TAX UPDATE P. Bruce Wright, Sutherland Asbill & Brennan LLP, Partner Tom Jones, McDermott Will & Emery LLP, Partner

Transcription

1 TAX UPDATE P. Bruce Wright, Sutherland Asbill & Brennan LLP, Partner Tom Jones, McDermott Will & Emery LLP, Partner

2 AGENDA PROGRESSION OF IRS RULINGS ON INSURANCE SINGLE MEMBER LLCs AS ENTITIES FOR RISK DISTRIBUTION HOMOGENEITY LOAN BACKS STATUTORY CHANGES TO IRC 831(b) BUSINESS VS. INSURANCE RISK - LTR STATE AND LOCAL ISSUES RECENTLY PROPOSED DEBT-EQUITY REGULATIONS 2

3 PROGRESSION OF IRS RULINGS ON INSURANCE HUMANA, TRANSACTIONS BETWEEN SUBSIDIARIES, BROTHER-SISTER ARRANGEMENTS, ARE INSURANCE (RISK SHIFTING) REV RUL , SAFE HARBOR IN HUMANA SITUATIONS (12 SUBSIDIARIES, NO ONE ACCOUNTED FOR MORE THAN 14% OR LESS THAN 5% OF RISK) REV RUL , IRS RULED THAT BROTHER-SISTER INSURANCE ARRANGEMENTS INVOLVING INSUREDS THAT WERE SINGLE-MEMBER LLCS WERE NOT INSURANCE. LLCS, AS DISREGARDED ENTITIES, WERE LOOKED THROUGH AND PARENT/OWNER WAS DEEMED INSURED (NO RISK SHIFTING) HEALTHMARK GROUP LTD., SINGLE-MEMBER LLCS, APPARENTLY ALLOWED TO DEDUCT PREMIUMS PAID TO SISTER CAPTIVE. IS THIS A CHANGE IN IRS POSITION OR WERE THE FACTS SO DIFFERENT? (ANY LIABILITY OF AN LLC IN EXCESS OF ITS POLICY LIMIT WAS SOLE FINANCIAL RESPONSIBILITY OF LLC) 3

4 FURTHER PROGRESSION OF INSURANCE ADDITIONAL MODIFICATIONS TO THE INSURANCE FRAMEWORK: RENT-A-CENTER - NEW STANDARD FOR RISK DISTRIBUTION AMOUNT OF RISKS NOT NUMBER OF ENTITIES SECURITAS FOLLOWED SAME THEORY AS RENT-A-CENTER FOCUSED ON NUMBER OF RISKS, NOT WHO OWNED THE RISKS WILL THESE RULINGS ALLOW FURTHER CAPTIVE ARRANGEMENTS TO QUALIFY FOR INSURANCE TREATMENT (THAT HISTORICALLY HAVE NOT)? 4

5 PROGRESSION PLANNING NEW STANDARDS FOR INSURANCE DEFINITION CAN WE LOOK MORE TO THE AMOUNT OF RISKS INVOLVED VERSUS THE AMOUNT OF ENTITIES INSURED? WHAT IS CORRECT BALANCE? WILL FEWER THEN 12 (SAFE HARBOR) BROTHER-SISTER SUBSIDIARIES SUFFICE? WILL RISKS IN SINGLE-MEMBER LLCS NOW BE CONSIDERED RISKS OF THE LLC AND NOT ITS OWNER UNDER THE RIGHT FACT PATTERNS? OR WILL SUCH RISKS ALWAYS BE DEEMED RISKS OF ITS OWNER? ARE LOAN-BACKS NOW MORE ACCEPTABLE? 5

6 RENT-A-CENTER V. COMMISSIONER MAJORITY FOUND ALL REQUISITE REQUIREMENTS OF INSURANCE TO BE MET: RISK SHIFTING (DISSENT DISAGREED RELIED ON HUMANA) RISK DISTRIBUTION (DISSENT DID NOT COMMENT) INSURANCE RISK COMMON NOTIONS OF INSURANCE (DISSENT DISAGREED ON LOAN BACK) IRS CHOSE NOT TO APPEAL 6

