United States: D.C. Circuit Court Rules Sec. 4371 Federal Excise Tax Does Not Apply To Foreign-To-Foreign Retrocessions

Article by Micah W. Bloomfield, Anthony J. Distinti, and Danielle E. Augustson (Summer Associate)

On May 26, 2015, the D.C. Circuit Court held in Validus Reinsurance, Ltd. v. United States1 that the federal excise tax ("FET") under Section 4371 of the Internal Revenue Code2 does not apply to foreign-to-foreign retrocessions. This decision will, unless the issue gets to the Supreme Court, have significant implications for the U.S. taxation of retrocession transactions between foreign (i.e., non-U.S.) parties. Nevertheless, as explained further below, the D.C. Circuit Court left many questions unanswered.

Background

The Validus case arose out of retrocessional protection purchased by Validus Reinsurance, Ltd. ("Validus Reinsurance"). The case addressed questions regarding the United States' ability to tax premiums retroceded by Validus Reinsurance under this agreement. Retrocession is the reinsurance of risks that were assumed by way of reinsurance. For example, assume Company A has issued a life insurance policy. Company A can enter into a reinsurance agreement with Company B, under which Company B agrees to indemnify Company A for some or all of the amount Company A is obligated to pay under the life insurance policy in the event that the insured dies.3 Company B, in turn, could then enter into a retrocession agreement with Company C, ceding some of Company B's reinsurance risk to Company C. Hedging by means of reinsurance and retrocession agreements enables insurers and reinsurers to achieve a variety of financial and operational objectives.

The question addressed in Validus – whether the United States could tax premiums paid by the foreign company, Validus Reinsurance, under a retrocession agreement – revolved around two sections of the Internal Revenue Code. The first – Section 4371(3) – imposes, among other things, a one cent per dollar FET on the premiums paid on reinsurance agreements that are issued by foreign reinsurance companies and that "cover" certain contracts.4 These contracts include casualty and life insurance, indemnity bonds, sickness and accident policies, and annuity contracts.

The second is Section 4372, which defines "reinsurance" as a policy of insurance made with respect to another company's casualty and life insurance contracts, indemnity bonds, sickness and accident policies, and annuity contracts.5 The company obtaining the reinsurance protection and paying the premium to the foreign reinsurer is responsible for the FET.6 If the tax is not paid by the company obtaining the reinsurance, Section 4371's tax must be paid by the foreign reinsurer.7

Congress implemented the FET under Sections 4371 and 4372 to level the playing field between domestic and foreign insurance companies engaged in the business of reinsurance and retrocession. According to the Validus court, Congress believed that foreign insurance and reinsurance companies had a competitive advantage over domestic insurance and reinsurance companies because, unlike the domestic companies, foreign insurance and reinsurance companies not engaged in trade or business in the United States would not be subject to U.S. federal taxation on their income relating to the policies.8

Under Section 4371, it is clear the FET applies when a domestic insurer seeking to hedge against a U.S.-based risk pays premiums on policies of reinsurance issued by any foreign reinsurer. At issue in Validus was whether Congress also intended for the FET to apply to a foreign reinsurance company paying premiums on a retrocession policy issued by another foreign reinsurance company to hedge against a U.S.-based risk. As explained below, this question arose because Section 4372 broadly defines a "policy of reinsurance" as a contract that "covers" insurance risks, without explicitly stating whether a foreign-to-foreign retrocessional agreement would also be subject to the FET.

Facts and Holding

Validus Reinsurance, a foreign reinsurer, entered into a retrocessional agreement with another foreign reinsurer. The IRS determined Validus Reinsurance was liable for Section 4371's FET and assessed $326,340 in excise tax against the company together with $109,040 in accumulated interest. Validus Reinsurance paid the FET and filed suit in the D.C. District Court for a tax refund.

Before the D.C. District Court, Validus Reinsurance argued that Sections 4371 and 4372 did not apply beyond the level of original reinsurance contracts and thus could not apply to retrocessional agreements. The United States Government, however, maintained that the plain language of the statutes also extended to retrocession "policies." It argued that as long as the property or insured risk was located or resident in the United States, Section 4371's FET should apply to each reinsurance and retrocession. The IRS had previously set forth its position on the cascading effect of the FET in Revenue Ruling 2008-15,9 and before the D.C. District Court, the Government adhered to this position, stating that, absent a tax treaty, foreign-to-foreign reinsurance and retrocession agreements were subject to the FET.

The District Court, however, agreed with Validus Reinsurance. The presiding judge, Judge Jackson, found the statute "clearly" only applied to reinsurance and could not extend to any purchase of retrocessional protection.10 Consequently, she granted summary judgment against the Government.

