When It Reigns, It Cascades
Sovereign calls for cascading excise
taxes for foreign insurance and reinsurance policies on U.S.
risks—and brokers could be left holding the
It’s often repeated that nothing’s certain in
life except death and taxes. U.S. revenuers are leaving no
stone unturned to find every bit of tax they believe is due
them, even if it means stepping on the toes of U.S. trading
You really can’t blame them. Their job is to fill the
federal coffers so government can spend our hard-earned tax
dollars. With the economy in turmoil, a huge deficit, an
expensive war and the presidential hopefuls calling for tax
cuts, you’d better believe every penny counts.
Of course, it’s better if the tax is so obscure and
complicated that the average person isn’t aware of it. If
it were a tax on gasoline or income, there would be a public
outcry. And believe me, raising taxes in an election year is
So who’s pocket is the IRS looking to pick? You
guessed it—the insurance industry’s. In March, the
IRS clarified that the Federal Excise Tax (FET) on foreign
insurance and reinsurance policies is a “cascading
tax.” In a nutshell that means the tax is not due just on
the primary transaction covering a U.S. risk, but also could be
due on subsequent reinsurance, retrocessions, etc.—as far
as the risk is spun out.
The FET is not a new tax. IRS Code Sec. 4371 imposes a 4%
tax on casualty policies and indemnity bonds issued by non-U.S.
insurers and reinsurers. A 1% tax is levied on life and health
policies as well as on reinsurance policies by foreign
insurers. There are some exceptions. The FET does not apply to
premiums that are connected with the conduct of a trade or
business within the U.S. and subject to federal income tax.
The U.S. has a number of tax treaties with other countries
that may exempt all or part of the tax along the reinsurance
chain. But the treaties vary country to country on what’s
exempt. The treaties don’t necessarily exempt the taxes
on the cascading aspect of the taxation.
For example, the U.S.-British tax treaty waives the FET as
long as the UK insurance or reinsurance policy issued for a
U.S. risk isn’t part of a so-called conduit arrangement.
Simply put, it is a conduit arrangement if it meets two tests:
If all or substantially all of premium income from a policy is
paid (directly or indirectly) to an entity in another
jurisdiction that doesn’t have a similar (or better) tax
treaty with the U.S.; and if the main purpose of the
transaction is to avoid the tax.
A fronting arrangement that is run through the UK to an
insurer in another country for the purpose of avoiding the FET
is most likely not acceptable under the IRS scenario.
This is just one example where the FET is owed. There are
numerous variations on this theme, which makes it fairly
complicated to figure out.
The interpretation of “cascading” raises a
number of sticky issues. The first is the question of whether
non-facultative reinsurance and retrocessions really cover U.S.
risks. Just figuring out what those cessions cover is
Who pays the tax—the insurer, reinsurer or broker?
According to the IRS, it can collect the FET from any party
involved in the transaction, including someone outside the U.S.
The IRS also believes it can levy fines on the U.S. assets of a
non-U.S. company for non-payment.
What jurisdiction does the IRS have to collect taxes from a
non-U.S. person? Cleverly, the IRS has set out a voluntary
compliance scheme that explains how taxpayers can voluntarily
comply with the cascading FET. By agreeing to the voluntary
plan, companies are also agreeing to U.S. tax authority, albeit
limited, even if they are outside U.S. borders.