Menu
Tax Notes logo

Insurance Group Suggests Changes to Proposed PFIC Regs

SEP. 9, 2019

Insurance Group Suggests Changes to Proposed PFIC Regs

DATED SEP. 9, 2019
DOCUMENT ATTRIBUTES

September 9, 2019

Attn: CC:PA:LPD:PR (REG-105474-18)

David J. Kautter
Assistant Secretary for Tax Policy
Department of the Treasury
1500 Pennsylvania Avenue, N.W.
Washington, D.C. 20220

L.G. “Chip” Harter
Deputy Assistant Secretary (International Tax)
Department of the Treasury
1500 Pennsylvania Avenue, N.W.
Washington, D.C. 20220

Re: REG-105474-18 Proposed Regulations Providing Guidance on Passive Foreign Investment Companies

Dear Messrs. Kautter and Harter:

On behalf of the American Council of Life Insurers (”ACLI”),1 we are providing written comments to the Department of the Treasury (“Treasury”) and the Internal Revenue Service (“IRS”) with respect to the Proposed Regulations providing guidance on passive foreign investment companies (“PFICs”).

The Proposed Regulations provide guidance regarding the status of a foreign corporation as a qualifying insurance corporation (“QIC”) under section 1297(f) and the amount of income that is excluded from its passive income pursuant to section 1297(b)(2)(B) (the “PFIC Insurance Exception”), as amended by the 2017 tax reform act (the Act). They also address a number of other issues such as the PFIC attribution rules, the PFIC asset and income tests (the “Asset Test” and the “Income Test,” respectively), and the PFIC look-through rules. The Proposed Regulations affect United States (U.S.) persons with direct or indirect ownership interests in certain foreign corporations. The Proposed Regulations withdraw proposed regulations REG-108214-15 which provided guidance regarding when a foreign insurance company's income is excluded from the definition of “passive income” under prior law section 1297(b)(2)(B) (the “2015 proposed regulations”).

The membership of the ACLI is comprised of U.S.-owned and foreign-owned U.S. life insurers and reinsurers whose foreign affiliates issue and reinsure life insurance and annuity contracts overseas in numerous jurisdictions. Our members are particularly interested in working with Treasury and the IRS to develop appropriate rules for the taxation of life insurance companies to ensure that overseas life insurers and life reinsurers that are actively engaged in insuring and reinsuring life insurance and annuity policies are not inappropriately mischaracterized as PFICs. Our comments are limited to the impact of the Proposed Regulations on life insurance companies.

I. Background

Life insurance companies invest premiums they receive from their policyholders in order to pay their long-term contractual obligations. Thus, earning investment income is intrinsic to the life insurance business model and constitutes an active component of the business of a life insurer or reinsurer. The Internal Revenue Code (“Code”) recognizes this by providing a carve-out from the PFIC rules for investment income received in the active conduct of an insurance business. Specifically, section 1297(f) defines a qualifying insurance corporation, and section 1297(b)(2)(B) excepts from the definition of passive income, income “derived in the active conduct of an insurance business by a qualifying insurance corporation.” The Proposed Regulations provide guidance on when a foreign insurance company's income satisfies this exception.

II. Comments on Proposed Regulations

(a) QIC

1) Definition

The proposed regulations provide guidance regarding whether the income of a foreign corporation is excluded from passive income pursuant to section 1297(b)(2)(B) because the income is derived in the active conduct of an insurance business by a QIC. Generally, section 1297(f) provides that a QIC is a foreign corporation that (1) would be subject to tax under subchapter L if it were a domestic corporation (the “subchapter L test”) and (2) has applicable insurance liabilities that constitute more than 25 percent of its total assets (the “25 percent test”).

The 25 percent test is made on the basis of the foreign corporation's liabilities and assets as reported on the corporation's applicable financial statement for the last year ending with or within the taxable year. Proposed §1.1297-4(c) provides guidance regarding the application of the 25 percent test. ACLI finds both the subchapter L test and the 25 percent test to be acceptable standards.