The Government appealed the District Court's decision to the D.C. Circuit Court. The D.C. Circuit Court upheld Judge Jackson's decision, but it disagreed with her reasoning. Although the D.C. Circuit Court found the statute did not explicitly exclude retrocession transactions, it held the statute was ambiguous. That is, Section 4371, standing alone, seemed to extend the FET to insurance and reinsurance contracts "anywhere in the world."11 The D.C. Circuit Court was unclear, however, about the scope of Section 4371 when viewed in conjunction with Section 4372. Section 4372 defines a "policy" of "reinsurance" as a contract made with respect to the risks covered by insurance policies. Before the D.C. Circuit Court, the Government and Validus Reinsurance gave competing arguments on the meaning of "to cover." The Government argued that the term "to cover" applied to all contracts of reinsurance issued with respect to U.S.-based risks (including retrocessions). Validus Reinsurance maintained "to cover" only applied to a contract of reinsurance directly indemnifying the original insurance contract's risk, not to all subsequent hedges. Because both parties offered plausible interpretations of the statute, the court concluded the text was ambiguous.

The D.C. Circuit Court resolved this ambiguity by applying a presumption against extraterritoriality. This presumption rests on a "longstanding principle of American law" that United States laws only apply within the territory of the United States, unless Congress explicitly states otherwise.12

The Supreme Court emphasized the importance of this presumption in Morrison v. National Australia Bank, a 2010 case involving the Securities Exchange Act (the "Act").13 In Morrison, the Supreme Court held the Act's definition of "interstate commerce" was insufficient to rebut the presumption against extraterritoriality, because the Act did not include an "affirmative intention" clearly expressed by Congress to give the statute extraterritorial effect.14 Justice Scalia, writing the majority opinion in Morrison, noted that the Circuits had repeatedly disregarded the presumption against extraterritoriality as it applied to the Act. The Second Circuit, in particular, relied on Congressional intent to apply extraterritorially despite the lack of clear statutory language suggesting this application. Although Morrison's holding centered on the Act, the Court highlighted the importance of applying "the presumption in all cases, preserving a stable background against which Congress can legislate with predictable effects."15

The D.C. Circuit Court in Validus applied Morrison's reasoning, stating that because Congress had not given clear indication that Sections 4371 and 4372 applied extraterritorially, the statutes must be presumed to apply only within the U.S. territorial jurisdiction. Otherwise, Section 4371 would allow the cascading tax to "compound into perpetuity with the creation of every new reinsurance contract" despite the absence of a contractual relationship with any U.S. entity.16 In its holding, the D.C. Circuit Court relied on this presumption and found for Validus Reinsurance.

Remaining Questions

Based on the D.C. Circuit Court's opinion, will the presumption against extraterritoriality apply only when there is ambiguity?

In Validus, the D.C. Circuit Court found that each party offered "plausible interpretations" for whether the statutory text applied to wholly foreign retrocessions.17 Consequently, the D.C. Circuit Court applied the presumption against extraterritoriality to resolve the ambiguity. Morrison, however, implied the presumption was to be used in all circumstances – regardless of ambiguity. The Supreme Court emphasized the need for an "affirmative intention" of Congress to apply a statute extraterritorially,18 but the D.C. Circuit Court only used the presumption to resolve the "statutory ambiguity."19 Will the D.C. Circuit now only apply this presumption when a statute is ambiguous?

Does the D.C. Circuit Court's holding apply to reinsurance contracts?

The D.C. Circuit Court's opinion in Validus does not address whether the holding also applies to foreign-to-foreign reinsurance contracts – stating only that the statute is ambiguous "with regard to its application to wholly foreign retrocessions" (emphasis added).20 Because the court did not explicitly apply its reasoning to foreign reinsurance contracts, it is uncertain whether the FET, as applied to wholly foreign reinsurance contracts, is also invalid.

It is possible that courts will interpret Validus as only invalidating Section 4371's FET on the premiums paid by a foreign reinsurance company that purchased a retrocession policy from another foreign reinsurer to hedge against its U.S.-based risk. If that were the case, the IRS could still apply Section 4371's FET to the premiums paid by a foreign insurance company purchasing original reinsurance from a foreign reinsurance company to hedge against its U.S.-based risk. However, courts might instead view Validus as holding that the presumption against extraterritoriality applies in all Section 4371 cases. In such circumstance, District Courts in the D.C. circuit most likely would find Section 4371's FET does not apply to premium payments on foreign-to-foreign original reinsurance contracts.

