Tax: PwC Top Issues

www.pwc.com/us/insurance
February 2016
Insurance Taxation

2 top issues
Legislative outlook
Election-year politics are
dominating legislative action this
year as both parties lay down
policy agendas for 2017 and
beyond. President Obama and the
Republican leaders of Congress are
offering competing plans on how
to reform the US tax system and
to promote other policies intended
to increase economic growth and
make American companies more
competitive. At the same time,
both Democratic and Republican
candidates seeking their party’s
presidential nomination are
advancing tax reform plans.
During his final year in
office, President Obama
likely will continue to rely
on his Administration’s
regulatory authority and the
presidential veto to preserve
the 2010 Affordable Care Act
(ACA) and other legislative
and regulatory actions taken
during his years in office.

3 top issues
Obama Administration action
President Obama on February
9 submitted an FY 2017 budget
to Congress that reaffirms his
support for “business tax reform”
that would lower the top US
corporate tax rate to 28 percent,
with a 25-percent rate for domestic
manufacturing income.
Significant international tax increase
proposals that have been re-proposed
include a 19-percent minimum tax on
future foreign income, and a one-time
mandatory 14-percent tax on previously
untaxed foreign income. The President’s
budget again reserves revenue from a
large number of previously proposed tax
increases to support business tax reform,
including specific proposals affecting
insurance taxation (discussed below),
but his budget identifies only part of the
revenue that would be needed to support
his proposed corporate rate reductions.

4 top issues
Congressional action
House Speaker Paul Ryan (R-WI)
has called for House Republicans
to vote in 2016 on comprehensive
tax reform legislation and on
changes to federal entitlement
programs as a way to define and
build support for a conservative
legislative agenda. Senate
Majority Leader Mitch McConnell
(R-KY) also is expected to advance
a conservative legislative agenda
with a focus on demonstrating
an ability to govern and with
an eye on protecting the 54-seat
Republican Senate majority.
House Ways and Means Committee
Chairman Kevin Brady (R-TX) recently
outlined his goals for producing a
blueprint for comprehensive tax reform
and plans to “move forward immediately
to draft international tax reform
legislation.” Chairman Brady has said
that he hopes the Obama Administration
and Congress can reach common
ground on some policies and build on
the momentum from the last year’s “tax
extender” legislation, which included a
provision making permanent Subpart F
exceptions for active financing income.
Chairman Brady said that comprehensive
tax reform “will not happen until we have
a new president” but he is “hopeful that
next January we will have a president
– Republican or Democrat – who is
committed to making pro-growth tax
reform a reality for the American people.”
The chairman outlined several principles
for comprehensive tax reform, including a
“competitive tax rate” and a “permanent
modern territorial-type system that helps
American companies compete and win
overseas.” He also said that the Ways and
Means Committee will look “with fresh
eyes” at a range of tax ideas, including
“consumption tax, cash flow tax, reformed
income tax, and any other approach that
will be pro-growth.”
On international tax reform, Chairman
Brady said “developments in the global
environment demand our immediate
attention.” He pointed to OECD “base
erosion and profit shifting” (BEPS)
proposals that “disproportionately burden
American companies” and the European
Commission anti-tax avoidance package
that would provide EU member countries
with an “arsenal of new revenue-grabbing
tax measures.” He also discussed the
growing number of corporate inversions
and foreign acquisitions involving US
companies. “We will send a clear signal
to American companies and shareholders
that help is on the way – that we won’t
stand idly by while our tax code drives
them overseas or makes them a target for
a foreign takeover,” said Chairman Brady.

