This month the Treasury Department issued proposed regulations that affect many taxpayers making payments to foreign counterparties. This Special Bulletin focuses on the provisions of the proposed regulations or their preambles that specifically deal with or would be of concern to the insurance industry.
One set of proposed regulations1 concerns the Foreign Account Tax Compliance Act, or FATCA, a statute that generally provides for a 30% withholding tax on payments of U.S. source income to foreign entities, unless the entities (if they are so-called financial institutions) register with the IRS and provide information regarding their U.S. account holders or provide information regarding their substantial direct or indirect U.S. owners (if they are not financial institutions).2
The second set of proposed regulations3 concerns the new corporate minimum tax (the BEAT tax), which can impose a 10% or 11%4 tax on modified taxable income, if that tax is greater than the regular tax on unmodified taxable income.5 Modified taxable income is generally taxable income increased by certain deductible payments that a domestic corporate taxpayer makes to a related foreign person.6
The BEAT tax is not imposed unless those deductible payments to related foreign persons equal or exceed 3% (for certain taxpayers 2%) of all its deductible payments and the corporation and its affiliates have average annual gross receipts that equal or exceed $500 million.
FATCA Proposed Regulations
The FATCA proposed regulations have a number of important provisions that affect all taxpayers, including the elimination of any withholding on gross proceeds from U.S. stocks and securities (which was scheduled to go into effect in 2019) for noncomplying foreign entities and a further deferral of withholding on so-called foreign passthru payments (which have not been defined, but are meant to protect against foreign financial institutions avoiding the FATCA rules).
As specifically concerns the insurance industry, the proposed regulations would provide that there is no FATCA withholding on insurance premiums, unless the insurance contract is cash-value insurance, which generally means insurance (other than indemnity reinsurance or certain term life policies) under which the holder has the right to terminate the policy and receive more than $50,000. Withholding on premium payments had generally been deferred under the final regulations until 2017 for so-called offshore obligations (but was required beginning in 2017).
In providing this exemption, Treasury sought to eliminate the administrative burden associated with documenting insurance carriers, intermediaries and syndicates of insurers for FATCA purposes for insurance contracts that do not have a cash value, especially because some of that information will be captured as a result of amendments made by the Tax Cuts and Jobs Act of 2017 to provisions applicable to passive foreign investment companies. According to the preamble, these proposed regulations can be relied on for all open tax years.
BEAT Minimum Tax Regulations
The proposed regulations dealing with the BEAT tax have important provisions for all affected taxpayers, including an exclusion from base erosion benefits for payments to a foreign affiliate if, generally speaking, the payment is included in the foreign affiliate's income from a U.S. business (so-called effectively connected income, or ECI). There is also a provision that resolves a statutory ambiguity by providing that the base erosion percentage for NOLs is determined using the base erosion percentage in the year the NOL arose.
A number of provisions in the proposed regulations are of particular interest to insurance companies, and the preamble to the proposed regulations asks for comment on other possible provisions. These are briefly discussed below.
Determining If Taxpayer Is Subject to the BEAT Tax
In determining whether a taxpayer is subject to the BEAT tax, it is necessary to determine if it (together with members of its "aggregate group" of corporations) has average annual gross receipts of at least $500 million.7 Consistent with the statute, the proposed regulations would not allow any reduction in gross receipts for reinsurance premiums paid or accrued by an insurance company.8
No Netting to Determine Base Erosion Benefits
The proposed regulations provide that base erosion benefits are determined on a gross basis, even if the parties are contractually or legally permitted to make or receive payments on a net basis.9 As an example, they state that "any premium or other consideration paid or accrued by a taxpayer to a foreign related party for any reinsurance payments is not reduced by or netted against other amounts owed to the taxpayer from the foreign related party or by reserve adjustments or other returns."
However, the preamble does ask for comments on whether reinsurance contracts that provide for settlement on a net basis should be distinguished in this regard from other commercial contracts. Insurance companies may want to comment on this provision, as there are some good arguments for allowing netting.
Qualified Derivative Payments
There is a special rule in the statute (Code section 59A(h)) that qualified derivative payments (QDPs) are not base erosions payments. The statute as well as the proposed regulations provide that derivatives do not include insurance contracts for this purpose.10
The preamble to the proposed regulation makes it clear that no special provision is required to exclude from the definition of related foreign corporation a so-called 953(d) company, because it is treated for purposes of the Code as a U.S. corporation under Code section 953(d).