2) Insurance Business

For purposes of the PFIC insurance exception, Proposed §1.1297-5(c)(2) defines an insurance business as the business of issuing insurance and annuity contracts or reinsuring risks underwritten by other insurance companies (or both). Under the Proposed Regulations, an insurance business also includes the investment activities and administrative services required to support (or that are substantially related to) those insurance, annuity, or reinsurance contracts issued or entered into by the QIC. Proposed §1.1297-5(h)(2) provides that investment activities are any activities that generate income from assets that a QIC holds to meet its obligations under insurance and annuity contracts issued or reinsured by the QIC.

We find the Proposed Regulations' definition of an insurance business to be an acceptable standard for determining whether a company is engaged in an insurance business. Indeed, sales, underwriting, investing, risk management, and claims settlement are essential to the life insurance business.

3) Active Conduct

Proposed §1.1297-5(c)(3)(i) provides that the term active conduct is based on all of the facts and circumstances and that, in general, a QIC actively conducts an insurance business only if the officers and employees of the QIC carry out substantial managerial and operational activities. For this purpose, active conduct is intended to be interpreted consistently with the active conduct standard in §1.367(a)-2(d)(5). The Proposed Regulations further provide that a QIC's officers and employees are considered to include the officers and employees of another corporation if the QIC satisfies the control test set forth in Proposed §1.1297-5(c)(3)(ii) (“related-party officers and employees”).

We appreciate that the Proposed Regulations remove the exclusion of related-party officers or employees in determining whether an insurance company is actively conducted by officers and employees that was in the 2015 proposed regulations. We agree that related officers and employees should be considered as officers and employees of the insurance corporation. However, instead of requiring the control test set forth in Proposed §1.1297-5(c)(3)(ii), we suggest substituting it with a section 954(d)(3) test of relatedness. Insurance companies pool resources and use the skills of personnel in related entities to maximize efficiencies. Many employees who perform the essential insurance functions are employed by a related service company and provide services to insurance companies via that company even within the US but also worldwide. Sometimes local rules result in structures where employees performing core insurance functions are employed by an affiliated service company. This is the case, for instance, in the United Kingdom (and other European Union countries) where employees of a life insurance company are only permitted to undertake work for that particular life insurance company, necessitating a service company structure when companies require employees to support more than one business or entity (such as two commonly owned insurance companies).

4) Active Conduct Percentage Requirement

Under Proposed §1.1297-5(c)(4), a QIC determines the annual amount of its income that is derived in the active conduct of an insurance business (the “active conduct test”) and excluded from passive income under section 1297(b)(2)(B) for purposes of section 1297(a). To make this determination, the QIC must determine its active conduct percentage.

If the QIC's active conduct percentage is greater than or equal to 50 percent, then all of the QIC's passive income is excluded from passive income pursuant to the exception in section 1297(b)(2)(B) for the active conduct of an insurance business. If the QIC's active conduct percentage is less than 50 percent, then none of its income is excluded from passive income pursuant to the exception in section 1297(b)(2)(B) for the active conduct of an insurance business.

We believe that the active conduct percentage test should only serve as an objective safe harbor. The general test for active conduct should be as described in Proposed §1.1297-5(c)(3)(i), which provides that the term “active conduct” is based on all of the facts and circumstances.2 Under that test, the officers and employees of the QIC and certain related entities must carry out substantial managerial and operational activities in order for the QIC to be treated as actively conducting an insurance business. We believe the facts and circumstance test must take into account the general practices of the life insurance and reinsurance industry. Industry practice is to actively conduct an insurance or reinsurance business through a combination of employees and officers of related and unrelated entities and unrelated service providers. For example, we identify underwriting — the ultimate decision to take on risk — as key to an insurance/reinsurance business that has to be done by the company or related-party officers and employees. However, other services critical to an insurance or reinsurance business, such as investment management, is routinely outsourced. The Proposed Regulations provide that the QIC must exercise regular oversight and supervision over the services performed by the related-party's officers and employees for the QIC. The exercise of managerial oversight by an officer or employee of the company over key insurance functions, whether they be performed by related or unrelated entities, should be sufficient to demonstrate that they are carrying out substantial managerial and operational activities. Such managerial oversight would include the power to select, hire, engage, or dismiss parties that would perform insurance business functions. Furthermore, life insurance and annuity policy sales are commonly conducted by independent agents; investment and claims settlement are likewise commonly outsourced to third parties. Taxpayers should be able to outsource such activities to independent contractors in line with general practices in the industry and still meet the active conduct test. Accordingly, we recommend a facts and circumstances test that requires an evaluation of all of the services performed for the insurance company, whether provided by in-house and related employees and officers or outside service providers, to determine whether the insurance company is engaged in the active conduct of an insurance business.

