Excise tax on foreign insurance premiums held unconstitutional.

The court of federal claims ruled that a tax imposed under IRC section 4371 on foreign insurance premiums violated the export clause of the U.S. Constitution (Article 1, Section 9, Clause 5). The court, in International Business Machines (IBM) v. U.S. (74 AFTR2d Par. 94-5029), sided with IBM because its insurance premiums were based on shipped goods' value, and the tax was therefore a tax on exported goods.

IBM insured all U.S.-manufactured products sold to foreign subsidiaries traveling between U.S. facilities and foreign customers and foreign subsidiaries' consolidation centers with casualty insurance.

The Internal Revenue Service asserted IBM was liable for excise tax under section 4371 for the casualty insurance premiums paid on U.S. goods sold to foreign subsidiaries when the insurance was purchased from a foreign insurance company. Section 4371 imposes an excise tax on insurance and reinsurance policies, indemnity bonds and annuity contracts issued by any foreign insurer, and section 4371(1) specifically imposes a 4% tax on premiums paid on casualty insurance policies and indemnity bonds.

However, the export clause of the U.S. Constitution says. "No tax or duty shall be laid on articles exported from any state." Pointing to Thames & Mersey Marine Insurance Co. v. U.S. (237 U.S. 19 [1915]), which held that the export clause prohibited the levying of stamp taxes on policies for marine insurance on exports, IBM argued that the section 4371 excise tax's application violated the export clause. In Thames & Mersey, the court said, "Insurance during the voyage is, by virtue of the demands of commerce, an integral part of the exportation." Furthermore, IBM argued that protection from taxation should begin as soon as goods enter the export stream.

The government claimed Thames & Mersey no longer applied because it had been superseded by two U.S. Supreme Court decisions that questioned whether a tax discriminates against exports in their capacity as exports: Michelin Tire Corp. v. Wages (423 U.S. 276 [1976]) and Department of Revenue v. Association of Washington Stevedoring Companies (435 U.S. 734 [1978]). The IRS maintained the tax did not target exports as exports but generally applied to insurance policies written by foreign insurers regardless of whether insured goods were in the export stream. Because the tax was nondiscriminatory, the IRS continued, it did not conflict with the export clause.

The court of federal claims agreed with IBM's assertion that insurance policies were vital to the exporting of the goods. Because the premiums paid by IBM and its subsidiaries were based on the shipments' value, the court concluded section 4371 was a tax on exported goods.

Observation: Taxpayers currently paying excise taxes on insurance purchased from foreign insurers to protect exported goods should consider whether they qualify for exemption from such taxes under the export clause.