5 top issues
Senate Finance Chairman Orrin Hatch
(R-UT) has said he “doubts very much”
that international-only tax reform
can be enacted this year. The Finance
Committee Republican Majority staff have
been working on options for corporate
integration tax reform proposals that
would seek to eliminate the double-
taxation of corporate earnings. Corporate
integration proposals generally have
focused on approaches providing that
any distributions made by such entities
either would be deductible by the
entity (dividends paid deduction) or
would be excludable by the recipient
(dividend exclusion). A December 2014
report prepared by the Senate Finance
Committee Republican staff stated that
a dividends paid deduction “would
generally be easy to implement and would
largely equalize the treatment of debt
and equity.” Chairman Hatch recently
asked Treasury Secretary Lew to “keep
an open mind” to a corporate integration
proposal might help to address make US
corporations more competitive globally
and reduce inversions.
Although there is bipartisan
agreement that the US
corporate tax rate should be
lowered significantly and that
our international tax system
should be updated, there is
significant disagreement
over key business tax issues,
including how to offset the cost
of a corporate rate reduction.

6 top issues
Insurance-related revenue raisers
The Obama Administration’s
FY 2017 budget re-proposes
several revenue-increase measures
specific to insurance companies.
The proposed legislative changes
generally would apply for tax
years beginning after December
31, 2016.
Among the insurance-related measures
are provisions that would:
• Disallow the deduction for non-
taxed reinsurance premiums paid
to affiliates – This proposal would
disallow any deduction to covered
insurance companies for the full
amount of reinsurance premiums
paid to foreign affiliated insurance
companies with respect to reinsurance
of property and casualty risks if the
premium is not subject to US income
taxation. The proposal would provide a
corresponding exclusion from income
for reinsurance recovered with respect
to a reinsurance arrangement for which
the premium deduction has been
disallowed. The proposal also would
provide an exclusion from income for
ceding commissions received with
respect to a reinsurance arrangement
for which the premium deduction has
been disallowed. The exclusions are
intended to apply only to the extent
the corresponding premium deduction
is disallowed. The proposal would
provide that a foreign corporation that
is paid a premium from an affiliate
that would otherwise be denied a
deduction under this provision may
elect to treat those premiums and
the associated investment income as
income effectively connected with the
conduct of a trade or business in the
United States. If that election is made,
the disallowance provisions would
not apply.
• Conform net operating loss rules of
life insurance companies to those of
other corporations – This proposal
would modify the carryback and
carryforward periods for losses from
operations of life insurance companies
to conform the treatment to that of
other taxpayers. Under the proposal,
losses from operations of life insurance
companies could be carried back up to
two taxable years prior to the loss year
and carried forward 20 taxable years
following the loss year.
• Modify rules that apply to sales of
life insurance contracts, including
transfer for value rules – This
proposal would create a reporting
requirement for the purchase of any
interest in an existing life insurance
contract with a death benefit equal to
or exceeding $500,000. The proposal
also would modify the transfer for
value rule to ensure that exceptions to
that rule would not apply to buyers
of policies.

7 top issues
• Modify dividends received deduction
for life insurance company separate
accounts – This proposal would repeal
the present-law proration rules for life
insurance companies and apply the
same proration regime separately to
both the general account and separate
accounts of a company. Under the
proposal, the policyholders’ share
would be calculated based on a ratio of
the mean of the reserves to the mean
of the total assets of the account. The
company’s share would be equal to one
less the policyholders’ share.
• Expand pro rata interest expense
disallowance for company-owned
life insurance (“COLI”) – This
proposal would curtail an exception
to a current law interest disallowance
of a pro rata portion of a company’s
otherwise-deductible interest expense,
based on the unborrowed cash value
of COLI policies. As modified, the
exception would apply only to policies
covering the lives of 20-percent
owners of the business. The proposal
would apply to contracts issued after
December 31, 2016, in tax years ending
after that date.
• Repeal special estimated tax
payment provision for insurance
companies under section 847 – This
proposal would repeal IRC Section 847
and would include the entire balance
of an existing special loss discount
account in income in the first tax year
beginning after 2016. Alternatively,
the proposal would permit an election
to include the balance in income
ratably over four years. Existing special
estimated tax payments would be
applied.