7 RENT-A-CENTER V. COMMISSIONER COURT APPLIED A FACTS AND CIRCUMSTANCES TEST WHICH CONSIDERED THE FOLLOWING KEY ITEMS: RAC IS A PUBLIC COMPANY IN RENT TO OWN BUSINESS OWNED A BERMUDA-BASED CAPTIVE, LEGACY INSURANCE COMPANY, LTD. IRC SECTION 953(D) ELECTION IN PLACE CAPTIVE INSURED 4-12 SUBSIDIARIES IN YEARS IN QUESTION ONE SUBSIDIARY REPRESENTED APPROXIMATELY 67% OF THE RISK PREMIUMS PARENTAL GUARANTY THE PARENT PROVIDED A LIMITED PARENTAL GUARANTY RELATING TO A DTA (~$25M) FOR THE BMA RELEVANT ASSET TEST PURPOSES CAPTIVE OWNED TREASURY SHARES OF THE PARENT WORTH ~$108M 7

8 RENT-A-CENTER V. COMMISSIONER KEY FACTS (CONT D) PARENT PAID PREMIUMS TO LEGACY ON BEHALF OF SUBS AND USED ITS COST ACCOUNTING FORMULA TO ALLOCATE PREMIUM EXPENSE BASED ON EACH SUB S EXPOSURE UNITS STANDARD COVERAGES WC, AL, GL STRUCTURED AS A DEDUCTIBLE BUY-BACK PROGRAM INDEPENDENT ACTUARY AND THIRD PARTY ADMINISTRATOR PREMIUMS AND PAID LOSSES WERE NETTED FOR SETTLEMENT PURPOSES SOME COVERAGE COST PROHIBITIVE OR UNAVAILABLE IN MARKET PLACE 8

9 RENT-A-CENTER V. COMMISSIONER KEY FINDINGS IRS SHAM ARGUMENT REJECTED LEGACY FORMED FOR VALID NON-TAX BUSINESS PURPOSES RISK CLEARLY SHIFTED TO LEGACY FROM SUBS (BUT NOT PARENT) BROTHER-SISTER THEORY ACCEPTED LIMITED PARENTAL GUARANTY NOT A FATAL FLAW MAJORITY BELIEVED GUARANTY DID NOT PREVENT RISK SHIFTING CAPTIVE WAS ADEQUATELY CAPITALIZED $25M RELATIVELY SMALL COMPARED TO PREMIUM LEVELS (>$250M) GUARANTY NEVER USED AND REMOVED AFTER UNNECESSARY FOR BMA 9

10 RENT-A-CENTER V. COMMISSIONER KEY FINDINGS (CONT D) NEW STANDARD FOR RISK DISTRIBUTION MAJORITY OPINION PRIMARILY FOCUSED ON RISKS RATHER THAN ENTITIES NO MENTION OF ENTITY THEORY AS SET FORTH IN REV RULS , AND TWO-THIRDS OF RISK IN ONE AFFILIATE (%-AGE NOT DISCLOSED IN THE OPINIONS) COURT ADDRESSED LOAN-BACKS WITH RESPECT TO TREASURY SHARES MAJORITY - NO CIRCULAR CASH FLOW AS SHARES WERE NOT SOLD DISSENT LEGACY A HOLDING TANK FOR CASH AND LOAN-BACK ALONG WITH PARENTAL GUARANTY NEGATED RISK SHIFTING 10

11 SECURITAS HOLDINGS, INC. V. COMMISSIONER KEY FACTS ULTIMATE PARENT WAS SECURITAS AB ( AB ), A SWEDISH PUBLIC COMPANY AB OWNED SECURITAS USA HOLDINGS, INC. ( SHI ), A US AFFILIATE AB ACQUIRED A NUMBER OF US BUSINESSES WHICH IT CONSOLIDATED INTO A FEW SUBSIDIARIES SHI OWNED BETWEEN 4-11 US SUBSIDIARIES FOR THE YEARS AT ISSUE LIKE R-A-C ONE SUBSIDIARY REPRESENTED ~ 67% OF THE TOTAL RISKS 4 US SUBSIDIARIES REPRESENTED ~ 90% OF THE TOTAL RISKS SHI ALSO OWNED PROTECTORS INSURANCE COMPANY ( PROTECTORS ) VERMONT BASED CAPTIVE INSUREDS WERE BROTHER-SISTER 11

