A federal court's rejection of the Internal Revenue Service's “cascading” excise tax theory on reinsurance transactions between two non-U.S. companies has been welcomed by reinsurance industry lawyers and professionals, who say it validates their interpretation of the federal law.
“It's a ruling that makes sense,” said Mark Goodman, a Chicago-based partner with Freeborn & Peters L.L.P.
Validus Reinsurance Ltd. v. United States of America pitted Pembroke, Bermuda-based Validus against the IRS. Validus sued to recover taxes paid on an assessment from the IRS for taxation on retrocession transactions, the subsequent ceding of risk after it has been initially ceded by the primary insurer. Validus, through a spokesman, declined to comment.
Validus Reinsurance Ltd. filed the suit, alleging that the IRS improperly assessed and collected excise taxes on its foreign retrocession transactions. “Plaintiff seeks to recover the full amount of the excise tax and related interest that it paid in connection with the challenged 2006 tax assessment,” court documents said.
On Feb. 4, U.S. District Court Judge Amy Berman Jackson ruled in favor of Validus, writing: “Because the court finds that the excise tax assessed was not authorized by the statute, it will grant plaintiff's motion for summary judgment, and it will therefore deny defendant's cross-motion for summary judgment.”
The case, she said, involved retrocession, “a form of reinsurance one more step removed from the original direct insurance policy: It occurs when a reinsurer buys insurance from yet another insurance company (a retrocessionaire).”
Judge Jackson said since the statute provided for a tax on casualty insurance and indemnity bonds, life insurance, sickness and accident policies, annuity contracts and reinsurance, retrocesssions were not mentioned and thus were exempt.
Industry sources consider the decision the correct one.
“The theory that the (federal excise tax) cascades onto multiple transactions never made any sense. It's heartening to see the federal court agree,” said Bradley Kading, president of the Association of Bermuda Insurers and Reinsurers.
The tax was designed to be applied only once, reinsurance experts say.
“From the beginning, it has been the RAA's position that the initial design of the Federal Excise Tax was as a stamp tax, which meant when the premium went offshore in the first instance,” said Joseph Sieverling, senior vice president and director of financial services for the Reinsurance Association of America. “So, it was only intended to be applied one time to the transaction and not on a cascading basis.”
Indeed, in the “olden days,” said Mr. Sieverling, one actually had to go to the post office and buy a special stamp showing that the tax had been paid.
“This is a great result for foreign insurers because now, if they write retrocession policies, they're not subject to the excise tax,” said David Miller, a New York-based tax attorney with Cadwalader, Wickersham & Taft L.L.P.
“The industry has always thought that the cascade theory was wrong — it doesn't make sense,” said Brenda Viehe-Naess, an attorney with industry lobbying group Washington Advocates Group. “Applying the tax twice has never made sense. The extraterritorial application of the tax has never made sense.”
“The industry is delighted with this decision. They're very pleased,” said Ms. Viehe-Naess. But the IRS has until April 7 to file a notice of appeal if it intends to contest the decision, she said.
The agency did not respond to a request for comment.
“I think the common perspective is that the government will appeal, because I think the decision was very broad,” said Mr. Sieverling. “Typically the government would appeal a decision that they lost.”
“I don't know if the IRS will appeal. My guess is that they will,” said Mr. Goodman.
In the meantime, other reinsurers may seek to leverage the decision to their advantage and file for tax refunds.
“I think that many insurance and reinsurance companies have already filed for refunds when they had to pay the tax and should expect to get refunds,” said Mr. Sieverling.
“Other companies may file for refunds,” said Mr. Goodman. He added that some reinsurers have what is called a “closing agreement” with the IRS that governs how such taxes are to be paid. Some of these reinsurers may look at whether they can and should change these agreements, Mr. Goodman said.
But one observer cautioned against a rush to judgment or action.
“The main point I would make is that I think it's pretty early in the game at this point and that companies have time to see how this develops before they take actions to try to take advantage of the court's decision,” said Seth Rosen, a New York-based partner with Debevoise & Plimpton L.L.P.
“It's too early — people are still digesting it,” said Mr. Miller of the decision and companies' potential reaction to it. He added, however, that “I'm sure this week there have been lots of calls to counsel,” and “I think the community is somewhat emboldened by this.”