IRS Issues Notice on Micro-Captive Transactions
Notice 2016-66
Transaction of Interest -- Section 831(b) Micro-Captive Transactions
SECTION 1. BACKGROUND
.01 Overview of Transaction
.02 Cases in Which Captive Enters into the Contract with Insured
.03 Cases in Which Insured and Captive Use an
.04 Claimed Tax Treatment and Benefits
SECTION 2. TRANSACTIONS OF INTEREST
.01 Transactions Identified as Transactions of Interest
.02 The Computation Period
.03 Exception for Compensatory Arrangements with Prohibited Transaction Exemption
SECTION 3. RULES OF APPLICATION
.01 Effective Date
.02 Participation
.03 Time for Disclosure
.04 Material Advisor Threshold Amount
.05 Disclosure
.06 Penalties
SECTION 4. REQUEST FOR COMMENTS
SECTION 5. DRAFTING INFORMATION
SECTION 1. BACKGROUND
.01 Overview of Transaction
In the micro-captive transaction, A, a person, directly or indirectly owns an interest in an entity (or entities) ("Insured") conducting a trade or business. A, persons related to A, or both, also directly or indirectly own another entity (or entities) ("Captive").
In some cases, Captive enters into a contract (or contracts) (the "Contract") with Insured as discussed below in section 1.02 of this notice. In these cases, Captive may enter into a reinsurance or pooling agreement under which a portion of the risks covered under the Contract are treated as pooled with risks of other entities, and Captive assumes risks from other entities as also discussed below in section 1.02 of this notice.
In other cases, Captive indirectly enters into the Contract by reinsuring risks that Insured has initially insured with an intermediary,
.02 Cases in Which Captive Enters into the Contract with Insured (a) In general. In cases in which Captive enters into the Contract with Insured, Captive and Insured treat the Contract as an insurance contract for federal income tax purposes. Captive provides coverage for Insured.
Captive may offer coverage only to persons related to or affiliated with Insured. If Captive also offers coverage to persons that are not related to or affiliated with Insured, Captive typically offers coverage only to other entities represented by a person who promotes the micro-captive transaction. Captive may enter into a reinsurance or pooling agreement under which a portion of the risks covered under the Contract are treated as pooled with risks of other entities and Captive assumes risks from other entities. Typically, the other entities participating in the reinsurance or pooling agreement are also represented by a person who promotes the micro-captive transaction.
Insured makes payments to Captive under the Contract, treats the payments as insurance premiums that are within the scope of Section 1.162-1(a), and deducts the payments as ordinary and necessary business expenses under Section 162. Captive treats the payments received from Insured under the Contract as premiums for insurance coverage. If Captive is not a domestic corporation, Captive makes an election under Section 953(d) to be treated as a domestic corporation. The micro-captive transaction is structured so that Captive has no more than
(b) Promoter. A promoter ("Promoter") typically markets the micro-captive transaction structure to A. Promoter, persons related to Promoter, or both, typically provide continuing services to Captive, including:
(1) providing the forms used for the Contract;
(2) management of Captive; and
(3) administrative, accounting, or legal services, including the filing of tax forms.
(c) Contract coverage. The coverage provided by Captive under the Contract has one or more of the following characteristics:
(1) the coverage involves an implausible risk;
(2) the coverage does not match a business need or risk of Insured;
(3) the description of the scope of the coverage in the Contract is vague, ambiguous, or illusory; or
(4) the coverage duplicates coverage provided to Insured by an unrelated, commercial insurance company, and the policy with the commercial insurer often has a far smaller premium.
(d) Amounts paid to Captive. The payments made by Insured to Captive under the Contract have one or more of the following characteristics:
(1) the amounts of Insured's payments under the Contract are designed to provide Insured with a deduction under Section 162 of a particular amount;
(2) the payments are determined without an underwriting or actuarial analysis that conforms to insurance industry standards;
(3) the payments are not made consistently with the schedule in the Contract;
(4) the payments are agreed to by Insured and Captive without comparing the amounts of the payments to payments that would be made under alternative insurance arrangements providing the same or similar coverage;
(5) the payments significantly exceed the premium prevailing for coverage offered by unrelated, commercial insurance companies for risks with similar loss profiles; or
(6) if Insured includes multiple entities, the allocation of amounts paid to Captive among the insured entities does not reflect the actuarial or economic measure of the risk of each entity.