12 SECURITAS HOLDINGS, INC. V. COMMISSIONER DEDUCTIBLE REIMBURSEMENT POLICY WITH SHI AFFILIATES AND PROTECTORS WC, AL, GL, ETC. PROTECTORS ENTERED INTO A 100% ASSUMPTION REINSURANCE ARRANGEMENT WITH SECURITAS GLOBAL REINSURANCE LIMITED ( SGRL ), AN IRISH CAPTIVE INSUREDS AND PROTECTORS WERE BROTHER-SISTER TO SGRL SHI PROVIDED A PARENTAL GUARANTY TO PROTECTORS TO NEGATE THE INSURANCE TRANSACTION BETWEEN THE SHI SUBSIDIARIES AND PROTECTORS PROTECTORS FILED FEDERAL RETURN AS NON-INSURANCE COMPANY (NO FORM 1120-PC) NO AMOUNT EVER PAID UNDER GUARANTY OTHER STAKEHOLDERS DID NOT REQUEST/REQUIRE THE GUARANTY 12

13 SECURITAS HOLDINGS, INC. V. COMMISSIONER FINDINGS: IRS ASSERTED THAT PROTECTORS WAS NOT AN INSURANCE COMPANY BECAUSE THE PARENTAL GUARANTY AND RISK WAS NOT SHIFTED TO SGRL IRS ASSERTED THE CONCENTRATION OF RISK IN THE SHI AFFILIATE RESULTS IN A LACK OF RISK DISTRIBUTION IN A TAX COURT MEMORANDUM DECISION, THE COURT CONCLUDED THE PARENTAL GUARANTY DID NOT NEGATE RISK SHIFTING TO SGRL FROM THE SHI AFFILIATES FOLLOWED THE RENT-A-CENTER DECISION WITH RESPECT TO RISK DISTRIBUTION IN COMMENTING WHO OWNS THE RISK IS NOT THE CRITICAL QUESTION; RATHER THE NUMBER OF RISKS RESULTING FROM THOUSANDS OF LOCATIONS, EMPLOYEES AND VEHICLES ARE KEY THE OPTION TO APPEAL THE CASE TO THE 9TH CIRCUIT EXPIRED JANUARY 28,

14 PASS-THROUGH ENTITIES REV. RUL , C.B. 4 DEALT WITH SINGLE-MEMBER LLCS DISREGARDED FOR TAX PURPOSES IRS POSITION THAT IN DETERMINING RISK DISTRIBUTION, SINGLE-MEMBER IS THE OWNER OF THE ASSETS/LIABILITIES IN THE LLC THUS IRS BELIEVES A SMLLC DOESN T COUNT AS AN SEPARATE ENTITY FOR BROTHER-SISTER RISK DISTRIBUTION 14

15 PASS-THROUGH ENTITIES REV. RUL X NUMBER LLC 1 LLC 2 LLC 3 LLC 4 LLC 5 LLC 6 LLC 7 LLC 8 LLC 9 LLC 10 LLC 11 LLC 12 Y INSURER 1 INSURED 15

16 PASS-THROUGH ENTITIES STATUS OF SINGLE MEMBER LLC S REGARDED HEALTHMARK GROUP LTD., GREGORY LENTZ A PARTNER OTHER THAN TAX MATTERS PARTNER v. COMMISSIONER, DOCKET NO , IRS EXAMINER HAD DISREGARDED 8 SUBSIDIARIES FORMED AS SINGLE-MEMBER LLC S AND DENIED DEDUCTION FOR PAYMENTS TO SISTER CAPTIVE BY THE LLCS MARCH 27, 2015 DECISION ENTERED STIPULATING ENTRY OF JUDGMENT PURSUANT TO WHICH ALL DEDUCTIONS ALLOWED WAS THIS CONCESSION A CHANGE IN THE IRS POSITION OR WAS IT DUE TO THE PARTICULARITIES OF THIS CASE? PERHAPS RELEVANT THAT UNDER STATE LAW ANY LIABILITY OF EACH LLC IN EXCESS OF ITS POLICY LIMIT WAS THE SOLE FINANCIAL RESPONSIBILITY OF THE LLC ITSELF (NOT THE SINGLE MEMBER OWNER)? 16