How did the D.C. Circuit Court have jurisdiction over the Validus Reinsurance case?

Taxpayers must follow procedural requirements to file a tax refund claim against the U.S. Government. The D.C. Circuit Court's opinion, however, does not clearly state how the D.C. Circuit had jurisdiction in Validus. Although we have not been able to determine the exact facts in this regard, the procedural statutes and the appellate briefs suggest that Validus Reinsurance was able to file its refund claim in Washington, D.C. because the company did not originally file an excise tax return.

Sections 1346 and 1402 of Title 28 state that the U.S. District Courts and U.S. Court of Federal Claims have original jurisdiction over any civil action filed against the U.S. Government for the recovery of federal taxes.21 If a corporation chooses to file a civil action with respect to a U.S. tax return in a District Court, the corporation must file in the U.S. judicial district in which the corporation has its principal place of business or principal office.22 If the corporation does not have a principal place of business or principal office in any U.S. judicial district, it must file the claim in the judicial district where the corporation filed the tax return in respect of which the claim was made.23 If the corporation had never filed a return, the civil action may be prosecuted in the D.C. District Court.24

Validus Reinsurance was a foreign corporation without a principal place of business in any U.S. judicial district. Had the company filed an excise tax return, the return should have been filed in Ohio.25 These facts, in conjunction with Sections 1346 and 1402 of Title 28, suggest the D.C. Circuit Court had jurisdiction because Validus Reinsurance did not originally file an excise tax return and that it only paid the FET on the relevant contract once the IRS assessed Validus Reinsurance for taxes due. As a result, under Section 1402 of Title 28, Validus Reinsurance was able to argue its case in the D.C. Circuit.

Although the procedural posture of this case was somewhat unusual, in order to assess the binding effect of Validus, it is important to understand how Validus Reinsurance was able to argue in front of the D.C. Circuit. Although the Government cannot choose the jurisdiction in which it will argue future cases, if another company is forced to file a federal tax refund in another U.S. judicial district, the Government may have another opportunity to argue for Section 4371's application on foreign-to-foreign retrocessions. The Government may also be able to argue its case in front of the U.S. Supreme Court if the Court grants a writ of certiorari. At this point, the Government has not filed a petition for a writ of certiorari, but it has until August 24, 2015 to do so.

Footnotes

1. Validus Reinsurance, Ltd. v. United States, 786 F.3d 1039 (D.C. Cir. 2015).

.2 All "Section" references are to the Internal Revenue Code of 1986, as amended.

3. The reinsurance may be indemnity reinsurance or assumption reinsurance; the latter is similar to a novation.

4. Section 4371, in full, 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:

(1) Casualty insurance and indemnity bonds

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);

(2) Life insurance, sickness, and accident policies, and annuity contracts

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

(3) Reinsurance

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).

5. Section 4372 – Definitions

(f) Policy of reinsurance

For the purpose of Section 4371(3), the term "policy of reinsurance" means any policy or other instrument by whatever name called whereby a contract of reinsurance is made, continued, or renewed against, or with respect to, any of the hazards, risks, losses, or liabilities covered by contracts taxable under paragraph (1) or (2) of Section 4371.

6. Treas. Reg. § 46.4374-1(c).

7. See id.

8. Validus Reinsurance, Ltd. v. United States, 786 F.3d 1039, 1043 (D.C. Cir. 2015) (citing H.R. Rep. No. 77-2333, at 61).

9. Rev. Rul. 2008-15, I.R.B. 2008-12.

10. Validus Reinsurance, Ltd. v. United States, 19 F. Supp. 3d 225, 227 (D.D.C. 2014).

11. Validus Reinsurance, Ltd., 786 F.3d at 1043.

12. See id. at 1045 (citing EEOC v. Arabian Am. Oil Co., 499 U.S. 244, 248 (1991) (internal citations omitted)).

13. Morrison v. National Australia Bank, 561 U.S. 247 (2010).

14. Id. at 255.

15. Morrison, 561 U.S. at 248.

16. Validus Reinsurance, Ltd. v. United States, 786 F.3d 1039, 1044 (D.C. Cir. 2015).

17. See id. at 1041.

18. Morrison, 561 U.S. at 255.

19. Validus Reinsurance, Ltd, 786 F.3d at 1045.

20. See id.

21. See 28 U.S.C.A. § 1346; 28 U.S.C.A. § 1402.

22. See 28 U.S.C.A. § 1402.

23. See id.

24. See id.

25. IRS Instructions for Form 720, Quarterly Federal Excise Tax return (2015).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Topics
 
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions