tax update - cdn.ymaws.com

17th Annual Executive Educational Conference

TAX UPDATE P. Bruce Wright

Partner Sutherland Asbill & Brennan LLP

Tom Jones Partner

McDermott Will & Emery LLP Daniel Kusaila

Partner Crowe Horwath LLP

37052013.1


PROGRESSION OF IRS RULINGS ON INSURANCE LTR 201609008 STATE AND LOCAL ISSUES ADDITIONAL IRS ISSUES

AGENDA


PROGRESSION OF IRS RULINGS ON INSURANCE • HUMANA, TRANSACTIONS BETWEEN SUBSIDIARIES, BROTHER-SISTER

ARRANGEMENTS, ARE INSURANCE (RISK SHIFTING)

• REV RUL 2002-90, SAFE HARBOR IN HUMANA SITUATIONS (12 SUBSIDIARIES, NO ONE ACCOUNTED FOR MORE THAN 14% OR LESS THAN 5% OF RISK)

• REV RUL 2005-40, IRS RULED THAT BROTHER-SISTER INSURANCE ARRANGEMENTS INVOLVING INSUREDS THAT WERE SINGLE-MEMBER LLCS WERE NOT INSURANCE. LLCS, AS DISREGARDED ENTITIES, WERE LOOKED THROUGH AND “PARENT/OWNER” WAS DEEMED INSURED (NO RISK SHIFTING)

• HEALTHMARK GROUP LTD., SINGLE-MEMBER LLCS, APPARENTLY ALLOWED TO DEDUCT PREMIUMS PAID TO SISTER CAPTIVE. IS THIS A CHANGE IN IRS POSITION OR WERE THE FACTS SO DIFFERENT? (ANY LIABILITY OF AN LLC IN EXCESS OF ITS POLICY LIMIT WAS SOLE FINANCIAL RESPONSIBILITY OF LLC)


FURTHER PROGRESSION OF INSURANCE • ADDITIONAL MODIFICATIONS TO THE INSURANCE

FRAMEWORK:

• RENT-A-CENTER - – NEW STANDARD FOR RISK DISTRIBUTION

– AMOUNT OF RISKS NOT NUMBER OF ENTITIES

• SECURITAS – FOLLOWED SAME THEORY AS RENT-A-CENTER

– FOCUSED ON NUMBER OF RISKS, NOT WHO OWNED THE RISKS

WILL THESE RULINGS ALLOW FURTHER CAPTIVE ARRANGEMENTS TO QUALIFY FOR INSURANCE TREATMENT (THAT HISTORICALLY HAVE NOT)?


PROGRESSION PLANNING

• NEW STANDARDS FOR INSURANCE DEFINITION

– CAN WE LOOK MORE TO THE AMOUNT OF RISKS INVOLVED VERSUS THE AMOUNT OF ENTITIES INSURED? WHAT IS CORRECT BALANCE?

– WILL FEWER THEN 12 (SAFE HARBOR) BROTHER-SISTER SUBSIDIARIES SUFFICE?

– WILL RISKS IN SINGLE-MEMBER LLCS NOW BE CONSIDERED RISKS OF THE LLC AND NOT ITS “OWNER” UNDER THE RIGHT FACT PATTERNS? OR WILL SUCH RISKS ALWAYS BE DEEMED RISKS OF ITS “OWNER”?

– ARE LOAN-BACKS NOW MORE ACCEPTABLE?


• MAJORITY FOUND ALL REQUISITE REQUIREMENTS OF INSURANCE TO BE MET:

• RISK SHIFTING (DISSENT DISAGREED – RELIED ON HUMANA)

• RISK DISTRIBUTION (DISSENT DID NOT COMMENT)

• INSURANCE RISK

• COMMON NOTIONS OF INSURANCE (DISSENT DISAGREED ON LOANBACK)

• IRS CHOSE NOT TO APPEAL

RENT-A-CENTER V. COMMISSIONER



COURT APPLIED A FACTS AND CIRCUMSTANCES TEST WHICH CONSIDERED THE FOLLOWING KEY ITEMS:

• RAC IS A PUBLIC COMPANY IN “RENT TO OWN” BUSINESS

• OWNED A BERMUDA-BASED CAPTIVE, LEGACY INSURANCE COMPANY, LTD.