17 HOMOGENEITY IRS ISSUES GUIDANCE WITH FACT PATTERN INCLUDES RISKS ARE HOMOGENEOUS REV. RUL REV. RUL NO COURT HAS RULED ON HOMOGENEITY IRS ISSUES NOTICE ASKING INDUSTRY THE RELEVANCE OF HOMOGENEITY IN DETERMINING WHETHER RISKS ARE ADEQUATELY DISTRIBUTED FOR AN ARRANGEMENT TO QUALIFY AS INSURANCE. 17

18 HOMOGENEITY ILM (JULY 24, 2008) CHIEF COUNSEL REFUSED TO TAKE A POSITION, RATHER THE IRS AUDITORS ARE LEFT TO MAKE THEIR OWN JUDGMENT. IRS SEEMS TO BE INVOKING HOMOGENEITY REQUIREMENT: PLR PLR PLR TAM

19 THE IRS HAS BEEN VAGUE ON THEIR POSITION ON LOAN BACKS REV. RUL REV. RUL REV. RUL LOAN BACKS NOTICE ASKED INDUSTRY HOW LOAN BACKS SHOULD BE TREATED STILL WAITING FOR IRS TO ADDRESS COMMENTS 19

20 RAC: LOAN BACK ISSUE LEGACY S PURCHASE OF $108 MILLION OF RAC TREASURY SHARES TREASURY SHARES BOUGHT AND HELD BY LEGACY DURING YEARS IN ISSUE JUDGE FOLEY SAID NO CIRCULAR CASH FLOW BECAUSE SHARES NOT SOLD DISSENT SAID TREASURY SHARES WERE A FACTOR IN CHARACTERIZING LEGACY AS A MERE HOLDING TANK FOR CASH BECAUSE THE SHARES WERE NON-INCOME PRODUCING AND ILLIQUID, DISSENT SAID THEY WERE POORLY SUITED FOR AN INSURANCE COMPANY S INVESTMENTS PLUS DISSENT FOUND A NEGATIVE CORRELATION SUCH THAT IF RAC EXPERIENCED LARGE LOSSES, THE VALUE OF THE SHARES WOULD DECLINE WHEN MOST NEEDED COUPLED WITH THE GUARANTY AND LOW CAPITALIZATION, DISSENT SAID NO RISK WAS SHIFTED TO LEGACY 20

21 LOAN BACKS PLR ACKNOWLEDGED THAT LOANS WERE MADE BETWEEN CIC AND AFFILIATES WHOM IT EXECUTED DIRECT WRITTEN CONTRACTS WITH. SEEMS TO IMPLY THESE LOANS ARE TYPICAL OF INSURANCE COMPANIES. AVRAHAMI VS. COMMISSIONER ALL BUT $6,000 LOANED TO AN AFFILIATE, BELLY BUTTON. AWAITING DECISION! 21

22 PROTECTING AMERICA FROM TAX HIKES ACT OF 2015 Protecting America from Tax Hikes of 2015 (HR 2029) which passed December 18, 2015 included changes to section 831(b): The maximum premium is increased to $2,200,000, and indexed for inflation. The captive must meets one of two diversification tests: No policy holder pays 20% of the premiums No wealth transfer or estate planning benefits Effective for years beginning after December 31,

23 WHAT HASN T CHANGED On their face, the amendments do not have anything to do with the definition of insurance. If the arrangement qualified as insurance before the amendments, it remains a good insurance arrangement after the amendments If the captive fails to meet the new tests in 2017 or beyond, it is still an insurance company for tax purposes. The consequence will be that it is taxed under section 831(a), just like any insurance company with more than $2.2 million of premiums (more than $1.2 million in premiums in 2016 or before) 23

24 PROTECTING AMERICA FROM TAX HIKES ACT OF 2015 (cont.) Must meet one of two: Test 1: No more than 20% from any one policy holder Premiums are the greater of net written or direct premiums Related insureds are treated as one policy holder Test 2: The spouse and lineal descendants cannot own more in the insurance company than the operating entity Examples are provided below There is a 2% de minimus tolerance for different ownership, which the IRS is authorized to change 24

25 LTR BACKGROUND AROSE OUT OF SITUATION INVOLVING FOREIGN ENTITY CLAIMING TAX-EXEMPT STATUS PER IRC 501(c)(15) ATTEMPTING ELECTION UNDER IRC 953(d) COMMENTS ON STATUS OF CERTAIN TYPES OF COVERAGE POOLING APPLICATION OF HARPER CASE INDIRECTLY COMMENTS ON APPLICATION OF RENT-A-CENTER AND SECURITAS 25

