James Berry and David Ash, KPMG discuss compliance with FATCA and the challenges that remain for the insurance sector in Bermuda, with a number of issues still unresolved for the industry.
In an effort to combat tax evasion, the US Government enacted the Foreign Account Tax Compliance Act (FATCA) into law on March 18, 2010. As a result, from July 1, 2014, a 30 per cent punitive withholding tax will be imposed on all US source income paid to foreign financial institutions (FFIs) unless they enter into an agreement with the Internal Revenue Service (IRS), requiring them to perform additional customer due diligence and report information on their US customers to the IRS.
Bermuda, like many other nations, is pursuing FATCA Partner status with the US by negotiating and entering into an Inter-Governmental Agreement (IGA) and it has been announced that this will be a ‘Model 2’ IGA, whereby impacted Bermudian FFIs will report information directly to the IRS rather than through the Bermuda Government. Negotiations have also taken place with the UK Government regarding the adoption of FATCA – type rules for reporting of UK citizens with a presence in Bermuda.
The FATCA regulations list a number of types of entity that are potential FFIs. One such category is ‘specified insurance companies’; these are defined as insurance companies that issue, or are obligated to make payments with respect to, cash value insurance (other than an indemnity reinsurance contract) or annuity contracts. Insurance companies with these types of products are dealt with in the regulations because they are considered to pose a higher risk of being used to evade tax (compared to property and casualty insurance, for example).
The final FATCA Regulations, released on January 17, 2013, did include a number of simplifying rules for the insurance industry; such as non-US insurers now may generally rely on their respective country’s classification of annuity and life insurance products when determining whether they are a foreign financial institution and whether a contract gives rise to a reportable financial account – instead of having to apply US tax law definitions and concepts in determining the FATCA treatment for these types of products. In some areas, however, the final regulations do little to reduce the complexity or ease the burden inherent in FATCA implementation and compliance.
Although the Bermuda insurance market is dominated by property and catastrophe reinsurance, the island is also home to life insurance companies which vary in size and complexity. These life insurance companies, with the exception of those issuing indemnity reinsurance contracts, are likely to be FFIs and therefore subject to the full weight of FATCA compliance; including; the requirement to perform customer due diligence procedures on existing customers to identify US customer accounts, the re-design of customer on-boarding procedures to ensure that appropriate information is collected at the start of the business relationship to ensure that all new US customers are appropriately identified, the implementation of information reporting systems to allow reporting to the IRS, and withholding systems designed to identify and withhold 30 per cent of US sourced income from recalcitrant (non-compliant) individuals and entities.
The majority of Bermuda’s (re)insurance sector (being property and casualty (re)insurance) would likely not be FFIs and instead be classed as Non-Financial Foreign Entities (NFFEs). The requirements for NFFEs are much more limited than for FFIs, but there are still important compliance considerations and issues for these entities.
Issue 1 – Not a specified insurance company? You may still be an FFI…
An insurance company that is not a specified insurance company must independently determine whether it is a depository institution, custodial institution, or investment entity. For certain insurance companies that do not issue cash value insurance contracts or annuities, or have minimal underwriting income, or are in runoff, tests contained in the final FATCA regulations to determine ‘insurance company’ or ‘cash value insurance contract’ status do not always yield clear results.
The final regulations provide that an insurance company’s ‘reserving activities’, with respect to its insurance and annuity contracts, are not taken into consideration for determining whether it is an FFI. This rule may provide some relief to insurance companies in that the ‘reserving activities’ of an insurance company do not, alone, trigger FFI status. The term ‘reserving activities’, however, is not defined in the final regulations.
Issue 2 – Requirements for Passive NFFEs
NFFEs are categorised into either an ‘excepted NFFE’ or ‘passive NFFE’. Excepted NFFEs include publicly-traded companies (or affiliated companies of publicly traded companies); companies that are residents of a US territory (ie, American Samoa, Guam, Northern Mariana Islands, Puerto Rico, US Virgin Islands); and active NFFEs (subject to passive income-based tests). Many Bermuda reinsurers are publicly traded and, thus, will be ‘excepted NFFEs’. For non-publicly traded companies (including many Bermuda captive insurers), the ‘active NFFE’ exception will likely not be available, as passive income for purposes of the active NFFE test includes “amounts earned by an insurance company in connection with its reserves for insurance and annuity contracts”.
Excepted NFFEs have no compliance obligations under FATCA; however, Passive NFFEs will be required to provide withholding agents with information on their substantial US beneficial owner(s) when receiving withholdable payments. Such payments would often relate to investment transactions with custodians. However, it should be noted that the final regulations also include insurance premiums as withholdable payments. Therefore, to the extent that Passive NFFEs receive premium payments from brokers, information on substantial US beneficial ownership would need to be provided by the insurer to the broker.
Property and casualty insurers in Bermuda and other jurisdictions have raised concerns about the treatment of such entities as Passive NFFEs including the additional compliance burden in reporting substantial US beneficial ownership, particularly as publicly traded property and casualty insurers would not have the same requirements. It is therefore possible that the United States Treasury may amend requirements in this area either directly in the FATCA regulations or through IGAs.
Issue 3 - The FATCA Status of Section 953(d) Companies
Many Bermudian companies (particularly captive insurers) elect under section 953(d) to be taxed as a US insurance company. However, the final regulations treat companies not licensed to do business in any US State as non-US persons for FATCA purposes, ie, they are treated as foreign entities.
Therefore, insurers who are treated as a US corporation for US tax purposes under section 953(d) need to analyse their FATCA obligations, including whether they are an FFI, from the perspective of being a non-US corporation.
Issue 4 - Insurance Linked Securities FATCA implications
Bermuda is currently experiencing significant activity in the insurance linked securities (ILS) market, including the issuance of catastrophe bonds and the creation of ILS funds. Depending on the structures involved, companies involved in these activities may be considered investment entities under the FATCA regulations and therefore be treated as FFIs, requiring a significant amount of FATCA compliance activity.
Participants in the ILS market should therefore carefully assess the extent of their FATCA obligations even if the underlying risks involved are property and casualty.
FATCA is a complex and far reaching regulation, such that all areas of the Bermuda (re)insurance market – life and non-life – need to give consideration to FATCA as the implementation date approaches, to ensure compliance.
Certain core challenges of FATCA compliance remain for the insurance sector in Bermuda, and there still remains a number of unresolved issues for the industry. Such issues include the complexity of evolving IGAs, the UK Government’s announcement to adopt its own FATCA regime, and delayed FATCA implementation timelines. As a result, insurers continue to ask themselves: “should we wait to see our jurisdiction’s final IGA before designing our FATCA compliance program? Should we look to future-proof our compliance systems to cover potential UK FATCA requirements? Will the implementation time-lines be delayed again? Should we continue to wait-and-see? Should I wait for more guidance from the IRS that will clarify my compliance position?”
However, with the release of the final regulations, and Bermuda’s IGA with the US and UK close to finalisation, with phased-in requirements commencing on July 1, 2014, it is critical that affected insurance companies move forward with their project planning and implementation programs.
David Ash is a Manager at KPMG Advisory Limited in Bermuda focusing on forensic advisory and regulatory compliance including anti-money laundering and FATCA.
James Berry is a Managing Director at KPMG Advisory Limited in Bermuda focusing on regulatory compliance in the (re)insurance and banking sectors including solvency regulation, anti-money laundering and FATCA.
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