• IRC SECTION 953(D) ELECTION IN PLACE

• CAPTIVE INSURED 4-12 SUBSIDIARIES IN YEARS IN QUESTION

• ONE SUBSIDIARY REPRESENTED APPROXIMATELY 67% OF THE RISK PREMIUMS

• “PARENTAL GUARANTY”

• THE PARENT PROVIDED A LIMITED “PARENTAL GUARANTY” RELATING TO A DTA (~$25M) FOR THE BMA “RELEVANT ASSET TEST” PURPOSES

• CAPTIVE OWNED TREASURY SHARES OF THE PARENT WORTH ~$108M


KEY FACTS (CONT’D) • PARENT PAID PREMIUMS TO LEGACY ON BEHALF OF SUBS AND USED

ITS COST ACCOUNTING FORMULA TO ALLOCATE PREMIUM EXPENSE BASED ON EACH SUB’S EXPOSURE UNITS

• STANDARD COVERAGES – WC, AL, GL • STRUCTURED AS A DEDUCTIBLE BUY-BACK PROGRAM • INDEPENDENT ACTUARY AND THIRD PARTY ADMINISTRATOR • PREMIUMS AND PAID LOSSES WERE “NETTED” FOR SETTLEMENT

PURPOSES • SOME COVERAGE COST PROHIBITIVE OR UNAVAILABLE IN MARKET

PLACE



KEY FINDINGS

• IRS SHAM ARGUMENT REJECTED

– LEGACY FORMED FOR VALID NON-TAX BUSINESS PURPOSES

• RISK CLEARLY SHIFTED TO LEGACY FROM SUBS (BUT NOT PARENT)

• “BROTHER-SISTER” THEORY ACCEPTED

• ‘LIMITED’ PARENTAL GUARANTY NOT A “FATAL FLAW”

– MAJORITY BELIEVED GUARANTY DID NOT PREVENT RISK SHIFTING

– CAPTIVE WAS ADEQUATELY CAPITALIZED

– $25M RELATIVELY SMALL COMPARED TO PREMIUM LEVELS (>$250M)

– GUARANTY NEVER USED AND REMOVED AFTER UNNECESSARY FOR BMA



KEY FINDINGS (CONT’D)

• NEW STANDARD FOR ‘RISK DISTRIBUTION’

– MAJORITY OPINION PRIMARILY FOCUSED ON RISKS RATHER THAN ENTITIES

– NO MENTION OF ‘ENTITY THEORY’ AS SET FORTH IN REV RULS 2002-90, 2002-91 AND 2005-40

– TWO-THIRDS OF RISK IN ONE AFFILIATE (%-AGE NOT DISCLOSED IN THE OPINIONS)

• COURT ADDRESSED ‘LOAN-BACKS’ WITH RESPECT TO TREASURY SHARES

– MAJORITY - NO CIRCULAR CASH FLOW AS SHARES WERE NOT SOLD

– DISSENT – LEGACY A ‘HOLDING TANK FOR CASH’ AND LOAN-BACK ALONG WITH PARENTAL GUARANTY NEGATED RISK SHIFTING



KEY FACTS

• ULTIMATE PARENT WAS SECURITAS AB (“AB”), A SWEDISH PUBLIC COMPANY

• AB OWNED SECURITAS USA HOLDINGS, INC. (“SHI”), A US AFFILIATE

• AB ACQUIRED A NUMBER OF US BUSINESSES WHICH IT CONSOLIDATED INTO A FEW SUBSIDIARIES

• SHI OWNED BETWEEN 4-11 US SUBSIDIARIES FOR THE YEARS AT ISSUE – LIKE R-A-C ONE SUBSIDIARY REPRESENTED ~ 67% OF THE TOTAL RISKS

– 4 US SUBSIDIARIES REPRESENTED ~ 90% OF THE TOTAL RISKS

• SHI ALSO OWNED PROTECTORS INSURANCE COMPANY (“PROTECTORS”) – VERMONT BASED CAPTIVE

– INSUREDS WERE ‘BROTHER-SISTER’

SECURITAS HOLDINGS, INC. V COMMISSIONER


• DEDUCTIBLE REIMBURSEMENT POLICY WITH SHI AFFILIATES AND PROTECTORS

– WC, AL, GL, ETC.

