Neal introduces bill to close reinsurance tax loophole
Click here to download the technical explanation of the bill.
(WASHINGTON) Congressman Richard E. Neal, Chairman of the Subcommittee on Select Revenue Measures, introduced a bill today in the U.S. House of Representatives that would close the reinsurance tax loophole. The following is a transcript of his floor statement.
MADAME SPEAKER, today I am pleased to come before the House to introduce legislation ending the use of excessive affiliate reinsurance by foreign insurance groups to strip their U.S. income into tax havens, avoid tax, and gain a competitive advantage over American companies. In the past, I have offered a number of bills to limit offshore tax avoidance. Today’s bill follows on that trend but focuses specifically on one area of the financial services sector.
The financial services industry has, like all us, experienced a tough year with the economic upheaval. As businesses realign, merge, and in some cases, cease operations, the advantages of a no- or low-tax jurisdiction from which to operate is tempting. The benefits of being headquartered in a tax haven can be quite significant for a company with investment income over long periods of time. Use of affiliate reinsurance allows foreign-based companies to shift their U.S. reserves and their investment income overseas into tax havens, thereby avoiding U.S. tax.
The President has recently suggested a number of proposals tightening tax rules for U.S.-based companies operating overseas. Those proposals deserve a thorough review to assess their merits. But before we consider cracking down on the foreign earnings of U.S. companies, we should make sure we are taxing the earnings of foreign groups that do business in the United States the same way we do for those based here. Ending the tax advantage for foreign-based insurance groups from use of affiliate reinsurance was even a platform issue for candidate Obama last year.
There is no doubt that there is a legitimate role for reinsurance. It is a fundamental business technique for risk management and is to be fostered. However, reinsurance among affiliates can serve other purposes as well, including tax avoidance. Just as Congress and Treasury have attempted to measure what is legitimate in debt transactions between affiliates, there have been previous attempts to address the problem of excessive reinsurance between related entities. Unfortunately, as recent data shows, those attempts have been unsuccessful.
Since 1996, the amount of reinsurance sent to offshore affiliates has grown dramatically, from a total of $4 billion ceded in 1996 to $33 billion in 2008, including nearly $21 billion to Bermuda affiliates and over $7 billion to Swiss affiliates. Use of this affiliate reinsurance provides foreign insurance groups a significant market advantage over U.S. companies in writing direct insurance here in the U.S. We have seen in the last decade a doubling in the growth of market share of direct premiums written by groups domiciled outside the US, from 5.1% to 10.9%, representing $54 billion in direct premiums written in 2006. Again, Bermuda-based companies represent the bulk of this growth, rising from 0.1% to 4%. And it should be noted that during this time, the percentage of premiums ceded to affiliates of non-U.S. based companies has grown from 13% to 67%. Bermuda is not the only jurisdiction favorable for reinsurance. In fact last year, one company moved from the Cayman Islands to Switzerland citing “the security of a network of tax treaties,” among other benefits.
Congress first recognized the problem of excessive reinsurance in 1984 and provided specific authority to Treasury under Section 845 of the tax code to reallocate items and make adjustments in reinsurance transactions in order to prevent tax avoidance or evasion. In 2003, the Treasury Department testified before Congress that the existing mechanisms were not sufficient. In 2004, Congress amended this provision to expand the authority of Treasury to not only reallocate among the parties to a reinsurance agreement but also to recharacterize items within or related to the agreement. Congress specifically cited the concern that these reinsurance transactions were being used inappropriately among U.S. and foreign related parties for tax evasion. Despite this grant of expanded authority, Treasury has still been unable to stem the tide moving offshore.
Recently, a coalition of U.S.-based insurance and reinsurance companies has been formed to express their concerns to Congress. With more than 150,000 employees and a trillion dollars in assets here in the U.S., I believe it is a message of concern that we should heed. Last month, they wrote to the leadership of the House and Senate tax-writing committees urging passage of my bill because, as they wrote, “This loophole provides foreign-controlled insurers a significant tax advantage over their domestic competitors in attracting capital to write U.S. business.”
That is why I am again filing legislation to disallow deductions for excess reinsurance premiums with respect to U.S. risks paid to affiliated insurance companies that are not subject to U.S. tax. The excess amount will be determined by reference to an industry fraction, by line of business, which will measure the average amount of reinsurance sent to unrelated parties by U.S. companies. The bill allows foreign groups to avoid the deduction disallowance by electing to be treated as a U.S. taxpayer with respect to the income from affiliate reinsurance. Thus, the bill merely restores a level-playing field, treating U.S. insurers and foreign-based insurers alike. The legislation provides Treasury the authority to carry out or prevent the avoidance of the provisions of this bill.
My colleagues may be thinking that this sounds similar to another provision in the code, and they would be right. The tax code currently tries to limit the amount of earnings stripping – that is, sending U.S. profits offshore through inflated interest deductions – by disallowing the interest deduction over a certain threshold. In the reinsurance context, U.S. affiliates of foreign based reinsurance entities may be sending offshore excessive amounts of reinsurance to strip those premiums out of the purview of the U.S. tax system. My bill limits the deduction for those premiums to the extent the reinsurance to a related party exceeds the industry average.
I hope that in the coming weeks, my colleagues and experts in the industry will carefully review this new proposal and provide constructive commentary on it. A fuller technical explanation of the bill will be posted on my website, which will provide some background on the industry as well as a technical description of the bill. Madame Speaker, I appreciate the opportunity to address the House on this important matter and I assure my colleagues that I will continue my efforts to combat offshore tax avoidance, regardless of what industry is impacted.