Passive Foreign Investment Companies: IRS and Treasury Department Issue Proposed Regulations Regarding the Treatment of Insurance Companies Under the “Passive Foreign Investment Company” Rules

Sullivan & Cromwell LLP - April 24, 2015
Download

On April 23, 2015, the IRS and Treasury Department released proposed Treasury Regulations (the “Proposed Regulations”) affecting insurance companies under the “passive foreign investment company” (“PFIC”) rules of the Internal Revenue Code (the “Code”).  The Proposed Regulations come in the wake of recent attention in the press and inquiries from Senator Ron Wyden regarding foreign insurance companies organized by or otherwise associated with hedge funds that manage all or a substantial portion of the insurance companies’ investment assets.  These arrangements have been  portrayed as tax avoidance schemes.  The Proposed Regulations, however, are not explicitly limited to hedge fund-linked insurance companies and could impact more traditional “offshore” insurance companies.

There are two principal features of the Proposed Regulations.  First, the Proposed Regulations provide that a foreign insurance company is generally not engaged in the “active conduct” of an insurance business (which includes both underwriting and investment activities) unless it conducts substantial managerial and operational functions through its own employees and not through employees of independent contractors (or even employees of affiliates).  Second, the Proposed Regulations provide that investment income is not earned in an “insurance business” unless that income is earned from assets held by the foreign corporation to meet obligations under the insurance company’s insurance, annuity or reinsurance contracts.  The Proposed Regulations do not specify a test for determining whether an asset is held to meet insurance-related obligations, but the preamble to the Proposed Regulations suggests that assets that exceed a specified percentage of the corporation’s total insurance liabilities could be treated as not so held.  The preamble then solicits comments on what an appropriate specified percentage might be.