I. SUMMARY CONCLUSIONS.

Transcription

1 Terri A. Merriam, J.D. SideCars, Inc. 532 South Main Street Suite Z Joplin, MO You requested an opinion letter that will assist business owners in assessing the federal tax benefits and risks related to the SideCars Insurance Company Ltd.'s reinsurance program. I. SUMMARY CONCLUSIONS. 1. Producer-Affiliated Reinsurance Companies in SideCars Insurance Company s reinsurance ceding program will qualify as an insurance company for insurance tax purposes if the conditions set forth below are met. 2. SideCars Insurance Company provides an acceptable arrangement for shifting, diversifying and distributing risk for insurance purposes. II. FACTS. SideCars Insurance Company ( SideCars ) offers a reinsurance program that allows business owners to acquire insurance at a reasonable price and participate in the profit associated with the insurance transaction. It is expected that these individuals own medical practices, construction companies, franchises, agricultural operations, management companies and various other active business ventures. The proposed reinsurance company ( Producer- Affiliated Reinsurance Company or PARC ) will provide a variety of business related insurance coverage to the producer (i.e., the business owned by the owner of the reinsurance company) or to the producer s customers. These products include Crop Insurance, Extended Warranties, Food Borne Illness, Business Interruption, Data Breach Liability, Deductible Coverage, and coverages for other business casualty risks. The insured can be either the producer or the producer s customers. SideCars is wholly independent of the insureds to which it offers and provides insurance coverage and from the reinsurance companies to which to cedes insurance risks. SideCars uses Cobb Merriam is a Joint Venture of Montgomery W. Cobb, LLP and Merriam & Associates, P.C Lakeview Dr, Suite 110, Kirkland, WA Tel: Fax

2 Page 2 of 13 its underwriting experience and acumen to determine whether various risks are appropriate risks for business insurance. SideCars determines the amount of premium required for a given amount of insurance coverage using its premium and risk models. All insurance policies are prepared by or under the direction of SideCars. All reinsurance ceding agreements are prepared by or under the direction of SideCars. SideCars, Inc. is an affiliated company that is an insurance manager and administrator. In the SideCars program, the business owner forms a reinsurance company in the Turks & Caicos Islands, the sovereign nation of the Delaware Tribe of Indian ( Delaware Tribe ) or another suitable jurisdiction. The reinsurance company, owned by the business owner, then offers to enter into a reinsurance ceding arrangement to SideCars. These reinsurance companies are often referred to as producer-affiliated insurance companies ( PARC ). The PARC is subject to the laws and insurance regulations of the domicile of its formation, typically the Delaware Tribe. SideCars provides insurance coverage to more than 300 operating companies. Risk is shifted from each operating company to SideCars. A premium is paid by each operating company as consideration for the transfer of risk. SideCars pools and manages risks of those companies. SideCars retains a significant portion of the risk in its risk pool and distributes the remaining risk. A portion of the risk is ceded by SideCars to various PARCs and reinsurers to distribute, spread and diversify risk. This risk shifting, pooling, ceding and distribution is typical of insurers. SideCars Insurance is also formed in the Turks & Caicos Islands. SideCars pays an insurance ceding premium to various PARCs. A domestic bank account is set up in the PARC s name and the PARC s owners have signature authority and control subject to requirements in insurance ceding agreements. The reserves and other contract amounts are held in this bank account or another suitable investment account. SideCars, Inc., in its role as administrator and insurance manager, prepares the PARC s tax returns, insurance reports, financial statements and other reports related to the reinsurance policy. A. Controlled Foreign Corporations. III. OPINION. In 1962, Congress enacted the Controlled Foreign Corporation ( CFC ) provisions in an attempt to curb perceived tax haven and deferral abuses. The CFC provisions attempt to attribute certain business and passive income to the United States owners of CFCs. The provisions focus generally on closely held corporations controlled by a small number of United States taxpayers. I.R.C Foreign for Federal tax purposes is defined as when applied to a corporation or partnership means a corporation or partnership which is not domestic. I.R.C. 7701(5). The term "domestic" when applied to a corporation or partnership means created or organized in the United States or under the law of the United States or of any State unless, in the case of a 1 Internal Revenue Code, 26, U.S.C. et. seq.

