Last week, we noted that the Internal Revenue Service suffered another defeat on January 14, 2014 as the U.S. Tax Court handed down its ruling which upheld that payments by Rent-A-Center to its Bermuda-domiciled captive insurance company, Legacy Insurance Co. Ltd., were deductible as an insurance expense.
This ruling is particularly informative to captive owners and captive managers as Rent-A-Center and its captive insurance company, Legacy, employed some practices that many in the industry have traditionally regarded as “aggressive.” In losing this case, the I.R.S. (The Service) “lost some ground” in a manner of speaking. Additionally, this ruling will likely reduce The Service’s ability to oppose similar arrangements in the future. Finally, this ruling provides even more “breathing room” to captive insurance companies who employ more “conservative” practices than those employed by Rent-A-Center.
The Rent-A-Center captive arrangement employed a brother-sister insurance arrangement with no third party insurance or unaffiliated insurance written by Legacy (Rent-A-Center’s captive). Our firm employs brother-sister arrangements as well but utilizes a more conservative (and stronger) approach with 51% unaffiliated insurance.
The Rent-A-Center captive arrangement also employed a parental guaranty by the parent company for its captive, and the I.R.S. seized upon this as proof that the captive was not adequately capitalized and was, therefore, established primarily for tax benefits. According to the ruling the parental guaranty provided:
The undersigned, Rent-A-Center, Inc. a Delaware corporation (“Rent-A-Center”) is sole owner of 100% of the issued and outstanding shares in your share capital and as such DOES HEREBY GUARANTEE financial support for you, Legacy Insurance Co., Ltd., * * * and for your business, as more particularly set out below, which is to say: Under the [Bermuda] Insurance Act * * * and related Regulations (the “Act”), Legacy Insurance Co., Ltd., must maintain certain solvency and liquidity margins and, in order to ensure continued compliance with the Act, it is necessary to support Legacy Insurance Co., Ltd. with a guarantee of its liabilities under the Act (the “Liabilities”) not to exceed Twenty-Five Million US dollars (US $25,000,000)…. During 2003, 2004, and 2005, Legacy included portions of the parental guaranty as general business assets.
The dissenting opinion of the court even noted that, “Numerous courts have likewise ruled that the existence of a parental guaranty, indemnification agreement, or similar instrument may negate the existence of “insurance” purportedly supplied by a captive.” Parental guarantees have traditionally been viewed as “aggressive,” and our firm currently refuses to employ such arrangements.
The majority of the court paid little attention to Rent-A-Center’s “more aggressive” practices and instead focused on whether or not Legacy achieved risk-shifting and risk-distribution. The majority opinion noted that, “The policies at issue shifted risk from RAC’s insured subsidiaries to Legacy, which was formed for a valid business purpose; was a separate, independent, and viable entity; was financially capable of meeting its obligations; and reimbursed RAC’s subsidiaries when they suffered an insurable loss.” The majority opinion also stated, “In analyzing risk distribution, we look at the actions of the insurer because it is the insurer’s, not the insured’s, risk that is reduced by risk distribution… A captive may achieve adequate risk distribution by insuring only subsidiaries within its affiliated group…Rent-A-Center’s subsidiaries had a sufficient number of statistically independent risks.”
This ruling is another in a long string of losses by the I.R.S. in its challenges against captive insurance companies. This case further proves that a well-structured captive insurance company with a legitimate business purpose that also employs risk-shifting and risk-distribution is extremely difficult for the I.R.S. to challenge and defeat. A plain reading of captive insurance law and captive case law further reinforces this point. The Rent-A-Center decision joins a well-established body of tax law that recognizes the validity of well- structured and well- administered captive insurance arrangements.
As a captive management firm, CIC Services, LLC, works with captive insurance company owners to ensure compliance with the law, case law and the Internal Revenue Code. If you would like a full copy of the U.S. Tax Court’s decision, please contact us.