Locke Lord QuickStudy: Validus Court of Appeals Decision - Wholly-Foreign Retrocessions Not Subject to Federal Excise Tax

On May 26, 2015, the United States Court of Appeals for the District of Columbia upheld a District Court decision and ruled that the Internal Revenue Service could not impose excise tax on certain wholly-foreign retrocessions of insurance under Section 4371 of the Internal Revenue Code.  Code Section 4371 generally imposes an excise tax on premiums paid to certain foreign insurers and reinsurers related to policies of insurance or reinsurance and indemnity bonds covering certain United States risks.  The Internal Revenue Service takes the position that this tax can apply multiple times through cascading layers of reinsurance, including where both parties to such contracts are wholly outside the United States.

Background 
This decision represents a second major victory for Validus, a Bermuda reinsurer, who was seeking a refund from the Internal Revenue Service of excise tax previously imposed on nine retrocession policies it had with foreign retrocessionaires. [The facts of the case are described in greater detail in a previous post on our Insurance and Reinsurance Blog, available here.] In the earlier decision, the District Court for the District of Columbia held that such tax was not permitted under the applicable statute, determining that “retrocessions” fell outside the literal definitions of reinsurance and other types of taxable insurance subject to the excise tax under Code Section 4371.

The Decision
In its decision, the Court of Appeals held that the excise tax assessed against Validus with respect to its retrocession contracts with other foreign insurers was not authorized by Code Section 4371, although on different, narrower grounds than the lower court.  After examining the plain language of the statute, the Court of Appeals found the text of Section 4371 to be ambiguous as to whether or not Congress intended to tax wholly-foreign retrocessions such as those involved in the case.  To resolve this ambiguity, the Court of Appeals turned to the legislative history of the statute, noting the long-standing judicial doctrine that, unless a contrary intent is apparent, Congressional legislation is not meant to apply to transactions wholly outside the territorial jurisdiction of the United States, generally known as the “presumption against extraterritoriality.”  The Court of Appeals could not find any explicit evidence of Congress’ intent to apply the Code Section 4371 excise tax to wholly-foreign retrocessions and, accordingly, applied the presumption against extraterritoriality to refuse to interpret the statute to allow the Internal Revenue Service to impose excise tax on wholly-foreign retrocessions. 

Takeaways
Despite this important victory for Validus, one should note as mentioned above that the Court of Appeals’ holding is narrower than the District Court’s earlier decision.  By limiting its holding to wholly-foreign retrocessions, the Court of Appeals did not question the application of the excise tax to retrocessions from domestic reinsurance policies, i.e., U.S. reinsurers ceding risk to a non-U.S. retrocessionaire.  As with the District Court decision, there remains the possibility of a further government appeal of this case (for example, if another federal circuit decision results in a split in the relevant circuits).  However, the narrower holding of the Court of Appeals decision may provide a middle ground sufficient to placate both sides of the issue.  

We are monitoring this situation and will keep you informed of any developments.  In the interim, if you have paid federal excise tax on wholly-foreign retrocessions, you should consider seeking a refund of such taxes based upon the current holding.  

For more information on the matters discussed in this Locke Lord QuickStudy, please contact the authors.