3 Page 3 of 13 partnership, the Secretary provides otherwise by regulations. I.R.C. 7701(4). However, the regulations under section 7701 expand the definition of domestic corporations to specifically include those organized under a statute of a federally recognized Indian tribe, if the status describes or refers to the entity as incorporated or as a corporation, body corporate, or a body politic. Treas. Reg (b)(1). Thus, an insurance corporation formed under the Delaware Tribe of Indians, Tribal Status Title 27 would not be a foreign insurance company or a CFC. B. Relevant Internal Revenue Code Sections: 1. Deduction for Insurance Premiums under I.R.C Captive insurers and the Internal Revenue Service ( Service ) have had a long running battle concerning whether the captive insurance company is actually an insurance company or is merely insuring the parent companies own risk (often called self-insurance ). Insurance premiums are usually deductible under I.R.C. 162 Trade or Business expenses. However, the deduction is only allowed for insurance premiums, not for amounts merely set aside in a separate fund, or even an irrevocable trust, functioning as a sinking fund or financial reserve. Steere Tank Lines, Inc. v. United States, 43 F.2d 78 (10th Cir. 1930), cert. denied 284 U.S. 654 (1931). 2. Section 831(b), Small Property and Casualty Company. Insurance companies are taxed under a special set of rules found at Subchapter L of the Internal Revenue Code 2 due to economic, regulatory and policy considerations that, in theory, are unique to insurance companies. The primary concern is the fact that insurance companies generally received their income first, in the form of a premium, while the expense (claim) might occur years later. In contrast, most businesses purchase their inventory first, then sell the product and receive their income. This mismatching of income with expense for insurance companies requires special tax rules. Other factors include the diverse range of insurance products, the difference in the types of companies, the interaction between the insurance company and its policyholders, and the impact of regulation. The Pension Funding Equity Act of 2004 ( PFEA ) changed the test for property and casualty ( non-life ) insurance companies from primary and predominant to the same statutory definition that is applied to life insurance companies, i.e., any company where more than half of the business is the issuance of insurance, annuity contracts, or the reinsurance of insurance risks. I.R.C. 501(c)(15)(A); 831(c); PFEA, Pub. L. No , 206. This change is effective for tax years beginning after December 31, The mathematical test to qualify as an insurance company is that more than 50% of the company s business is the business of insurance or annuity contracts or the reinsuring of risks underwritten by insurance companies. I.R.C. 816(a). Once a company qualifies as a property and casualty company for Federal tax purposes, it can potentially qualify for the election under I.R.C. 831(b). 2 I.R.C

4 Page 4 of 13 A small non-life section 831(b) company is taxed only on its investment income, not on its premium income. I.R.C. 831(b). Previously, to qualify as a small non-life company, a company had to have premiums between $350,000 and $1,200,000; lower, and it was assumed the company would be a section 501(c)(15) company; higher, and the company would be taxed at regular corporation rates, albeit still utilizing many deductions only available to insurance companies. In 2004, Congress eliminated the $350,000 floor in section 831(b), and non-life insurance companies with premiums between $0.00 and $1,200,000 qualify for section 831(b) treatment (as long as the I.R.C. 831(c) insurance company test is met). For a number of years, there has been proposed legislation to increase the $1.2 million ceiling and tie it to a cost-of- living increase. a. Qualified Dividends. The JOBS Act of 2003 reduced the tax rate for most dividends to that of the capital gains tax rate. This change applied to dividends issued by domestic and certain foreign corporations. The reduced rate was scheduled to expire on December 31, However in 2012, Congress permanently tied the qualified dividend tax rate to the lower capital gains tax rate. Effective for tax years beginning after December 31, 2012, qualified dividends are taxed at either 0%, 15% or 20%, depending on the taxpayer s tax bracket. I.R.C. 1(h)(11). C. Internal Revenue Service Position. The Service was initially concerned about the potential for abuse in offshore Reinsurance Companies similar to its concern with many other foreign corporations. On October 15, 2002, the Service issued Notice concerning Certain Reinsurance Arrangements, which listed Reinsurance Companies as potentially abusive tax shelter transactions. Notice , I.R.B Notice identified transactions involving Reinsurance Companies (or similar transactions) as transactions that could be used to improperly shift income from taxpayers (the underlying business) to related reinsurance companies. However, the Service recognized that it had over reached and removed Reinsurance Companies from the tax shelter list by Notice Notice , IRB The Notice does set the framework for the Service s position concerning Reinsurance Companies and when it feels a transaction becomes potentially abusive. 1. Is the PARC an Insurance Company? The Internal Revenue Code does not define the term insurance ; however, case law has determined that insurance transactions must (1) contain insurance risk, (2) have risk shifting and risk distribution, and (3) conform to the commonly accepted principles of insurance. Harper Group & Subsidiaries v. Commissioner, 96 T.C. 45, 58 (1991), aff d. 979 F.2d 1341 (9 th Cir. 1992); See also Helvering v. LeGierse, 312 U.S. 531, 539 (1941). 3 If a PARC did not comply, Notice is still valid concerning PARC transactions that occurred prior to the issuance of Notice

