Taxpayer Wins In R.V.I. Guaranty Case Challenging The Legitimacy As Insurance For Federal Tax Purposes.
The Tax Court recently issued it’s opinion in R.V.I. Guaranty Co. Ltd. v. Commissioner, Dkt. No. 27319-12, to decide whether residual value insurance policies are insurance for federal income tax purposes.
RVI is an insurer that offers residual value insurance, which protects insureds’ property from unexpected declines in value over the life of the contract. R.V.I. Guarantee Co. Ltd. (RVI) insures taxpayers engaged in the business of leasing passenger vehicles, commercial real estate, and commercial equipment to others. Let’s breakdown the case in order to understand the arguments, the court’s opinion and potential implications for captive insurance companies.
The IRS in 2012 issued a notice of deficiency to RVI for 2006 alleging a $55 million underpayment in taxes. The IRS argued two main points:
1. That the covered risks do not qualify as insurable risks as the covered losses were speculative in nature. Speculative risk is not formally insurable as it involves risk that the value will either decrease or increase in nature (fortuity).
2. That the risks at hand lacked sufficient risk distribution as the policies in question did not conform to the law of large numbers (LLN). Essentially, LLN is a mathematical principal that states that as a sample size grows, its mean becomes closer to the average of the population as a whole. Basically, the more number you have, the more accurate the average. The IRS argued that LLN was not present in this case due to the nature of loss as a loss event under this coverage would cause a payout to all insureds instead of a just a few of them.
RVI countered the challenge of the IRS by arguing the following:
1.All of the policies in question fit into the regulatory framework of what is considered “insurance”. Actual policies were written, premiums were collected, claims paid, etc.
2. Residual value insurance is indeed insurance as all state courts that have addressed the issue for state regulatory purposes have decided that it is.
3. Risk distribution was indeed satisfied as the insureds are unrelated to each other and RVI.
The Court’s Opinion
Once again, the IRS lost its argument and the taxpayer retained the benefit of the $55 million in tax deductible premiums. Some notable quotes from the court that do a good job of summarizing the decision are as follows:
“RVIA insured a vast array of DIFFERENT risk exposures and its policies clearly do pool risks to take advantage of the law of large numbers.”
“Respondent’s (IRS) efforts to split hairs by disentangling the causes of “loss” are philosophically interesting. But we do not think they carry much weight in determining whether the RVI policies constitute “insurance” for Federal income tax purposes”
“We have no difficulty concluding, as respondent’s (IRS) expert Mr. Cook ultimately did, that the RVI policies accomplish sufficient risk distribution to be classified as “insurance” for Federal tax purposes.”
Implications of the Decision
Not surprisingly the court once again came to the same conclusion that the lesser courts and state regulatory bodies had arrived at: the residual value insurance at hand was indeed “insurance”. This has been a recurring theme in recent opinions and again highlights the importance of domiciling a captive in a location that practices effective and efficient regulation.
As equally unsurprising is the court’s unwillingness to establish a definition for insurance risk. Without a statutory definition of insurance these cases like these will continue. Recent court cases have simply provided guidance on what is more than likely to be determined to be acceptable, not a black and white version of what is (or is not) allowed.
Because of the court’s acceptability of residual value insurance in this case we are also provided with some insight into the potential opinion(s) of other similar coverages. As many captives provide coverages for exposures like loss of key customer or supplier, a decision for the IRS would have made it easier for them to argue that these risks were business risks, and not truly insurable. This reinforces the position that has been commonly accepted by progressive captive professionals and gives the industry better defensibility when/if similar programs are challenged.
Contact us today to find out how this decision impacts your captive or decision to form a captive insurance company.
About Assurance Partners:
As one of the largest providers of risk management services in the Midwest, we specialize in partnering with strategic advisors and their clients to help them guide them through the process of determining risks that are unique to their organizations. We then translate those risks into a legitmate insurance program allowing them to obtain the protection and financial benefits that are unavailable in the traditional insurance marketplace, all while strengthening the advisors’ value and providing their clients opportunities for significant wealth growth and asset protection.
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