26 LTR STATUS OF COVERAGES IRS CONSIDERS STATUS OF A NUMBER OF COVERAGES WE DO NOT HAVE COMPLETE UNDERLYING POLICY PROVISIONS OR UNDERSTANDING OF INSUREDS BUSINESS (MACHINERY REPAIR AND SERVICING) COMMENTS ON WHETHER COVERAGES CONSTITUTE INSURANCE IN THE NORMAL COURSE 26

27 LTR STATUS OF COVERAGES SPECIAL RISK LOSS OF SERVICES INSURANCE POLICY INVOLUNTARY LOSS OF SERVICES FOR KEY EMPLOYEES. LOSS MUST BE INVOLUNTARY, INCLUDES: SICKNESS, DISABILITY, DEATH, LOSS OF LICENSE, RESIGNATION OR RETIREMENT AFTER 14 DAYS. EXCLUSIONS: (1) TERMINATE EMPLOYEES OR (2) IF NO ATTEMPT TO REPLACE EMPLOYEE TIMELY NOT INSURANCE, POLICY COVERING DEATH OR DISABILITY OK, BUT THIS COVERS OTHER PERILS THAT ARE BUSINESS OR INVESTMENT RISKS ( BIR ) 27

28 LTR STATUS OF COVERAGES SPECIAL RISK PRODUCT RECALL COVERS MANDATORY OR VOLUNTARY RECALL OF PRODUCTS MANUFACTURED DUE TO A KNOWN OR SPECIFIC DEFECT, DEFICIENCY OR DANGEROUS CONDITION NOT INSURANCE. ONLY BIR SPECIAL RISK WEATHER RELATED BUSINESS INTERRUPTION COVERS BUSINESS INTERRUPTION DUE TO WEATHER RELATED EVENTS INSURANCE 28

29 LTR STATUS OF COVERAGES SPECIAL RISK REGULATORY CHANGES INSURANCE POLICY COVERS ACTUAL COMPLIANCE EXPENSES AND BI LOSS <12 MONTHS THAT HAS ADVERSE IMPACT ON NORMAL BUSINESS OPERATIONS NOT INSURANCE BIR SPECIAL RISK TAX LIABILITY INSURANCE POLICY COVERS ADDITIONAL TAX LIABILITY (SUBJECT TO $X DEDUCTIBLE) UP TO $Y OF ACTUAL IRS FILING PREPARED AND SIGNED BY CPA. COVERS DEFENSE EXPENSES IN DETERMINING LIABILITY, ETC. NOT INSURANCE - BIR 29

30 LTR STATUS OF COVERAGES SPECIAL RISK PUNITIVE WRAP LIABILITY INSURANCE POLICY COVERS CLAIMS FOR PUNITIVE OR EXEMPLARY DAMAGES ON FAILURE OF INSURER UNDER LISTED POLICIES SOLELY DUE TO ENFORCEMENT OF ANY LAW OR JUDICIAL RULING WHICH PRECLUDES INSURING PUNITIVES AND FOR WHICH INSURED IS OBLIGATED TO PAY NOT INSURANCE BIR 30

31 LTR STATUS OF COVERAGES EXCESS POLLUTION LIABILITY SEVERAL COVERAGES: (A) CLEAN UP COSTS RESULTING FROM PRE-EXISTING OR NEW ONSITE POLLUTION CONDITIONS; (B) THIRD-PARTY CLAIMS LIABILITY; (C) POLLUTION RELEASE FROM TRANSPORTED CARGO CARRIED BY COVERED AUTOS (ALTHOUGH NO COVERED AUTO IS IDENTIFIED IN DECS); (D) THIRD- PARTY CLAIMS FROM TRANSPORTING PRODUCT OR WASTE; (E) BI RESULTING FROM POLLUTION NOT INSURANCE - BIR 31