• PROTECTORS ENTERED INTO A 100% ASSUMPTION REINSURANCE ARRANGEMENT WITH SECURITAS GLOBAL REINSURANCE LIMITED (“SGRL”), AN IRISH CAPTIVE

– INSUREDS AND PROTECTORS WERE BROTHER-SISTER TO SGRL

• SHI PROVIDED A “PARENTAL GUARANTY” TO PROTECTORS TO NEGATE THE “INSURANCE” TRANSACTION BETWEEN THE SHI SUBSIDIARIES AND PROTECTORS

– PROTECTORS FILED FEDERAL RETURN AS NON-INSURANCE COMPANY (NO FORM 1120-PC)

– NO AMOUNT EVER PAID UNDER GUARANTY

– OTHER STAKEHOLDERS DID NOT REQUEST/REQUIRE THE GUARANTY



FINDINGS:

• IRS ASSERTED THAT PROTECTORS WAS NOT AN INSURANCE COMPANY BECAUSE THE PARENTAL GUARANTY AND RISK WAS NOT SHIFTED TO SGRL

• IRS ASSERTED THE CONCENTRATION OF RISK IN THE SHI AFFILIATE RESULTS IN A LACK OF RISK DISTRIBUTION

• IN A TAX COURT MEMORANDUM DECISION, THE COURT CONCLUDED

– THE PARENTAL GUARANTY DID NOT NEGATE RISK SHIFTING TO SGRL FROM THE SHI AFFILIATES

– FOLLOWED THE RENT-A-CENTER DECISION WITH RESPECT TO RISK DISTRIBUTION IN COMMENTING WHO OWNS THE RISK IS NOT THE CRITICAL QUESTION; RATHER THE NUMBER OF RISKS RESULTING FROM THOUSANDS OF LOCATIONS, EMPLOYEES AND VEHICLES ARE KEY

• THE OPTION TO APPEAL THE CASE TO THE 9TH CIRCUIT EXPIRED JANUARY 28, 2015



PASS-THROUGH ENTITIES

– REV. RUL 2005-40, 2005-2 C.B. 4

• DEALT WITH SINGLE-MEMBER LLCS DISREGARDED FOR TAX PURPOSES

• IRS POSITION THAT IN DETERMINING RISK DISTRIBUTION, SINGLE-MEMBER IS THE “OWNER” OF THE ASSETS/LIABILITIES IN THE LLC

• THUS IRS BELIEVES A SMLLC DOESN’T COUNT AS AN SEPARATE ENTITY FOR BROTHER-SISTER RISK DISTRIBUTION



X NUMBER

LLC 1

LLC 2

LLC 3

LLC 4

LLC 5

LLC 6

LLC 7

LLC 8

LLC 9

LLC 10

LLC 11

LLC 12

Y INSURER

1 INSURED

• REV. RUL 2005-40



• STATUS OF SINGLE MEMBER LLC’S REGARDED – HEALTHMARK GROUP LTD., GREGORY LENTZ A PARTNER OTHER THAN

TAX MATTERS PARTNER v. COMMISSIONER, DOCKET NO. 8269-14, IRS EXAMINER HAD DISREGARDED 8 SUBSIDIARIES FORMED AS SINGLE-MEMBER LLC’S AND DENIED DEDUCTION FOR PAYMENTS TO SISTER CAPTIVE BY THE LLCS

– MARCH 27, 2015 DECISION ENTERED STIPULATING ENTRY OF JUDGMENT PURSUANT TO WHICH ALL DEDUCTIONS ALLOWED

– WAS THIS CONCESSION A CHANGE IN THE IRS’ POSITION OR WAS IT DUE TO THE PARTICULARITIES OF THIS CASE? PERHAPS RELEVANT THAT UNDER STATE LAW ANY LIABILITY OF EACH LLC IN EXCESS OF ITS POLICY LIMIT WAS THE SOLE FINANCIAL RESPONSIBILITY OF THE LLC ITSELF (NOT THE SINGLE MEMBER OWNER)?


LTR 201609008

• BACKGROUND – AROSE OUT OF SITUATION INVOLVING

• FOREIGN ENTITY • CLAIMING TAX-EXEMPT STATUS PER IRC § 501(c)(15) • ATTEMPTING ELECTION UNDER IRC § 953(d)

– COMMENTS ON • STATUS OF CERTAIN TYPES OF COVERAGE • POOLING • APPLICATION OF HARPER CASE • INDIRECTLY COMMENTS ON APPLICATION OF RENT-A-CENTER AND

SECURITAS

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LTR 201609008

• STATUS OF COVERAGES – IRS CONSIDERS STATUS OF A NUMBER OF COVERAGES – WE DO NOT HAVE COMPLETE UNDERLYING POLICY PROVISIONS OR

UNDERSTANDING OF INSUREDS BUSINESS (MACHINERY REPAIR AND SERVICING)

– COMMENTS ON WHETHER COVERAGES CONSTITUTE INSURANCE IN THE NORMAL COURSE

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LTR 201609008

• STATUS OF COVERAGES • SPECIAL RISK – LOSS OF SERVICES INSURANCE POLICY – INVOLUNTARY LOSS OF

SERVICES FOR KEY EMPLOYEES. LOSS MUST BE INVOLUNTARY, INCLUDES: SICKNESS, DISABILITY, DEATH, LOSS OF LICENSE, RESIGNATION OR RETIREMENT AFTER 14 DAYS. EXCLUSIONS: (1) TERMINATE EMPLOYEES OR (2) IF NO ATTEMPT TO REPLACE EMPLOYEE TIMELY • NOT INSURANCE, POLICY COVERING DEATH OR DISABILITY OK, BUT THIS COVERS

OTHER PERILS THAT ARE BUSINESS OR INVESTMENT RISKS (“BIR”)

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LTR 201609008

• STATUS OF COVERAGES – SPECIAL RISK PRODUCT RECALL COVERS MANDATORY OR VOLUNTARY

RECALL OF PRODUCTS MANUFACTURED DUE TO A KNOWN OR SPECIFIC DEFECT, DEFICIENCY OR DANGEROUS CONDITION

• NOT INSURANCE. ONLY BIR – SPECIAL RISK – WEATHER RELATED BUSINESS INTERRUPTION COVERS

BUSINESS INTERRUPTION DUE TO WEATHER RELATED EVENTS • INSURANCE

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LTR 201609008

• STATUS OF COVERAGES – SPECIAL RISK – REGULATORY CHANGES INSURANCE POLICY COVERS

ACTUAL COMPLIANCE EXPENSES AND BI LOSS <12 MONTHS THAT HAS ADVERSE IMPACT ON NORMAL BUSINESS OPERATIONS

• NOT INSURANCE – BIR – SPECIAL RISK – TAX LIABILITY INSURANCE POLICY COVERS ADDITIONAL

TAX LIABILITY (SUBJECT TO $X DEDUCTIBLE) UP TO $Y OF ACTUAL IRS FILING PREPARED AND SIGNED BY CPA. COVERS DEFENSE EXPENSES IN DETERMINING LIABILITY, ETC.

• NOT INSURANCE - BIR

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LTR 201609008

• STATUS OF COVERAGES – SPECIAL RISK – PUNITIVE WRAP LIABILITY INSURANCE POLICY COVERS

CLAIMS FOR PUNITIVE OR EXEMPLARY DAMAGES ON FAILURE OF INSURER UNDER LISTED POLICIES SOLELY DUE TO ENFORCEMENT OF ANY LAW OR JUDICIAL RULING WHICH PRECLUDES INSURING PUNITIVES AND FOR WHICH INSURED IS OBLIGATED TO PAY

• NOT INSURANCE – BIR

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LTR 201609008

• STATUS OF COVERAGES – EXCESS POLLUTION LIABILITY SEVERAL COVERAGES: (A) CLEAN UP

COSTS RESULTING FROM PRE-EXISTING OR NEW ONSITE POLLUTION CONDITIONS; (B) THIRD-PARTY CLAIMS – LIABILITY; (C) POLLUTION RELEASE FROM TRANSPORTED CARGO CARRIED BY COVERED AUTOS (ALTHOUGH NO COVERED AUTO IS IDENTIFIED IN DECS); (D) THIRD-PARTY CLAIMS FROM TRANSPORTING PRODUCT OR WASTE; (E) BI RESULTING FROM POLLUTION


