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BURLINGTON, Vt. — Vermont has created an alternative for companies that could be caught up in the Base Erosion and Anti-Abuse Tax provisions featured in last year’s overhaul of the U.S. tax code as tax experts continue to monitor the ongoing implications of the BEAT tax for captive insurers.
The BEAT provisions, which will levy a 10% tax on transactions with foreign affiliates, aim to circumvent profit movement overseas by applying a minimum tax.
Prior to the legislation’s passage, U.S. tax law allowed the investment of reinsurance premiums raised overseas without tax ramifications. Under the BEAT provisions, such investments would be taxed in an amount equal to the base erosion minimum tax amount for the taxable year. An applicable taxpayer as defined by the legislation would pay the excess of a certain percentage — 5% in 2018, 10% from 2019 through 2025, and 12.5% thereafter — of modified taxable income for a taxable year over a base erosion minimum tax amount, according to an analysis by the Risk & Insurance Management Society Inc. released in January.
“The BEAT is the part of tax reform that is going to impact some offshore structures, specifically those that are large companies,” Matt Gravelin, a Burlington, Vermont-based principal and tax service lead with Johnson Lambert L.L.P., said at the Vermont Captive Insurance Association’s annual conference in Burlington on Thursday.
The BEAT tax will apply to companies that have average annual gross receipts of $500 million over the prior three-year period and a base erosion percentage of at least 3%, meaning a portion of deductible payments made to affiliates compared with total U.S. deductions of at least 3%.
“If you hit both of those, you’re going to be subject to this calculation,” he said.
Tax reform removed the alternative minimum tax for corporations, “which is a really good thing in my opinion, but it replaced it with this BEAT tax … which is very similar in nature to how the alternative minimum tax was being calculated,” he said.
If a U.S. entity, for example, pays zero tax but cedes $10 million to a foreign reinsurance company, when factoring in the 10% BEAT tax in 2019, “now you’re stuck with a $1 million U.S. tax,” he said.
A domestic captive that has a foreign affiliate and pays a loss to that affiliate would be subject to the BEAT tax if the provisions otherwise apply to the captive, said Bruce Wright, a New York-based partner with Eversheds Sutherland (US) L.L.P. who counsels companies on tax and insurance law issues.
“This is going to be a problem, and I think a lot of companies are thinking about moving their captives onshore to avoid this because then you’re just paying domestic or making a 953(d) election, which would treat your offshore company as a domestic and as a domestic payment, and it wouldn’t be a problem,” he said, referring to a provision of the U.S. tax code that allows a controlled foreign corporation engaged in the insurance business to affirmatively elect to be treated as a U.S. corporation for U.S. tax purposes. “I think we will see during the course of the year there will be a lot of structuring to try to get around the BEAT provisions. They’re really quite complex and lengthy.”
There is a group of commercial insurers lobbying the U.S. Treasury Department to remove claim or loss payments when developing the regulatory language for domestic companies pooling risks in the United States with foreign subsidiaries to whom claims payment are made, but it’s unclear when or if that will happen, experts say.
“These days, more so than ever, I think it’s more difficult to predict what and when the IRS is going to do anything,” Mr. Gravelin said. “I know their hands are incredibly full with tax reform and dealing with guidance around a lot of other issues.”
Vermont has created an alternative for companies affected by the BEAT tax by allowing reinsurance of affiliated companies — an option created after a company that was ceding $1 billion to an offshore entity, which would subject it to a $100 million BEAT tax, asked state regulators to create an alternative to “help us with our BEAT problem,” said David Provost, deputy commissioner for captive insurance with the Vermont Department of Financial Regulation in Montpelier, Vermont.
Vermont regulators had two significant issues to consider in developing the option, he said. These companies qualify as multistate companies and will be subject to the traditional National Association of Insurance Commissioners accreditation standards, including filing statements with the NAIC, using statutory accounting and following holding company rules, among other requirements. Vermont regulators have pledged to work closely with the ceding company’s state regulator to ensure they will allow credit for the reinsurance, Mr. Provost said.
In addition, Vermont has built in some flexibility in investments into its statute, while still meeting NAIC accreditation standards, by requiring companies to file an investment for the state’s approval that addresses diversity and liquidity of their portfolio. Many states follow an “outdated investment model law that is very prescriptive and antiquated,” but Vermont’s is “more adaptable to rapid changes in the investment marketplace,” he said via email.
“We think it will pass our accreditation review — we’ll find out soon,” Mr. Provost said at the conference. “That was as far as we could go. We think that will offer some options both for avoiding a BEAT tax situation, but also just for aggregating and managing your reinsurance for commercial insurance companies.”
“We’ve been asked about why would a captive do this,” Mr. Provost added. “A captive won’t do this. This is for commercial insurance companies.”
Vermont licensed 24 new captive insurers in 2017, again led by growth in the health care sector, according to data released by the state’s Department of Financial Regulation on Tuesday.