5 Page 5 of 13 A commercially viable PARC transaction should contain the following features: a. Risk Shifting. Risk shifting is the transfer of risk where there is present uncertainty. Beech Aircraft Corp. v. United States, 797 F.2d 920, 922 (10 th Cir. 1986). Risk is the probable amount of loss foreseen by an insurer in issuing a contract. Union Labor Life Insurance Company v. Pireno, 458 U.S. 119, 130 (1982). Therefore, excessive limitations on the risk assumed by the reinsurance company could arguably eliminate the shifting of risk. If no risk shifting occurs, the reinsurance transaction would not be considered insurance for federal income tax purposes. b. Risk Distribution. For federal tax purposes, risk distribution incorporates the law of large numbers, which requires the presence of many independent risks within an insurance pool. By assuming numerous relatively small, independent risks that occur randomly over time, the insurer smoothes out losses to match more closely the receipt of premiums. Appeals Settlement Guidelines for Captive Insurance Companies (June 7, 1991); Gulf Oil Corp. v. Commissioner, 89 T.C (1987), aff d, 914 F.2d 39 (3 rd Cir. 1990); Harper Group v. Commissioner, 96 T.C. 45 (1991), aff d, 979 F.2d 1341 (9 th Cir. 1992). i. Rev. Rul /Single Insured. The Service recently raised concerns where it believes that the insurance transaction only involves a single insured. Rev. Rul , C.B. 4, I.R.B. 4; see also Notice , C.B. 14, I.R.B. 14. For example, if the PARC reinsures contracts only from one source (here it might be the producer), the Service might challenge the transaction as having insufficient risk distribution. This problem can be cured if there is sufficient unrelated risk in the insurance company, then risk distribution exists and the transactions constitute insurance. Ocean Drilling & Exploration Co. v. U.S., 988 F.2d 1135 (Fed. Cir. 1992); AMERCO, Inc. v. Commissioner, 979 F.2d 162 (9 th Cir. 1992); The Harper Group v. Commissioner, 979 F.2d 1341 (9 th Cir. 1992); Sears, Roebuck & Co. v. Commissioner, 972 F.2d 858 (7 th Cir. 1992). In Revenue Ruling , the Service presented four examples of insurance transactions, but concluded that three of the four transactions did not have sufficient risk distribution for purposes of Federal income tax. Rev. Rul , C.B. 4, I.R.B. 4; see also Notice , C.B. 14, I.R.B. 14. In the first fact pattern, the reinsurance company insured only one producer s risks. In the second, there were two producers, but 90% of the risk belonged to one producer. The third fact pattern involved 12 single member limited liability companies and, as the Service generally disregards single member LLCs, there was effectively one producer. It is noteworthy that while it was the Service s position is that there is not sufficient risk distribution, it did not matter if the reinsurance company had related ownership. What matter was the number of insureds. Therefore, this issue is not part of the self-insurance issue as discussed below. The fourth fact pattern had sufficient risk distribution as there were twelve limited liability companies, all owned by the same