23


LTR 201609008

• STATUS OF COVERAGES – SPECIAL RISK – LOSS OF MAJOR CUSTOMER COVERS BI ARISING FROM

LOSS OF SERVICE OF MAJOR CUSTOMER, COVERING LOST REVENUE AND EXTRA EXPENSE FINDING REPLACEMENT CUSTOMER. EXCLUDES LOSS (A) FROM LOSS DUE TO INITIATION BY INSURED; (B) IF THERE WAS NO INTEND TO REPLACE; (C) IF THERE WAS SUBSTANTIAL NON-COMPLIANCE BY THE INSURED


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LTR 201609008

• STATUS OF COVERAGES – EXCESS INTELLECTUAL PROPERTY PACKAGE. SEVERAL COVERAGES: (A)

INFRINGEMENT OF COPYRIGHTS, TRADEMARK, ETC., PLAGARISM OR UNAUTHORIZED USE OF IDEAS OR CHARACTER, LIBEL, SLANDER, PIRACY, UNFAIR COMPETITION, (B) WRONGFUL ACTS BY THIRD PARTIES AGAINST INSURED’S INTELLECTUAL PROPERTY

• NOT INSURANCE, NOT INSURANCE IN COMMONLY ACCEPTED SENSE, BIR

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LTR 201609008

• STATUS OF COVERAGES – SPECIAL RISK – EXPENSE REIMBURSEMENT INSURANCE POLICY.

COVERAGE “A” DEALS WITH CRISIS MANAGEMENT AND PUBLIC RELATIONS EXPENSES, PRODUCT RECALL, EMPLOYEE LAYOFF OR LABOR DISPUTE, GOVERNMENT LITIGATION, FINANCIAL CRISIS; COVERAGE “B” COVERS DEFENSE EXPENSE FOR ACTUAL OR ALLEGED CIVIL LIABILITY IF NO OTHER INSURER COVERS OR COVERAGE USED. COVERAGE (A) IS NOT INSURANCE – BIR; COVERAGE (B) MAY BE INSURANCE, VAGUE AS TO LIABILITY/CONTRACT UNDERLIES THE NEED FOR DEFENSE EXPENSES. MORE INFO IS NEEDED

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LTR 201609008

• STATUS OF COVERAGES – EXCESS EMPLOYMENT PRACTICES LIABILITY COVERS 11 CATEGORIES

OF WRONGFUL ACTS INCLUDING, e.g., WRONGFUL TERMINATION, REFUSAL TO HIRE OR PROMOTE, SEXUAL HARASSMENT, DISCRIMINATION

• NOT INSURANCE – BIR – EXCESS D&O

• INSURANCE

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LTR 201609008 • STATUS OF COVERAGES

– EXCESS CYBER RISK. COVERAGE “A” OF DAMAGES INSURED OBLIGATED TO PAY AND DEFENSE EXPENSES RELATING TO WRONGFUL ACT (DEFAMATION, INFRINGEMENT OF INTELLECTUAL PROPERTY, FAILURE TO PREVENT UNAUTHORIZED ACCESS TO, USE OF, TAMPERING WITH, OR INTRODUCING MALICIOUS CODE INTO DATA OR SYSTEMS. COVERAGE “B” IS PARTY PROPERTY AND BI. COVERAGE “C” COVERS COST OF PUBLIC RELATIONS SERVICES TO PROTECT IMAGE, CONSULTANTS FEES

• A AND B ARE INSURANCE; C IS NOT – BIR AS IT IS TOO VAGUE AND BROAD. THEN SEEMS TO CONCLUDE ENTIRE POLICY IS NOT INSURANCE

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LTR 201609008

• ARGUMENT THAT THERE IS BUT ONE INSURED – NO EVIDENCE AFFILIATES PAID SEPARATELY OR WERE CHARGED – EVEN IF THEY DID, NOT A BIG ENOUGH GROUP – ONLY THREE – NO REFERENCE TO RENT-A-CENTER OR SECURITAS – CONCLUSION THERE WAS SELF-INSURANCE

