Insuring the Risks of Brother-Sister Corporations: Think Captive
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Insuring the Risks of
Brother-Sister Corporations:
Think Captive
Reprinted from the Journal of Taxation of Financial Institutions
By Irving Salem and Jocelyn Noll
Irving Salem is a partner and Jocelyn Noll is an associate at the law firm of Latham & Watkins,
New York.
This article first appeared in the May/June 2002 issue of the Journal of Taxation of Financial Institutions. Reprinted with permission.Insuring the Risks of
Brother-Sister Corporations:
Think Captive
Recent developments — including the demise of the economic family test and the emphasis on the number of risks
transferred — should embolden taxpayers to explore brother-sister captive insurance arrangements.
IRVING SALEM and JOCELYN NOLL
S
ince 9/11, insurance coverage ple denying a deduction in both Federal Claims, in allowing a
has been harder to obtain parent-subsidiary and brother-sis- deduction, provides this pro-tax-
and is far more expensive. ter arrangements and even where payer analysis of the risk shifting
Fortuitously, both the courts and the captive had substantial occurring with respect to brother-
the IRS have opened a door pre- amounts of outside business; how- sister corporations:
viously considered problematic — ever, the pendulum has swung.1
Indeed, the Seventh and Ninth As explained in Humana, the
brother-sister companies that are
Circuits, in the Sears and Amerco wholly owned subsidiaries have
members of the same affiliate
cases, have expressed doubts as to no ownership interest in the
group can deduct premiums paid parent’s captive insurer and
to an insurer which is a sibling the importance of the risk shifting
hence would not suffer any addi-
(even though the insurance com- and distribution requirements. 2
tional loss if payments by the
pany insures no unrelated par- In devaluing the significance of the captive insurer of future claims
ties). Accordingly, it behooves risk shifting/distribution analysis, against the subsidiaries exceed-
affiliated groups to think captive both the Seventh and the Ninth ed the amount of premiums the
Circuits suggest an alternative captive insurer received. For
insurance while seeking adequate
approach which seems to shift the example, because a $1,000 claim
and affordable insurance coverage.
burden to the IRS: against a Kidde subsidiary paid
This article will analyze the devel-
by [the captive insurer] KIC
opments and the open questions. However, we also agree with the would not result in a corre-
Seventh Circuit that discussions sponding decrease in that sub-
of this area might seem less sidiary’s net worth, the risk as
BACKGROUND abstruse if we asked ourselves a to that claim was shifted from
One of the most contentious areas somewhat different question: the subsidiary, through Nation-
in the tax law has been the debate Suppose we ask not ‘What is al, to KIC.4
over the definition of insurance insurance?’ but ‘Is there ade-
and the ability of a corporate tax- quate reason to recharacterize The court then provided a pro-tax-
this transaction?’, given the payer risk distribution analysis:
payer to deduct premiums paid to
norm that tax law respects both
another member of its affiliated
the form of the transaction and Similarly, when viewed from
group. The IRS and some courts the form of the corporate struc- the perspective of that sub-
were very rigid at first, for exam- ture. (Emphasis supplied)3 sidiary, risk distribution also
took place in that KIC distrib-
The most recent judicial decision uted the risk faced by that sub-
Irving Salem is a partner and Jocelyn Noll is an addressing the brother-sister issue sidiary in a pool with the risks
associate at Latham & Watkins, New York. is Kidde Industries. The Court of of other entities in which the
May/June 2002 Vol 15 / No 5 INSURING BROTHER-SISTER CORPORATIONSsubsidiary did not have an own- IRS Concedes Pending Brother-Sister would retain a note and value of
ership interest.5 Cases in FSAs. Somewhat surpris- $1.00 per share, bids were sought
ingly, in 2000, the IRS signaled a from unrelated third-party insurers.
