Listed Transaction #18 (DE-LISTED)
Abusive Producer Owned Reinsurance Companies (PORCs)
IRS Notice 2002-70
In this notice, the IRS indicates that it has become aware of a type of transaction that is being used by taxpayers to improperly shift income to related companies purporting to be insurance companies that are subject to little or no US federal income tax. Depending on the facts and circumstances (e.g., the size and activities of ay staff, whether Company Y engages in other trades/businesses, and its sources of income), the IRS may assert that Company Y is not an insurance company for federal income tax purposes. If Company Y is not a valid insurance company, then it is not entitled to the benefits of Sections 501(c)(15), 806, or 831(b) and any election under Section 953(d) is not valid. This will mean that Company Y will be treated as a controlled foreign corporation (CFC), as defined under Section 957, and taxpayer, as a US shareholder, will have to include in its gross income on a current basis any subpart F income of Company Y, under Section 951 (Company Y will not qualify for the exceptions form subpart F income under Sections 953(a)(2) and 954(i), since it is not viewed as having engaged in a valid insurance business). The IRS may also apply Sections 482 or 845 to allocate income from Company Y back to taxpayer (to clearly reflect income). Also, in appropriate cases, the IRS may disregard the insurance and reinsurance arrangements as shams in fact or shams in substance, and require taxpayer to recognize an additional portion of premiums received from its customers as its income.
NOTE: In late December 2002, the IRS provided guidance in Rev. Rulings 2002-89, 2002-90, and 2002-91, which set forth safe harbors for parent-subsidiary, brother-sister, and small-group captive insurance companies. From these rulings, the IRS’ Notice on abusive PORCs appears to be focused primarily on those captive reinsurance arrangements involving companies claiming the benefits of Sections 501(c)(15), 806, or 831(b). See also, Notice 2003-34 (offshore companies are not insurance companies for federal income tax purposes because their actual insurance activities are small in comparison with their investment activities). Taxpayers working with captive insurance arrangements should carefully evaluate such arrangements in light of these announcements and the latest IRS guidance.
In IRS Notice 2004-65, the IRS and the Department of Treasury concluded that the transactions described as PORCs should no longer be identified as “listed transactions”, after a review of these arrangements found fewer abuses than anticipated. The IRS notice suggested that recent amendments to IRC Section 501(c)(15) will curtail use of that provision. The IRS did say that they will continue to scrutinize PORC arrangements.