District court finds that insurance premium excise tax does not apply to retrocession transactions

by DLA Piper

On February 5, 2014, the US District Court for the District of Columbia held that the federal excise tax ("the FET") on insurance and reinsurance premiums does not apply to retrocession insurance transactions.1  Under a plain reading of the statute, the court reasoned, premiums with respect to such retrocession policies are not subject to the FET.  Of note, the court specifically declined to rule on whether the FET could be applied with respect to foreign-to-foreign reinsurance transactions (as opposed to retrocession transactions) for US-situs risks.  Retrocession agreements are essentially reinsurance agreements between reinsurers.  Clients who have paid such amounts on (or had such amounts deducted or withheld from) retrocession premiums are urged to file refund claims in order to preserve their right to such refunds.

Background and Court Challenge

Generally, section 4371(3) of the Internal Revenue Code of 1986, as amended (the "Code")2 imposes a 1% tax upon each policy of reinsurance whereby a contract of reinsurance is made, continued or renewed, if issued (1) by a nonresident alien individual, a foreign partnership or a foreign corporation, as reinsurer; and (2) to any person against, or with respect to any policy of (A) casualty insurance or an indemnity bond or (B) life, sickness, or accident insurance, or annuity contract, in each of (A) and (B) where the insurance related to US-situs risks.

The IRS has taken the position that the FET applies on a "cascading basis"—that is, it applies sequentially to every insurance and reinsurance arrangement regarding the same US risk without regard to whether such risk has already been subject to the FET.3  In conjunction with this ruling position, the IRS announced a voluntary compliance initiative pursuant to which foreign persons who, inter alia, had failed to pay the cascading FET could become compliant with how the IRS views the law.4  Many taxpayers questioned the IRS’ view, especially in light of case law that explicitly rejects a cascading theory of tax, although in the context of withholding taxes on royalties.5  In January of 2013, Validus Reinsurance, Ltd., a Bermuda based reinsurer, filed a tax refund suit in the US District Court for the District of Columbia challenging the imposition the FET on a cascading basis on premiums that it paid in connection with retrocession contracts it entered into outside of the US with non-US reinsurers where a portion or all of the underlying insurance risks were US-situs.

Court’s Analysis and Holding

In Validus’ summary judgment motion, it asserted that, among other arguments, the FET did not apply extraterritorially, the FET did not apply to retrocession agreements, the application of the FET extraterritorially violates international law and due process, and the IRS’ interpretation exceeds Congress’ taxing power.

The court found that the case presented a straightforward question of law and gave its opinion based on summary judgment motions submitted by the parties and undisputed material facts.  This question was whether Section 4371(3) (which applies to reinsurance transactions) imposes the FET on retrocession insurance transactions. The court concluded that under the plain language of the statute, the definition of the term "policy of reinsurance" did not include retrocessions.  Accordingly, the court granted the taxpayer’s motion for summary judgment and ordered the US to refund the money Validus paid to satisfy the claimed deficiency.

In its conclusory paragraph, the court stated that Section 4371 does not impose an excise tax on retrocession insurance transactions,6 however, it explicitly noted that its "decision is in no way predicated on [Validus’] argument that Congress did not intend and does not have the power to tax purely foreign-to-foreign insurance transactions."  Thus, a foreign direct insurer that reinsures US-situs risks with a foreign reinsurer is still potentially subject to extraterritorial application of the FET.


Although this ruling can be appealed by the government to the US Court of Appeals for the D.C. Circuit, it represents a favorable development for reinsurance companies that have either been subjected to the cascading FET or that are negotiating contracts that provide for withholding or deduction of such FET.

Reinsurers that have paid the FET (or had such FET withheld or deducted from premiums paid to them) with respect to retrocession agreements should consider filing protective refund claims with the IRS before the applicable statute of limitations expires (generally the later of three years from the date that the original return was filed or two years from the date that the FET was paid) to preserve their refund claims. 

A reinsurer negotiating retrocession agreements should consider including provisions in the agreements that require the retrocedent to submit refund claims on its behalf, in the event the retrocedent insists on withholding or deducting the FET.

1 https://ecf.dcd.uscourts.gov/cgi-bin/show_public_doc?2013cv0109-29

2 All Section references are to the Code.

3 The IRS ruled on March 7, 2008 that the tax would apply to all contracts with an underlying risk based in the US, irrespective of whether or not payments to a retrocedent had already been subject to the tax. See Rev. Rul. 2008-15, 2008-12 IRB.

4 Announcement 2008-18, 2008-1 CB 667, 03/07/2008.

5 In SDI Netherlands B.V. v. Commissioner, 107 T.C. 161 (1996),  the Tax Court rejected the cascading theory in the context of a withholding tax on US-source royalty stating "[w]e are not disposed to conclude, in the absence of legislative expression on the subject, that Congress intended the statutory provision to permit ‘cascading' with the question of relief left to the mercy of the respondent."

6 The court defined retrocessions as "a form of reinsurance … when a reinsurer buys insurance from yet another insurance company ("a retrocessionaire") to protect the reinsurer in the event that it is required to pay claims under one or more of the reinsurance policies that it has issued to the direct insurers."


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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