On March 13, 2015, the Office of Chief Counsel of the IRS issued advice regarding insurable risk for captive insurance companies. In the Chief Counsel Advice (CCA), the taxpayer is a manufacturer which conducts business worldwide and deals in multiple currencies. The taxpayer has several subsidiaries, including a captive insurance company. The captive provides coverage for auto liability, product liability, general liability, workers’ compensation, product warranty, credit guarantee insurance, earthquake damage, retiree medical cost, and guaranteed renewable accident and health insurance to the other subsidiaries. The CCA does not make any determination on the validity of this risk and the captive insurance arrangement. In addition to the coverage listed above, the captive also insures losses by the subsidiaries that are due to changes in the value of foreign currencies relative to the U.S. dollar. The foreign currency loss insurance is the main topic of the CCA.
The coverage for foreign currency risk is provided for through two separate contracts. One contract insures the “loss of earnings” due to a decrease in the value of a specified foreign currency. The second contract insures the “loss of earnings’ due to an increase in the value of a foreign currency. The Office of Chief Counsel concludes that these contracts do not address an insurance risk. Instead, the IRS defined this as investment risk. Therefore, the contracts did not provide insurance in the commonly accepted sense. The CCA provides an in-depth discussion about the difference between insurance and investment risk, which they say is synonymous with business risk. Unfortunately, the CCA does not provide the proper tax treatment of these contracts.
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