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Benefits of US tax reform elude captive insurers

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FORT LAUDERDALE, Fla. — The biggest benefit of U.S. corporate tax reform was the reduction in the corporate tax rate, but other provisions are not particularly favorable for captive insurers, experts say.

In December, President Donald Trump signed the Tax Cuts and Jobs Act, which replaced the graduated corporate income tax structure and its previous top rate of 35% with a 21% rate, among other things.

“That’s a good thing in general,” Thomas Jones, counsel, McDermott Will & Emery L.L.P. in Chicago, told attendees of Business Insurance’s World Captive Forum in Fort Lauderdale, Florida, on Friday about the lowering the corporate tax rate. “There’s a flip side. Not that anyone sets up captives predominantly for tax purposes, but the tax bang for the buck is not quite as good anymore.”

While there are several relevant provisions for captive owners to be aware of, “not a huge deal, but nothing’s really favorable to taxpayers except the rate,” he added.

For example, the rule determining what constituted a controlled foreign corporation has been changed, said Bruce Wright, partner, Eversheds Sutherland (US) L.L.P. in New York. A CFC is generally defined as a foreign corporation in which U.S. persons owned more than 50% of the corporation’s stock, with the standard for insurers being that the combined voting power of all classes of stock had to exceed 25%. However, the definition of U.S. shareholder, which had been defined as a U.S. person that owns 10% or more of the voting stock of a foreign corporation, was expanded to also include U.S. persons that own 10% or more of the value of the stock of the foreign corporation.

“Now we have a value or vote test, rather than a vote test which then goes to a value test,” Mr. Wright said.

The passive foreign investment company provision was one of “probably the most convoluted of all” the provisions, he said. These rules are essentially designed to prevent U.S. persons from investing in corporations with a view toward not reporting the earnings and profits as they were earned in a foreign corporation, with penalties imposed on the taxes that must be paid on this income, he said.

A company is defined as a PFIC based on either income, meaning that at least 75% of the corporation’s gross income is “passive” income that is derived from investments rather than from the company’s regular business operations, or based on assets, meaning at least 50% of the company’s assets are investments that produce passive income or held for the production of passive income.

“If you think about the second test, the assets test, every single insurance company on the planet would flunk that test because all their assets are held in the production of passive income,” he said, adding that an exemption was added that a company was exempt if it was in the “active conduct” of the insurance business.

“Unfortunately, there is no regulation or rule that kind of tells you what that means,” Mr. Wright said.

In 2015, the Internal Revenue Service proposed rules that would determine what constituted active conduct, but the regulation was never promulgated after questions were raised about the proposal, he said.

While there are some technical issues that need to be fixed, “the consensus is, given the partisanship right now in D.C., it’s highly improbable for the next couple of years that you’ll have technical corrections,” Mr. Jones said.

The change that “has probably gotten the most publicity” in the tax reform discussions is the adoption of the Base Erosion Anti-Abuse Tax provision, Mr. Wright said. The BEAT provision, which aims to circumvent profit movement overseas, imposes a minimum tax on certain deductible payments made to a foreign affiliate, including payments such as management fees and royalties, but excluding costs of goods sold, beginning in tax years after Dec. 31, 2017. The BEAT provision by applying a minimum tax of 10% of taxable income.

But the calculation of the BEAT tax, which applies to both insurance and reinsurance premiums, is “very complicated,” he said.

Andrew Kush, chief administrative officer, Healthcare Services Group Inc. in Bensalem, Pennsylvania, said his organization was still assessing the tax reform implications for his captive, but “really, it’s a nonevent for us.”

“Tax reform doesn’t change 98% of the stuff that we do,” Mr. Jones said.