Rev. Rul. 78-277

Advice has been requested whether the tax on policies issued by foreign insurers imposed by section 4371 of the Internal Revenue Code of 1954 applies to a contract entered into under the circumstances described below.

A domestic parent company and its wholly owned foreign subsidiary corporation entered into a contract under which the subsidiary agreed to insure the parent company and its domestic affiliated companies against certain high risk casualties for which the parent and other affiliates might become liable as a result of their operations. In consideration for such coverage, the foreign subsidiary receives a premium. The subsidiary is engaged exclusively in providing coverage to the parent company and affiliates and does not accept or solicit such coverage from parties outside the affiliated group.

Section 4371 of the Code imposes a tax on each policy of insurance, indemnity bond, annuity contract, or policy of reinsurance issued by any foreign insurer or reinsurer, and (in the case of casualty insurance under section 4371(i)) if issued to or for, or in the name of, an insured as defined in section 4372(d).

Section 4372(a) of the Code provides that the term "foreign insurer or reinsurer" means an insurer or reinsurer who is a nonresident alien individual, a foreign partnership, or a foreign corporation.

Under the provisions of section 4372(d) of the Code, the term "insured" (for purposes of section 4371(1)) includes a domestic corporation or partnership, or an individual resident of the United States, against, or with respect to hazards, risks, losses, or liabilities wholly or partly within the United States.

The tax imposed by section 4371 of the Code is applicable to policies, etc., that fall within the context of insurance contracts, whether they be in the nature of casualty policies, indemnity bonds, life, sickness and accident policies, or annuity contracts. One of the requisites of a true insurance contract is that there be present an element of risk-shifting or risk-distribution. See Guy T. Helvering v. Edythe LeGierse, 312 U.S. 531 (1941). See also Rev. Rul. 77-316, 1977-2 C.B. 53, which concludes, in part, that when there is no economic shift or distribution of the risk "insured," the contract is not one of insurance, and the amounts paid as premiums therefor are not deductible as ordinary and necessary business expenses for federal income tax purposes.

The foreign subsidiary in the instant case has not solicited or accepted insurance risks outside the affiliated group. Thus, in the event any member of the affiliated group should be reimbursed by the foreign subsidiary, there has been no economic change to the affiliated group because there has been no distribution of the burden of risk outside the affiliated group. Therefore, the element of risk-shifting and risk-distribution essential to an insurance contract is not present in the contract between the foreign subsidiary and the parent corporation.

Accordingly, the contract described is not a contract of insurance within the purview of section 4371 of the Code and the tax imposed by that section does not apply to such contract.