(b) Qualifying Domestic Insurance Corporations

1) General

Under the Proposed Regulations, a qualifying domestic insurance corporation (“QDIC”) is a 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. Proposed §§1.1297-5(d) and 1.1297-5(e)(2) state that the income and assets of a qualifying domestic insurance corporation are not treated as passive (the “QDIC rule”). The Preamble provides that the QDIC rule is intended to address situations where a foreign corporation owns a domestic insurance corporation through a structure to which section 1298(b)(7) (the “domestic subsidiary look-through rule”) does not apply. We welcome this rule and commend Treasury and IRS for providing it.

2) Indirect Ownership of a PFIC

Section 1298(a)(2)(A) treats a US person owning 50 percent or more (by value) of the stock of a non-PFIC foreign corporation as owning a proportionate share (by value) of the stock owned directly or indirectly by the non-PFIC foreign corporation. Section 1298(a)(2)(B) provides that, for purposes of determining whether a shareholder of a PFIC is treated as owning stock owned directly or indirectly by or for such company, subparagraph (A) shall be applied without regard to the 50 percent limitation contained therein.

Proposed §1.1291-1(b)(8)(ii)(B) provides that section 1298(b)(7) does not apply in determining whether a foreign corporation is a PFIC for purposes of that paragraph, which deals with the application of section 1298(a)(2). This rule applies in addition to the anti-abuse rules that disregard section 1298(b)(7). See Proposed §1.1298-4(f)(1) and (2).

A foreign holding company may own both foreign life insurance companies and QDICs through a domestic holding company. For purposes of section 1298(a)(2), as section 1298(b)(7) is turned off under the Proposed Regulations, section 1297(c) applies. The foreign holding company may be determined to be not a PFIC by applying section 1297(c), especially after application of the QDIC rule.

The Proposed Regulations, however, provide that the QDIC rule does not apply to determine whether the foreign holding company is a PFIC for purposes of section 1298(a)(2) (the “QDIC rule exception”). Accordingly, solely for purposes of section 1298(a)(2), the foreign holding company in the above example may be treated as a PFIC, as the assets and income of its QDICs are treated as passive. Therefore, a US person with a minority interest in the foreign holding company may be deemed to own an indirect interest in any PFIC owned by the foreign holding company even though the foreign holding company is not a PFIC under the general rules. It is typical for a foreign holding company of a multinational insurance group to own multiple investments that may be PFICs throughout its organization as part of its active insurance business. Examples of such investments include foreign investment funds owned by QICs. Attribution of the ownership of those indirectly owned PFICs to minority owners by reason of the QDIC rule exception places a significant burden on both the US shareholders and the foreign holding company. The QDIC exception rule will burden taxpayers by subjecting foreign corporations which are otherwise not PFICs to nevertheless undertake extensive analysis of their investments to determine if their lower tier investments are PFICs. Such attribution may also serve as a disincentive to US investors from holding shares in foreign-owned insurance groups that have significant US operations. Most significantly, because the attribution rule is triggered by ownership of QDICs, it serves as a disincentive to foreign-owned insurance groups from investing in US domestic insurance companies. Such a result is in direct contravention of the economic goals underlying tax reform and, in particular, the international rules of tax reform to motivate inbound investments in the US. But for the QDIC rule exception, the ownership of the PFIC would not be attributed to the US person under section 1298(a)(2)(B) as it owns less than 50 percent of the foreign holding company which is not a PFIC. We believe that the QDIC rule exception should be removed as it makes US shareholders that do not have a controlling interest in the foreign holding company owners of PFICs indirectly, even when they actually do not own a direct interest in a PFIC.

