Validus Case Has “Serious Ramifications”

March 27, 2013

A 2008 ruling by the US Internal Revenue Service on Bermudian reinsurer Validus has serious ramifications for other insurers and reinsurers, US law firm Edwards Wildman has warned.

In January Validus Reinsurance filed a lawsuit against the US to challenge the ruling under which the IRS considered the cascading Federal Excise Tax [FET] to be applicable even when both parties concerned were based outside the US.

London-based Edwards Wildman attorney William Haig blogged last week: “On 25 January 2013, Validus Reinsurance Ltd., a reinsurer domiciled in Bermuda, filed a suit in the District Court of the District of Columbia against the United States of America for the repayment of taxes which they allege were wrongly demanded by the IRS. The tax was assessed under the Federal Excise Tax [FET] regime, which — among other things — imposes a one percent tax on premiums under contracts of reinsurance with foreign reinsurers covering risks in the US [s4371 of the Internal Revenue Code]. FET also applies at a rate of 4% to premiums for property and casualty insurance, and at 1% to policies for life insurance, sickness, accident and annuities … The IRS ruled on 7 March 2008 that the tax would apply to all contracts with an underlying risk based in the US …

Validus chief executive officer Ed Noonan

Noonan

“This ruling was controversial, as the analysis it included made it clear that the IRS considered the tax to apply to reinsurance and retrocession contracts even where both the cedent — or retrocedent — and the reinsurer — or retrocessionaire — were based outside the US, and neither party conducted any business within the US. Even in the case of insurers domiciled in countries with a tax treaty which exempts them from FET, the one percent tax on reinsurance premiums is still payable if they obtain reinsurance from a foreign reinsurer domiciled in a country without such a tax treaty. Furthermore, if a UK insurer (which is ordinarily exempt under a treaty) insures a US risk and passes it on to a foreign reinsurer as part of a conduit arrangement, FET becomes payable both on the reinsurance policy and the underlying insurance policy, which loses the exemption. This sort of arrangement is common with captive insurers, and would result in double (or multiple, if the risk is further reinsured) taxation on the same risk.

“While many have questioned whether this interpretation of the code is correct (as it appears to be double taxation), and whether the IRS has the authority to demand FET on a transaction between two non-US parties, neither of which conducts business in the US, the tax has been paid by a number of reinsurers since the 2008 ruling. Validus, as can be seen in their Complaint, was one such party. In February 2012, the IRS demanded $326,340 from Validus in unpaid FET for retrocession premiums paid to foreign retrocessionaires during 2006, and later demanded $109,040 in interest accrued on that sum. Validus paid both sums in full, and filed claims for a refund, as they considered the tax to have been wrongly assessed. In the absence of a response from the IRS, Validus has now launched a test case to recover the money paid plus interest.”

Mr. Haig said the result of this case has “serious implications” for other non-US insurers and reinsurers which have paid the cascading FET.

“However, the statute of limitations for tax returns in the US is relatively short, and expires for returns made for the first quarter of 2011 on 30 April 2013,” he added. “In anticipation of the result of the claim, insurers and reinsurers who are concerned they may have paid this tax in error should file a protective refund claim with the IRS, which effectively freezes the limitation period for a particular claim.”

International law firm Edwards Wildman has 15 offices in the US, Europe and Asia.

Validus Holdings, Ltd. was incorporated in Bermuda in 2005. The company conducts its operations worldwide through three operating segments — Validus Reinsurance, Ltd, Talbot Holdings Ltd. and AlphaCat Managers, Ltd.

The company provides reinsurance, insurance and insurance linked securities management. Validus Re is a Bermuda based reinsurer focused on short tail lines of reinsurance. Talbot is the Bermuda parent of the specialty insurance group primarily operating within the Lloyd’s insurance market through Syndicate 1183. AlphaCat is a Bermuda based investment adviser, managing third-party capital in insurance linked securities and other investments in the property catastrophe reinsurance space.

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Comments (2)

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  1. Bermudican says:

    wow. excellent article.

  2. Phil says:

    Validus won the case in federal district court I read.
    The conclusion to the judgement says it applies to retrocession contracts. Will it set a precedent for ordinary reinsurance contracts too?