Senator Wyden Introduces Bill to Limit Offshore Reinsurance by Hedge Funds

Senator Ron Wyden (D-OR) introduced a bill titled "The Offshore Reinsurance Tax Fairness Act" (the "Bill"). The Bill is intended to address the concern that hedge funds (and their investors) are bypassing the passive foreign investment company ("PFIC") tax regime by holding investments through offshore reinsurance companies.

Generally, the PFIC rules prevent a U.S. investor in a PFIC from deferring tax on its passive income derived from its investment in that PFIC. Under an exception, however, income derived from the active conduct of an insurance business by a foreign corporation that is "predominantly" engaged in an insurance business is not subject to tax under the PFIC rules.

The Bill would provide guidance concerning when an offshore reinsurance company was "predominantly" engaged in an insurance business. Proposed regulations, issued in April 2015, addressed the definition of passive income under the PFIC rules without addressing this point.

The Bill would ensure that offshore reinsurance companies could not benefit from the insurance exception to the PFIC rules unless their insurance liabilities represented more than 25% of their total assets. In addition, investors in offshore reinsurance companies whose insurance liabilities represented between 10-25% of their total assets could qualify for the insurance exception to the PFIC rules if, based on the applicable facts and circumstances, the failure to meet the 25% threshold was "due solely to temporary circumstances involving such insurance business."

If enacted, the Bill would become effective at the beginning of the 2016 taxable year.

See: The Offshore Reinsurance Tax Fairness Act; Senate Finance Committee Summary of the Bill; Prior IRS Guidance.