32 LTR STATUS OF COVERAGES SPECIAL RISK LOSS OF MAJOR CUSTOMER COVERS BI ARISING FROM LOSS OF SERVICE OF MAJOR CUSTOMER, COVERING LOST REVENUE AND EXTRA EXPENSE FINDING REPLACEMENT CUSTOMER. EXCLUDES LOSS (A) FROM LOSS DUE TO INITIATION BY INSURED; (B) IF THERE WAS NO INTEND TO REPLACE; (C) IF THERE WAS SUBSTANTIAL NON- COMPLIANCE BY THE INSURED NOT INSURANCE - BIR 32

33 LTR STATUS OF COVERAGES EXCESS INTELLECTUAL PROPERTY PACKAGE. SEVERAL COVERAGES: (A) INFRINGEMENT OF COPYRIGHTS, TRADEMARK, ETC., PLAGARISM OR UNAUTHORIZED USE OF IDEAS OR CHARACTER, LIBEL, SLANDER, PIRACY, UNFAIR COMPETITION, (B) WRONGFUL ACTS BY THIRD PARTIES AGAINST INSURED S INTELLECTUAL PROPERTY NOT INSURANCE, NOT INSURANCE IN COMMONLY ACCEPTED SENSE, BIR 33

34 LTR STATUS OF COVERAGES SPECIAL RISK EXPENSE REIMBURSEMENT INSURANCE POLICY. COVERAGE A DEALS WITH CRISIS MANAGEMENT AND PUBLIC RELATIONS EXPENSES, PRODUCT RECALL, EMPLOYEE LAYOFF OR LABOR DISPUTE, GOVERNMENT LITIGATION, FINANCIAL CRISIS; COVERAGE B COVERS DEFENSE EXPENSE FOR ACTUAL OR ALLEGED CIVIL LIABILITY IF NO OTHER INSURER COVERS OR COVERAGE USED. COVERAGE (A) IS NOT INSURANCE BIR; COVERAGE (B) MAY BE INSURANCE, VAGUE AS TO LIABILITY/CONTRACT UNDERLIES THE NEED FOR DEFENSE EXPENSES. MORE INFO IS NEEDED 34

35 LTR STATUS OF COVERAGES EXCESS EMPLOYMENT PRACTICES LIABILITY COVERS 11 CATEGORIES OF WRONGFUL ACTS INCLUDING, e.g., WRONGFUL TERMINATION, REFUSAL TO HIRE OR PROMOTE, SEXUAL HARASSMENT, DISCRIMINATION NOT INSURANCE BIR EXCESS D&O INSURANCE 35

36 LTR STATUS OF COVERAGES EXCESS CYBER RISK. COVERAGE A OF DAMAGES INSURED OBLIGATED TO PAY AND DEFENSE EXPENSES RELATING TO WRONGFUL ACT (DEFAMATION, INFRINGEMENT OF INTELLECTUAL PROPERTY, FAILURE TO PREVENT UNAUTHORIZED ACCESS TO, USE OF, TAMPERING WITH, OR INTRODUCING MALICIOUS CODE INTO DATA OR SYSTEMS. COVERAGE B IS PARTY PROPERTY AND BI. COVERAGE C COVERS COST OF PUBLIC RELATIONS SERVICES TO PROTECT IMAGE, CONSULTANTS FEES A AND B ARE INSURANCE; C IS NOT BIR AS IT IS TOO VAGUE AND BROAD. THEN SEEMS TO CONCLUDE ENTIRE POLICY IS NOT INSURANCE 36

37 LTR ARGUMENT THAT THERE IS BUT ONE INSURED NO EVIDENCE AFFILIATES PAID SEPARATELY OR WERE CHARGED EVEN IF THEY DID, NOT A BIG ENOUGH GROUP ONLY THREE NO REFERENCE TO RENT-A-CENTER OR SECURITAS CONCLUSION THERE WAS SELF-INSURANCE NO HOMOGENEITY QUESTIONS ACTUARALLY DETERMINED PREMIUM AMOUNTS NO ACTUARIAL PRINCIPLES AND FACTORS USED IN DETERMINING PREMIUM 37

