953(d) Elections: The Basics
Editor's note: Some non-US domiciled captive insurers may elect, under section 953(d) of the Internal Revenue Code (IRC), to be taxed as if they were domestic companies. In an IRMI.com expert commentary article, titled "Has the IRS Lost Its Collective Mind?," the late Donald J. Riggin wrote the following.
The main reason [a non-US captive insurer would volunteer to be taxed by the U.S. Internal Revenue Service (IRS)] is that the U.S. shareholders of a foreign captive are subject to U.S. taxation anyway. Since 1986, owners of what are known as controlled foreign corporations (CFCs) must declare such ownership and pay taxes commensurate with their respective earnings. The captive itself, as a CFC, is not taxed, but the shareholders are, which washes out the pre-1986 tax advantage of forming a CFC.
In Taxnotes, Volume 152, Number 11, September 12, 2016, from KPMG, Sheryl Flum, Jean M. Baxley, and Liz Petrie shared the following.
US-source premiums of a US-controlled foreign insurance company are subject to federal excise tax (FET), adding "1 percent or 4 percent [based on the type of coverage provided] to the cost of insurance for the U.S. insured." A non-US insurer electing to be taxed as a US company is not subject to FET "on premiums paid to foreign insurers and reinsurers," which can improve the insurance company's competitiveness in the United States.
Thereby, "a foreign corporation that makes the election is subject to U.S. income tax on its worldwide income" as well as state and local income tax.
"Also, a foreign insurance company engaged in a U.S. insurance business is subject to a branch profits tax on its … [specific] earnings and profits … at a statutory rate of 30 percent."
The following article from Saren Goldner and P. Bruce Wright provides a basic overview of requirements, procedures, and compliance aspects surrounding the 953(d) election.
The IRC allows certain non-US insurance companies to elect under IRC section 953(d) (a "D election") to be subject to US federal income tax as if they are US domestic corporations.
In order to make a D election, the following four requirements must be met.
- It must, in general, be a 25 percent US-owned and controlled foreign corporation.
- It must qualify as an insurance company (which would include a reinsurance company) for federal tax purposes.
- It must meet the requirements that the secretary of treasury prescribes to ensure that taxes imposed by the IRC are paid.
- It must make a D election and waive all benefits to such entity granted by the United States under any treaty.
Making a D Election—Procedure
In order to make a D election, the following must occur.
- The electing corporation must file an "election statement" to which must be attached a list of all US shareholders as of a date no more than 90 days prior to the date of the statement. The list must be updated each taxable year that the election is in effect. Also in the election statement, the electing corporation must include an agreement to produce its books and records or a true and accurate copy in the United States upon request by the IRS.
- The election must be filed by the due date (including extensions) for the return that is due if the election becomes effective. Once approved, the election is effective from the first day of the first year for which it is made. Thus, for example, if the election is to be effective January 1, 2018, the due date for the return would be October 15, 2019.
- An electing corporation must determine the tax due on its income as if it were a domestic corporation and "timely file the US tax return that is due when the election becomes effective and must timely pay any US taxes due (including estimated payments)" (emphasis added).
It is important to note that the IRS currently takes the position that the election statement cannot be filed with the IRS until the year for which the election is to be effective has closed.
In addition, the electing corporation must comply with one of the following requirements.
- It must maintain an office or another fixed place of business within the United States and own assets physically located in the United States with an adjusted basis equal to 10 percent of its gross income for the base year.
- Its affiliate (in the case of membership in a US-consolidated group) must comply with the above office test. If this option is selected, the affiliate must enter into a closing agreement with the IRS and agree to be liable for the federal excise tax FET in the event that the election is revoked or terminated.
- The electing corporation provides a letter of credit of 10 percent of gross income (but not less than $75,000 nor more than $10,000,000).
For the above purposes, a property and casualty company's "gross income" is gross premiums written less return premiums and reinsurance premiums ceded plus gross investment income (and any other income listed in IRC section 832(b)(1)). The base year is the taxable year immediately prior to the election year, or if there is no income in such year, then it is the first election year. If the first year is not a full year, gross income is earned on an annualized basis. A later year will become a base year if the gross income in that year is 120 percent of the original base year's income.