Why is this Topic Important to Wealth Managers? Provides insight into relevant taxation issues regarding the ownership of a foreign insurance company, premium payments made to a foreign insurance company, and foreign insurance company income taxation. Discusses information wealth managers may find relevant in regards to advanced family and business estate plans.

What are the U.S. tax implications, generally, for a United States Corporation that owns a foreign insurance company?

To begin, a well known rule is that premiums paid to a foreign insurance company are subject to a federal income premium tax. The tax is due even though the U.S. parent may own the foreign insurance company, either in part or in full.  The tax is remitted by the premium payor who “must file Form 720 to pay the tax at the time of the premium payment.”[1]

For casualty insurance policies the tax is 4% of the total premium payment to a foreign insurer and for life insurance and annuity contracts the tax is 1% of the premium paid.[2] The tax only applies to premium payments to a foreign insurer.

If a foreign company carrying on an insurance business within the United States qualifies as a life or casualty insurer under the Code, “if it were [otherwise] a domestic corporation,” then the company is “taxable under such part on its income effectively connected with its conduct of any trade or business within the United States.” [3]

To determine what income then is effectively connected with a trade or business within the United States, one must know what a trade or business within the United States means.  “Neither the Code nor the regulations fully define the term ‘trade or business within the United States.’ ” [4] Most “cases hold that profit oriented activities in the United States, whether carried on by the taxpayer directly or through agents, are a trade or business if they are regular, substantial, and continuous.” [5] Additionally, an insurance company “makes contracts over a period of years”, which leads one to believe the issuance of insurance contracts on persons or activities in the United States is continuous. [6]

A foreign insurance company is subject to the tax rates under I.R.C. § 11 and income from the insurance operations is calculated as if it were a domestic corporation.  See yesterday’s blog on the general income determination process of domestic insurers.  Furthermore, once the tax is paid from on the trade or business activity, “residual FDAP” in the form of dividends or branch profits is paid by the foreign insurance company based on income from sources within the United States.[7] The amount of “residual FDAP” withheld at a rate of 30% from the source making payment, [8] “but the tax is often reduced or eliminated by treaty.” [9] In the case with the United Kingdom and U.S. tax treaty, the rate can be as low as 0% for a wholly owned subsidiary. [10]

Additionally, as a general rule, shareholders of a company will pay a tax on dividends received at the normal dividend tax rates.  Since the owner of the foreign insurance company is a domestic corporation, the domestic corporation can make an election to have the Dividends Received Deduction apply, which would eliminate the tax on dividends paid back to the domestic corporation. [11] However, when the domestic corporation pays a dividend, general taxation of dividends will apply to the shareholders of the domestic corporation.

Lastly, the insurance company, owned by the U.S. parent may be considered a Controlled Foreign Corporation. Insurance companies are CFCs when it is owned by 25% or more by U.S. corporations.  Under the CFC rules, the parent corporation recognizes it’s pro rata share of income each year. [12]

See also our discussion on CFCs from last month (Sept 28^th), Offshore Planning’s Impact on Calculation of U.S. Income Tax Liability.

Tomorrow’s blogticle will discuss the financial considerations and comparisons generally of Section 953(d) elections, (election of foreign insurer to be taxed as U.S. insurance company) versus foreign insurance company taxation.

We invite your questions and comments by posting them below, or by calling the Panel of Experts.

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[1] “Private Placement Life Insurance and Annuities: Applications for U.S. and Non-U.S. Taxpayers”. By Leslie C. Giordani and Michael H. Ripp, Jr. and Robert W. Chenser, Jr. and Mari M. Reed.  SS020 ALI-ABA 569 (200).  Lexis Nexis.

[2] 26 USCS § 4371 (1), 26 USCS § 4371 (2).

[3] 26 U.S.C.A. § 842.

[4] TAXES—THE TAX MAGAZINE, CCH Draft.  “Income Effectively Connected with U.S. Trade or Business: A Survey and Appraisal”.  Pg. 62.   Lawrence Lokken .  March 2008. 

[5] Id.

[6] Id. at 63.

[7] 26 U.S.C. § 871; 26 U.S.C. § 884

[8] 26 U.S.C. § 1441; 26 U.S.C. § 1442.

[9] “Income Effectively Connected with U.S. Trade or Business: A Survey and Appraisal”  at 61.

[10] United Kingdom Convention Between the Government of the United States of America and the Government of the United Kingdom of Great Britain and Northern Ireland tor the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and on Capital Gains. Art. 10, Para. 3,.  (2001).

[11] 26 U.S.C. § 243(b)(3).

[12] 26 U.S.C. § 953(b), 26 U.S.C. § 951 (a)(1)(A)(i).

Tags: Business, Carriers, Financial services, insurance, premium excise tax, Subsidiary, Tax, Taxation, United States

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