6 Page 6 of 13 individual, but that as elected to be treated as associations rather than disregarded. Once each LLC was considered a separate legal entity for Federal tax purposes, the Service determined there were effectively multiple producers and sufficient risk distribution. It appears that the Service will be flexible with implementation of its position based upon the Service s analysis in a 2008 legal memorandum. IRS CCA (Release Date: July 24, 2008). The facts did not precisely meet the requirements of the safe harbor of Rev. Rul , but the Service found [T]hey have fulfilled the purpose of the 5% threshold. ii. Pooling. When there is a concern that a PARC or captive reinsurance company might have insufficient risk distribution (i.e., insufficient unrelated risk), captives and PARCs often participate in reinsurance pools. The reinsurance pool generally consists of other insureds that are unrelated to the first PARC. In a recent case, the Service determined: The present situation involves Company directly writing a small number of policies to related insureds. More importantly, however, under Coinsurance Agreement A, Company contributes a substantial amount of its direct consideration (received from its insureds) and associated risks to the pool, and under Coinsurance Agreement B, receives a quota share of the consideration and associated risks from the pool roughly equal in dollar terms to Number J percent of the amount Company ceded to the pool on each line of coverage. The result is that there are a significant number of unrelated covered entities such that none is paying for a significant portion of its own risk. Accordingly, given that insurance risks are covered, the arrangement achieves adequate risk shifting and risk distribution such that the contracts issued by Company to its insureds constitute insurance for federal income tax purposes. For the year for which the predicate facts were represented, this appears to be more than half of Company s business. PLR ; see also PLR , PLR The Harper line of cases found that 30% unrelated risk is sufficient for risk distribution. However, the Service continues to require 50% unrelated risk. In several recent Private Letter Rulings, the Service disagreed with taxpayers reliance on Harper and determined that 50% unrelated risk was necessary, relying on the fact that the Harper group involved separate thirteen entities that made up nearly two thirds of the risk concentration. PLR ; PLR ; & PLR The Service s analysis of Harper has not been tested in court; however, it is prudent at this time to make certain that 50% unrelated risks are present in the PARC. A pool is one method to make certain that sufficient unrelated risks exist. c. Commonly Accepted Principles of Insurance. This test is more simply identified as the smell test, i.e., does the transaction (and insurance company) look and act like other insurance transactions and companies. The case that

7 Page 7 of 13 stated this test reviewed the adequacy of the company s capitalization and whether the premiums charged by the company to its customers were the result of arms-length transactions. AMERCO, Inc. v. Commissioner, 96 T.C. 18, 38, aff d, 979 F.2d 162 (9 th Cir. 1992). d. Arms-Length Transaction. The arms-length transaction doctrine requires that the transaction be one that unrelated parties would enter into, using a willing buyer/willing seller standard. For example, it would be highly unlikely that an unrelated party would loan money to the business and not require (at the least) interest payments. Another example of a transaction that might not be considered arms-length is the loan at a lower than IRS approved rate, as that could be detrimental to the company s solvency. Thus, a PARC should not make nonperforming or lower than IRS approved rate loans to its shareholders. It is imperative that all transactions with related parties must meet this arms-length standard. Thus, a commercially viable PARC transaction would (1) transfer real risk pursuant to the reinsurance contract; (2) have risk distribution; and (3) be a transaction that could occur with a third party. The reinsurance company must (1) be solvent and thus capable of accepting the risk; only engage in arms-length transactions with related parties; and (3) have more than half of the business is either the issuance of insurance or the reinsurance of insurance risk. It is noteworthy that in 2004, the Service determined in two Technical Advice Memoranda (or Private Letter Rulings ( PLR )) 4 that certain PARC transactions qualified to elect section 953(d) treatment (to be treated as domestic insurance companies) and were not shams. The Service reached this conclusion even though aspects of the transaction were not properly documented. PLR (December 29, 2004) & PLR (December 29, 2004). The Service was able to reach this conclusion because the parties honored the transactions as if there were no defects in the documents and under the relevant state 5 law, the parties conduct made the contracts enforceable. It is unclear if the Service would have reached the same result if a different state law applied. Notably, it appears that there were no pricing issues in these transactions, i.e., no understated commissions or overstated premiums. Thus, these PLRs are evidence that less than perfect transactions are still acceptable and that transactions without similar defects should pass the Service s scrutiny. a. Reallocation/Assignment of Income. If the Service determines that the transactions do not clearly reflect income or are an attempt to evade taxes, the Service may reallocate that income to what they believe is the proper source. 4 Technically, the private letter rulings were issued as technical advice memoranda, but are cite to as private letter rulings. 5 The PLR does not identify in which state the parties were located.

