The U.S. Court of Appeals for the District of Columbia Circuit today affirmed a federal district court’s holding that section 4371 does not impose federal excise tax on foreign-to-foreign retrocession transactions.
The case is: Validus Reinsurance, Ltd. v. United States, No. 14-081 (D.C. Cir. May 26, 2015)
Read the D.C. Circuit’s decision [PDF 57 KB]
The taxpayer filed suit for a refund of excise tax and related interest that it had paid with respect to an IRS assessment of federal excise tax under section 4371 imposed on the taxpayer’s foreign-to-foreign retrocession transactions.
Section 4371 imposes an excise tax on insurance and reinsurance transactions involving policies on certain identified U.S. risks that are issued by foreign insurers or reinsurers. At issue in this case was whether the retrocession transactions between the taxpayer (a foreign reinsurer) and the foreign reinsurer to whom the taxpayer ceded reinsurance was subject to federal excise tax. The IRS’s position regarding this type of transaction, set forth officially in Rev. Rul. 2008-15, was that a “cascading” federal excise tax can be imposed on such foreign-to-foreign retrocessions.
The D.C. federal district court found that this case presented a straightforward question of law—i.e., did section 4371(3) impose an excise tax on retrocession insurance transactions. The district court concluded that under the plain language of the statute, the definition of the term “policy of reinsurance” did not include retrocessions. Accordingly, the federal district court granted the taxpayer’s motion for summary judgment.
The D.C. Circuit disagreed with the federal district court regarding whether the plain language of the statute was ambiguous, and finding that the language was indeed ambiguous. The appellate court went on to apply the presumption against extraterritorial application of a U.S. taxing statute and concluded that the foreign-to-foreign retrocession at issue in the case was not subject to the federal excise tax.
The D.C. Circuit engaged in de novo review, given the decision below was on summary judgment and the issue in the case was a pure question of statutory interpretation.
The appellate court noted that the federal excise tax statute was meant to tax only policies issued to persons with residence in, or “commercial connections to” the United States with regard to U.S. based risks and liabilities, and noted that adopting the government’s view would allow for the taxation of transactions that were “attenuated” from any U.S. entity or entity doing business in the United States.
The appeals court discussed the taxpayer’s and the government’s differing interpretations of the term “cover” as that term is used in section 4371(3), focusing on the coverage of “contracts” rather than the coverage of “risks.” The appeals court rejected the government’s sweeping definition of what it means to “cover” in the reinsurance context—but observed that retrocession perhaps “indirectly” “covers” direct insurance contracts.
The appeals court reviewed the legislative history of the statute, pointing out that reinsurance was not included in the original (1939 Code) statute, and declining to believe that Congress would have broadened the reach of the federal excise tax so substantially, and in an extra-territorial manner, without much discussion in the legislative history.
The D.C. Circuit did not adopt the distinction drawn by the district court between reinsurance and retrocession, explaining that if this were the rule, then the federal excise tax would be inapplicable any time a U.S. reinsurer purchased coverage from, or retroceded to, a foreign reinsurer.
The appeals court also did not accord deference to the IRS’s interpretation of the federal excise tax statute as set forth in Rev. Rul. 2008-15 and in this litigation.
The appeals court distinguished the Northumberland case based on the fact that extraterritoriality was not addressed by the court in that opinion, and distinguished American Bankers case on the facts.
The D.C. Circuit avoided both an overly broad and an overly narrow interpretation of the statute, in reversing the district court’s distinction between “reinsurance” and “retrocession.”
The appeals court affirmed that the “first leg” of a reinsurance transaction involving U.S. risks that goes to a foreign reinsurer is subject to the federal excise tax.
It has been observed that some taxpayers had filed “protective” cascading federal excise tax refund claims, both before and after the federal district court’s decision, and were awaiting the outcome of the appeal in today’s decision.
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