December 13, 2018
Under §1.1473-1(a)(1), a withholdable payment generally includes any payment of U.S. source FDAP income, subject to certain exclusions, such as for “excluded nonfinancial payments.” Excluded nonfinancial payments do not include premiums for insurance contracts. The 2013 final chapter 4 regulations included, however, a transitional rule that deferred withholding on payments with respect to offshore obligations until January 1, 2017, which was extended in the 2014 chapter 4 regulations to include premiums paid by persons acting as insurance brokers with respect to offshore obligations. Additionally, in response to comments noting the burden of providing to withholding agents withholding certificates and withholding statements for payments of insurance premiums, the chapter 4 regulations provide a rule generally allowing a withholding agent to treat as a U.S. payee a U.S. broker receiving a payment of an insurance premium in its capacity as an intermediary or an agent of a foreign insurer. The IRS also generally permits non-U.S. insurance brokers that are NFFEs to become qualified intermediaries in order to alleviate burden on the foreign brokers and U.S. withholding agents.
Notwithstanding these allowances, the Treasury Department and the IRS continued to receive comments requesting elimination of withholding under chapter 4 on premiums for insurance contracts that do not have cash value (non-cash value insurance premiums). The comments cited the burden on insurance brokers of documenting insurance carriers, intermediaries, and syndicates of insurers for chapter 4 purposes, noting examples to demonstrate the volume and complexity of placements with insurers of the insurance policies typically arranged by the brokers for their clients. The comments argued that withholding on non-cash value insurance premiums is not necessary to further the purposes of chapter 4.
At the same time, certain foreign entities that conducted a relatively small amount of insurance business had taken the position that they were not passive foreign investment companies (PFICs) under section 1297(a). Section 1297(a) generally defines a PFIC as a foreign corporation if 75 percent or more of the corporation’s gross income for the taxable year is passive income or 50 percent or more of its assets produce, or are held for the production of, passive income. Section 1297(b)(2)(B), prior to a recent change in law (described below), provided an exception from the U.S. owner reporting and anti-deferral rules applicable to PFICs for corporations “predominantly engaged” in an insurance business. Withholding under chapter 4 on non-cash value insurance premiums strengthened the IRS’s enforcement efforts, with respect to the use of the exception in section 1297(b)(2)(B) by U.S. owners of foreign corporations for tax avoidance and evasion, by facilitating reporting of the U.S. owners to avoid withholding on premiums received by the entity.
The preamble to the 2017 chapter 4 regulations noted that future changes to the PFIC rules may create an opportunity to revise the treatment of foreign insurance companies under chapter 4. 82 FR 2140. On December 22, 2017, the Tax Cuts and Jobs Act, Pub.L. No. 115-97 (2017) amended section 1297(b)(2)(B) to provide a more limited exception to PFIC status by replacing the exception for corporations predominantly engaged in an insurance business with a more stringent test based generally on a comparison of the corporation’s insurance liabilities and its total assets. This amendment is expected to mitigate the need for reporting on the U.S. owners of these companies under chapter 4 because the Treasury Department and the IRS anticipate that these entities will either amend their business models on account of the change in law or will otherwise comply with the PFIC reporting requirements. In light of the aforementioned change in law and in furtherance of the burden reducing policies in Executive Orders 13777 and 13789, these proposed regulations provide that premiums for insurance contracts that do not have cash value (as defined in §1.1471-5(b)(3)(vii)(B)) are excluded nonfinancial payments and, therefore, not withholdable payments.