8 top issues
Insurance Developments:
Judicial and Administrative
A number of judicial and
administrative developments
occurred in 2015 concerning
insurance companies.
These developments affected insurers in
various lines of business:
• Life insurers – The most significant
development for life insurers was
not solely a tax development. Life
principle-based reserves (PBR) will be
effective when 42 states representing
75% of total direct written premiums
amend their standard valuation law.
At the current rate of adoption, Life
PBR is expected to be effective January
1, 2017, for contracts issued on or after
that date. Life PBR will implicate a
number of tax issues, and for the first
time the IRS and Treasury included
guidance on Life PBR in its annual
Priority Guidance Plan. Also during
2015, the Tax Court decided in Webber
v. Commissioner, 144 T.C. No. 17 (June
30, 2015) that a policyholder was liable
for taxes on income earned on assets
supporting a variable life insurance
contract based on the policyholder’s
control over the assets. The case
accorded deference to a number of the
IRS’s “investor control” revenue rulings
and could result in closer attention
to variable life insurance and annuity
contracts that are privately placed.
• Non-life insurers – The Tax Court
in 2015 addressed what qualifies
as insurance risk for purposes of
classifying contracts as insurance
contracts. In R.V.I. Guaranty Co., Ltd v.
Commissioner, 145 T.C. 9 (September
21, 2015), the court held that residual
value insurance (RVI) contracts that
protect against an unexpected decline
in the market value of leased personal
property qualify as insurance contracts
for Federal income tax purposes. The
case’s reasoning relies heavily on the
treatment of the contracts by non-tax
regulators, and it provides taxpayers
further guidance for distinguishing
between investment risk and insurance
risk.
• Health insurers – In 2015, a
Treasury Inspector General for Tax
Administration (TIGTA) report
criticized the IRS for the “finality”
requirement that prevents the Service
from assessing health insurers that
inadvertently or otherwise were not
assessed the correct amount (or any)
of the Health Insurance Provider
Fee, which is apportioned among all
covered health insurers. Other health
insurance providers still wait for the
IRS to act on refund requests of the
fee in 2015. The ultimate resolution
remains uncertain.
• Captive insurance companies –
During 2015, the IRS issued two Chief
Counsel Advice (CCA) that analyze
whether specific types of policies
issued by captive insurance companies
constitute insurance for federal income

9 top issues
tax purposes. In CCA 201511021,
the IRS determined that contracts
indemnifying the policyholder for
loss of earnings resulting from foreign
currency fluctuations did not satisfy
the three-prong test to be considered
insurance, because foreign currency
risk is not an insurance risk. The CCA
was issued before the tax court’s
decision in R.V.I. Guaranty Co., Ltd., so
did not take the tax court’s approach
into account. In CCA 201533011,
the IRS concluded that excess loss
policies issued by a captive insurance
company that covered healthcare
risks of members of unrelated HMOs
are not insurance contracts because
they lacked the requisite element
of risk shifting. Based on the facts
as presented, the CCA analysed the
arrangement as an interest-bearing
deposit, but then concluded that
receipts were included in income and
deductions were allowed for future
claim payments when made. Also in
2015, the IRS issued IR 2015-19, which
added section 831(b) companies to
the “Dirty Dozen” list of tax scams,
indicating that the IRS would target
these companies in examination.
• PFIC exception for income derived
in the active conduct of an insurance
business – During 2015, the IRS
proposed regulations that would
provide guidance on investment
income that is treated as derived in the
active conduct of an insurance business
and therefore not treated as “passive
income” under the passive foreign
investment company (PFIC) rules.
In particular, Prop. Reg. §1.1297-4
would provide that “active conduct”
requires that an insurer conduct its
activities through its own officers
and employees, and that investment
income be earned on assets held to
meet obligations under insurance and
annuity contracts. Several comments
were submitted on these issues and on
the use of a bright line test for whether
assets are held to meet obligations
under insurance contracts.
• Cross-border reinsurance – The
Court of Appeals for the District of
Columbia Circuit ruled in Validus
Reinsurance, Ltd v. United States
of America, 786 F.3d 1039 (2015)
that the Federal Excise Tax (FET)
on insurance premiums does not
apply to retrocessions between two
foreign insurers regardless of whether
the underlying risks are US-based.
Accordingly, the IRS issued Rev. Rul.
2016-3, 2016-3 I.R.B. 282, which
revokes the ruling setting forth the
IRS’s prior position on the application
of FET on a cascading basis to
either reinsurance or retrocession
arrangements between two foreign
insurers. The Validus decision and
Rev. Rul. 2016-3 mark the end of
controversy with the IRS on this
issue, and most companies already
have submitted claims for refund
of previously-paid excise tax on a
cascading basis, or plan to do so.

