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Neal Reintroduces Offshore Reinsurance Tax Bill

by Mike Godfrey, Tax-News.com, Washington

06 August 2009


Congressman Richard E. Neal has resubmitted legislation in the House of Representatives that seeks to curb tax advantages for reinsurance operations based offshore.

The bill, H.R. 3424, would amend the Internal Revenue Code to “disallow the deduction for excess non-taxed reinsurance premiums with respect to United States risks paid to affiliates,” and was referred to the House Committee on Ways and Means on July 30.

Neal, who chairs the Ways and Means Select Revenue Measures subcommittee, introduced the same bill in the previous Congress last September, but the legislation did not progress beyond the committee stage.

“I am pleased to come before the House to introduce legislation ending the use of excessive affiliate reinsurance by foreign insurance groups to strip their US income into tax havens, avoid tax, and gain a competitive advantage over American companies,” the Massachusetts Democrat stated during his floor statement. “In the past, I have offered a number of bills to limit offshore tax avoidance. Today’s bill follows on that trend but focuses specifically on one area of the financial services sector.”

Some members of Congress are arguing for a change in the law because foreign insurance entities, unlike their domestic competitors, can use related party reinsurance to reduce their tax liabilities on investment income. This may be accomplished when a US subsidiary writes the initial insurance policy and then reinsures the policy to its foreign parent corporation, or related party, which is located in a low or no-tax jurisdiction. The US subsidiary deducts the premium and the foreign parent company does not pay US or local tax on the premium while earning investment income subject to low or no tax.

The Senate has been studying similar proposals that seek to ensure that offshore reinsurance entities are taxed "appropriately," so as to limit any competitive advantage they may currently hold over American companies, and last December, Senate Finance Committee Chairman Max Baucus released a discussion paper addressing ‘related party’ reinsurance, especially cases where a parent company headquartered offshore reinsures a policy written by its US subsidiary.

While measures are already in place under Section 845 of the US Tax Code to permit the Treasury to reallocate items and make adjustments in reinsurance transactions in order to prevent tax avoidance or evasion, Neal argues that these have failed to stem the offshore tide.

According to Neal, since 1996, the amount of reinsurance sent to offshore affiliates has grown from a total of USD4bn ceded in 1996 to USD33bn in 2008, including nearly USD21bn to affiliates in Bermuda, where corporate tax is 0%, and over USD7bn to Swiss affiliates. “Use of this affiliate reinsurance provides foreign insurance groups a significant market advantage over US companies in writing direct insurance here in the US,” he said.

Neal also notes that in the last decade there has been a doubling in the growth of market share of direct premiums written by groups domiciled outside the US, from 5.1% to 10.9%, representing USD54bn in direct premiums written in 2006, with Bermuda-based companies representing the bulk of this growth, rising from 0.1% to 4%. During this time, the percentage of premiums ceded to affiliates of non-US based companies has grown from 13% to 67%. Switzerland is also proving popular for foreign reinsurers due to “the security of a network of tax treaties, among other benefits,” Neal observed.

“Recently, a coalition of US-based insurance and reinsurance companies has been formed to express their concerns to Congress,” Neal said, referring to these trends. “With more than 150,000 employees and a trillion dollars in assets here in the US, I believe it is a message of concern that we should heed.”

Under H.R. 3424, the excess amount will be determined by reference to an industry fraction, by line of business, which will measure the average amount of reinsurance sent to unrelated parties by US companies. The bill allows foreign groups to avoid the deduction disallowance by electing to be treated as a US taxpayer with respect to the income from affiliate reinsurance. “Thus, the bill merely restores a level-playing field, treating US insurers and foreign-based insurers alike,” Neal explained.

In addition, the legislation provides the Treasury Department with powers to carry out or prevent the avoidance of the provisions of this bill.

”My colleagues may be thinking that this sounds similar to another provision in the code, and they would be right,” Neal said. “The tax code currently tries to limit the amount of earnings stripping – that is, sending US profits offshore through inflated interest deductions – by disallowing the interest deduction over a certain threshold. In the reinsurance context, US affiliates of foreign based reinsurance entities may be sending offshore excessive amounts of reinsurance to strip those premiums out of the purview of the US tax system. My bill limits the deduction for those premiums to the extent the reinsurance to a related party exceeds the industry average.”

However, according to some in the insurance industry, America’s consumers may pay a high price for a level playing field, in the form of higher insurance premiums. Earlier this year, the Coalition for Competitive Insurance Rates (CCIR) released a study carried out by the Brattle Group, a Massachusetts-based economic consulting firm, which concluded that Neal’s proposals would cost consumers an additional USD10 - USD12bn per year to maintain their current insurance coverage.

"We urge members of Congress to reject this legislation, as they have twice before,” said Bradley Kading, president of the Association of Bermuda Insurers and Reinsurers, a CCIR member. “Only a handful of very large, very profitable US insurance companies would benefit from this bill. In contrast, the economic data make clear that American consumers and businesses would pay a steep price if Representative Neal’s proposal becomes law. This legislation represents a punitive and unnecessary tax aimed at benefiting some competitors at the expense of others."

The Competitive Enterprise Institute, a free market think tank, is also dismissive of the proposals, maligning Neal’s bill as an “awful, awful idea.”

The CEI says that the Neal bill would impose a special 25% tax on the offshore affiliated reinsurance – transactions which already taxed under a federal excise tax - and would reduce the supply of reinsurance and increase insurance rates. “This is the last thing that disaster-prone homeowners need,” said Eli Lehrer, Director of CEI’s Center for Risk, Regulation, and Markets.

Lehrer also believes that the legislation would not raise any significant amounts of tax revenue for the Treasury.

“Those who hope for a revenue windfall are hoping in vain. If this bill becomes law, it’s likely that tax revenues will probably fall as companies stop using offshore affiliated reinsurance,” he concluded.

A comprehensive report in our Intelligence Report series which studies the 20 main offshore jurisdictions which offer captive insurance regimes is available in the Lowtax Library at http://www.lowtaxlibrary.com/asp/subs_reports.asp and a description of the report can be seen at http://www.lowtaxlibrary.com/asp/description_report11.asp

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