As described below, some recent change in attitude by releasing an However, they were expensive and
developments confirm the trend FSA which agreed to a 100% con- a mutual insurer was formed to
and make a captive arrangement cession with respect to the brother- insure the RIC against credit
well worth considering. sister captive structure in the trans- default risks.
action at issue, explaining: In a recent follow-up PLR
he IRS seems to have agreed (200121019 8 ), the IRS again
T with the brother-sister cases
it has lost, and concluded that
[B]oth the United States Court
of Appeals for the Sixth Circuit
[in Humana] and the United
responded favorably even though
the 33 RICs consolidated into
States Court of Federal Claims “no less than V Funds.” The PLR
premiums paid to a bona fide notes the initial ruling was based
insurance subsidiary insuring the [in Kidde] have held that pay-
ments to a captive insurer by its in part on the analysis in Rev. Rul.
risks of brother-sister members sibling subsidiary were 78-33 (1978-2 CB 107) which
of the same affiliated group are deductible as insurance premi- involved 30 unrelated corpora-
likely to be deductible. ums...The court in Humana tions. In affirming the prior PLR,
explained that brother-sister the diversity of the risks, not the
transactions should be consid-
RECENT IRS POSITION number of insureds, was empha-
ered insurance for Federal
FURTHER OPENS BROTHER- sized: “[W]e note that the pro-
income tax purposes, unless
SISTER CAPTIVE DOOR either the captive entity or the posed transaction will not reduce
transaction is a sham.7 the number of independent risks
In a flurry of recent activity, the IRS
Mutual accepts... .” As indicated
seems to have agreed with the broth-
PLR 20012109 Emphasizes Number below, the emphasis on the num-
er-sister cases it has lost, and con-
of Risks, Demphasizes Number of ber of independent risks has
cluded that premiums paid to a bona become a consistent theme.
Insureds. In a prior PLR (9624028,
fide insurance subsidiary insuring
June 14, 1996), the IRS ruled
the risks of brother-sister members favorably on a captive utilized by Rev. Rul. 2001-31 Eliminates Eco-
of the same affiliated group — 33 unrelated regulated investment nomic Family Test. Revenue Ruling
regardless of the existence of out- companies (RICs). Each RIC was a 2001-31 9 provides that the IRS
side business6 — are likely to be money market fund which held “will no longer invoke the econom-
deductible. Chronologically, here- securities used by numerous issuers. ic family theory” enunciated in Rev.
in follow the recent developments: Seeking coverage to insure the RICs Rul. 77-316,10 citing the failure of
1 ruling in part 88 TC 197 (1987), the tax- insurance subsidiary was a sham and there-
The IRS initially took the position that
captive insurance arrangements were not payer began winning cases. In Humana, the fore reversing the Tax Court’s finding of
insurance for tax purposes because the Sixth Circuit reversed the Tax Court and risk shifting).
insuring corporation(s) and the captive sub- held that, in respect to the sibling insureds, Some courts have allowed both the par-
sidiary represented one “economic family,” both risk shifting and risk distribution were ent and subsidiary insureds to deduct pre-
and consequently there was no risk shift- present because payment of a claim by the miums paid to a captive insurance sub-
ing or risk distribution. Rev. Rul. 77-316, captive insurer did not affect the balance sidiary when the captive received what the
1977-2 C.B. 53. Although no court fully sheet of sibling insureds and the losses were court considered to be a significant amount
accepted the economic theory, several spread among the several separate corpo- of premiums from unrelated insureds,
courts denied deductions for premiums paid rations within the affiliated group. As despite a contrary ruling by the IRS in Rev.
