IRS Concludes That Non-Derivative Contracts Used to Shift FX Risk Are Not "Insurance"

The IRS publicly released a Memorandum by its Chief Counsel related to advice dated December 1, 2014. In the Memorandum, the IRS concluded that an arrangement between a multinational group and an affiliated, state-regulated captive insurance company to mitigate foreign currency risk does not constitute "insurance" for federal tax purposes.

The parent of the multinational group entered into contracts on behalf of certain of its members to protect it against a loss of earnings due to either an increase or decrease in the value of certain specified foreign currencies. Each month, parent and captive entered into a one-year contract under which the captive agreed to pay an amount meant to approximate the loss of earnings related to currency fluctuations of the participating group members. The group did not use derivatives to hedge their foreign currency risk.

The IRS noted that insurance risk generally "requires a fortuitous event or hazard" rather than a timing or investment risk, and concluded that the arrangement between the group and the captive was "an investment-type risk as it [was] solely the manifestation of fiat currency valuation." Additionally, the IRS concluded that the contracts had many features in common with insurance policies generally but were not insurance in the accepted sense because they lacked a casualty event. The Memorandum stated that the Chief Counsel Advice may not be used or cited as a precedent.

See: IRS Press Release.