• NO HOMOGENEITY • QUESTIONS ACTUARALLY DETERMINED PREMIUM AMOUNTS

– NO ACTUARIAL PRINCIPLES AND FACTORS USED IN DETERMINING PREMIUM

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LTR 201609008 • IN ADDRESSING POOLING, COMMENT THAT OTHERS WERE

SIMILAR AND THUS MUCH OF WHAT SHARED WAS NOT INSURANCE

• IN CONSIDERING HARPER v. COMMISSIONER, IRS AGAIN SAYS (SEE PVT LTR 201126041) THAT MUCH OF PREMIUM (2/3) WAS FROM BROTHER/SISTER (13), AND THAT WAS RELEVANT IN DETERMINING THAT APPROXIMATELY 30% UNRELATED PREMIUM WAS ENOUGH – BUT IN F/N 10 IN THE HARPER CASE, THE COURT SAID THAT THE

HUMANA ANALYSIS, i.e., BROTHER/SISTER ANALYSIS WOULD HAVE NO IMPACT ON ITS ULTIMATE CONCLUSION ON RISK DISTRIBUTION

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STATE AND LOCAL ISSUES • IN re BAYERISCHE BEAMTENKRANKENKKASSEAG

– FACTS • PETITIONER IS INCORPORATED IN GERMANY AND SELLS A&H NON-LIFE

INSURANCE THERE • NO INSURANCE BUSINESS CONDUCTED IN U.S. FOR YEARS AT ISSUE OR

ANY OTHER PERIOD • NOT AUTHORIZED BY NYDFS FOR YEARS AT ISSUE, OR ANY OTHER

PERIOD • NEVER OBTAINED CERTIFICATE OF AUTHORITY FROM SECRETARY OF

STATE

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– FACTS • DURING AUDIT PERIOD, PETITIONER PARTICIPATED IN TWO

PARTNERSHIPS WHICH INVESTED IN REAL ESTATE INCLUDING REAL ESTATE IN NEW YORK AND INVOLVED OWNERSHIP AND MANAGEMENT OF REAL ESTATE

– CONCLUSION • PETITIONER’S INCOME FROM PARTNERSHIP IS SUBJECT TO INSURANCE

FRANCHISE TAX

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– NOTES • NEXUS ISSUES MAY INCLUDE MANAGEMENT ACTIVITIES OF

PARTNERSHIP IN NEW YORK AS WELL AS OWNERSHIP OF REALTY • INVESTMENTS THUS MAY GIVE RISE TO INCOME TAX IN NEW YORK STATE

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STATE AND LOCAL ISSUES

• STEWART’S SHOPS CORPORATION (NY DIV. TAX APPEALS) – FACTS

• ENTITY FOR YEARS AT ISSUE OWNED 318-326 CONVENIENCE STORES AND 820-1000 GAS STATIONS

• CAPTIVE WROTE MULTIPLE COVERAGES INCLUDING, e.g., GENERAL LIABILITY, PROFESSIONAL LIABILITY, AUTO LIABILITY, BOILER AND MACHINERY, D&O, EPLI, UMBRELLA LIABILITY

• ALL RISKS IN PARENT OF CAPTIVE WHICH PAID ALL PREMIUM

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STATE AND LOCAL ISSUES

• STEWART’S SHOPS CORPORATION (NY DIV. TAX APPEALS) – FACTS

• NO DEDUCTION TAKEN FOR FEDERAL INCOME TAX PURPOSES – CONCLUSION

• NEW YORK STATE FOLLOWS FEDERAL AND, THUS, NO DEDUCTION FOR FRANCHISE TAX PURPOSES CITING HUMANA, RENT-A-CENTER AND SECURITAS

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HOMOGENEITY

• IRS ISSUES GUIDANCE WITH FACT PATTERN INCLUDES RISKS ARE HOMOGENEOUS – REV. RUL. 2002-89 – REV. RUL. 2005-40

• NO COURT HAS RULED ON HOMOGENEITY • IRS ISSUES NOTICE 2005-49 ASKING INDUSTRY THE

RELEVANCE OF HOMOGENEITY IN DETERMINING WHETHER RISKS ARE ADEQUATELY DISTRIBUTED FOR AN ARRANGEMENT TO QUALIFY AS INSURANCE.