(e) Claims procedures and management of Captive. Captive, Insured, or both does one or more of the following:
(1) Captive fails to comply with some or all of the laws or regulations applicable to insurance companies in the jurisdiction in which Captive is chartered, the jurisdiction(s) in which Captive is subject to regulation because of the nature of its business, or both;
(2) Captive does not issue policies or binders in a timely manner consistent with industry standards;
(3) Captive does not have defined claims administration procedures that are consistent with insurance industry standards; or
(4) Insured does not file claims for each loss event covered by the Contract.
(f) Captive's capital. Captive's capital has one or more of the following characteristics:
(1) Captive does not have capital adequate to assume the risks that the Contract transfers from Insured;
(2) Captive invests its capital in illiquid or speculative assets usually not held by insurance companies; or
(3) Captive loans or otherwise transfers its capital to Insured, entities affiliated with Insured, A, or persons related to A.
.03 Cases in Which Insured and Captive Use an
In certain cases, Captive indirectly enters into the Contract by reinsuring risks that Insured has initially insured with an intermediary,
In these cases, the coverage provided by Captive under the Contract, the payments made to Captive by
Moreover, in these cases,
.04 Claimed Tax Treatment and Benefits
In the micro-captive transaction, Insured, Captive, and, if applicable,
However, if the transaction does not constitute insurance, Insured is not entitled to deduct the amount of that payment under Section 162 as an insurance premium. In addition, if Captive does not provide insurance, Captive does not qualify as an insurance company and Captive's elections to be taxed only on its investment income under Section 831(b) and to be treated as a domestic insurance company under Section 953(d) are invalid.
SECTION 2. TRANSACTIONS OF INTEREST
.01 Transactions Identified as Transactions of Interest The following transaction is identified as a transaction of interest under this notice:
(a) A, a person, directly or indirectly owns an interest in an entity (or entities) ("Insured") conducting a trade or business;
(b) an entity (or entities) directly or indirectly owned by A, Insured, or persons related to A or Insured ("Captive") enters into a contract (or contracts) (the "Contracts") with Insured that Captive and Insured treat as insurance, or reinsures risks that Insured has initially insured with an intermediary,
(c) Captive makes an election under Section 831(b) to be taxed only on taxable investment income;
(d) A, Insured, or one or more persons related (within the meaning of Section 267(b) or 707(b)) to A or Insured directly or indirectly own at least 20 percent of the voting power or value of the outstanding stock of Captive; and
(e) one or both of the following apply:
(1) the amount of the liabilities incurred by Captive for insured losses and claim administration expenses during the Computation Period (defined in section 2.02 of this notice) is less than 70 percent of the following:
(A) premiums earned by Captive during the Computation Period, less
(B) policyholder dividends paid by Captive during the Computation Period; or
(2) Captive has at any time during the Computation Period directly or indirectly made available as financing or otherwise conveyed or agreed to make available or convey to A, Insured, or a person related (within the meaning of Section 267(b) or 707(b)) to A or Insured (collectively, the "Recipient") in a transaction that did not result in taxable income or gain to Recipient, any portion of the payments under the Contract, such as through a guarantee, a loan, or other transfer of Captive's capital.
A transaction described in this section 2.01 is identified as a transaction of interest regardless of whether the transaction has the characteristics described in section 1 of this notice.
.02 The Computation Period
The Computation Period is (a) the most recent five taxable years of Captive or (b) if Captive has been in existence for less than five taxable years, the entire period of Captive's existence. For purposes of the preceding sentence, if Captive has been in existence for less than five taxable years and Captive is a successor to one or more Captives created or availed of in connection with a transaction described in this notice, taxable years of such predecessor entities are treated as taxable years of Captive. For purposes of this section 2.02, a short taxable year is treated as a taxable year.
