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IRS releases proposed regulations under Section 1297

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Tax Hot Topics - IRS releases proposed regulations under Section 1297On April 24, the IRS released proposed regulations under Section 1297 to provide guidance regarding when a foreign insurance company's income is excluded from the definition of passive income under Section 1297(b)(2)(B). These regulations are proposed to apply on the date of publication of the Treasury Decision adopting these rules as final regulations in the Federal Register.

Under Section 1297, a foreign corporation is a passive foreign investment company (PFIC) if either 75% or more of its gross income for the taxable year is passive income, or, on average 50% or more of its assets produce passive income or are held for the production of passive income. Section 1297(b)(1) generally defines the term “passive income” to mean any income of a kind that would be “foreign personal holding company income” as defined in Section 954(c).

For purposes of applying the passive income test, Section 1297(b)(2)(B) says that except as provided in regulations, the term “passive income” does not include any income that is derived in the active conduct of an insurance business by a corporation that is predominantly engaged in an insurance business and would be subject to tax under subchapter L of the Internal Revenue Code as an insurance company if the corporation were a domestic corporation.

The proposed regulations provide that the term “active conduct” has the same meaning as in Treas. Reg. Sec. 1.367(a)-2T(b)(3), except that officers and employees are not considered to include the officers and employees of related entities. The proposed regulations also define the term “insurance business” to mean the business activity of issuing insurance and annuity contracts and the reinsuring of risks underwritten by insurance companies, together with investment activities and administrative services that are required to support or are substantially related to insurance contracts issued or reinsured by the foreign insurance company.

The proposed regulations also provide that an investment activity is any activity engaged in to produce income of a kind that would be foreign personal holding company income as defined in Section 954(c). The proposed regulations further provide that investment activities will be treated as required to support or as substantially related to insurance or annuity contracts issued or reinsured by the foreign corporation to the extent that income from the activities is earned from assets held by the foreign corporation to meet obligations under the contracts.

The proposed regulations do not set forth a method to determine the portion of assets held to meet obligations under insurance and annuity contracts and the IRS has requested comments on appropriate methodologies for determining the extent to which assets are held to meet obligations under insurance and annuity contracts.

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Brandon Boyle
T _1 202 521 1533
E brandon.boyle@us.gt.com

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