Foreign insurers could use local statement reserves under section 954

Plain-English summary

Two U.S.-owned controlled foreign corporations sold life insurance and annuity products under their home country's insurance rules. They asked to use underwriting, loss, policyholder dividend, and advance-premium reserves from their foreign regulatory statements when calculating foreign personal holding company income. The IRS found that both companies were qualifying insurance companies, their contracts were exempt contracts, and the local regulator's reserving factors appropriately measured income under section 954(i)(4)(B)(ii). It approved use of the specified foreign statement reserves for the companies' life insurance and annuity contracts. The ruling remained subject to revocation if material facts, business circumstances affecting the reserving method, or applicable law changed.

Ruling snapshot

• Question: Could the two foreign insurance companies use specified home-country statement reserves to compute foreign personal holding company income?
• Outcome: Approved.
• Key authorities: IRC §§ 953, 954, and 957.

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201644009 Third Party Communication: None
Release Date: 10/28/2016 Date of Communication: Not Applicable
Index Number: 954.02-00
Person To Contact:
------------------ -----------------------
--------------------------------------------------------- Telephone Number:
--------------- --------------------
----------------------- Refer Reply To:
---------------------------------- CC:INTL:B05
PLR-106586-15
Date:
August 01, 2016

Legend

A = ------------------------
CFC 1 = --------------------------
CFC 2 = -----------------------------------------
Country A = ---------
Parent = ---------------
US Sub = -----------------------------------------------
Corp A = -------------------------------------------------------
Corp B = --------------------------------------------------------
W% = --------
Corp C = -----------------------------------------------------------------
X% = --------
Partnership A = --------------------------------------------------
Y% = ----------
Z% = ----------
Regulator = -------------------------------------------------------
Day X = ------------------

Dear ---------------:

In a letter dated A, you requested a ruling allowing CFC 1 and CFC 2 (collectively, the
“CFCs”) to use certain foreign statement insurance reserves in computing foreign
personal holding company income under section 954 on the grounds that these
insurance reserves are an appropriate means of measuring income within the meaning
PLR-106586-15 2

of section 954(i)(4)(B)(ii). Specifically, you requested permission to use the underwriting
reserves, loss reserves, policyholders’ dividend reserves, and premiums paid in
advance reserves for life insurance and annuity contracts reported by CFCs on their
Country A Annual Report.

The rulings given in this letter are based on facts and representations submitted by
Parent and accompanied by a statement executed under penalty of perjury by an
appropriate party. This office has not verified any of the materials submitted in support
of the request for rulings. Verification of the information, representations, and other data
may be required as part of the audit process.

                                        Facts

Parent is a publicly-traded domestic corporation that is engaged, through its
subsidiaries, in various lines of business, which primarily include life insurance, accident
and health insurance, credit insurance, annuities, endowment and retirement and
savings products. Parent directly and indirectly owns all the stock of US Sub. US Sub
owns all the stock of Corp A. Corp A owns all the stock of Corp B. Corp B owns W% of
Corp C. Corp C owns X% of the interests in Partnership A. Partnership A owns Y% of
CFC 1 and Z% of CFC 2. CFC 1 and CFC 2 were both formed under the laws of
Country A. Parent represents that CFCs are controlled foreign corporations as defined
in section 957. CFCs are both engaged in the life insurance business in Country A and
their principal products are traditional life, universal life, group life, credit life and fixed
annuities.

Country A regulates any insurance business conducted in Country A through its
insurance laws and regulations. Regulator developed and is responsible for enforcing
insurance laws and regulations in Country A. An insurance company must obtain a
license from the Regulator to conduct an insurance business in Country A.

CFCs are licensed by the Regulator to sell life insurance and annuity contracts to
residents of Country A and are subject to regulation by Regulator as a life insurance
company. CFCs derive more than 50 percent of their aggregate net written premiums
from the issuance of life insurance and annuity contracts covering applicable home
country risks. No policyholder, insured, annuitant, or beneficiary to a life insurance or
annuity contract that the CFCs issue is a related person as defined in section 954(d)(3).
CFCs do not carry on business other than life insurance and certain activities that are
incidental to the life insurance business. Parent has represented that CFCs would be
subject to tax under Subchapter L if they were domestic corporations.

