Court rejects cascading excise tax theory

In a major victory for international reinsurers, a Federal District Court in the United States rejected the cascading excise tax theory, holding that any such excise tax paid by reinsurers must be refunded. This decision is particularly significant for international groups that include reinsurers that are located in offshore financial centers, such as Bermuda.

The United States imposes an excise tax on reinsurance premiums paid to non-U.S. reinsurers at a rate of 1% of the premiums paid.  For some time, the Internal Revenue Service expressed its view informally that the tax was due whenever a United States risk was transferred, even if it was transferred between two non-U.S. entities.  Thus, if a U.S. risk was reinsured by one non-U.S. reinsurer, and then retroceded to another non-U.S. reinsurer, both transactions would trigger a liability for the tax.  This position was formalized in Revenue Ruling 2008-15.

The imposition of the tax by the United States was challenged by Validus Reinsurance, Ltd., a Bermuda reinsurer.  Validus challenged the imposition of the tax on several grounds, including an assertion that the tax violates international law and the Due Process Clause of the U.S. Constitution.  Ultimately, the court held for Validus on simpler grounds.  It concluded that the statute as written only applies to reinsurance transactions, and was never intended to apply to retrocessions.

The Internal Revenue Service has not yet indicated whether it intends to appeal the decision, so it is not yet entirely clear whether this is the last word on the subject.  Any reinsurers who have paid excise tax on retrocessions should carefully review whether they should file claims for refund of the tax, and should be aware that the statute of limitations may preclude them from filing a refund claim if they fail to do so on a timely basis.