. As discussed above, passive income and assets for purposes of the 50% Test and the 75% Test is defined by reference to section 954(c) and foreign personal holding company ("FPHC") income. If a CFC has FPHC income, its United States shareholders typically have to include such income in their subpart F income inclusions, because FPHC income is a component of subpart F income.⁶³ ECI and PE income is excluded from subpart F income by section 952(b). Because this exclusion applies to all of the types of subpart F income, the exclusion is found in the definition of subpart F income instead of to each type of subpart F income, such as FPHC income.

2. Comments

Income characterized as ECI/PE income, and the assets held to produce such income, should be characterized as non-passive, or at the least not included in either the numerator or the denominator for purposes of the 50% Test or 75% Test. Non-US corporations should not be penalized for having US branches instead of subsidiaries. Excluding such income is consistent with the purpose of section 1298(b)(7) as stated in the legislative history (discussed above) and Treasury has been given authority to prescribe regulations as may be necessary or appropriate to carry out the purposes of the PFIC rules.⁶⁴ One approach would be to exclude such income from passive income by applying section 952(b) to the FPHC component, or to each component, of subpart F income for purposes of section 1297.

K. Limitation on Applicable Insurance Liabilities

1. Overview of the Statutory Provisions and Proposed Regulation Section 1.1297-4(e)(2) and (3)

As noted above, in order for a non-US insurance company to be a QIC for a taxable year the company's applicable insurance liabilities as reported on its applicable financial statements must constitute more than 25% of its total assets (or it must meet the alternative facts and circumstances test. For purposes of determining the quantum of applicable insurance liabilities, such amount is limited to "the amount required by applicable law or regulation * * *, or * * * as determined under regulations prescribed by the Secretary."⁶⁵ The Proposed Regulations section 1.1297-4(e)(2) provides:

applicable insurance liabilities may not exceed the lesser of: (i) The amount of applicable insurance liabilities shown on the most recent applicable financial statement; (ii) The minimum amount of applicable insurance liabilities required by the applicable law or regulation of the jurisdiction of the applicable regulatory body; or (iii) For a foreign corporation that prepares a financial statement on the basis of a financial reporting standard for a purpose other than financial reporting, the amount of the applicable insurance liabilities on that financial statement.

Further, Proposed Regulation Section 1.1297-4(e)(3) provides that if a non-US insurance company's applicable financial statements do not discount incurred buy unpaid losses and loss reserves on an economically reasonable basis, the amount of such company's applicable insurance liabilities may not exceed the applicable insurance liabilities on the applicable financial statement reduced in accordance with the discounting principals of GAAP or IFRS.

2. Comments

The statutory provisions of section 1297(f)(3)(B) require interpretation. Although Proposed Regulation section 1.1297-4(e)(2) provides some interpretive guidance, interpretation is still required. Given Congress' express authority for Treasury to provide guidance on this point and given Congress' clear preference for utilizing the GAAP and IFRS rules, as well as Congress' intent that QIC status be largely determinable by review of a non-US insurance company's applicable financial statements, we recommend that Proposed Regulation section 1.1297-4(e)(2) provides that the amount required by applicable law or regulation is the amount that is required based on GAAP or IFRS. To take another approach that would take into account the various regulatory rules of every jurisdiction in which insurance companies operate appears unmanageable and fraught with a lack of clarity and the necessity for individual interpretation.

With respect to Proposed Regulation Section 1.1297-4(e)(3) discounting requirement based on GAAP or IFRS, it is important to note that GAAP does not discount loss reserves, with a limited exception. Although imposing a discounting requirement on insurance companies for purposes of determining the appropriate amount of such companies' income to subject it to taxation has merit and is statutorily prescribed, requiring discounting in order to compare the quantum of a non-US insurance company's assets to liabilities under the QIC Test is inappropriate given the nature of the comparison. All other assets and liabilities on an insurance company's financial statements are measured and stated on a non-discounted economic basis and it would skew the comparison to only discount the company's insurance reserves. Congress chose not to include a discounting requirement and to rely on the GAAP and IFRS financial reporting standards. As noted above, having to consider the economic reasonability of the various regulatory rules of every jurisdiction in which insurance companies operate appears unmanageable and fraught with a lack of clarity and the necessity for interpretation. A better approach is to require the use of GAAP or IFRS standard.

IV. Contact Information

We would be pleased to answer any questions about these comments. Please contact Saren Goldner (212-389-5063 sarengoldner@eversheds-sutherland.us) or M. Kristan Rizzolo (202-383-0908 KristanRizzolo@eversheds-sutherland.us).

Very truly yours,

John M. Huff
President and CEO
Association of Bermuda Insurers and Reinsurers
Washington, DC