As required by Country A’s insurance laws and regulations, CFCs file an Annual Report
and financial statements with the Regulator. The Annual Reports are audited by an
external accounting auditor in addition to the company’s internal auditor. The accounting
records of CFCs that form the basis for preparing the Annual Report are subject to
PLR-106586-15 3

inspection by the Regulator at any time. The Annual Reports are made available to the
public. The Annual Reports are used for financial purposes in addition to regulatory
purposes, such as for Country A credit rating purposes, by lenders, and by the public.
Day X is the official year-end for life insurance companies operating in Country A.

To comply with Country A’s insurance laws and regulations, CFCs must establish and
maintain certain reserves for obligations to holders of their life insurance and annuity
contracts and must report the amount of such reserves on the Annual Report. The
reserves at issue in the ruling request are (1) underwriting reserves; (2) loss reserves;
(3) policyholders’ dividend reserves; and (4) premiums paid in advance reserves that
the CFCs maintain on their Country A Annual Reports for life insurance and annuity
contracts.

CFCs have appointed a qualified actuary to be involved in matters designated by the
Regulator as actuarial matters, including the method of calculating reserves. The
actuary has knowledge and experience concerning actuarial matters for a company in
Country A engaged in the insurance business--------------------------------------------------------
--------------------------------------------------------------------------------------------------------------------.

The reserve system for Country A includes the following requirements as to
assumptions and method with respect to life insurance and annuity contracts including
those issued by CFCs.

Underwriting reserves are required to secure the performance of future obligations
arising from life insurance contracts. Underwriting reserves are comprised of insurance
premium interpolated terminal reserves, unearned premium reserves, and risk reserves.
The sum of insurance premium reserves and unearned premium reserves (referred to
as the “standard valuation reserve”) for life insurance and annuity contracts may not be
less than the amount calculated in accordance with the designations of the Regulator
concerning the reserve method, interest rate, mortality rate and other coefficients. The
Regulator requires life insurance and annuity reserves to be determined as follows: (1)
the prescribed reserve method to be a method analogous to the Commissioner’s
reserve valuation method in form, although not identical in amount; (2) the prescribed
standard annual interest rate assumption; and (3) the prescribed mortality tables.

CFCs also hold: (1) loss reserves for outstanding claims (including incurred but not
reported claims) under life insurance and annuity contracts issued by the CFCs and
calculated using the company’s individual loss experience, in accordance with rules and
regulations prescribed by the Regulator; (2) policyholders’ dividend reserves, which
comprise policyholders’ dividend reserves and policyholders’ profit dividend reserves.
Policyholders’ dividend reserves are reserves for dividends that have been declared
and that have been credited, or will be credited at the next policy anniversary date, to
policyholders, and that have not been withdrawn by policyholders. Policyholders’ profit
dividend reserves are reserves with respect to certain dividends that are not yet
PLR-106586-15 4

reflected in the policyholders’ dividend reserves; and (3) premiums paid in advance
reserves which include any premium that has been paid but whose due date falls in the
following year.

Parent represents that: (1) CFCs are not engaged in any insurance business outside of
Country A and do not carry on non-life insurance business; and (2) each contract
covered by the rulings requested is a life insurance contract or annuity contract for
federal income tax purposes, without regard to sections 72(s), 101(f), 817(h) and 7702.

The reserves covered by this ruling do not include: (1) deficiency reserves; (2)
contingency reserves; (3) equalization reserves; (4) excess interest reserves for excess
interest credited beyond the end of the taxable year; (5) reserves for administrative
expenses (including guarantees intended to cover future expenses associated with the
payment of claims such as bank fees or inflation risk); (6) underwriting or loss reserves
for non-cancellable and guaranteed renewable accident and health contracts; (7)
reserves for any amount to protect against a future decline in the value of investment
assets; or (8) any reserves for accrued liabilities.

                                      Law

In general, a United States shareholder of a controlled foreign corporation (“CFC”) must
include in gross income its pro rata share of the CFC’s Subpart F income for each year.
Subpart F income includes, among other types of income, insurance income under
section 953 and foreign base company income under section 954.

Section 953(a)(1) defines the term “insurance income” to include any income which is
attributable to issuing or reinsuring of an insurance or annuity contract, and which would
be taxed under Subchapter L if such income were the income of a domestic insurance
company. Section 953(a)(2) provides that section 953 insurance income does not
include “exempt insurance income” derived by a “qualifying insurance company.”
Section 953(b)(3) provides that reserves for any insurance or annuity contract shall be
determined in the same manner as under section 954(i).

