Internal Revenue Service
Revenue Ruling
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smCAPTIVE INSURANCE TRANSACTIONS
Released: June 5, 2001
Published: June 25, 2001
Section 118.--Contributions to the Capital of a Corporation, 26 CFR 1.118-1: Contributions to the capital of a corporation.
The revenue ruling obsoletes Rev. Rul. 77-316 (1977-2 C.B. 53), which provided that payments between related parties that were disallowed as deductions for insurance premiums should be recharacterized as contributions to capital under I.R.C. § 118.
Section 162.--Trade or Business Expenses, 26 CFR 1.162-1: Business expenses.
The revenue ruling announces that the Service will not raise the economic family theory, originally set forth in Rev. Rul. 77-316 (1977-2 C.B. 53), in determining whether payments between related parties are deductible insurance premiums.
Section 165.--Losses, 26 CFR 1.165-1: Losses.
The revenue ruling obsoletes Rev. Rul. 77-316 (1977-2 C.B. 53), which provided that losses paid by a captive insurance company pursuant to a related- party transaction deemed not to be insurance were deductible by the captive insurer's respective parent or affiliate under IRC § 165(a).
Section 301.--Distributions of Property, 26 CFR 1.301-1: Rules applicable with respect to distributions of money and other property.
The revenue ruling obsoletes Rev. Rul. 77-316 (1977-2 C.B. 53), which provided that losses paid by a captive insurance company pursuant to a related- party transaction deemed not to be insurance were viewed, to the extent of available earnings and profits, as distributions under IRC § 301 to the respective parent.
Section 801.--Tax Imposed, 26 CFR 1.801-3: Definitions.
The revenue ruling obsoletes Rev. Rul. 77-316 (1977-2 C.B. 53), which provided that certain captive insurance companies were not taxable as insurance companies pursuant to IRC §§ 801, 831, and the applicable regulations because the related-party transactions could not be considered "insurance" for purposes of determining whether the captive insurer was "primarily and predominantly engaged in the insurance business," as required in Treas. Reg. § 1.801-3(a).
Section 831.--Tax on Insurance Companies Other Than Life Insurance Companies, 26 CFR 1.831-3: Tax on insurance companies (other than life or mutual), mutual marine insurance companies, mutual fire insurance companies issuing perpetual policies, and mutual fire or flood insurance companies operating on the basis of premium deposits; taxable years beginning after December 31, 1962.
The revenue ruling obsoletes Rev. Rul. 77-316 (1977-2 C.B. 53), which provided that certain captive insurance companies were not taxable as insurance companies pursuant to IRC §§ 801, 831, and the applicable regulations because the related-party transactions could not be considered "insurance" for purposes of determining whether the captive insurer was "primarily and predominantly engaged in the insurance business," as required in Treas. Reg. § 1.801-3(a).
26 CFR 1.162-1: Business expenses.
Captive insurance transactions. This ruling explains that the Service will no longer raise the "economic family theory," set forth in Rev. Rul. 77-316 (1977-2 C.B. 53), in addressing whether captive insurance transactions constitute valid insurance. Rather, the Service will address captive insurance transactions on a case-by-case basis. Rev. Ruls. 77-316, 78-277, 88-72, and 89-61 obsoleted. Rev. Ruls. 78-338, 80-120, 92-93, and 2000-3 modified.
This ruling explains that the Service will no longer raise the "economic family theory" set forth in Rev. Rul. 77-316 (1977-2 C.B. 53), in addressing whether captive insurance transactions constitute valid insurance. Rather, the Service will address captive insurance transactions on a case-by-case basis.
In Rev. Rul. 77-316 (1977-2 C.B. 53), three situations were presented in which a taxpayer attempted to seek insurance coverage for itself and its operating subsidiaries through the taxpayer's wholly-owned captive insurance subsidiary. The ruling explained that the taxpayer, its non-insurance subsidiaries, and its captive insurance subsidiary represented one "economic family" for purposes of analyzing whether transactions involved sufficient risk shifting and risk distribution to constitute insurance for federal income tax purposes. See Helvering v. Le Gierse, 312 U.S. 531 (1941). The ruling concluded that the transactions were not insurance to the extent that risk was retained within that economic family. Therefore, the premiums paid by the taxpayer and its non-insurance subsidiaries to the captive insurer were not deductible.
No court, in addressing a captive insurance transaction, has fully accepted the economic family theory set forth in Rev. Rul. 77-316. See, e.g., Humana, Inc. v. Commissioner, 881 F.2d 247 (6 superth Cir. 1989); Clougherty Packing Co. v. Commissioner, 811 F.2d 1297 (9 superth Cir. 1987) (employing a balance sheet test, rather than the economic family theory, to conclude that transaction between parent and subsidiary was not insurance); Kidde Industries, Inc. v. United States, 40 Fed. Cl. 42 (1997). Accordingly, the Internal Revenue Service will no longer invoke the economic family theory with respect to captive insurance transactions.
The Service may, however, continue to challenge certain captive insurance transactions based on the facts and circumstances of each case. See, e.g., Malone & Hyde v. Commissioner, 62 F.3d 835 (6 superth Cir. 1995) (concluding that brother-sister transactions were not insurance because the taxpayer guaranteed the captive's performance and the captive was thinly capitalized and loosely regulated); Clougherty Packing Co. v. Commissioner (concluding that a transaction between parent and subsidiary was not insurance).
EFFECT ON OTHER DOCUMENTS
Rev. Rul. 77-316, 1977-2 C.B. 53; Rev. Rul. 78-277, 1978-2 C.B. 268; Rev. Rul. 88-72, 1988-2 C.B. 31; and Rev. Rul. 89-61, 1989-1 C.B. 75, are obsoleted. Rev. Rul. 78-338, 1978-2 C.B. 107; Rev. Rul. 80-120, 1980-1 C.B. 41; Rev. Rul. 92-93, 1992-2 C.B. 45; and Rev. Proc. 2000-3, 2000-1 I.R.B. 103, are modified.
DRAFTING INFORMATION
The principal author of this revenue ruling is Robert A. Martin of the Office of Associate Chief Counsel (Financial Institutions & Products). For further information regarding this revenue ruling, contact Mr. Martin at (202) 622-3970 (not a toll-free call).
Rev. Rul. 2001-31, 2001-26 I.R.B. 1348