by affiliated corporations to captive insur- there was no evidence that the captive was Rul. 88-72, 1988-2 C.B. 31. See Ocean
ance subsidiaries. See Clougherty Packing a sham or that the transactions lacked busi- Drilling and Exploration Co., 988 F.2d
Co., 811 F.2d 1297 (9th Cir. 1987), aff’g ness purpose, the Sixth Circuit allowed the 1341 (Fed. Cir. 1993), aff’g 24 Cl. Ct. 714
84 TC 948 (1985); Beech Aircraft Corp., sibling insureds to deduct premiums paid (1991) (44-46% from unrelated insureds);
797 F.2d 920 (10th Cir. 1986), aff’g 1984- to the captive insurer. Subsequent decisions Sears, Roebuck and Co., 972 F.2d 858 (7th
2 USTC 9803 (D. Kan. 1984); Stearns- followed the Sixth Circuit’s analysis and Cir. 1992), aff’g 96 TC 63 (1991) (99.75%
Roger Corp., 774 F.2d 414 (10th Cir. allowed deductions for premiums paid from unrelated insureds); Amerco, Inc., 979
1985), aff’g 577 F.Supp. 833 (D. Col. pursuant to brother-sister arrangements. F.2d 162 (9th Cir. 1992), aff’g 96 TC 18
1984); Carnation Co., 640 F.2d 1010 (9th See Kidde Industries, Inc., 40 Fed. Cl. 42 (1991) (52-74% from unrelated insureds);
Cir. 1981), aff’g 71 TC 400 (1978); Mobil (1997); Hospital Corp. of America, TCM The Harper Group, 979 F.2d 1341 (9th Cir.
Oil Corp., 8 Cl. Ct. 555 (1985). 1997-482; Malone & Hyde, Inc., TCM 1992), aff’g 96 TC 45(1991) (29-32% from
However, beginning with Humana, 1993-585, overruled by 62 F.3d 835 (6th unrelated insureds).
Inc., 881 F.2d 247 (6th Cir. 1989), over- Cir. 1995) (holding that the wholly owned For a more comprehensive discussion of
May/June 2002 Vol 15 / No 5
JOURNAL OF TAXATION OF FINANCIAL INSTITUTIONSthe courts (specifically in Humana, will continue to view such factors with unrelated insurers. The TAM
Clougherty, and Kidde) fully to as guaranty and indemnity agree- said there was sufficient risk shift-
accept the theory. The ruling, how- ments, capitalization of subs, ing and risk distribution, conclud-
ever, cautioned that the IRS may actuarially determined reserves, ing that the insurer qualified as an
and whether premiums are priced
continue to challenge certain cap- insurance company under subchap-
at arm’s length to gauge whether
tive insurance transactions based on premiums paid to a sub are
the facts and circumstances, citing deductible.
n 2000, the IRS signaled a
the Sixth Circuit’s decision in Mal-
one. At a tax conference shortly
after the publication of Rev. Rul.
‘It’s a sliding scale,’ Martin said
of the analysis. ‘The closer it
I change in attitude by
releasing an FSA which agreed
2001-31, the tax press reported the resembles a commercial, arm’s- to a 100% concession with
following comments of Robert A. length insurance transaction, the respect to the brother-sister
Martin, an IRS official in the Office better you’ll be,’ he added.11
captive structure in the
of the Associate Chief Counsel transaction at issue.
(Financial Institution & Products) While unstated, presumably anoth-
with a high degree of involvement er of the factors the IRS will con-
in the new ruling: tinue to focus on will be whether ter L. Factors which the TAM
the balance sheet of the insured found important in analyzing the
Martin, who drafted the latest rul- entity is affected by the captive
issue were:
ing, explained that the IRS had insurer’s payment of a claim.12
successfully invoked the eco- Thus, the IRS is likely to apply a
nomic family theory in cases balance sheet test to disallow a 1. There were no parental or
involving wholly owned insur- deduction for premiums paid by a related party guarantees
ance subsidiaries without unre- parent to a captive insurance sub- propping up Insurer;
lated insurance contracts. How- sidiary, particularly where there is 2. Insurer was adequately
ever, the Service was not little or no outside business. capitalized;
successful in applying the theory
to cases in which the sub insured 3. Insurer’s premium to surplus
TAM 200149003 Blesses Brother-Sister ratio was strong;
unrelated parties or in “brother-
sister” captive situations.