Section 953(e)(1) defines exempt insurance income as income derived by a qualifying
insurance company which is attributable to the issuing (or reinsuring) of an exempt
contract by such company and such income is treated as earned by such company in its
home country for purposes of such country’s tax laws. Exempt contracts are defined
under section 953(e)(2) to include insurance or annuity contracts issued by a qualifying
insurance company in connection with the lives or health of residents of a country other
than the U.S. but only if such company derives more than 30 percent of its net written
premiums from otherwise exempt contracts which cover applicable home country risks
and with respect to which no policyholder, insured, annuitant or beneficiary is a related
person within the meaning of section 954(d)(3).
PLR-106586-15 5

In general, section 953(e)(3) defines a “qualifying insurance company” as any controlled
foreign corporation which:

   (A) is subject to regulation as an insurance company by its home country, and is

licensed, authorized, or regulated by the applicable insurance regulatory body for its
home country to sell insurance or annuity contracts to persons other than related
persons (within the meaning of section 954(d)(3)) in such home country;
(B) derives more than 50 percent of its aggregate net written premiums from the
issuance by such controlled foreign corporation of contracts covering applicable home
country risks of such corporation and with respect to which no policyholder, insured,
annuitant, or beneficiary is a related person (as defined in section 954(d)(3); and
(C) is engaged in the insurance business and would be subject to tax under
Subchapter L if it were a domestic corporation.

Section 954(a)(1) defines the term “foreign base company income” to include, among
other types of income, foreign personal holding company income. Section 954(c)(1)
sets forth the types of income that are considered to be foreign personal holding
company income. Section 954(i)(1) provides that for purposes of section 954(c)(1),
foreign personal holding company income does not include “qualified insurance income”
of a “qualifying insurance company”.

Section 954(i)(2) defines the term “qualified insurance income” to mean income of a
qualifying insurance company falling into two categories. First, income received from
unrelated persons and derived from investments made by a qualifying insurance
company or qualifying insurance company branch (collectively referred to as a “QIC”)
either of its reserves allocable to exempt contracts or of 80 percent of its unearned
premiums from exempt contracts (as both are determined in accordance with section
954(i)(4)). Second, income received from unrelated persons and derived from
investments made by a QIC of an amount of its assets allocable to exempt contracts
equal to: (1) in the case of property, casualty, or health insurance contracts, one-third of
the premiums earned on those contracts during such year; and (2) in the case of life
insurance or annuity contracts, 10 percent of the reserves described in section
954(i)(2)(A) for such contracts.

Section 954(i)(4)(B)(i) generally provides that in the case of life insurance and annuity
contracts, a QIC’s reserves allocable to exempt contracts are equal to the greater of (1)
the net surrender value of the contract or (2) the reserve determined under section
954(i)(5). Section 954(i)(4)(B)(ii), however, provides:

   The amount of the reserves under section 954(i)(4)(B)(i) shall be the
   foreign statement reserve for the contract (less any catastrophe,
   deficiency, equalization, or similar reserves), if, pursuant to a ruling
   request submitted by the taxpayer or as provided in published guidance,
   the Secretary determines that the factors taken into account in

PLR-106586-15 6

  determining the foreign statement reserve provide an appropriate means
  of measuring income.

Section 954(i)(4)(B)(ii) was originally enacted by section 614 of the Job Creation and
Worker Assistance Act of 2002. Under the Protecting Americans from Tax Hikes
(PATH) Act of 2015 (P.L. 114-113, 12/18/2015), section 954(i) was permanently
extended and made effective for taxable years of foreign corporations beginning after
December 31, 2014, and for taxable years of U.S. shareholders with or within which
such taxable years of such foreign corporations end. In its Technical Explanation to the
PATH Act, the staff of the Joint Committee on Taxation explains section 954(i)(4)(B)(ii)
as follows:

  The provision does, however, permit a taxpayer in certain circumstances, subject
  to approval by the IRS through the ruling process or in published guidance, to
  establish that the reserve for such contracts is the amount taken into account in
  determining the foreign statement reserve for the contract (reduced by
  catastrophe, equalization, or deficiency reserve or any similar reserve). IRS
  approval is to be based on whether the method, the interest rate, the mortality
  and morbidity assumptions, and any other factors taken into account in
  determining foreign statement reserves (taken together or separately) provide an
  appropriate means of measuring income for Federal income tax purposes.

