The IRS recently issued Proposed Treasury Regulation §1.1297-4 to provide guidance regarding whether a foreign insurance company’s income is excluded from the definition of passive income for purposes of determining whether the company is a passive foreign investment company (PFIC). Specifically, the Proposed Regulations define “active conduct” and “insurance business.”
The Proposed Regulations
Under IRC §1297, a foreign corporation is a PFIC if either 75% or more of its gross income for the taxable year is passive income, or on average 50% or more of its assets produce passive income or are held for the production of passive income. For purposes of applying the passive income test, §1297(b)(2)(B) provides that the term “passive income” does not include any income that is derived in the active conduct of an insurance business by a corporation which is predominantly engaged in an insurance business and which would be subject to tax as an insurance company under the Code. In Prop. Reg. §1.1297-4, Treasury and the IRS are proposing to define “active conduct” and “insurance business” to clarify the circumstances under which investment income earned by a foreign insurance company is derived in the active conduct of an insurance business for purposes of determining whether the income is passive income, and thus the extent to which the company’s assets are treated as passive assets for purposes of determining whether the company is a PFIC.
The Proposed Regulations provide that the term “active conduct” has the same meaning as Treas. Reg. §1.367(a)-2T(b)(3). A trade or business is actively conducted under Treas. Reg. §1.367(a)-2T if the officers and employees of the corporation carry out substantial managerial and operational activities. However, under the Proposed Regulations officers and employees of related entities will not be considered officers and employees of the foreign insurance company for determining whether a trade or business is actively conducted.
The Proposed Regulations provide that the term “insurance business” means the business of issuing insurance and annuity contracts and the reinsuring of risks underwritten by insurance companies, together with those investment activities and administrative services that are required to support or are substantially related to insurance and annuity contracts issued or reinsured by the foreign corporation. An investment activity is any activity engaged in by the foreign corporation to produce income that would be foreign personal holding company income under IRC §954(c). Investment activities are required to support or are substantially related to insurance and annuity contracts issued or reinsured by the foreign corporation to the extent that income from the activities is earned form assets held by the foreign corporation to meet obligations under the contracts.
The Proposed Regulations could affect foreign insurance companies with U.S. owners. The Proposed Regulation’s exclusion of officers and employees from related entities could affect whether the company satisfies the active conduct requirement of the PFIC test. This could impact companies that rely on employees of a related entity to perform services for the foreign company or companies that outsource core and administrative functions to various third party service providers. Companies that underwrite low frequency/high severity risks and those that are in runoff should monitor their investment activities to demonstrate the need for assets or whether assets should be distributed to shareholders so that the foreign company satisfies the passive income test.
If you have any questions, please contact David Kaseff.
About the author
David Kaseff, as the leader of the Insurance team, brings both accounting and legal expertise to clients in the areas of taxation, captive insurance and alternate risk financing. He works with Fortune 500 companies and large privately held companies. He specializes in tax and legal matters for the auto dealer industry and producer-owned reinsurance companies.