HOMOGENEITY

• ILM 200849013 (JULY 24, 2008) CHIEF COUNSEL REFUSED TO TAKE A POSITION, RATHER THE IRS AUDITORS ARE LEFT TO MAKE THEIR OWN JUDGMENT.

• IRS SEEMS TO BE INVOKING HOMOGENEITY REQUIREMENT: – PLR 200715012 – PLR 200837041 – PLR 201025077 – TAM 201517018


– THE IRS HAS BEEN VAGUE ON THEIR POSITION ON LOAN BACKS •REV. RUL. 2002-89 •REV. RUL. 2002-90. •REV. RUL. 2014-15

– NOTICE 2005-49 ASKED INDUSTRY HOW LOAN BACKS SHOULD BE TREATED •STILL WAITING FOR IRS TO ADDRESS COMMENTS

LOAN BACKS


•LEGACY’S PURCHASE OF $108 MILLION OF RAC TREASURY SHARES TREASURY SHARES BOUGHT AND HELD BY LEGACY DURING YEARS IN

ISSUE JUDGE FOLEY SAID NO CIRCULAR CASH FLOW BECAUSE SHARES NOT SOLD DISSENT SAID TREASURY SHARES WERE A FACTOR IN CHARACTERIZING

LEGACY AS “A MERE HOLDING TANK FOR CASH” ‒ BECAUSE THE SHARES WERE NON-INCOME PRODUCING AND

ILLIQUID, DISSENT SAID THEY WERE POORLY SUITED FOR AN INSURANCE COMPANY’S INVESTMENTS

‒ PLUS DISSENT FOUND A NEGATIVE CORRELATION SUCH THAT IF RAC EXPERIENCED LARGE LOSSES, THE VALUE OF THE SHARES WOULD DECLINE WHEN MOST NEEDED

‒ COUPLED WITH THE GUARANTY AND LOW CAPITALIZATION, DISSENT SAID NO RISK WAS SHIFTED TO LEGACY

RAC: LOAN BACK ISSUE


PLR 201613016

– ACKNOWLEDGED THAT LOANS WERE MADE BETWEEN CIC AND AFFILIATES WHOM IT EXECUTED DIRECT WRITTEN CONTRACTS WITH. SEEMS TO IMPLY THESE LOANS ARE TYPICAL OF INSURANCE COMPANIES.

AVRAHAMI VS. COMMISSIONER

– ALL BUT $6,000 LOANED TO AN AFFILIATE, BELLY BUTTON. – AWAITING DECISION!

LOAN BACKS


PROPOSED IRC § 385 REGS. • BACKGROUND

– IRS/TREASURY HAS A PERCEIVED CONCERN ASSOCIATED WITH EXCESSIVE INDEBTEDNESS

– PROP. REGS ADDRESS TREATMENT OF CERTAIN CORPORATE INTERESTS ISSUED AS DEBT AS STOCK

– EFFECTIVE • DEBT ISSUED AFTER EFFECTIVE DATE OF PUBLICATION OF PROP. REGS

IN FINAL FORM • BUT AS TO DEBT DISTRIBUTED TO AFFILIATES, ISSUED IN SPECIFIC

ACQUISITIONS INVOLVING AFFILIATES OR ISSUED TO FUND DISTRIBUTIONS TO AFFILIATES – APPLIES TO DEBT ISSUED AFTER 4/4/2016 THAT REMAIN OUTSTANDING FOR 90 DAYS AFTER REGS PUBLISHED IN FINAL

41


PROPOSED IRC § 385 REGS.

