Although Congress, in its closing days before the Presidential Election, discussed the U.S. Tax aspects on insurance companies insuring U.S. risks from Bermuda and Barbados, most accounting practitioners seem unaware of the excise tax liability of clients that are using foreign insurers. The auditor examines insurance policies for the purpose of determining the prepaid amount of the premium, but oftentimes ignores the significance of the insurance carrier. This article is written to remind the reader of the tax consequences of dealing with a foreign insurer of U.S. risks, or of those risks that become U.S. risks.

Sec. 4371 taxes policies of insurance, idemnity bonds and annuity contracts issued by a foreign insurer if the insured is a U.S. corporation, partnership or resident individual who insures against hazards, risks, losses or liabilities wholly or partially within the U.S. It also imposes a tax on foreign corporations, partnerships and non-resident individuals who are engaged in a trade or business within the U.S. on hazards, risks, losses or liabilities within the U.S.

The tax rate is four cents on each dollar or fractional part of a dollar paid on the premium. The tax rate on a reinsurance policy on the same risks is one cent on each dollar or fractional part of a dollar.

Reg. 46.4374-1 informs the taxpayer that the tax is paid with a return filed by the person who makes the premium payment to the foreign insurer, reinsurer or nonresident agent, solicitor or broker. That payer of the premium is liable when the premium payment is made. The penalty for failure to pay the tax is a fine of double the amount of tax.

Rev. Proc. 84-82 concerns tax treaty exemptions from this tax. A person otherwise required to remit the excise tax may consider the premiums paid to the foreign insurer or reinsurer exempt under a treaty that allows an unqualified exemption from this excise tax. To be exempt under the treaty, the foreign insurer or reinsurer must be certified by the taxing authority of the treaty country as having been a resident of the treaty country either during the last three months of the preceding calendar year or, during the immediate taxable period. Such certification may be in the form of a list compiled by the taxing authority of the treaty country of all insurers or reinsurers that were residents. A copy of either this list, or of an individual certification upon which an exemption is based, must be retained by the person otherwise required to remit the excise tax.

If the treaty that the taxpayer relied on permits a qualified exemption from tax, the person required to remit the tax may only consider the policy exempt if, prior to the filing of the return, such person has knowledge that there was in effect for such taxable period a closing agreement between the insurer or reinsurer and the Commissioner of Internal Revenue. That agreement would provide for the insurer or reinsurer to be liable as a U.S. taxpayer for the excise tax on premiums that were not entitled to exemption from the excise tax under the treaty or any other convention.

An example of the latter is the Insurance Enterprises and Mutual Assistance Tax Treaty between the U.S. and Bermuda. This was signed on July 11, 1986. At the time of writing this article it has yet to be ratified by the U.S. Senate. If it is ratified in its present form it will be effective for excise tax on premiums paid or credited on or after January 1, 1986. Article 6 of this treaty states in part that it shall apply to excise taxes imposed on insurance premiums paid to foreign insurers only to the extent that the risks covered by such premiums are not reinsured with a person not entitled to the benefits of this or any other convention which applies to these taxes. This is clearly a qualified exemption. A closing agreement would therefore need be in place and communicated to the payer of the insurance premium to give the payer any comfort in not paying the tax.

An example of the unqualified exemption is contained in Article 2 of the Tax Treaty with the United Kingdom. This merely states that it covers the tax on insurance premiums paid to foreign insurers.

The tax is imposed on hazards, risks etc., which are wholly or partly within the U.S. (See IRC 4374(d)). If the liability does not fix itself to any U.S. risk, the premium would not be subject to United States withholding tax. Rules on what is a U.S. risk are amplified by Rev. Rul. 57-257, 1957-1 CB417.

The above Rev. Rul. states the following rules:

A policy of insurance covering property shipped from a foreign country to a port in the U.S. which terminates upon unloading, is not taxable because the coverage within the U.S. is only a trifling portion of the total coverage. If coverage, however, was to continue after unloading, it would be subject to the tax under Sec. 4371. If coverage is desired after unloading, the excise tax on the international leg of the voyage may still be avoided. To do so, a separate inland policy would need to be written to cover the post-unloading risk. This inland policy would be subject to the excise tax. If only one policy is written the entire premium would be subject to the excise tax.

Policies of foreign insurance covering shipments to or from the U.S. and moving to or from Puerto Rico, Hawaii and/or the Virgin Islands, where the insured party is a foreign corporation, foreign partnership, or non-resident individual, are not taxable for the reason that the hazards, risks, etc., insured against are not wholly in the U.S.

Foreign insurance policies covering shipments from the U.S. to Puerto Rico or the Virgin Islands, when the insured is domestic, (that is, a domestic corporation, a domestic partnership, or an individual resident of the U.S.), are not taxable unless the insurance becomes effective prior to the time the property is actually shipped. If the policies are effective before shipment, the policies would be taxable because the insured risk would be partly within the U.S.

Policies of foreign insurance covering shipments to the U.S. from Puerto Rico or the Virgin Islands, where the insured is domestic, are not taxable unless the insurance continues in effect beyond the point of time of unloading at the U.S. port of entry. In such a case the insured risk would be partly in the U.S. and therefore taxable.

Foreign insurance policies covering shipment from the U.S. to Hawaii or Alaska, where the insured is domestic are not taxable unless the insurance becomes effective prior to the time the property is actually shipped or continues to cover the risk after the property is unloaded at the Hawaiian or Alaskan port of destination. In either case, the coverage would be partly in the U.S.

Policies of foreign insurance covering shipments to the U.S. mainland from Hawaii or Alaska, where the insured is domestic, are not taxable unless the insurance becomes effective prior to the time the property is actually shipped or continues in effect after the property is unloaded at the U.S. port of destination. In either of these events, the coverage would be partly in the U.S.

Rev. Rul. 57-256 came about after the decision in the case of Amtarg Trading Corporation v. United States, 103 Fed (2nd) 339. In that case the court had before it the question of whether or not a foreign insurance policy covering a cargo shipped to the U.S. was subject to the documentary stamp tax. The policy of insurance provided that the insurer's liability should cease upon discharge of the cargo at the port of destination. The court held that the policy was not taxable because the cargo was only within the U.S. during the brief time of passage through the three mile limit and the place of discharge, which was only a trifling portion of the voyage.

Rev. Ru. 57-256 announced to the world that the position of the IRS is that an insurance policy covering property shipped from a foreign country to a U.S. port is not taxable where the coverage within the U.S. constitutes only a trifling portion of the total coverage. The amount of the trip considered to be trifling, however, is limited to the passage through the three mile limit of the territorial waters of the U.S. to the point of unloading at the port of entry in the U.S. Therefore it concludes that the tax does not apply to a foreign insurance policy covering property shipped from a foreign country to the U.S. if the coverage terminates at the point of unloading in the port of entry. If, however, the insured is a domestic corporation, partnership, or an individual resident of the U.S., such a policy that covers the property beyond the point of unloading is subject to the tax. Therefore, a foreign insurer's policy covering the movement of property after unloading, even when the total movement is to a warehouse within the boundaries of the port of entry is taxable.

Because the excise tax is 4% of the insurance premium and the penalty is twice the tax, it is important to advise clients properly on the consequences of this tax.