D.C. Circuit Appeals Court to IRS: Hands Off Wholly Foreign Retrocession Agreements

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In Validus Reinsurance Ltd. v. United States of America, the D.C. Circuit Court of Appeals decided whether 26 U.S.C. § 4371, which taxes premiums on certain reinsurance policies issued by foreign reinsurers, applies where the reinsurance contract is between two wholly foreign entities.

Validus Reinsurance is a Bermuda-domiciled company located in Bermuda that provides reinsurance for companies either incorporated in the United States or doing business in the U.S. It also purchases retrocession contracts from wholly foreign entities to cover its own risks. Validus paid the § 4371 excise tax on nine retrocession agreements between itself and a wholly foreign retrocessionaire. Validus filed for a refund on the basis that the retrocession contracts were with a wholly foreign company and the IRS refused to grant it. The U.S. District Court granted summary judgment in favor of Validus and the IRS appealed.

The question ultimately centered on whether § 4371 could be applied extraterritorially to wholly foreign retrocession transactions. The court cited Supreme Court instruction “that a court must presume that a statute has no extraterritorial application unless there is the affirmative intention of the Congress clearly expressed to give a statute extraterritorial effect.” Based on an analysis of the legislative text, the court concluded that because § 4371 did not specifically contain any language applying its provision extraterritorially, it had no extraterritorial effect. Consequently, the IRS could not apply the excise tax to wholly foreign retrocession contracts and Validus was entitled to a refund.

IMPACT (REINSURANCE): Wholly foreign retrocession transactions are not subject to the § 4371 excise tax on premiums. Companies should consult with their tax advisors/attorneys to determine how this case applies to their financial situation.