10 top issues
• Inversions – In 2014, the Treasury
Department (Treasury) and the IRS
issued Notice 2014-52, which describes
regulations the Treasury and IRS
intend to issue concerning transactions
sometimes referred to as “inversions.”
The notice included a “cash box” rule,
which targeted taxpayers who engage
in certain inversion transactions
with foreign corporations and their
subsidiaries with substantial liquid
assets. As a follow up to that notice, the
Treasury and IRS issued Notice 2015-
79, providing more information about
the intended regulations. In particular,
Notice 2015-79 describes regulations
that IRS and Treasury intend to
issue addressing transactions that
are structured to avoid the purposes
of §7874 (concerning expatriated
entities) and addressing “post-
inversion tax avoidance transactions.”
The latter notice clarifies that property
held by a US insurance corporation and
a foreign corporation that is engaged
in the active conduct of an insurance
business will be exempted from the
“cash box” rule.
As in prior years, the IRS and Treasury
jointly issued a Priority Guidance Plan
outlining guidance it intends to work
on during the 2015-2016 year. The
plan continues to focus more on life
than property and casualty insurance
companies. The following insurance-
specific projects were listed as priority
items. Many carried over from last year’s
plan, including:
• Final regulations under §72 on the
exchange of property for an annuity
contract. Proposed regulations were
published on October 18, 2006;
• Regulations under §§72 and 7702
defining cash surrender value;
• Guidance on annuity contracts with a
long-term care insurance feature under
§§72 and 7702B;
• Guidance under §§807 and 816
regarding the determination of life
insurance reserves for life insurance
and annuity contracts using
principles-based methodologies,
including stochastic reserves based on
conditional tail expectations;
• Guidance under §833 (expected to
address de minimis MLR relief);
• Guidance on exchanges under §1035 of
annuities for long-term care insurance
contracts; and
• Guidance relating to captive insurance
companies.

11 top issues
Implications
• Election year politics and
disagreements between President
Obama and Congressional Republicans
(notably on how to offset any corporate
tax reductions) make domestic or
international tax reform unlikely in the
coming year.
• President Obama’s FY2017 budget
proposes several revenue-increase
measures specific to insurance
companies. However, it remains to be
seen which, if any, of the measures will
come into effect.
• Multinational insurers and reinsurers
should closely monitor legislative and
regulatory developments pertaining
to taxation of overseas profits. Both
the PFIC regulation and the promised
regulations on inversions could have a
significant effect on some companies
and their shareholders.
• Life insurers should consider the effect
of Life PBR tax issues on product
development, financial modeling, and
compliance as they prepare for the
January 1, 2017, effective date.
• Non-life insurers with non-traditional
lines of business should consider the
effect, if any that the R.V.I. Guaranty
Co. case and the two Chief Counsel
Advice memoranda on the nature of
insurance risk and the presence of
risk shifting may have on insurance
qualification.
• Captive insurers should be prepared
for additional IRS scrutiny as a result
of the Priority Guidance Plan item
promising guidance, and the inclusion
of §831(b) companies in the IRS “Dirty
Dozen” list.

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Contacts
Mark S. Smith
Managing Director, Tax Services
+1 202 312 7518
mark.s.smith@pwc.com
Larry Campbell
+ 1 202 414 1477
larry.campbell@pwc.com
Surjya Mitra
+1 202 414 4382
surjya.mitra@pwc.com
Adam Fisher
Director, Tax Services
+1 646 471 1536
adam.fisher@pwc.com
Fiona Wang
Manager, Tax Services
+1 202 312 7663
fiona.wang@pwc.com

Tax: PwC Top Issues

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