The Treasury Department recently released a Chief Counsel Advice memorandum, CCA 202134017, hypothesizing when a withholding tax adjustment may be necessary when an abusive micro-captive insurance transaction is at issue.
The CCA contemplates an abusive micro-captive arrangement between a foreign entity that is treated as an insurance company and elects to be treated as a domestic corporation under section 953(d) and a domestic entity taxpayer that makes payments to the captive insurance company and claims them as deductible premiums. In its scenario, the entities are related and the taxpayer neither withholds any tax on the payments to the captive insurance company, nor files a Form 1041, Annual Withholding Tax Return for U.S. Source Income of Foreign Persons.
The CCA states that, as a result as an examination, the payments to the captive insurance company may be determined to not be insurance payments because either the arrangement does not involve insurance risk, there is no risk distribution, there is no risk shifting or the arrangement is not insurance in its commonly accepted sense. In that case, the revenue agent may deny the taxpayer’s deduction for payments of insurance premiums. If the revenue agent finds the payments are for insurance premiums, then the captive company does not qualify as an insurance company under section 831(c) and 816(a) because more than half of the business of the captive was not insurance. Under this situation, the IRS could properly assert that the payments made to the captive entity to be amounts for which the taxpayer has the burden to prove that it does not have a withholding liability under section 1461. Therefore, the examiner may propose a withholding tax adjustment on the taxpayer in addition to denying the taxpayer’s claimed deduction. The CCA further provides sample language to explain the adjustment.
Taxpayers who have participated in micro-captive insurance transactions and are subject to examination should consult with their tax advisors to determine if there is any additional impact to a denial of a claimed deduction.