Two PLRs Provide Some Clarity on Section 351 and Indemnity Reinsurance

Twenty years after the Internal Revenue Service (IRS) changed its position on the application of section 351 to assumption reinsurance transactions in Rev. Rul. 94-45, 1994-2 C.B. 39, through the issuance of two private letter rulings, we have some clarity on the corollary question of whether section 351 can also apply to indemnity reinsurance transactions even if novations are not expected as part of the overall transaction. The bottom line is that, if the indemnity reinsurance transaction is of a permanent nature, the IRS has concluded that section 351 can apply so that the ceding commission is not subject to tax pursuant to subchapter L (assuming all of the other section 351 requirements are satisfied). However, if the indemnity reinsurance agreement permits recapture by the ceding company or includes profit sharing provisions, the principles of subchapter L will apply to determine the proper tax treatment of the arm’s length reinsurance portion of the transaction.

Section 351 provides that no gain or loss is recognized if property is transferred to a corporation by one or more persons solely in exchange for stock and immediately after the exchange such person(s) are in control of the corporation. In Rev. Rul. 94-45, the IRS held that the transfer of assets to a subsidiary which included the transfer of the insurance business via assumption reinsurance was tax-free under section 351. In that case, the ceding company was not subject to tax on the transfer of the insurance in force which was included in the value of the stock received in the exchange. If the reinsurance portion of the transfer is carved out of the section 351 transaction and treated as a taxable transaction, the results can be very different (e.g.increases/decreases in tax reserves, DAC, etc.)