38 LTR IN ADDRESSING POOLING, COMMENT THAT OTHERS WERE SIMILAR AND THUS MUCH OF WHAT SHARED WAS NOT INSURANCE IN CONSIDERING HARPER v. COMMISSIONER, IRS AGAIN SAYS (SEE PVT LTR ) THAT MUCH OF PREMIUM (2/3) WAS FROM BROTHER/SISTER (13), AND THAT WAS RELEVANT IN DETERMINING THAT APPROXIMATELY 30% UNRELATED PREMIUM WAS ENOUGH BUT IN F/N 10 IN THE HARPER CASE, THE COURT SAID THAT THE HUMANA ANALYSIS, i.e., BROTHER/SISTER ANALYSIS WOULD HAVE NO IMPACT ON ITS ULTIMATE CONCLUSION ON RISK DISTRIBUTION 38

39 STATE AND LOCAL ISSUES IN re BAYERISCHE BEAMTENKRANKENKKASSEAG FACTS PETITIONER IS INCORPORATED IN GERMANY AND SELLS A&H NON- LIFE INSURANCE THERE NO INSURANCE BUSINESS CONDUCTED IN U.S. FOR YEARS AT ISSUE OR ANY OTHER PERIOD NOT AUTHORIZED BY NYDFS FOR YEARS AT ISSUE, OR ANY OTHER PERIOD NEVER OBTAINED CERTIFICATE OF AUTHORITY FROM SECRETARY OF STATE 39

40 STATE AND LOCAL ISSUES IN re BAYERISCHE BEAMTENKRANKENKKASSEAG FACTS DURING AUDIT PERIOD, PETITIONER PARTICIPATED IN TWO PARTNERSHIPS WHICH INVESTED IN REAL ESTATE INCLUDING REAL ESTATE IN NEW YORK AND INVOLVED OWNERSHIP AND MANAGEMENT OF REAL ESTATE CONCLUSION PETITIONER S INCOME FROM PARTNERSHIP IS SUBJECT TO INSURANCE FRANCHISE TAX 40

41 STATE AND LOCAL ISSUES IN re BAYERISCHE BEAMTENKRANKENKKASSEAG NOTES NEXUS ISSUES MAY INCLUDE MANAGEMENT ACTIVITIES OF PARTNERSHIP IN NEW YORK AS WELL AS OWNERSHIP OF REALTY INVESTMENTS THUS MAY GIVE RISE TO INCOME TAX IN NEW YORK STATE 41

42 STATE AND LOCAL ISSUES STEWART S SHOPS CORPORATION (NY DIV. TAX APPEALS) FACTS ENTITY FOR YEARS AT ISSUE OWNED CONVENIENCE STORES AND GAS STATIONS CAPTIVE WROTE MULTIPLE COVERAGES INCLUDING, e.g., GENERAL LIABILITY, PROFESSIONAL LIABILITY, AUTO LIABILITY, BOILER AND MACHINERY, D&O, EPLI, UMBRELLA LIABILITY ALL RISKS IN PARENT OF CAPTIVE WHICH PAID ALL PREMIUM 42

43 STATE AND LOCAL ISSUES STEWART S SHOPS CORPORATION (NY DIV. TAX APPEALS) FACTS NO DEDUCTION TAKEN FOR FEDERAL INCOME TAX PURPOSES CONCLUSION NEW YORK STATE FOLLOWS FEDERAL AND, THUS, NO DEDUCTION FOR FRANCHISE TAX PURPOSES CITING HUMANA, RENT-A-CENTER AND SECURITAS 43

44 PROPOSED IRC 385 REGS. BACKGROUND IRS/TREASURY HAS A PERCEIVED CONCERN ASSOCIATED WITH EXCESSIVE INDEBTEDNESS PROP. REGS ADDRESS TREATMENT OF CERTAIN CORPORATE INTERESTS ISSUED AS DEBT AS STOCK EFFECTIVE DEBT ISSUED AFTER EFFECTIVE DATE OF PUBLICATION OF PROP. REGS IN FINAL FORM BUT AS TO DEBT DISTRIBUTED TO AFFILIATES, ISSUED IN SPECIFIC ACQUISITIONS INVOLVING AFFILIATES OR ISSUED TO FUND DISTRIBUTIONS TO AFFILIATES APPLIES TO DEBT ISSUED AFTER 4/4/2016 THAT REMAIN OUTSTANDING FOR 90 DAYS AFTER REGS PUBLISHED IN FINAL 44

45 PROPOSED IRC 385 REGS. ESSENTIALLY THREE SETS OF RULES BIFURCATION RULES DOCUMENTATION RULES COVERED TRANSACTION AND FUNDING RULES 45