Arrangement. In TAM 200149013,13
4. Insurer was formed in part
a domestic insurance company (the
“Insurer”) provided workers’ com- because of significant disrup-
According to Martin, the IRS will
focus on this fact-based approach pensation coverage only to its sib- tions in the market price of
for transactions resembling the ling operating subsidiaries. A por- workers’ compensation
last two situations. The Service tion of the insurance was reinsured insurance;
this history, see Emanuel Burstein, “What all of the risk, but the upper and low- insurer should accept risks from unrelat-
is Insurance?” The Insurance Tax Review er bounds are set so that almost all ed corporations, either directly or through
25 (January 1997); Joe Taylor, “Myster- of the time the insured firm pays the reinsurance arrangements.
ies of the Term ‘Insurance’ Continue Fol- full costs of the losses it generates. 7
lowing Sixth Circuit Reversal of Tax Court FSA 200029010 (July 21, 2000).
Both experience rating and retro-
in Malone & Hyde,” The Insurance Tax spective rating attempt to charge the Similar FSAs are FSA 200125009 (June 22,
Review 1723 (November 1995). firm the full cost of its own risks over 2001); FSA 200125005 (June 22, 2001);
2
Amerco, 979 F.2d at 168. The Seventh the long run, a run as short as one FSA 200043012 (October 27, 2000); FSA
Circuit in Sears was emphatic in its deval- year with retrospective rating. 200105014 (October 26, 2000).
uation of the significance of risk shifting (Emphasis supplied) 8
May 25, 2001.
and risk distribution: 9
Sears, 972 F.2d at 862. 2001-26 I.R.B. 1348.
3 10
Much insurance sold to corporations Internal citations in all quotations gen- 1977-2 C.B. 53.
is experience-rated. An insurer sets erally omitted. 11
4 The Insurance Tax Review 9 (July
a price based on that firm’s recent 40 Fed. Cl. 42, 46.
and predicted losses, plus a loading 2001).
5
Id. 12
and administrative charge. Some- The “balance sheet” approach was
6
times the policy is retrospectively However, courts may be more inclined originally put forth by the Ninth Circuit in
rated, meaning that the final price to rule that premiums paid to a captive
Clougherty, in connection with the court’s
is set after the casualties have insurance subsidiary are deductible if the
analysis of the IRS’s economic family the-
occurred. Retrospective policies captive writes a significant amount of
ory. See note 1, supra.
have minimum and maximum pre- unrelated business (see note 1, supra).
13
miums, so the buyer does not bear Accordingly, if practicable, the captive December 7, 2001.
May/June 2002 Vol 15 / No 5 INSURING BROTHER-SISTER CORPORATIONS5. Insurer was a fully regulated 2 The dilution of the insurance and b works with a joint pro-
domestic insurance company coverage allowed by the cessing faculty (sic) on the same
under the laws of State of C; contract if subsequent property). (Emphasis supplied)
6. Insurer issued a separate insurance were issued to
policy to each sibling, and another insured, Thus, the large number of inde-
maintained separate records; 3 The retroactive change made pendent risks is highlighted in dis-
and to the policies; and cussing all three judicial decisions
7. Insurer hired a number of 4 The investment of 97.5% of analyzed in the FSA, and the num-
employees in the year in issue, the premium by the insurer in ber of corporate siblings is only
and hired more after that. affiliates of the insured. mentioned with respect to one of
the decisions.
Perhaps most critically, while the The FSA, however, could be viewed
numbers of siblings and insured as supportive of many brother-sis-
workers were undisclosed, the ter arrangements. While reviewing SOME OPEN ISSUES
TAM noted the Insurer distributed the brother-sister judicial deci-
a “large number of homogeneous, sions, the FSA emphasizes the num- Is One Subsidiary Enough? Probably.
independent risks among its ber of properties insured, rather There is no conclusive authority
insureds.” than the number of insureds: dealing with the minimum number
of subsidiaries that would meet the
Similarly in the present case, we risk distribution test under the
n PLR (200121019 the IRS again brother-sister analysis. Based on
I responded favorably even though
the 33 RICs consolidated into an
expect that with only the work-
ing operations of Operating
Subsidiary 1 and 2, Insurance
Humana, and the IRS’s acceptance
of the Sixth Circuit’s analysis, it
Subsidiary was unable to achieve seems clear that even a relatively
unspecified number of funds. adequate risk distribution small number of insureds, each of
which, as discussed previously,
whom insure a significant number
incorporates the concept of the
FSA 200202002 Expresses Doubt in of risks, can achieve risk distribu-
law of large numbers. The inher-
Dubious Brother-Sister Arrangement; ent risk distribution in the pre- tion. Although there were from 22
Quantum of Risks Again Emphasized. sent case is much more limited to 48 brother-sister corporations
Lastly, FSA 200202002, 14 again than the three brother-sister involved in Humana, the Sixth Cir-
emphasizing a facts and circum- captive insurance cases that the cuit’s language could be read broad-
stances approach, expressed seri- Government has lost. In ly as blessing a much smaller group:
ous reservations over a brother-sis- Humana, supra, during the years
ter captive arrangement. Only two under consideration the tax- [W]e see no reason why there
subsidiaries were involved and payer operated an average of 77 would not be risk distribution in
hospitals with 12,558 patient the instant case where the captive
only a few properties (two plants,
beds for which it needed liabil- insures several separate corpo-
one of which was operated joint- ity coverage. In HCA v. Com- rations within an affiliated group
ly). The FSA, after reviewing the missioner, the taxpayer operat- and losses can be spread among
case law on brother-sister insur- ed an average of 160 hospitals the several distinct corporate
ance, expressed concern over: with an average of 26,574 entities.15 (Emphasis supplied).
patient beds for which it need-
1 The few entities and few ed similar coverage. In Kidde In Malone, the Tax Court accept-
properties insured (one Industries, Inc., supra, the tax- ed risk distribution with respect to
insured accounted for 86- payer was a broad based decen- eight brother-sister corporations,
tralized conglomerate with 15
88% of the captive insurer’s suggesting that the above-quoted
separate operating divisions and
premium income, and that language from the Sixth Circuit
100 wholly owned operating
same insured’s single process- subsidiaries for which it needed did not foreclose “the ability of a
ing facility accounted for the workers’ compensation, auto- few insureds with many different
“vast majority” of the risks mobile and general (including insurable risks to demonstrate
transferred), products) liability coverage. In that they also had achieved risk
contrast, the present case distribution” (emphasis supplied):
involves risks of two insureds
14
January 11, 2002. and two working operations We conclude that petitioner has
15
Humana, 881 F.2d at 257. (one of which consists of the a demonstrated the presence of
May/June 2002 Vol 15 / No 5
JOURNAL OF TAXATION OF FINANCIAL INSTITUTIONSrisk distribution in this case. The IRS had a chance to reject stated that, “[g]enerally, the more
Although at most only eight the single insured case, but blinked. policies that the primary insurer
subsidiaries, as compared with There was apparently only one writes, the more predicable its
between 22 and 48 subsidiaries subsidiary insured in FSA underwriting results will be.”25 In
in Humana, participated in the 200125009, in which the IRS con- order to get a better understanding
reinsurance agreement, worker’s ceded the deduction of premiums of the parameters of “large num-
compensation, automobile lia-
paid by a subsidiary (“a domestic
bility, and general liability
corporation”) to its sibling sub-
claims involve diverse risks and n Malone , the factors the
potentially represent thousands
of individual loss events. 16
sidiary insurance company. The
analysis by the IRS did not, how- I Sixth Circuit pointed to in
determining that the transaction
(Emphasis supplied) ever, address the issue of risk dis-
tribution beyond stating that risk was a sham were that the
Conversely, based on FSA distribution is a requisite element insurer subsidiary was thinly
200202002, risk distribution will of insurance; moreover, FSAs have capitalized, it was propped up
be a problematic issue when there no precedential value. with parent guaranties and a
are only two subsidiary insureds, A classic single sibling case hold harmless agreement with
would involve an insured like the unrelated primary insurer,
and each of whom are insuring a
“Hertz.” Assuming that thousands and it was loosely regulated by
small number of risks located in
of automobiles rented throughout the jurisdiction in which it was
the same area.17
the country by Hertz were owned incorporated.
