3 June 2015

In a major victory for the reinsurance industry, the Court of Appeals upheld the decision of the lower court, invalidating the IRS’ position on the cascading federal excise tax.
As has been discussed, for many years the Internal Revenue Service has taken the position that Federal Excise Tax is due whenever risks located in the United States are reinsured, even if excise tax had already been paid on the original policy of insurance or reinsurance. This position, known as the cascading excise tax, imposed significant costs on international reinsurance, including both the tax and the costs of compliance. On behalf of the reinsurance industry, Validus Reinsurance challenged this position in federal court, and in a decision rendered last February, the district court agreed that the IRS was incorrect in asserting the cascading FET.
On appeal, the appellate court agreed with the lower court, rejecting the IRS’ interpretation of the statute imposing the FET. Although it conceded that the statute was ambiguous, and could reasonably be interpreted in the manner suggested by the IRS, it viewed the policy against extraterritorial application of United States law as compelling a contrary reading unless Congress had clearly articulated that it intended the tax to be imposed on a world-wide basis. Since Congress did not indicate any such intent, the Court held that it was more reasonable to apply FET only to transactions directly involving United States insureds.
It remains to be seen whether the IRS will withdraw its position on cascading FET, or will continue to assert the position in further litigation. Although appeal to the United States Supreme Court is possible, most observers believe that this decision spells the end of the cascading FET doctrine. In that case, the IRS should announce its acquiescence in the decision, and provide streamlined procedures for an orderly refund of taxes that were previously collected.