D.C. Circuit strikes down ‘cascading’ retrocession excise taxes
The federal excise tax does not apply to reinsurance or retrocession transactions between foreign insurers, even if the transaction covers U.S. risks, according to a May 26 decision from the U.S. Court of Appeals for the District of Columbia.
At issue in Validus Reinsurance Ltd. v. U.S. was the Internal Revenue Service’s Revenue Ruling 2008-15, issued in March 2008. Under the rule, the IRS declared that the 1 percent federal excise tax on reinsurance created by Section 4371(3) of the Internal Revenue Code applied any time U.S. risks were transferred to a foreign reinsurer, no matter how many times the risks had been ceded or retroceded.
While it didn’t challenge the application of excise tax on reinsurance sold to a U.S. insurer or foreign insurer doing business in the United States, Validus argued that, as interpreted by the agency, the IRS ruling had the effect of creating a “cascading” excise tax that applies each time the risks were shifted from one foreign insurer or reinsurer to another, even when both parties to the transaction were outside U.S. jurisdiction.
Under this ‘cascading tax’ theory, there is no limit to the number of times the United States can collect excise tax on retrocessions, provided they can ultimately be traced back, through any number of intermediate contracts, to U.S.-based risks.
There were no factual disputes in the case, which ultimately came down to competing requests for summary judgment on grounds that the plain text of the statute did or did not apply to wholly extraterritorial transactions. In many cases, the IRS’ interpretation of the law likely would receive deference from the court, under principles established in the famous 1984 case Chevron U.S.A. Inc. v. Natural Resources Defense Fund. Here, the appeals court pointed to precedent limiting extraterritorial application of law without evidence of Congress’ clear intent, and found that the IRS did not appear to consider such limitations when it issued its ruling.
Because both parties offer plausible interpretations based on different readings of the statutory text, we conclude the text of section 4371 is ambiguous with regard to its application to wholly foreign retrocessions. This statutory ambiguity is resolved by the presumption against extraterritoriality.