46 PROPOSED IRC 385 REGS. BIFURCATION RULES U.S. PARENT U.S. OPCO $100 FOREIGN CAPTIVE NOTE: PAYS INTEREST & REPAYS NOTE IF IRS CAN ESTABLISH NOT INITIALLY EXPECTED THAT 15% WOULD BE REPAID, IRS WOULD ARGUE * $15 OF REPAYMENT A REDEMPTION * 15% OF INTEREST IS A DIVIDEND 46

47 PROPOSED IRC 385 REGS. DOCUMENTATION RULES REQUIRES DOCUMENTARY EVIDENCE FOR RELATED PARTY INSTRUMENT TO BE TREATED AS DEBT WITHIN 30 DAYS OF ISSUANCE DEMAND OR FIXED DATE OBLIGATION BY ISSUER LENDER HAS RIGHTS OF THIRD-PARTY CREDITOR EVIDENCE ISSUER HAS REASONABLE EXPECTATION IT CAN PAY 47

48 PROPOSED IRC 385 REGS. DOCUMENTATION RULES HOLDCO UK OPCO NON-US LOAN WITH NO DOCUMENTS, NO CASH FLOWS, ETC. CAPTIVE US > IRS COULD ARGUE THIS IS EQUITY 48

49 PROPOSED IRC 385 REGS. COVERED TRANSACTION RULE AND FUNDING RULE AUTOMATICALLY TREATS DEBT AS STOCK IF USED IN CERTAIN TYPES OF TRANSACTIONS DISTRIBUTION OF DEBT INSTRUMENT TO A RELATED PARTY SHAREHOLDER USE OF DEBT TO PURCHASE STOCK OF A RELATED ENTITY USE OF DEBT IN AN INTERNAL REORGANIZATION FUNDING RULE ESSENTIALLY CREATED A NON- REBUTTABLE PRESUMPTION THAT IF YOU ISSUE DEBT TO FUND WHAT WOULD BE A COVERED TRANSACTION 49

50 PROPOSED IRC 385 REGS. COVERED TRANSACTION RULE AND FUNDING RULE THERE ARE SOME EXCEPTIONS, BUT LIKELY THE MOST IMPORTANT IS THE ONE CORPORATION RULE. IF ALL INVOLVED MEMBERS ARE WITHIN A CONSOLIDATED GROUP, THEN THESE RULES DO NOT APPLY 50

51 PROPOSED IRC 385 REGS. COVERED TRANSACTION, FUNDING RULE, ONE CORPORATION RULE FOREIGN HOLDCO FOREIGN CAPTIVE $ NOTE US HOLDCO CONSOLIDATED GROUP DIVIDEND 2) 2 YEARS LATER DIVIDEND PAID 1) DOC. RULES FOLLOWED US OPCO SINCE DIVIDEND WITHIN THREE YEARS OF NOTE, NON-REBUTTABLE PRESUMPTION DEBT IS STOCK HELD BY FOREIGN CAPTIVE IN US OPCO 51

52 PROPOSED IRC 385 REGS. COVERED TRANSACTION, FUNDING TRANSACTION, ONE CORPORATION RULE SAME FACTS, BUT CAPTIVE IS OWNED BY US CONSOLIDATED GROUP AND IS EITHER A DOMESTIC CAPTIVE OR FOREIGN CAPTIVE WITH A 953(d) ELECTION. SINCE EVERYONE IS A US CONSOLIDATED GROUP, NO APPLICATION SAME FACTS, BUT THE US BORROWER LENDS THE FUNDS TO A FOREIGN BORROWER WITHIN THE GROUP. POSSIBLE RECHARACTERIZATION 52

53 PROPOSED IRC 385 REGS. STOCK TREATMENT CONSEQUENCES INTEREST PAID DIVIDEND AND NOT DEDUCTIBLE REPAYMENT OF PRINCIPAL REDEMPTION GAIN OR DIVIDEND FOREIGN COMPANY OWNS > 20% IN US CO -> UNCONSOLIDATION US COMPANY OWNS SHARES IN FOREIGN COMPANY, FOREIGN COMPANY CAN BE CFC AFFECT ON FOREIGN TAX CREDIT 53

54 PROPOSED IRC 385 REGS. CASH POOLING AGREEMENTS BACKGROUND EFFECT 54