An intriguing question is
by a single entity, such entity
whether a captive subsidiary insur-
should be able to deduct premiums
er which insures only a single sub- bers,” one is required to understand
paid to a bona fide sibling captive.
sidiary that has a large number of some statistical nightmares (for
However, whereas reliance on the
independent risks can achieve risk number of risks, not entities or example, “The Central Limit The-
distribution. The Tax Court has insureds, seems eminently sound, orem”), an adventure beyond the
addressed this issue, in dicta, in it may take some time to fully clar- scope of this article.
Gulf Oil,18 in which the court ify the issue since language (one
said “risk transfer and risk distri- might suggest is merely “loose”) Be Careful to Do What You Said You
bution occur only when there are referring to the number of either Were Going to Do. Both the courts
sufficient unrelated risks in the entities or insureds can be found and the IRS have identified factors
pool for the law of large numbers in the case law,21 IRS publica- that may indicate that the transac-
to operate,” and that “a single tions,22 a Joint Staff document,23 tion is a sham and thus not true
insured can have sufficient unre- and certain non-tax descriptions of insurance. In Malone, the factors the
lated risks to achieve adequate insurance.24 Sixth Circuit pointed to in deter-
risk distribution.”19This language Assuming one entity is accept- mining that the transaction was a
was quoted by the Tax Court in able, that still leaves open the ques- sham were that the insurer sub-
Malone, in support of its conclu- tion of how many risks must the sidiary was thinly capitalized, it was
sion that risk distribution was entity insure in order to meet the propped up with parent guaranties
present.20 law of large numbers. It has been and a hold harmless agreement with
16 of other entities”) (Emphasis supplied); 41-85), 60 (September 20, 1985) (risk dis-
TCM 1993-585 at 93-3084.
17 Humana, 881 F.2d at 257 (risk distribu- tribution occurs when there is a “group of
Query, if the two plants in FSA tion was present where “the captive insures a large number of individual insureds who
200202002 were split among 30 corpora-
several separate corporations and losses can share a similar type of risk of loss”).
tions, would the result be different. A
be spread among the several distinct cor- (Emphasis supplied)
very close question.
porate entities”). (Emphasis supplied) 24
18 See R. Riegel & J. Miller, Insurance
89 TC 1010 (1987), reversed in part 22
FSA 199915004 (April 16, 1999) Principles and Practices (6th ed. 1976)
on other grounds, 914 F.2d 396 (3rd Cir.
(risk distribution is accomplished “where (referring to insurance as an arrangement
1990).
19
the risk is distributed among insureds oth-
Id. at 1025-26. in which risks of individuals are combined
er than the entity that incurred the loss.”)
20 in a group).
TCM 1993-585, at 93-3084. (Emphasis supplied)
25
21 23 R. Michael Cass et al., Reinsurance
Kidde, 40 Fed. Cl. at 46 (risk distri- Staff of the Joint Committee on Tax-
bution took place because the subsidiary’s ation, Tax Reform Proposals: Taxation of Practices 35 (2nd ed. vol. 1, 1997).
26
risk was placed in a pool “with the risks Insurance Products and Companies (JCS- 62 F.3d at 840.
