IRS Looks At Which Captive Cell Arrangements Are Insurance

The Internal Revenue Service says it will treat a captive cell arrangement as insurance for income tax purposes if the cell insures several different subsidiaries of the corporation that owns control of the cell.

The IRS will not treat the captive cell arrangement as insurance if the cell simply covers the corporation directly, officials write in IRS Revenue Ruling 2008-8.

The ruling deals with efforts by companies to reduce the cost of setting up captive insurance operations by setting up captive arrangements through “protected cell companies.”

Protected cell companies establish many different accounts, or cells, and each of the cells insures one company, or collection of corporate siblings.

Offshore jurisdictions have started allowing protected cell company arrangements to help users cut the overhead costs associated with running captive insurers, according to officials with the Isle of Man Insurance and Pensions Authority.

Even if a wholly owned subsidiary that insures one parent company behaves in all other respects as if it were an independent insurance company, “a transaction between a parent and its wholly owned subsidiary does not satisfy the requirements of risk shifting and risk distribution if only the risks of the parent are insured,” IRS officials write in the revenue ruling.

But the IRS would treat an insurance company subsidiary that insured several sibling companies as an insurance company, and it will extend that same kind of treatment to a captive cell that insures several different subsidiaries of the corporation that controls the captive cell, IRS officials write.

In a captive cell arrangement that is eligible for treatment as insurance, “premiums are pooled such that a loss by one subsidiary is not in substantial part paid from its own premiums,” officials write.

The ruling refers to a professional liability company, but life insurers and reinsurers also can use captive cell arrangements.