Appellate Court Limits Reach of U.S. Insurance Excise Tax
A recent decision by the United States Court of Appeals for the District of Columbia, Validus Reinsurance, LTD v. United States, limits the scope of section 4371, which imposes an excise tax on premiums paid with respect to certain insurance and reinsurance policies written to cover U.S. risks. The appellate court found that the U.S. excise tax cannot be imposed on premiums paid with respect to wholly foreign retrocessions. The case is of interest because it is an example of the courts reading a statute to circumscribe the IRS’s taxing jurisdiction.
Validus is a reinsurance company organized, and doing business, in Bermuda. Its business includes selling reinsurance to insurance companies that sell policies covering risks, liabilities and hazards within the United States. In managing its risk portfolio, Validus enters into “retrocessions” (i.e., the purchase reinsurance by a reinsurer) with other insurance companies, “retrocessionaires.”
Section 4371 imposes an excise tax on premiums paid on any insurance or reinsurance policy (or indemnity bond) “covering” generally casualty, life insurance and other risks when the insureds are domestic entities or individual residents and the risks are wholly or partly within the United States. The excise tax also reaches premiums on policies covering individuals and foreign entities engaged in a trade or business within the United States.
On audit, the IRS determined that Validus was liable for the section 4371 excise tax on premiums paid to foreign retrocessionaire’s with respect to reinsurance policies that Validus had written covering U.S. risks. Validus paid the excise tax and sued the IRS for a refund.
Section 4371 does not explicitly cover retrocessions. The District Court granted a motion of summary judgment in favor of Validus finding that the statute covered only insurance and reinsurance policies and not retrocessions. The question considered by the DC Circuit was whether wholly foreign-to-foreign retrocessions fall within the ambit of section 4371.
Reasoning of the Court
On appeal, Validus and the IRS argued the meaning of “covering” in section 4371 to support their position that the excise tax was, or was not, due. After reviewing both arguments, the circuit court concluded “because both parties offer plausible interpretations based on different readings of the statutory text, we conclude the text of section 4371 is ambiguous with regard to the application to wholly foreign retrocessions.”
The circuit court turned then to the judicial presumption against extraterritoriality to resolve the question of whether foreign-to-foreign retrocessions are within the scope of section 4371. The circuit court, citing a 2010 Supreme Court opinion, stated “a court must presume that the statute has no extraterritorial application ‘unless there is the affirmative intention of the Congress clearly expressed to give a statute extraterritorial effect.’” The circuit court then found that there was no clear congressional intent in the legislative history or elsewhere for the excise tax to apply to wholly foreign retrocessions.
The circuit court also focused on the potential for the excise tax to be compounded, i.e. applied repeatedly, if foreign-to-foreign retrocessions were taxed under section 4371. For example, if the government’s argument were accepted, the excise tax would be due on the initial reinsurance contract and on each retrocession made thereafter as to the same risk. This would allow the tax “to compound in perpetuity” according to the court. The circuit court also states that the purpose of the statute, to level the tax playing field between U.S. and non-U.S. insurers, is satisfied as long as the excise tax is imposed on the reinsurance of risk with a foreign insurer.
The IRS also argued that its interpretation the statute was due judicial deference under Chevron and later cases.  The circuit court rejected this argument stating that there was no evidence that the IRS considered the presumption against extraterritoriality in arriving at its interpretation the statute.
The United States determines the source of royalties based on place of use of the licensed intellectual property. Thus, if a non-U.S. person owning the U.S. rights to certain intellectual property licenses those rights to another non-U.S. person who then sublicenses those rights to a U.S. sub-licensee who exploits those rights, the IRS position is that the royalty paid by the foreign licensee to the foreign licensor is subject to U.S. withholding tax. This has caused consternation to U.S. treaty partners, and one court has rejected this position. This decisions provides another rationale for rejecting this approach should a court again face this issue.
 No. 14-05081 (May 26, 2015). Section 4371 provides:
There is hereby imposed, on each policy of insurance, indemnity bond, annuity contract, or policy of reinsurance issued by any foreign insurer or reinsurer, a tax at the following rates:
 The IRS takes the position that the excise tax applies to premiums on policies written with respect to U.S. risk without regard to whether the tax has been paid on premiums on a policy written by another insurer earlier in the chain of insurance. See Rev. Rul. 58-612, 1958-2 C.B. 850 and U.S. v. Northumberland Ins. Co., Ltd., 521 F. Supp. 70 (D. N.J. 1981). Morrison v. Nat’l Austl. Bank Ltd., 561 U.S. 247, 255 (2010). Chevron USA Inc. v. Natural Res. Def. Council Inc., 467 U.S. 837 (1984). Section 861(a)(4). See Rev. Rul. 80-362, 1980-2 C.B. 208. SDI Netherlands v. Commissioner, 107 T.C. 161 (1996).KEYWORD: FDAP Income
- 4 cents on each dollar, or fractional part thereof, of the premium paid on the policy of casualty insurance or the indemnity bond, if issued to or for, or in the name of, an insured as defined in section 4372(d);
- 1 cent on each dollar, or fractional part thereof, of the premium paid on the policy of life, sickness, or accident insurance, or annuity contract; and
- 1 cent on each dollar, or fractional part thereof, of the premium paid on the policy of reinsurance covering any of the contracts taxable under paragraph (1) or (2).
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