After months of negotiating and much speculation, on November 2 the House released its proposed tax reform legislation in the form of the Tax Cuts and Jobs Act (H.R. 1) (the “Act”). The 429-page document is far from final and includes certain expected changes that would reduce federal tax burdens for some, such as the reduction of the corporate tax rate to 20 percent, but also includes various revenue raisers. The revenue raisers are needed to balance the $1.5 trillion net tax cut allowed for in the House budget resolution.
Various provisions of the Act will affect insurance companies, and insurance companies should be aware of such proposals. The Act provides a new standard for whether a non-U.S. insurance company will be treated as a passive foreign investment company (a PFIC) for U.S. federal income tax purposes. This proposal is only relevant if the non-U.S. insurance company is owned by U.S. persons. A PFIC generally means a non-U.S. corporation that meets certain tests with respect to earning “passive income” or owning assets that generate “passive income.” PFICs are subject to special tax rules that could have adverse consequences to their U.S. owners.
Under the current test for determining whether an insurance company is a PFIC, “passive income” would not include income derived in the active conduct of an insurance business by a corporation that is predominately engaged in an insurance business and that would be taxed as an insurance company if it were U.S. company. Under the proposal, the PFIC exception for insurance companies would be amended to only apply if the foreign corporation would be taxed as an insurance corporation if it were domestic, and if the applicable insurance liabilities of the foreign corporation constitute more than 25 percent of its total assets as reported on the company’s applicable financial statement for the last year ending with or within the taxable year.
In addition to changing the test to determine whether a non-U.S. insurance company will be treated as a PFIC, the Act imposes a new 20 percent tax on “specified amounts” paid by domestic corporations to a foreign corporation if both the foreign corporation and domestic corporation are members of the same international financial reporting group. The specified amount is any amount that is allowable by the payor as a deduction or includible in the costs of goods sold, or inventory, or in the basis of an amortizable or depreciable asset. Exceptions would apply for intercompany services that a U.S. company elects to pay at cost and certain commodity transactions. The excise tax would only apply to international financial reporting groups with payments from U.S. corporations to their foreign affiliates totaling at least $100 million annually.
The excise tax can be avoided if the foreign corporation elects to take into account all such specified amounts as if the foreign corporation were engaged in a U.S. trade or business and has a permanent establishment. Under the election, the specified amount would be treated as effectively connected with that U.S. trade or business and be attributed to the permanent establishment.
This legislation is far from final, indeed House Ways and Means Committee Chairman Kevin Brady (R-TX) indicated on November 7 that he and his colleagues would be considering the “unintended consequences” of the 20 percent excise tax for the re/insurance industry. The Senate will take its own approach to tax reform also, with the two chambers eventually reconciling their proposals. We will follow the developments as they occur.
For more information on the application of these rules or federal income taxes in general, please contact the author listed above or the Drinker Biddle lawyer with whom you regularly work.