8 Page 8 of 13 i. I.R.C Section 482 authorizes the Service to allocate income between controlled enterprises if such an allocation is necessary to prevent evasion of taxes or to clearly reflect the true income of the controlled enterprises. The purpose of section 482 is to prevent the artificial shifting of the true net income of controlled taxpayers by placing controlled taxpayers on parity with uncontrolled, unrelated taxpayers. A controlled taxpayer is defined as any one of two or more organizations, trades, or businesses owned or controlled directly or indirectly by the same interest. Treas. Reg (i)(5). The Service first challenged a credit insurance producer arrangement in Commissioner v. First Security Bank of Utah, N. A., et al., 405 U.S. 394 (1972). First Security, and the associated case, involved finance companies and banks that under state or federal law could not receive commissions from the sale of credit insurance policies. In both cases, the parent company set up wholly-owned reinsurance companies to reinsure the credit policies sold by the banks. The Service attempted to reallocate 40% of the income from the reinsurance companies to the parent companies under I.R.C The Supreme Court held that the income could not be reallocated to the parent because the parent companies were prohibited by law from earning commissions. ii. I.R.C The Service also believes that I.R.C. 845 applies to certain PARC transactions. Section 845(a) allows the Service to reallocate between two or more related parties to a reinsurance agreement, if the allocation is necessary to reflect the proper source and character of taxable income. As related parties are defined by reference to section 482, much of the above analysis applies. However, section 845(b) allows the Service to make proper adjustments concerning any reinsurance contract that has a significant tax avoidance effect, which is broader than the adjustments allowed under section 482. While section 845 appears to give the Service broad discretion, the Service lost the only case tried under this statute. Trans City Life Insurance Company v. Commissioner, 106 T.C. 274 (1996). To win a section 845(b) adjustment, in my opinion, the Service would have to prove that insurance risk does not pass to the PARC under the reinsurance agreements. However, if the reinsurance transaction meets the commonly accepted principles of insurance, including risk transfer and risk diversification, then section 845 should not apply to the transaction. b. Lack of Economic Substance (Sham). If the Service suspects that the transactions are shams, it is really asserting that the transactions do not qualify as insurance transactions. A critical factor in many of these cases is that the reinsurance company is undercapitalized. If the reinsurance company is undercapitalized, it might be unable to pay claims. If the reinsurance company lacks the ability to pay claims, then the risk never truly passed to the company. See Gulf Oil Corp. v. Commissioner, 914 F.2d 396 (3 rd Cir. 1990); Malone & Hyde v. Commissioner, 62 F.3d 835 (6 th Cir. 1995); Wright v. Commissioner, T.C. Memo , aff d without opinion, 73 F.3d 372 (9 th Cir. 1995)[1995 U.S. Ap. LEXIS 38231].

9 Page 9 of 13 It is noteworthy that the reinsurance companies in Gulf Oil and Malone & Hyde both had paid in capital of $120,000, and yet the courts determined that the transactions and/or the companies were shams. This, of course, creates concern that capitalization under $120,000 is insufficient. However, there are legal and factual arguments supporting lower initial capitalization for Reinsurance Companies in this transaction. Both Gulf Oil and Malone & Hyde involved insurance products other than service contracts or credit insurance. Different insurance products carry different risks, and the fact that a court felt that the insurance company in Malone & Hyde was undercapitalized for worker s compensation does not mean that the same court would find that the PARC was undercapitalized. For example, the initial capitalization in First Security was only $25,000.00, but the Supreme Court still found the transactions to be legitimate. Commissioner v. First Security Bank of Utah, N. A., et al., 405 U.S. 394 (1972). Currently, we have no specific guidance, either from the Service or the courts, concerning adequate capitalization for traditional PARC products such as credit insurance and VSCs. The two PLRs referenced above did not report the amount of actual capitalization. However, they did note that the transactions were different from the transactions in Wright, supra in that the PLR transactions did not have negative capital and surplus. PLR & PLR A primary problem found in most sham cases is that the shareholders of the companies failed to honor the separate legal existence of the corporation and the insurance nature of the business. An example of a PARC that was determined to be a sham is found in Wright, supra. The United States Tax Court determined that both the transaction and the reinsurance company in Wright were shams. The following factors contributed to the Tax Court determining the company was a sham: 1. Large nonperforming shareholder loans; 2. Unsupported reserve strengthening; 3. No employees, furniture, or office; 4. Extremely low capitalization (i.e. $1,000); 5. Fraudulent reserves; 6. Negative surplus; 7. Over submits placed in the reinsurance company; 8. Reduction of up-front commissions; and 9. Letters of Credit supported by the producer. The Service may challenge PARC transactions that have one or more of the factual circumstances identified above. A simple rule of thumb to apply to these transactions is to determine if the producer would have entered into the same transaction if the PARC was not owned by related parties. To determine if a specific transaction might be challenged, that transaction should be reviewed by a tax professional. It is unclear if the Service would win a sham case if only one of the characteristics was present. In the most recent PARC (or similar transaction) case, UPS, the Service lost its sham argument. United Parcel Service v. Commissioner, T.C. Memo , rev d 254 F.3d 1014 (11 th Cir. 2001). In UPS, the Service argued that the reinsurance transaction was a sham,

