IRS Chief Counsel Memorandum Confirms IRS Position Concerning Offshore Micro-Captives
Although it should come as no surprise, in CCM 202134017, the Internal Revenue Service (IRS) has made clear its position regarding micro-captives formed in a jurisdiction outside the United States.
The IRS has characterized a "typical abusive" micro-captive involving a foreign entity as one including the following.
- The micro-captive foreign entity makes an election to be treated as a domestic entity under section 953(d) of the Internal Revenue Code (IRC).
- A taxpayer (US domestic) makes payments to the micro-captive that are claimed to be deductible insurance premiums.
- The taxpayer does not withhold any tax on the payments made as insurance premiums or file a return on Form 1042 with regard to withholding tax (at a 30 percent rate) on US source income paid to foreign persons resident in jurisdictions which, in general, have not entered into an income tax treaty with the United States.
- The micro-captive and the taxpayer are controlled indirectly or directly by the same person or persons.
The CCM notes that the IRS agent may be able to find that (i) the payments treated as deductible insurance premiums should not be treated as such leading to a denial of the deduction, and (ii) because half of the business of the captive would not be insurance, it is reasoned that it may be asserted that the taxpayer has the burden to prove the payments are not subject to withholding tax (which is due on certain types of US source income paid to a foreign entity) and such amounts would be assessed as due from the taxpayer who made payments to the micro-captive.
The CCM suggests sample language to be included in the agent's report to support such allegations. Accordingly, the IRS is suggesting that micro-captive audits may reflect:
- a conclusion that the micro captive’s transactions are not insurance;
- a denial of deduction for premium paid; and
a withholding tax at a rate of 30 percent be imposed on the amount paid as premium (and possibly on certain investment income) even though the micro-captive paid income tax as if it were a US person.1
P. Bruce Wright and Saren Goldner are partners in the Tax Department of Eversheds Sutherland (US) LLP located in New York.
1. There are other possible repercussions not addressed in the CCM. In addition, the IRS in the CCM and the Tax Courts have not addressed how and when an IRC 953(d) election terminates in the micro-captive situation.