Joint Comm. on Taxation, Technical Explanation of the Revenue Provisions of the
Protecting Americans from Tax Hikes Act of 2015, House Amendment #2 to the Senate
Amendment to H.R. 2029 (Rules Committee Print 114-40) (JCX-144-15 (December 17,
2015)).

                                    Analysis

CFC 1 and CFC 2 are subject to regulation as life insurance companies by Country A.
CFC 1 and CFC 2 are licensed, authorized, and regulated by the Regulator, which is the
insurance regulatory body for Country A, to sell life insurance and annuity contracts to
persons other than related persons (within the meaning of section 954(d)(3)) in Country
A. Parent has represented that CFC 1 and CFC 2 each derive more than 50 percent of
their aggregate net written premiums from the issuance of life insurance and annuity
contracts covering risks in connection with the lives or health of residents of Country A
and with respect to which no policyholder, insured, annuitant, or beneficiary is a related
person (as defined in section 954(d)(3)). Finally, Parent has represented that CFC 1
and CFC 2 are engaged in the life insurance business and would be subject to tax
under Subchapter L if they were domestic corporations. Accordingly, CFC 1 and CFC 2
are QICs.

CFC 1 and CFC 2 issue life insurance and annuity contracts in connection with the lives
and health of residents of Country A, a country other than the United States. CFC 1 and
PLR-106586-15 7

CFC 2 derive more than 30 percent of their net written premiums from contracts that
cover Country A risks with respect to which no policyholder, insured, annuitant, or
beneficiary is a related person within the meaning of section 954(d)(3). Such contracts
are, therefore, exempt contracts within the meaning of section 953(e)(2).

CFC 1 and CFC 2 must establish, maintain, and calculate their reserves in accordance
with rules prescribed by the Regulator. The Regulator generally requires a life
insurance company to determine the amount of its reserves based on guidance
provided by the Regulator. CFC 1 and CFC 2 must set forth their reserves on the
Country A Annual Report, which must be filed annually with the Regulator. As such, the
reserves are the measure of the legal obligations to policyholders on the financial
statement used for regulatory purposes by life insurance companies doing business in
Country A generally (whether U.S.-owned, locally owned, or owned by companies
headquartered in other foreign countries). The Regulator requires CFC 1 and CFC 2 to
hold reserves for the fulfillment of claims owed to policyholders and beneficiaries. The
reserves are not catastrophe, deficiency, equalization, or similar reserves. Under the
rules prescribed by the Regulator for determining reserves required to be calculated for
purposes of the Country A Annual Report, the method, interest rate, the mortality and
morbidity assumptions and other factors taken into account provide an appropriate
means of measuring income within the meaning of section 954(i)(4)(B)(ii).

                                     Ruling

Based on the information submitted and the representations made, we rule as follows:

Under the facts set forth above, the foreign statement underwriting reserves, loss
reserves, policyholders’ dividend reserves, and premiums paid in advance reserves
maintained by CFC 1 and CFC 2 with respect to its exempt life insurance or annuity
contracts are an appropriate means of measuring income within the meaning of section
954(i)(4)(B)(ii) and may be used in determining the foreign personal holding company
income of CFC 1 and CFC 2 under section 954(i).

                                    Caveats

We express no opinion on any provisions of the Code or regulations not specifically
covered by the above ruling. This ruling will be subject to revocation if any of the
following circumstances occurs: (1) a change in the material facts on which this ruling
was based; (2) a material change in the business circumstances of CFC 1 or CFC 2
which would impact its reserving method; or (3) a change in the applicable law or
foreign rules relating to the current reserving method of CFC 1 or CFC 2.

                            Procedural Statements

PLR-106586-15 8

This ruling is directed only to CFC 1 and CFC 2. Section 6110(k)(3) provides that it may
not be used or cited as precedent.

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax consequences of any aspect of any transaction or item discussed or referenced in
this letter.

In accordance with the power of attorney on file with this office, a copy of this letter is
being sent to your authorized representative.

A copy of this letter must be attached to any income tax return to which it is relevant.
Alternatively, taxpayers filing their returns electronically may satisfy this requirement by
attaching a statement to their return that provides the date and control number of the
letter ruling.

                                    Sincerely,


                                    Mark E. Erwin
                                    Branch Chief, Branch 5
                                    Office of Associate Chief Counsel (International)

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