Insurance Company That Is an Affiliate of a Bank or Dealer
An affiliated group (as defined in Code section 1504(a)(1)) that includes a bank or registered securities dealer is subject to the 1% higher BEAT tax rate (and the 2% rather than 3% test for being subject to the BEAT tax). The proposed regulations would apply the higher rate to any member of an aggregate group, including an insurance company, that has a bank or registered securities dealer that is a member of the affiliated group, but would exclude all the members of an aggregate group or affiliated group if the gross receipts of the bank or dealer are less than 2% of the group's receipts.11
Life vs. Nonlife Companies
Base erosion benefits are defined to include not only deductible payments to foreign related parties but also premium payments to a related foreign person "which are taken into account" under Code sections 803(a)(1)(B) or 832(b)(4)(A).12
The reason for this special provision is presumably to treat life and nonlife insurance companies in a similar matter even though nonlife companies (but not life companies) compute their gross income with a reduction (rather than a deduction) for premiums paid for reinsurance.
The preamble to the proposed regulation notes that complete comparability is not provided by this provision since nonlife companies can also reduce their gross income by losses (see Code section 832(b)(3)), and it asks for comment on whether a life company should have the equivalent treatment. Life companies may want to comment.
Reliance and Opportunity to Comment
The preamble to the proposed regulation states that "[u]ntil finalization, a taxpayer may rely on these proposed regulations for taxable years beginning after December 31, 2017, provided the taxpayer and all related parties of the taxpayer (as defined in proposed §1.59A-1(b)(17)) consistently apply the proposed regulations for all those taxable years that end before the finalization date." Written comments or a request for a public hearing on the proposed regulation must be received by February 19, 2019.
1 83 Fed Reg pp. 64757-64768 (December 18, 2018).
2 FATCA is contained in sections 1471-1474 of the Internal Revenue Code of 1986, as amended (the "Code"). There are already extensive final regulations in effect under those Code provisions, and the US has entered into Intergovernmental Agreements (so-called IGAs) with many countries that modify the FATCA rules but generally continue to require either the entity or the government to report to the IRS.
3 83 Fed Reg pp. 65956-65997 (December 21, 2018).
4 The BEAT tax rate goes up to 12.5% or 13.5% in taxable years after 2025. For 2018 the BEAT tax rate is 5% or 6%. The rate is one percent higher for any taxpayer that is a member of an affiliated group that includes a bank or registered securities dealer.
5 The BEAT can be applicable in more situations than might at first be obvious, because most tax credits cannot be taken against the BEAT (including foreign tax credits). Until 2025, the research credit and 80% of the low income housing credits and certain renewable energy credits may be taken against the BEAT tax.
6 The statute is Code section 59A. More exactly, modified taxable income is computed without regard to the deduction for "base erosion benefits" (including the base erosion percentage of NOLs). Base erosion benefits include payments or accruals (a "base erosion payment") to foreign related parties and include the deduction for depreciation with respect to depreciable property acquired by a "payment" to a foreign related party. The proposed regulation would treat noncash payments for depreciable property including stock issued in a nonrecognition transaction as payments for purposes of the BEAT tax. A base erosion payment also includes "any premium or other consideration paid by the taxpayer to a foreign person which is a related party of the taxpayer for any reinsurance payments which are taken into account under sections 803(a)(1)(B) or 832(b)(4)(A)". See also Code section 59A(c)(2)(A)(iii)(setting out the base erosion benefit from this base erosion payment). Relatedness is generally determined using a 25% or greater overlap of ownership, with constructive ownership rules. There is also a special base erosion benefit for certain payments to expatriated entities which reduce gross receipts (if the entity expatriated after November 9, 2017).
7 An aggregate group is generally a group of corporations with 50% common ownership. Foreign corporations are generally included in the group only to the extent of their US effectively connected income. For more details, see Proposed Reg. §1.59A-1(b)(1).
8 Prop. Treas. Reg. §1.59A-2(d)(2).
9 Prop. Treas. Reg. §1.59A-3(b)(2)(ii).
10 See Code section 59(h)(4)(C) and Prop. Treas. Reg. §1.59A-6.
11 Prop. Treas. Reg. §1.59A-2(e)(2).
12 See Code section 59A(d)(3).
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.