10 Page 10 of 13 that there was no risk transfer, and that the transaction had no business purpose. The Eleventh Circuit rejected many of the Service s arguments and stated that the business purpose for setting up a transaction does not have to be free of tax considerations. Rather, a transaction has a business purpose, as long as it figures in a bona fide, profit-seeking business. The Court found that the transaction served a genuine need for customers to enjoy loss coverage and for UPS to lower its liability exposure. However, it is clear that if a transaction contains a number of the above characteristics, the transaction will not be considered insurance. D. Reinsurance of Related Party Risks can qualify as Insurance for Federal Tax Purposes. Self-insurance is traditionally at issue where a parent company insures its risks with a whollyowned insurance company, often referred to as a captive insurance company. The early cases held that insurance arrangements between related corporations are not true insurance but selfinsurance. Spring Canyon Coal Company v. Commissioner, 43 F.2d 78 (10 th Cir. 1930), cert. denied, 284 U.S. 654 (1930); Rev. Rul , C.B. 53; Steere Tank Lines, Inc., v. United States, 577 F.2d 279 (5 th Cir. 1978); Carnation Company v. Commissioner, 640 F.2d 1010 (9 th Cir. 1981); Stearns-Roger Corporation v. United States, 774 F.2d 414 (10 th Cir. 1985); Beech Aircraft Corporation v. United States, 797 F.2d 920 (10 th Cir. 1986). Because the risk was insured with a related company, the parent company was not allowed to deduct the insurance premiums as an ordinary and necessary business expense under I.R.C Where the reinsurance company is reinsuring its parent s risk, the Service has historically argued that self-insurance occurred. However, the Service has lost this issue in similar cases involving brother/sister corporations claiming a deduction for insurance payments. Humana, Inc. v. Commissioner, 881 F.2d 247 (6 th Cir. 1989); Kidde Industries, Inc. v. United States, 40 Fed. Cl. 42 (Fed. Cl. 1997). The Service appears to concede this issue in Revenue Ruling , but retained the ability to challenge certain captive arrangements based upon the facts and circumstances. Rev. Rule , I.R.B The SideCars insurance and reinsurance structure does not permit a reinsurance company to reinsure the risk of a parent company. No direct insurance contractual arrangement is allowed between the reinsurer and the producing company. All insurance contracts must flow to SideCars and all reinsurance contracts must flow from SideCars, the independent insurer. E. Shareholder Loans. The Commissioner has long been concerned about loans between related parties. However, the mere fact that the loans are between related parties does not make such loans invalid. In 2005, the Service requested comments on circumstances under which the qualification of an arrangement between related parties as insurance may be affected by a loan back of amounts paid as premiums. Notice , C.B. 14. However, even though the Service requested comments on the issue, the Service has not provided further guidance since Thus, at this time, loans to shareholders by the reinsurance company are acceptable as long as they meet two tests. First, the loans should not be detrimental to the company s solvency, as stated above.

