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Today's trials, taxes and treaties.

Today's Trials, Taxes and Treaties

A court case which has generated a great deal of interest recently is Humana Inc. v. Commissioner.

In that case, the Sixth Circuit Court of Appeals decided that payments allocated to a domestic operating subsidiary of Humana, which were made to a non-consolidated domestic subsidiary of Humana operating as an insurance company, were deductible by the operating subsidiary. In essence, the court concluded that although the balance sheet of a parent corporation which makes similar payments to a subsidiary remains economically unaffected (and therefore not subject to a deduction), the balance sheet of an affiliate becomes economically affected when the affiliate makes premium payments to another affiliate with which it is not consolidated.

Although taxpayers may find some solace in the case, its benefits may not be easily reaped. First, the case may be dependent upon the fact that the insurance subsidiary was not consolidated with the balance of the companies involved in the group. This may occur if foreign insurance companies (such as those in Bermuda, Barbados, Cayman Islands, etc.) are involved in the group. Second, there may be a substantial number of affiliated groups in which such payments were not deducted in prior years. Humana would then require amendment of outstanding tax returns.

Furthermore, it is possible that the Internal Revenue Service will attempt to appeal the case claiming that a conflicting Claims Court opinion exists regarding the Mobil case, which had a somewhat different result on similar facts. Alternatively, if the IRS is not successful in the courts, it may decide to seek congressional action.

CFC Tax Year Proposal

On August 4, House Ways and Means Committee Chairman Dan Rostenkowski introduced to Congress the Revenue Reconciliation Act of 1989. Section 11401 of the act would require every controlled foreign corporation (CFC) to adopt as its U.S. tax year the same tax year used by the CFC's U.S. shareholders who aggregately own more than 50 percent by value of the total stock of such CFC owned by all U.S., shareholders. If no group of U.S. shareholders with a common tax year owns more than 50 percent of the total value owned by all U.S. shareholders, then the CFC would be required to adopt a tax year specified in regulations. Any such regulations, without doubt, would require the use of a calendar year.

This provision is intended to prevent taxpayers from deferring income inclusions by manipulating the tax years of a CFC and other entities. As presently drafted, the change would be effective for taxable years of CFCs after July 10, 1989. Because the change in a CFC's tax year could result in a short tax year and "bunching" of income, the income taxable to a U.S. shareholder for the short tax year would be phased-in over four years.

Treaty Tax Provisions Terminated

In Notice 89-89, the IRS announced that effective January 1, 1990, exemptions from federal excise tax imposed by IRC4371 under the Bermuda and Barbados income tax treaties will not apply to insurance premiums.

The IRS notes that the Senate ratification of the Bermuda Treaty stated that effective January 1 the treaty will not prevent the imposition of excise tax imposed by IRC4371 on premiums paid to Bermuda insurers or reinsurers. In addition, Section 6139 of the Technical and Miscellaneous Revenue Act of 1988 states that the treaties will not prevent imposition of federal excise tax imposed by IRC4371 on premiums regardless of when paid or accrued, allocable to insurance coverage for periods after December 31, 1989. Accordingly, the IRS concludes that exemptions from excise tax available under Article 7 of the Barbados Treaty and Article 4(1) of the Bermuda Treaty will not longer apply to insurance premiums for periods beginning on or after January 1, 1990.

The IRS intends that the notice will modify any closing agreements with the insurers or reinsurers residing in Barbados and Bermuda, who will be required to file a return on Form 720, marked "final return," for a tax period ending on December 31, 1989, and furnish a duplicate of such final returns to Associate Chief Counsel, International, Room 3319, 950 L'Enfante Plaza, Washington, DC. Letters of credit supplied to the IRS will be required to be maintained for three years from the date this return is filed.

RPGs the Second Time Around

In Swanco Insurance Company v. Hager, the Eighth Circuit Court of Appeals considered an appeal of the case which determined that a risk purchasing group is "located" in each jurisdiction in which an insured is located.

Under the facts of the case, Swanco Insurance Company was licensed in the State of Arizona as a property/casualty insurance company. It was not licensed to do business under Iowa law. It insured, however, the Ugly Duckling Purchasing Group, certain members of which were located in Iowa.

The Iowa insurance commissioner held a hearing to determine whether Swanco was in violation of state law regarding unauthorized insurers. Swanco appealed a magistrate's decision and contended that the plain meaning of the term "located" in Section 4(f) of the Liability Risk Retention Act of 1986 as well as the legislative history of the statute make it clear that a purchasing group is located in only one state (i.e., the state in which the group is domiciled). In addition, Swanco argued that the Liability Risk Retention Act of 1986 preempts Iowa from requiring Swanco to be licensed in the state.

The court concluded that Swanco's interpretation of the term "located" in Section 4(f) is correct. However, it also concluded that neither Section 4(f) nor any other provision of the Liability Risk Retention Act of 1986 preempts states from applying licensing requirements on insurers writing purchasing groups that do not directly conflict with the express preemption provisions in Section 4(a) of the act. Accordingly, Iowa can require Swanco to obtain a license.

It follows that in the future we may see a great deal more regulation by states over risk purchasing groups.

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