IRS Foreign Insurance Excise Tax - Tax Audit Techniques Guide Present Questionable Positions

Section 4371 imposes an excise tax on a policy of insurance or reinsurance issued by a foreign insurer or reinsurer. The tax is four percent of premiums paid for direct insurance of U.S. property/casualty risks or one percent of premiums paid for a life or accident and health policy or annuity with respect to a U.S. citizen or resident or for reinsurance of U.S. risks. The tax does not apply when the insurer or reinsurer is engaged in a U.S. business and is subject to U.S. income tax. The persons liable for the tax include any person who makes, signs, issues or sells the policy of insurance or reinsurance. Many tax treaties with foreign countries contain provisions that eliminate the excise tax liability under certain circumstances.

In October 2008, the Internal Revenue Service (IRS) added to its Web site a guide for IRS agents to follow when auditing foreign insurance excise tax liability. An introduction to the guide cautions that it is not an official pronouncement of the law or of the IRS’s position, but it undoubtedly reflects input from the IRS personnel who administer the excise tax and audit compliance.

The guide is detailed, containing 12 chapters. Chapter 7 contains an extensive discussion of the controversial cascading excise tax issue. In Rev. Rul. 2008-15, the IRS set forth its position that the excise tax can apply to the same risks more than once—once to insurance (or reinsurance from a U. S. insurer) of U.S. risks by a foreign insurer, and again if the foreign insurer reinsures the risks with another foreign reinsurer. According to the IRS, this conclusion applies whether or not the foreign reinsurance treaty has a nexus with the United States other than the fact that the reinsured risks found their origin in the United States. In Announcement 2008-18, the IRS set forth a voluntary compliance program which, when followed, provides excise tax audit protection for premiums paid before Oct. 1, 2008. Major insurance trade associations jointly submitted comments on Rev. Rul. 2008-15, explaining several legal and practical reasons why the IRS’s cascading excise tax theory is suspect. Undoubtedly, the issue will be litigated if the IRS declines to withdraw the ruling. The portion of the audit guide added to the IRS Web site on the cascading excise tax issue does not break new ground beyond what has been stated in prior IRS pronouncements. The same cannot be said for the discussion in Chapter 4 of the timing of “premium paid,” on which the excise tax is based.