COVID-19: IRS Provides Very Limited U.S. Trade or Business Relief for Foreign Insurance Companies and Other Foreign Corporations

Background 

Generally, a foreign corporation engaged in USTB during a given tax year is taxable in the United States on a net basis on its income effectively connected with such USTB. Whether a foreign corporation is engaged in a USTB status is determined annually based on a facts and circumstances analysis with little guidance in case law or other authorities. If the foreign corporation is entitled to the benefits of a tax treaty with the United States, U.S. federal net income taxation is imposed on the income effectively connected with a USTB only if such USTB is conducted through a USPE. In the case of a foreign corporation, this may result in a 44.7 percent U.S. federal income tax on the corporation’s taxable income as well as U.S. income tax return filing obligations.⁴

To mitigate this risk, foreign insurers, foreign reinsurers and insurance-linked securities funds typically adopt tax operating guidelines intended to minimize the risk of being engaged in a USTB by virtue of activities conducted in the United States. Such guidelines typically require that activities performed on behalf of the foreign principal by U.S.-based individuals must be undertaken only when the individuals are physically present outside the United States. However, the COVID-19 crisis has significantly limited the ability of such individuals to leave the United States, thereby potentially exposing foreign insurance industry participants to U.S. federal income tax on a net basis.⁵

The New Guidance

• USTB. The Guidance provides, effective immediately, that a foreign corporation may choose an uninterrupted period of up to 60 calendar days, beginning on or after February 1, 2020, and on or before April 1, 2020, during which activities conducted in the United States will not be taken into account in determining whether the foreign corporation is engaged in a USTB. This relief applies only in respect of activities (i) that are performed by an “individual temporarily present in the United States” and (ii) that would not have been performed in the United States but for “travel disruptions caused by the COVID-19 emergency.”
  • An “individual temporarily present in the United States” is any individual who (i) is present in the United States on or after February 1, 2020, and on or before April 1, 2020, and (ii) is either (A) a nonresident alien⁶ or (B) a U.S. citizen or lawful permanent resident who had a tax home (as defined in section 911(d)(3) of the Internal Revenue Code) outside the United States in 2019 and reasonably expects to have a tax home outside the United States in 2020.
  • “Travel disruptions caused by the COVID-19 emergency” encompass (i) orders of government authorities restricting movements, (ii) canceled flights and disruptions in other forms of transportation, (iii) shelter-in-place orders, (iv) quarantines and (v) border closures. Travel disruptions also extend to individuals who may feel unsafe traveling during the COVID-19 outbreak due to recommendations to implement social distancing and limit exposure to public spaces.
• USPE. Consistent with the principles applicable to a USTB, the Guidance provides that activities conducted in the United States during an uninterrupted period of up to 60 calendar days, beginning on or after February 1, 2020, and on or before April 1, 2020, will not be taken into account in determining whether a nonresident alien or foreign corporation has a USPE if such activities (i) are performed by an individual temporarily present in the United States and (ii) would not have occurred in the United States but for travel disruptions caused by the COVID-19 emergency. 

Practical Implications

• Relief Is Extremely Limited as a Practical Matter. The Guidance is of extremely limited use as a practical matter.
  • First, and most important, the Guidance is limited to individuals who are normally not U.S.-based (i.e., have their “tax home” outside of the United States in 2019 and 2020). Thus, for example, executives or board members who are U.S. citizens or have a green card and have their primary personal residence in the United States would not fall within the scope of the Guidance. Thus, the activities of those individuals (Disqualified Individuals) would have to be assessed under generally applicable law without the benefit of the Guidance. In our experience, a significant number of executives, board members and employees would fall into the category of Disqualified Individuals.
    • As a result, Disqualified Individuals who are locked down in the United States due to COVID-19-related travel restrictions may want to consider temporarily transferring their authority to another individual who is outside of the United States. Thus, for example, the chief underwriting officer could consider transferring his or her authority to a colleague based in Bermuda until the chief underwriting officer is able to leave the United States.
  • Second, the scope of the specified 60-day period is unclear. On the one hand, it may be construed as applying only to a 60-day period that must end no later than April 1, 2020, in which case the Guidance is irrelevant for activities conducted in the United States after April 1, 2020. On the other hand, the Guidance may be interpreted such that the specified 60-day period may extend beyond April 1, 2020, provided it begins on or before April 1, 2020.
•  Removal of Risk Concerning USTB Status for 2020 Due to Past Actions. To the extent the criteria described above are satisfied, the Guidance removes uncertainty as to the USTB status of a foreign corporation due to activities occurring during the specified 60-day period within the United States by the corporation to ensure continued operations and an adequate transition into the COVID-19 crisis state of the world.
  • These past activities would generally include both underwriting activities and participation in board of directors meetings, provided that the relevant individual satisfied the requirements described above.
  • As described above, it is unclear whether the Guidance provides relief for activities occurring after April 1, 2020.

Additional Guidance Possible

The Guidance notes that the IRS will continue to monitor the evolving effects of the COVID-19 emergency on nonresident alien individuals and foreign corporations and may update the Guidance as appropriate. It remains to be seen whether the IRS will extend the period of relief to more than 60 days, clarify whether it applies beyond April 1, 2020, or expand the Guidance to provide relief in respect of currently Disqualified Individuals.

¹ See https://www.irs.gov/newsroom/information-for-nonresident-aliens-and-foreign-businesses-impacted-by-covid-19-travel-disruptions.

² In addition to foreign corporations, the Guidance also applies to nonresident aliens and partnerships, which are beyond the scope of this client alert. 

³ For example, Ireland and Australia have issued similar guidance.

⁴ $100 of income effectively connected with a USTB times 21 percent of corporate tax results in $21 of corporate tax and $79 after tax net income; $79 times 30 percent branch profits tax results $23.7 of branch profits tax and $55.3 after U.S. tax proceeds, reflecting a total U.S. tax liability of $44.7.

⁵ For example, Bermuda has restricted travel to Bermuda due to COVID-19; see https://www.gov.bm/coronavirus. 

⁶ Nonresident alien status is determined under Section 7701(b) of the Internal Revenue Code, as modified by Revenue Procedure 2020-20, released on April 21, 2020.