Proposed regulations issued by the IRS on Thursday would clarify the circumstances under which investment income earned by a foreign insurance company is derived in the active conduct of an insurance business for purposes of determining whether the income is passive income, and thus the extent to which the company’s assets are treated as passive assets for purposes of determining whether the company is a passive foreign investment company (PFIC) (REG-108214-15).
Under Sec. 1297, a foreign corporation is considered a PFIC if either 75% or more of its gross income for the tax year is passive income (the passive income test) or on average 50% or more of its assets produce passive income or are held for the production of passive income (the passive asset test). For these purposes, “passive income” means any income that would be “foreign personal holding company income” under Sec. 954(c). In general, an asset is passive if it generates (or is reasonably expected to generate in the foreseeable future) passive income as defined in Sec. 1297(b). Assets that generate both passive and nonpassive income in a tax year are treated as partly passive and partly nonpassive in proportion to the relative amounts of income those assets generated in that year.
Under Sec. 1297(b)(2)(B), except as provided in regulations, the term “passive income” does not include any income that is derived in the active conduct of an insurance business by a corporation that is predominantly engaged in an insurance business and that would be subject to tax under subchapter L of the Code as an insurance company if the corporation were a domestic corporation.
Because “active conduct” and “insurance business” are not defined in Sec. 1297, the IRS is proposing regulations to do so. “Active conduct” would have the same meaning as in Temp. Regs. Sec. 1.367(a)-2T(b)(3), except that “officers and employees” as used in that section would not be considered to include the officers and employees of related entities.
“Insurance business” would be defined to mean the business activity of issuing insurance and annuity contracts and the reinsuring of risks insurance companies underwrite, together with investment activities and administrative services that are required to support or that are substantially related to insurance contracts issued or reinsured by the foreign insurance company.
The regulations would also provide that an investment activity is any activity engaged in to produce income of a kind that would be foreign personal holding company income under Sec. 954(c).
Under the proposed rules, investment activities will be treated as required to support or as substantially related to insurance or annuity contracts issued or reinsured by the foreign corporation to the extent that income from the activities is earned from assets held by the foreign corporation to meet obligations under the contracts.
The proposed regulations do not set forth a method for determining the portion of assets held to meet obligations under insurance and annuity contracts, but the IRS is requesting comments on that issue.
The proposed regulations also do not define what it means to be “predominantly engaged” in an insurance business. Under the definitions of insurance business in subchapter L, more than half of a company’s business must be insurance business. As a result, any company taxable under subchapter L as an insurance company is therefore predominantly engaged in an insurance business under Sec. 1297(a)(2)(B).
The proposed rules will be effective when they are published as final in the Federal Register.
— Sally P. Schreiber ( sschreiber@aicpa.org ) is a JofA senior editor.