• ESSENTIALLY THREE SETS OF RULES – BIFURCATION RULES – DOCUMENTATION RULES – COVERED TRANSACTION AND FUNDING RULES

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PROPOSED IRC § 385 REGS. • BIFURCATION RULES

43

U.S. PARENT

U.S. OPCO FOREIGN CAPTIVE

$100

NOTE: PAYS INTEREST & REPAYS NOTE

IF IRS CAN ESTABLISH NOT INITIALLY EXPECTED THAT 15% WOULD BE REPAID, IRS WOULD ARGUE

* $15 OF REPAYMENT A REDEMPTION * 15% OF INTEREST IS A DIVIDEND



• DOCUMENTATION RULES – REQUIRES DOCUMENTARY EVIDENCE FOR RELATED PARTY

INSTRUMENT TO BE TREATED AS DEBT WITHIN 30 DAYS OF ISSUANCE • DEMAND OR FIXED DATE OBLIGATION BY ISSUER • LENDER HAS RIGHTS OF THIRD-PARTY CREDITOR • EVIDENCE ISSUER HAS REASONABLE EXPECTATION IT CAN PAY

44



45

• DOCUMENTATION RULES

45

HOLDCO UK

OPCO NON-US

CAPTIVE US

LOAN

WITH NO DOCUMENTS, NO CASH FLOWS, ETC.

> IRS COULD ARGUE THIS IS EQUITY


PROPOSED IRC § 385 REGS. • COVERED TRANSACTION RULE AND FUNDING RULE

– AUTOMATICALLY TREATS DEBT AS STOCK IF USED IN CERTAIN TYPES OF TRANSACTIONS

• DISTRIBUTION OF DEBT INSTRUMENT TO A RELATED PARTY SHAREHOLDER • USE OF DEBT TO PURCHASE STOCK OF A RELATED ENTITY • USE OF DEBT IN AN INTERNAL REORGANIZATION

– FUNDING RULE ESSENTIALLY CREATED A NON-REBUTTABLE PRESUMPTION THAT IF YOU ISSUE DEBT TO FUND WHAT WOULD BE A COVERED TRANSACTION

46


PROPOSED IRC § 385 REGS. • COVERED TRANSACTION RULE AND FUNDING RULE

– THERE ARE SOME EXCEPTIONS, BUT LIKELY THE MOST IMPORTANT IS THE “ONE CORPORATION RULE.” IF ALL INVOLVED MEMBERS ARE WITHIN A CONSOLIDATED GROUP, THEN THESE RULES DO NOT APPLY

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PROPOSED IRC § 385 REGS. • COVERED TRANSACTION, FUNDING RULE, ONE

CORPORATION RULE

48

FOREIGN HOLDCO

FOREIGN CAPTIVE US HOLDCO

CONSOLIDATED GROUP

US OPCO

DIVIDEND

2) 2 YEARS LATER DIVIDEND PAID

NOTE

$

1) DOC. RULES FOLLOWED

SINCE DIVIDEND WITHIN THREE YEARS OF NOTE, REBUTTABLE PRESUMPTION DEBT IS STOCK HELD BY FOREIGN CAPTIVE IN US OPCO


PROPOSED IRC § 385 REGS. • COVERED TRANSACTION, FUNDING TRANSACTION, ONE

CORPORATION RULE – SAME FACTS, BUT CAPTIVE IS OWNED BY US CONSOLIDATED GROUP

AND IS EITHER A DOMESTIC CAPTIVE OR FOREIGN CAPTIVE WITH A 953(d) ELECTION. SINCE EVERYONE IS A US CONSOLIDATED GROUP, NO APPLICATION

– SAME FACTS, BUT THE US BORROWER LENDS THE FUNDS TO A FOREIGN BORROWER WITHIN THE GROUP. POSSIBLE RECHARACTERIZATION

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PROPOSED IRC § 385 REGS. • STOCK TREATMENT CONSEQUENCES

– INTEREST PAID – DIVIDEND AND NOT DEDUCTIBLE – REPAYMENT OF PRINCIPAL – REDEMPTION – GAIN OR DIVIDEND – FOREIGN COMPANY OWNS > 20% IN US CO -> UNCONSOLIDATION – US COMPANY OWNS SHARES IN FOREIGN COMPANY, FOREIGN

COMPANY CAN BE CFC – AFFECT ON FOREIGN TAX CREDIT

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PROPOSED IRC § 385 REGS. • CASH POOLING AGREEMENTS

– BACKGROUND – EFFECT

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