Court Strikes Down IRS’s Imposition of Excise Tax on Retrocessional Agreements by Foreign Reinsurers

VALIDUS REINSURANCE, LTD V. UNITED STATES (No. 13-0109; February 5, 2014)

The U.S. District Court for the District of Columbia recently held that a retrocession insurance policy is exempt from the excise tax of Section 4371 of title 26 of the U.S. Code. Section 4371 is a tax on insurance transactions issued by foreign insurers or reinsurers. In 2006, Validus Reinsurance, LTD (Validus) paid premiums on nine retrocession policies it obtained from foreign insurers. In 2012, the Internal Revenue Service (IRS) requested that Validus consent to an assessment of an excise tax on the retrocession premiums. The reinsurer paid the assessment in full, then filed a claim for refund with the IRS. After six months, and with no action by the IRS, the reinsurer filed this action seeking a refund of the excise tax.

Both parties submitted motions for summary judgment. Validus argued that the plain language of section 4371 does not apply beyond the first level of reinsurance transactions, i.e., between a direct insurer and reinsurer. The IRS argued that Congress intended to impose the tax on any and all successive levels of insurance or reinsurance obtained from a foreign insurer.

The court agreed with Validus and held that the plain language of the statute does not impose an excise tax on retrocession insurance transactions. Section 4371(3) contains a clear internal limitation on its application to reinsurance policies. The contracts taxable under section 4371 are contracts for “[c]asualty insurance and indemnity bonds … [l]ife insurance, sickness and accident policies, and annuity contracts.” A retrocession policy that provides reinsurance is outside the scope of section 4371(3) and not subject to the excise tax imposed on second-level reinsurance contracts. Therefore, Validus’ motion for summary judgment was granted.

IMPACT — REINSURANCE: This decision removes an excise tax imposed by the IRS on foreign reinsurers, yielding a more favorable tax environment in which foreign reinsurers may issue retrocessional cover.