11 Page 11 of 13 Second, such loans should be considered valid as long as such loans meet the provisions of Treasury Regulation (a)(2). The Regulation provides: In general. For purposes of section 482 and paragraph (a) of this section, an arm s length rate of interest shall be a rate of interest which was charged, or would have been charged, at the time the indebtedness arose, in independent transactions with or between unrelated parties under similar circumstances. All relevant factors shall be considered, including the principal amount and duration of the loan, the security involved, the credit standing of the borrower, and the interest rate prevailing at the situs of the lender or creditor for comparable loans between unrelated parties. Treas. Reg (a)(2)(i). (The Regulation also provide for a safe haven based upon the applicable Federal rate. Treas. Reg (a)(2)(ii)). Whether shareholder loans (or loans to related entities) meet arms length standard must be determined on a case by case basis. However, if the loan does not impair solvency and meets the safe haven provisions of Treasury Regulation (a)(2), it is more likely than not that the loan transaction would be accepted by the Service. IV. CONCLUSION. As proposed, the reinsurance company and the reinsurance transactions will be recognized for Federal tax purposes as long as there is actual risk transfer, risk distribution, and the transaction meets the other tests of commonly accepted insurance principles. Actual risk transfer occurs if the operating company enters into an appropriate insurance contract. Risk distribution is achieved through due to third party risks. Where there is the potential for a single insured, risk distribution is achieved through the pooling of risk with unrelated parties. The transfer of risk by SideCars to reinsurance companies is a customary method for risk management, diversification and distribution. LIMITATIONS ON SCOPE OF OPINION This is a limited scope opinion which addresses only the issues set forth above. Additional issues may exist that could affect the Federal tax treatment of the transactions or matters that are the subject of this opinion. This opinion does not consider nor provide a conclusion with respect to any additional issues. With respect to any significant Federal tax issues outside the scope of this opinion, the opinion was not written, and cannot be used, for the purpose of avoiding penalties that may be imposed. The conclusions set forth above are based upon, and subject to, the further comments, assumptions, limitations, qualifications and exceptions set forth below: 1. If any one of the factual statements, representations, warranties or assumptions upon which we have relied to make the conclusions expressed herein is incorrect, this opinion may be modified in whole or in part.

12 Page 12 of The conclusions expressed are as of October 25, 2013, and I assume no obligation to update or supplement such conclusions to reflect any facts or circumstances that may hereafter come to my attention or any changes in law that may hereafter occur. 3. These conclusions represent and are based upon my best judgment regarding the application of Federal income tax laws arising under the Code, existing judicial decisions, and current administrative regulations and published rulings and procedures. My conclusions are not binding upon the Service or the courts, and there is no assurance that the Service will not successfully assert a contrary position and such position would be upheld by the courts. Furthermore, no assurance can be given that future legislative, judicial or administrative changes, on either a prospective or retroactive basis, would not adversely affect the accuracy of the conclusions stated herein and we undertake no responsibility to advise you of any new developments in the application or interpretation of the Federal income tax laws. 4. This opinion only opines on the Federal tax aspects of the transaction. Specifically, this opinion does not express an opinion on the application of the laws and regulations of the any state or jurisdiction besides those specifically identified in this letter. IRS Circular 230 Disclosures: This letter was written to support the marketing of Sidecars' insurance and reinsurance practices; however, the undersigned does not receive any compensation related to the sale of any specific transaction, and compensation is not dependent upon the sale of any of the referenced transactions. This letter is furnished to you with the expectation that each taxpayer will consult his or her own tax representatives before organizing the PARC. Furthermore, this opinion does not evaluate any specific PARC transaction, but sets forth the general federal tax environment in which Reinsurance Companies operate. As this opinion is intended to address PARC transactions generally, reliance on this opinion may not be sufficient to avoid section 6662 penalties relating to a specific transaction. No assurance can be given that the law or facts will not change, with possible retroactive effect, and we have not undertaken to advise you or any other person with respect to any event subsequent to the date hereof. Finally, this opinion is not binding on the Internal Revenue Service and, as a result, we cannot insure that the Service will agree with the conclusion reached in this opinion. Sincerely, Terri A. Merriam

13 Page 13 of 13 SCHEDULE A DOCUMENTS REVIEWED 1. SideCars, Inc. Structure for Financial Risk; 2. SideCars, Inc. Reinsurance Agreement Financial Risk & Warranty; 3. SideCars, Inc. Financial Rick & warranty Insurance Policy; 4. Sample Feasibility Study; 5. Product Analysis; 6. Pooling Pro Forma example; 7. Sample language for Foodborne Illness coverage; 8. Sample language for Extended Warranties coverage; 9. Sample language for Crop Insurance coverage; 10. FAQ on Federally-recognized Indian Tribes; 11. Delaware Tribe of Indians announcement concerning new captive domicile program; 12. Delaware Tribe of Indians introduction letter concerning proposed captive domicile; and