(c) Exceptions from Passive Income

Section 1297(b)(2)(A) provides that, except as provided in section 1297(b)(2)(B), the term “passive income” means any income which is of a kind which would be foreign personal holding company income (“FPHCI”) as defined in section 954(c). Among other things, under section 954(i), income from an active insurance business is excluded from FPHCI for purposes of section 954(c)(1). Therefore, a plain reading of section 1297(b) suggests that investment income of a foreign insurance company that is excluded from FPHCI under section 954(i) does not have to be considered passive income to again be tested under section 1297(b)(2)(B). However, the Proposed Regulations provide that the section 954(i) exception to FPHCI does not apply in addition to the PFIC exception. See Proposed §1.1297-1(c)(1)(i)(B).

The Preamble to the Proposed Regulations recognizes that the section 1297(b) cross-reference to section 954(c) could be read to include the exceptions provided in section 954(h) and (i), which apply for purposes of section 954(c) by their terms. However, given the statutory change to section 1297(b)(2)(B) and the tests contained in the definition of QIC in section 1297(f), the Treasury Department and the IRS have determined that the exception for insurance income in section 954(i) should not apply in addition to the newly modified exception in section 1297(b)(2)(B).

A section 954(i) exception to FPHCI is met only with respect to qualifying insurance income of a qualifying insurance company, each defined by sections 954(i) and 953(e)(3) respectively. Both these definitions are extremely detailed and are intended to identify the amount of investment income of a foreign insurance company earned from the active conduct of an insurance business, with sufficient local presence in the country of its incorporation. However, these rules are different from the definition of a QIC in section 1297(f). Accordingly, there may be situations where a foreign insurance company generates income that is excepted from FPHCI under section 954(i) but the company does not qualify as a QIC. ACLI believes that income that is excluded from FPHCI under section 954(i) should be excluded from passive income, as such income meets separate detailed tests for active conduct of an insurance business. There is no express Congressional intent to limit the exclusion from passive income in the case of investment income from a foreign insurance company to section 1297(b)(2)(B).

(d) Applicability Dates

The Preamble provides that the Proposed Regulations apply to taxable years of US persons that are shareholders in certain foreign corporations beginning on or after the date of publication of the Treasury decision adopting these rules as final regulations in the Federal Register.

We believe that the Proposed Regulations should be effective the later of taxable years of US persons beginning on or after the later of the date of publication of the Treasury decision adopting these rules as final regulations in the Federal Register, on or after January 1, 2021, or such other later date. This would allow time for taxpayers to apply the rules once they are finalized to determine if they are invested in PFICs and foreign corporations, analyze their structures under the new rules to identify any PFICs they may own, and obtain and provide information necessary for their US shareholders in a timely manner.

* * *

III. Conclusion

We thank you for your consideration of this request and are available to discuss the issues that we have presented in this letter at your convenience. If you have questions or need for additional information, please contact us.

Sincerely,

Regina Rose
ACLI
Washington, DC


cc:
Josephine Firehock
Attorney-Advisor
Internal Revenue Service

Douglas Poms
International Tax Counsel
Department of Treasury

Mandana Parsazad


Angela J. Walitt
Attorney-Advisor
Department of Treasury

Brett York
Attorney-Advisor
Department of Treasury

FOOTNOTES

1The American Council of Life Insurers (ACLI) advocates on behalf of 280 member companies dedicated to providing products and services that promote consumers' financial and retirement security. 90 million American families depend on our members for life insurance, annuities, retirement plans, long-term care insurance, disability income insurance, reinsurance, dental and vision and other supplemental benefits. ACLI represents member companies in state, federal and international forums for public policy that supports the industry marketplace and the families that rely on life insurers' products for peace of mind. ACLI members represent 95 percent of industry assets in the United States. Learn more at www.acli.com.

2The facts and circumstances test could be met by reference to the satisfaction of the economic substance requirements in a foreign jurisdiction in which the foreign QIC operates. We recommend that a QIC include a regulated insurance company that meets its country of domicile's economic substance rules as an insurance company. The economic substance rules of the country of domicile must be of a nature that complies with the OECD's BEPS rules and does not place the country of domicile on the EU's or other similar body's “blacklist.”

END FOOTNOTES

DOCUMENT ATTRIBUTES
Copy RID