.03 Exception for Compensatory Arrangements with Prohibited Transaction Exemption
There may be limited circumstances in which a captive insurance company arrangement that provides insurance for employee compensation or benefits is described in this section and accordingly is identified as a transaction of interest under this notice. However, if such an arrangement is one for which the
SECTION 3. RULES OF APPLICATION
.01 Effective Date
Transactions that are the same as, or substantially similar to, the transaction described in section 2.01 of this notice are identified as "transactions of interest" for purposes of Section 1.6011-4(b)(6) and Sections 6111 and 6112 effective
Independent of their classification as transactions of interest, transactions that are the same as, or substantially similar to, the transaction described in section 2.01 of this notice may already be subject to the requirements of Sections 6011, 6111, or 6112, or the regulations thereunder. When the
.02 Participation
Under Section 1.6011-4(c)(3)(i)(E), A, Insured, Captive, and, if applicable,
.03 Time for Disclosure
For rules regarding the time for providing disclosure of a transaction described in section 2.01 of this notice, see Section 1.6011-4(e) and Section 301.6111-3(e). However, if, under Section 1.6011-4(e), a taxpayer is required to file a disclosure statement with respect to a transaction described in section 2.01 of this notice after
.04 Material Advisor Threshold Amount
The threshold amounts are the same as those for listed transactions. See Section 301.6111-3(b)(3)(i)(B).
.05 Disclosure
(a) General rule. Under Section 1.6011-4(d) and the Instructions to Form 8886, Reportable Transaction Disclosure Statement, the required disclosure must identify and describe the transaction in sufficient detail for the
(b) Information required of all participants. For all participants, describing the transaction in sufficient detail includes, but is not limited to, describing on Form 8886 when and how the taxpayer became aware of the transaction.
(c) Information required of Captive. For Captive, describing the transaction in sufficient detail includes, but is not limited to, describing the following on Form 8886:
(1) whether Captive is reporting because (i) the amount of the liabilities incurred by Captive for insured losses and claim administration expenses during the Computation Period is less than 70 percent of the amount specified in section 2.01(e)(1) of this notice; (ii) Captive has at any time during the Computation Period made available as financing or otherwise conveyed or agreed to make available or convey any portion of the payments under the Contract to A, Insured, or a person related (within the meaning of Section 267(b) or 707(b)) to A or Insured through a separate transaction, such as a guarantee, a loan, or other transfer; or (iii) both (i) and (ii);
(2) under what authority Captive is chartered;
(3) a description of all the type(s) of coverage provided by Captive during the year or years of participation (if disclosure pertains to multiple years);
(4) a description of how the amounts treated as premiums for coverage provided by Captive during the year or years of participation (if disclosure pertains to multiple years) were determined, including the name and contact information of any actuary or underwriter who assisted in these determinations;
(5) a description of any claims paid by Captive during the year or years of participation (if disclosure pertains to multiple years), and of the amount of, and reason for, any reserves reported by Captive on the annual statement; and
(6) a description of the assets held by Captive during the year or years of participation (if disclosure pertains to multiple years); that is, the use Captive has made of its premium and investment income, including but not limited to, securities (whether or not registered), loans, real estate, or partnerships or other joint ventures, and an identification of the related parties involved in any transactions with respect to those assets.
.06 Penalties
Persons required to disclose these transactions under Section 1.6011-4 who fail to do so may be subject to the penalty under Section 6707A. Persons required to disclose these transactions under Section 6111 who fail to do so may be subject to the penalty under Section 6707(a). Persons required to maintain lists of advisees under Section 6112 who fail to do so (or who fail to provide such lists when requested by the
SECTION 4. REQUEST FOR COMMENTS
Comments should be submitted in writing on or before
[email protected]. Please include "Notice 2016-66" in the subject line of any electronic communications. All comments submitted will be available for public inspection and copying.
SECTION 5. DRAFTING INFORMATION
The principal author of this notice is
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