A guidance to be issued by the Internal Revenue Service next week will require payment of an excise tax on property-casualty insurance premiums every time the money is ceded to foreign insurers and reinsurers.

However, to ease compliance, the agency said it will give carriers that haven't complied with the law until Oct. 1 to voluntarily file.

Of greatest concern is that the new guidance will impose a 1 percent excise tax on subsequent cedings, on top of the original 4 percent tax, creating a "cascading" effect, according to industry lawyers and lobbyists.

This will complicate recordkeeping and likely raise the cost of insurance to all U.S. customers, industry officials warned.

The revenue ruling (2008-15) will be published in The Federal Register on March 24. The guidance sets out the IRS position that the federal excise tax on insurance and reinsurance premiums imposed by Sec. 4371 of the IRS Code of 1986 is indeed a so-called "cascading" tax.

Bradley Kading, president and executive director of the Association of Bermuda Insurers and Reinsurers, called the interpretation "a dramatic overreaching of the law." Warning that the impact will be far broader than on Bermuda insurance and reinsurance companies, he said the effect "will be to call into question many reinsurance arrangements with reinsurers in the U.S., Europe and Bermuda."

Obviously, he added, "it will have a big effect on pricing, because you are theoretically adding multiple applications of the excise tax, and it would be an enormously complex compliance problem."

Specifically, he explained, "any time there is U.S. business that is involved in retrocession," meaning reinsurance of reinsurance, "you will have another application of the excise tax."

The fee will be waived for foreign companies whose home countries have tax treaties with the United States, according to Bruce Wright, a partner at Dewey & LeBoeuf LLP, in New York, but virtually all the waivers are conditional, he said.

In addition, the treaties require that the carrier located in a treaty nation agree to pay federal income tax on the ceded premiums, he noted.

"Most of these treaties contain a 'qualified' federal excise tax waiver. That is, such treaties waive the tax as long as the U.S. risks are not subsequently reinsured with an 'unprotected' reinsurer--i.e., one that is not entitled to the benefits of a U.S. income tax treaty with an excise tax waiver," Mr. Wright explained in an alert to clients.

He noted that the U.S.-United Kingdom treaty is unique in that the excise tax is waived as long as the insurance or reinsurance policy issued by a U.K. insurer or reinsurer covering U.S. risks is not entered into as part of a "conduit arrangement."

According to Mr. Wright's note to clients, Code section 4374 places the liability for the federal excise tax on "any person who makes, signs, issues, or sells any of the documents and instruments subject to the [excise tax], or for whose use or benefit the same are made, signed, issued, or sold."

For a U.S. payer of premium--whether it be a U.S. broker, policyholder, or insurer--to be relieved of any liability to pay the excise tax on premiums paid to a non-U.S. insurer or reinsurer, the IRS generally requires that the non-U.S. insurer or reinsurer obtain an excise tax closing agreement establishing its eligibility for a waiver pursuant to a U.S. income tax treaty.

Special Reports /

Foreign Reinsurers May Get Hit With A 'Cascading' Excise Tax

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