The US IRS on April 23 issued proposed regulations (REG-108214-15) defining the terms “active conduct” and “insurance business” for purposes of determining when a foreign insurance company’s income is excluded from the definition of passive income under section 1297(b)(2)(B). The regulations are designed to prevent hedge funds from using offshore reinsurance companies located in tax havens to avoid paying tax.
The IRS proposes that the term “active conduct” have the same meaning as in reg. section 1.367(a)-2T(b)(3), except that officers and employees are not considered to include the officers and employees of related entities. That regulation section uses a facts and circumstances test to define active conduct.
The regulations further propose to define “insurance business” as “the business of issuing insurance and annuity contracts and the reinsuring of risks underwritten by insurance companies, together with those investment activities and administrative services that are required to support or are substantially related to insurance and annuity contracts issued or reinsured by the foreign corporation.”
The regulations note that Treasury and the IRS “are aware of situations in which a hedge fund establishes a purported foreign reinsurance company in order to defer and reduce the tax that otherwise would be due with respect to investment income. Such foreign corporations may be Passive Foreign Investment Companies (PFICs),” the regs state.
In a statement, Oregon Sen. Ron Wyden, ranking Democrat on the Senate Finance Committee, called the regulations “important first step” in preventing hedge funds from operating as offshore insurance companies to avoid paying tax. He said that more work is needed to close the loophole down for good.
“This glaring tax loophole has been a thorn in the side of taxpayers over ten years,” said Wyden.
See:
UPDATE: See, also PWC.
Tax experts, we invite your comments on this guidance. Will this regulation will be effective serve the purposes intended? Will it have unintended consequences? Please share your expertise in the comments, below.
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