The IRS released a Chief Counsel Advice memorandum (“CCA”) concluding that contracts issued by a captive insurance company that offered protection from the loss of earnings arising from foreign exchange fluctuations are not insurance contracts. CCA 201511021 (release date March 13, 2015 and dated December 1, 2014).
Taxpayer Group, a manufacturer, conducts business around the world through numerous US subsidiaries (“Subs”). Taxpayer is the parent of Taxpayer Group. One member of Taxpayer Group is InsCo, the group’s captive insurance company, which covers several different risks of the Subs. One risk in particular is the financial risk arising from the fluctuations in the currency exchange rates to which the Subs are exposed since they do business in several different currencies. That is the risk on which we are focusing here.
Taxpayer Group’s parent company (Parent) entered into contracts with Captive on behalf of some members of the Taxpayer Group to guard against the risk arising from fluctuations in the rate of exchange between the U.S. dollar and certain foreign currencies. One type of contract protects the member against a decrease in the value of the specified foreign currencies and the other protects against an increase in value of the specified foreign currencies.
Under the contracts, Captive agrees to indemnify the participating members for the “loss of earnings” connected to either a decrease or increase in the value of each specified foreign currency relative to the U.S. dollar up to a stated coverage limit for the one-year term of the contract. The coverage limit is the lesser of: (1) an undefined “specified loss limit” (according to the CCA, this limit may be based on the prior year’s export sales), or (2) the sales revenue during the contract period (for contracts covering decreases in value). Contracts covered multiple foreign currencies.
The Service seems to have a fairly narrow sense that insurance risks must be casualties: “[a] factor found in insurance contracts that weighs heavily in this case is that insurance policies protect against damage or impairment to an asset or income from an asset caused by a casualty event. . . [and] change in a foreign currency exchange rate is [not] a casualty event in the commonly accepted sense.” While the 2015 CCA seems to focus on real casualties (such as fires or accidents) in the earlier TAM the Service makes greater effort to explain that when it says casualty it really means a fortuitous triggering incident that is out of the control of the insured. According to the Service, title insurance, surety insurance, municipal bond insurance and aggregate medical stop-loss insurance among others may, on the face, appear to require no true casualty in the nature of a fire or accident to trigger the insurance, that they all require some incident occurring that impairs value of the insured property that is fortuitous. While the foreign currency fluctuations and the reduction in value of leased property from unexpected market forces during the term of the contracts impair value, neither of those are triggering events; rather the triggering event in both cases is the termination of the foreign currency or lease contracts and contract termination, according to the Service, “is not the type of event that gives rise to a casualty event.”
The CCA concludes that the risk involved is an investment-type risk as it is “solely the manifestation of fiat currency valuation.” The CCA notes as support for its position that although SSAP No. 60, Financial Guaranty Insurance, references protection against the fluctuation in currency exchange rates, “insurance” for this risk does not appear to be commonly available from the major carriers. Furthermore, the CCA points to the lack of a casualty event as further evidence the contracts do not provide insurance and contrasts this coverage with property coverage and business interruption coverage, i.e., “known” insurance products. The CCA also notes that the pricing of the contracts does not appear to leave sufficient risk of loss to qualify as insurance for federal tax purposes.