Reinsurance, Hedge Fund Tax “Loophole” Rule Set for the Spring

Chris Westfall
Chris Westfall

Reworked tax rules on how hedge funds can set up reinsurance shop in in offshore domiciles and continue to receive a favorable tax treatment are expected to be issued in the next 90 days, according to Internal Revenue Service Commissioner John Koskinen.

“90 days has a nice ring to it,” Koskinen said in response to the prodding of Sen. Ron Wyden (D-Ore.) during a Senate Finance Committee hearing yesterday. “We have prepared guidance and we are working with Treasury to put it into final form.”

Under current tax law hedge funds can defer taxes on their assets until they sell an investment and pay the only 20% capital gains, but only if they set up as an insurer or reinsurer in an offshore domicile. Otherwise, the hedge fund would be paying the much higher income tax rate.

Several of the largest U.S. hedge funds — including Paulson & Co., Third Point LLC and Greenlight Capital — have set up reinsurance operations in recent years to take advantage of the favorable treatment.

Wyden, who has been pushing for both the IRS and the U.S. Treasury Department to change the rules for hedge funds setting up as reinsurers, said at the hearing he would hold the commissioner to the deadline pledge and threat he was going to “bulldog” the issue.

“There are some hedge funds that masquerade as insurance companies and then they go to places like Bermuda and the Cayman Islands where they are not taxed and where their earnings are sheltered from us taxes,” Wyden said during the hearing. “I consider [the rule] a decades worth of foot dragging at the agency, and I am using this very deliberately because its been impossible to get some answer and get this resolved.”

In response to Wyden’s remarks, Koskinen said that the IRS and Treasury were proceeding carefully to avoid penalizing legitimate uses of the reinsurance and tax laws.

“We met with insurance associates to get their ideas to get wha will work and not work,” Koskinen added. “The concern everyone has is that there are legitimate reinsurance companies that have large reserves because their claims are episodic. But given  that context we should be able to move this forward.”

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