May/June 2002 Vol 15 / No 5 INSURING BROTHER-SISTER CORPORATIONSthe unrelated primary insurer, and it a managing director of Marsh Inc. there has been risk distribution
was loosely regulated by the juris- as saying: “The entire market that and risk shifting...[if the parent
diction in which it was incorporat- provided workers’ compensation corporation] changes its corpo-
ed.26 The IRS has cited these factors catastrophe insurance has dried rate structure and that change
and identified several more, in FSA up.” Another article, also in the involves risk shifting and risk
200043012: Wall Street Journal, on February distribution, and that change is
26, 2002, “Property-Casualty for a legitimate business purpose
In addition to the factors set Insurers’ 4th-Period Charges To and is not a sham to avoid the
forth in Malone, other factors Boost Claims Reserves Don’t Faze payment of taxes, then it is irrel-
considered in determining evant whether the changed cor-
Investors,” further confirms the
whether a captive insurance porate structure has the side
need to consider alternative ways
transaction is a sham include: effect of also permitting [the par-
whether the parties that insured of obtaining necessary insurance
coverage: “You pick up the paper ent’s] affiliates to...deduct pay-
with the captive truly faced haz-
every day and everyone is talking ments to a captive insurance
ards; whether premiums charged
about 30% rate increases, 100% company under the control of
by the captive were based on
rate increases.” the...parent as insurance pre-
miums. (Emphasis supplied)30
The facts and circumstances
enerally, meeting the business
G purpose requirement should
be a non-issue today.
test is a sort of Gregory28-type
analysis — did the taxpayer in fact Thus, provided that the require-
ments discussed in the preceding
do what he said he did, namely,
was the risk of loss in fact trans- subsection are met, courts should
commercial rates; whether the ferred to a separate and distinct respect the form of a brother-sis-
validity of claims was estab- entity which functioned like a nor- ter captive insurance arrangement.
lished before payments were mal insurance company, and was
made on them; and whether the there a business purpose for the
captive’s business operations CONCLUSION
arrangement? If this test is met,
and assets were kept separate
presumably the transaction will Current developments — includ-
from its parent’s.
also meet the test suggested by the ing the demise of the economic
Seventh and Ninth Circuits (that family test and the emphasis on the
Additionally, favorable IRS opin-
is, “no adequate reason to rechar- number of risks transferred —
ions normally mention that busi- acterize this transaction”).
ness reasons prompted the use of should embolden taxpayers to
a captive. 27 Generally, meeting explore brother-sister captive
Will Courts Respect the Form of the insurance arrangements. While
the business purpose requirement Brother-Sister Transaction? A con-
should be a non-issue today. For the IRS will scrutinize the facts and
cern that prompted the Tax Court
example, an article in the Wall circumstances, large affiliated
in Humana to extend the analysis
Street Journal of January 9, 2002, and the holdings of the parent-sub- groups with numerous subsidiaries
“Workers’ Compensation Insur- sidiary cases to the brother-sister and risks should be able to deduct
ance Now Harder to Get,” quotes arrangement at issue was that a premiums paid to a bona fide
failure to do so “would exalt form insurance subsidiary even though
over substance and permit a tax- it is a sibling and insures no out-
27
For two recent articles that plumb the side risks. Further, the number of
payer to circumvent our holdings
depths of “business purpose,” see Stephen
by simple corporate structural subsidiaries, while still an open
Bowen, “Whither Business Purpose?” Tax-
es 275 (March 2002); David Garlock, “Is
changes.”29 In overturning the Tax question, need not be very signif-
There Any Substance to the Sham Trans- Court, the Sixth Circuit rejected icant — indeed, could be a single
action Doctrine?” Tax Management Mem- this rationale: corporation — if one or more sib-
orandum 83 (2002). lings has a large number of inde-
28 Such an argument provides no
Gregory, 293 U.S. 465 (1935). pendent risks (e.g., workers’ com-
legal justification for denying the
29 pensation) which are effectively
88 TC at 213. deduction in the brother-sister
30
881 F.2d at 255-56. context. The legal test is whether being pooled. ■
May/June 2002 Vol 15 / No 5
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