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Court upholds refunds to insurers under tax agreement.

Court Upholds Refunds to Insurers Under Tax Agreement

Concluding a lengthy court proceeding, the U.S. Court of Appeals for the Second Circuit recently ruled that Reffet Ltd. and 174 British property/casualty insurance companies could retain more than $150 million in refunded taxes and related interest.

Reffet, under the U.S./U.K. Double Taxation Agreement of 1980, had recovered the money on behalf of its member companies due to the overpayment of U.S. federal excise taxes. Columbia Marine Services brought the class action suit on behalf of numerous U.S. insureds who purchased insurance from the U.K. resident insurers claiming that the recovered taxes were owed to the insureds on the grounds that they had borne the burden of the tax. Columbia filed a motion to certify a class with the district court, but the motion had not been heard when the case was dismissed.

The disputed tax refunds arose as a result of the Double Taxation Convention of 1980 between the United States and the United Kingdom, which provided that U.K. resident insurers are exempt from the federal excise tax as of January 1, 1975. The negotiations which preceded ratification of the convention, however, were stalled from 1975 to 1980. As a consequence, authority to operate the exemption was not effective until July 1981. Therefore, refunds of federal excise taxes paid by the insurers from 1975 to 1981 had to be claimed.

Columbia's complaint contained three causes of action. First, Columbia sought recovery directly under the treaty. Second, it asserted that the U.K. insurers converted the federal excise tax refunds that belonged to the insureds. Lastly, it alleged a violation of the federal Racketeer Influenced, Corrupt Organizations Act (RICO).

The appellate court concluded that the lower court had properly dismissed all three claims and that Columbia had no treaty right to the federal excise tax refunds. The court maintained that the treaty's purpose was the elimination of the double taxation that results when both treaty parties tax the same transaction and that it was designed expressly to eliminate the U.S. tax on insurance premiums paid to U.K. insurers. It stated that it "is inconceivable that either the treaty signatories or the ratifying senators intended the refund provisions of the treaty to be a $150 million bonanza to United States companies or individuals simply because they purchased insurance from U.K. insurers." Furthermore, the court maintained that the treaty made it clear that the U.K. insurers were to receive the refunds.

The Internal Revenue Service had previously concluded that the treaty sought to relieve the person who bore the burden of the tax. When the tax was included in the premium charged, the burden was borne by the insurer; when it was added as a separate item, it was borne by the insured.

Bermuda Treaty Effective

The income tax treaty between the U.S. and Bermuda became effective on December 2. As a result, an exemption from federal excise taxes on insurance premiums is available through December 31, 1989, and refunds are available for past periods, retroactive to January 1, 1986, during which insurers were controlled foreign corporations.

Tax-Exempt's Unrelated Income

In Letter Ruling 8842002, the IRS considered the question of whether income derived from an insurance program by a tax-exempt organization is taxable as unrelated business taxable income. The organization made available to its members, by endorsement, a group insurance program, which was administered by an independent insurance company. Although the organization did not directly collect the premiums paid by its members, it did promote the insurance program, and was involved in its operation through its insurance committee and solicitation of members and prospective members.

The organization had three sources of income from the insurance program. First, it received reimbursement from the insurance company for expenses in publicizing the program. Second, it received distributions from the insurance company based on earned income credited to a reserve account (maintained by the insurance company to minimize fluctuations in the premiums paid). Third, it received income from its investment of the funds in a separate trusteed account. The funds were considered to belong to, and were held by, the organization for the benefit of program participants. The organization had custody and investment authority over the account and had the fiduciary responsibility of maintaining its principal.

The IRS held that all three of the items of income should be taxed, under IRC [section] 511(a), as income from an unrelated business.


A sentence on the technical corrections bill in the November column iwas misprinted. It should have read, "An electing corporation would have to pay a tax equal to .75 percent of capital and surplus (limited to $1,500,000)."

P. Bruce Wright is a member of the New York Bar. Mr. Wright is also a member of the law firm of LeBoeuf, Lamb, Leiby and MacRae.
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Author:Wright, P. Bruce
Publication:Risk Management
Article Type:column
Date:Jan 1, 1989
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