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IRS publishes proposed regulations for hedge fund reinsurance arrangements

Thursday, April 30, 2015
Opalesque Industry Update - In April 24’s Federal Register, the IRS released proposed regulations (REG-108214-15) to restrict when a foreign insurance company’s income can be excluded as passive income by giving a more strict definition for the “active conduct of an insurance business” exemption under IRC section 1297(b)(2)(B).

The U.S. Treasury and Internal Revenue Service (IRS) state that the new rules aim to prevent situations where a hedge fund attempts to use a purported foreign reinsurance company to defer and reduce the tax that otherwise would be due with respect to investment income. Instead, the rules would treat such companies as passive foreign investment companies.

Once effective, the proposed rules are likely to cover both existing and future entities. Under the proposed regulations, “active conduct” has the same meaning under Treas. Reg. § 1.367-2T(b)(3), which generally provides that a corporation actively conducts a trade or business if its officers and employees “carry out substantial managerial and operational activities.” However, for purposes of the proposed regulations, officers and employees of related entities will not be considered.

Furthermore, the proposed regulations define the term “insurance business” to mean business activity of issuing insurance and annuity contracts and the reinsuring of risks underwritten by insurance companies, together with investment activities and administrative services that are required to support or are substantially related to insurance contracts issued or reinsured by the foreign insurance company.

The proposed regulations do not provide a method for determining the portion of assets held to meet obligations under insurance and annuity contracts, and the IRS has requested comments to propose appropriate methodologies.

Sarah Ma, Baker Hostler, LLP

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