A federal district court in Washington handed Validus Reinsurance a major win on Wednesday, declaring that the IRS has no authority to assess excise tax on retrocessions. The decision in Validus Reinsurance, Ltd. v. United States of America, No. 13-0109 (D.D.C. Feb. 5, 2014), is available here.
Validus is a Bermuda reinsurer. It sells reinsurance policies to other insurance companies. In 2006, Validus paid premiums on nine retrocession policies. In February 2012, citing 26 USC § 4371, the IRS requested that Validus consent to the assessment of excise tax on those policies in the amount of $326,340. Validus paid the assessment, plus an additional $109,040 in interest, and then filed for a refund. Six months later, not having received any response from the IRS, Validus filed this suit.
The Court held that the excise tax assessed against Validus was not authorized by law. Looking to the plain text of the statute, the Court noted that excise tax was imposed only on (1) casualty insurance and indemnity bonds; (2) life insurance, sickness, and accident policies, and annuity contracts; and (3) reinsurance covering any of the contracts taxable under the prior subdivisions of the statute. The challenged excise taxes, the Court noted, were imposed on premiums paid on policies of reinsurance that Validus purchased to cover the risks associated with its own reinsurance contracts. Accordingly, these “second-level” reinsurance policies did not themselves cover casualty insurance, indemnity bonds, life insurance, or annuity contracts – with the result that the transactions did not fall within the plain terms of Section 4371(3). As further support for its holding, the Court noted that the statute defined “policy of reinsurance” to mean only reinsurance contracts that were “made, continued, or renewed against, or with respect to, any of the hazards, risks, losses, or liabilities covered by contracts taxable under paragraph (1) or (2) of section 4371.” See 26 U.S.C. § 4372(f). The court ordered that Validus receive a refund.
The Court’s ruling, while welcome news for reinsurers and retrocessionaires alike, is not the end of the case. There is simply too much money at issue. Accordingly, we believe that the DC Circuit will be the next to weigh in. Stay tuned.