Corporate groups often have internal chargeback mechanisms by which certain expenses are passed on to lower-tier subsidiaries by the parent company. One such expense can be for insurance premiums. The expense generally arises when the parent purchases insurance coverage on a group basis for all its subsidiaries; this practice usually gives the parent more negotiating power with the insurance companies and results in lower insurance costs for the whole enterprise. The premiums then are allocated/apportioned to the various subsidiaries based on some criteria, such as sales volume for general liability insurance, salaries for workers' compensation, or number of directors for directors' and officers' liability insurance.
Sec. 4371 generally imposes a 4% federal insurance excise tax on the gross amount of premiums paid to a non-U.S. insurer for U.S risks. When group policies are purchased from foreign insurance companies, there may be federal insurance excise tax issues. This is particularly relevant when the parent of a U.S. subsidiary is foreign, because the chances of the group policy being placed with a non-U.S. insurer are greater. Essentially, if the internal chargeback is for procurement of insurance on behalf of the U.S. subsidiary from a foreign insurance company, a potential excise tax obligation arises.
Some U.S. corporations are unaware of this obligation. The obligation may be uncovered in several ways, such as through internal review of chargebacks in the context of the Foreign Account Tax Compliance Act (FATCA), through evaluation of insurance coverage for the company, or through an IRS audit.
If the U.S. company determines that it has excise tax obligations by reason of internal charges for premiums, it should take steps to comply with its obligations. This would require it first to assess its exposure and then to determine how it may come into compliance.
Amount of premiums paid that may be subject to the excise tax
As a first step, the company must examine its chargebacks/internal accounting records to determine the amount of insurance premiums paid and when they were paid or considered paid to the foreign insurance company. The company must be able to determine the basis on which the allocation/apportionment of its share of the premium was undertaken.
The company then needs to determine the names and addresses of the foreign insurance companies to which it paid the premiums. The United States has treaties with several countries that allow an exemption from the excise tax. Insurance companies may obtain a closing agreement from the IRS stating that they are eligible for the excise tax exemption under an applicable treaty. The IRS publishes a list of companies with these closing agreements. A taxpayer may rely on such a closing agreement to avoid paying the excise tax. Therefore, it would be helpful to determine whether the insurance was purchased from a company that had such a closing agreement when the policy was procured.
Absent a closing agreement, even if the foreign insurance company is domiciled in a treaty country, it may be difficult to prove that the exemption under a treaty is available. Other exemptions may be available—for example, if the foreign insurance company was operating a U.S. branch and the policy was procured from the branch, or if the insurance company elected to be treated as a U.S. company for tax purposes.
Confirm that some other party has not paid the excise tax
The excise tax liability is joint and several among various parties, including the broker and the foreign insurance company. If the excise tax already has been paid for a premium, then the U.S. company does not need to pay it again. A good place to start the inquiry would be with the broker that placed the policy with the insurance company. It does not seem likely that the foreign insurance company would have paid the excise tax.
Determine whether the U.S. company has filed excise tax returns
The federal insurance excise tax is reported quarterly on Form 720, Quarterly Federal Excise Tax Return. The U.S. company may have excise tax obligations as a result of other insurance contracts such as ones that it directly placed with a foreign insurance company or other excise tax obligations for which it may have filed returns on Form 720 in the past. Form 720 is used for other excise taxes as well. A review of the returns would indicate whether the statute of limitation for the federal insurance excise tax has closed for any years.
Taking steps to become compliant
Form 720 is due by April 30, July 31, Oct. 31, and Jan. 31 for each respective quarter of a calendar year. A deposit of tax generally is required for each semimonthly period in which tax liability is incurred. The deposit of tax for a semimonthly period is due by the 14th day following that period; this generally is the 29th day of a month for the first semimonthly period and the 14th day of the following month for the second semimonthly period. The U.S. company should be able to compute its excise tax exposure for prior years. It can then file Forms 720 for prior years or amend its prior Forms 720. It also may reach out to the IRS in an attempt to become compliant.
A late return filing and late deposit of the tax would trigger penalties and interest obligations. The taxpayer may seek to obtain a waiver of the penalties. If the failure was inadvertent, as often is the case in these situations, it may be able to obtain a waiver.
Lastly, the taxpayer should take steps to institute a system to capture its excise tax obligations on an ongoing basis so that it makes excise tax deposits on time, and files the required returns regularly, going forward.
Annette Smith is a partner with PricewaterhouseCoopers LLP, Washington National Tax Services, in Washington.
For additional information about these items, contact Ms. Smith at 202-414-1048 or firstname.lastname@example.org.
Unless otherwise noted, contributors are members of or associated with PricewaterhouseCoopers LLP.