February 2013 FATCA insurance alert

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Final FATCA regulations refine definitions and provide some relief for requirements specific to insurance companies

www.ey.com/FATCA Executive summary

In the final FATCA regulations, the US Treasury and the Internal Revenue Service (IRS)

adopted a significant number of changes that impact insurance companies. Many of

these comeintoeffect on1 January 2014. Of the changes, four stand out as having the

greatest impact across all segmentsofthe insurance industry:

• A new de minimis rule to exclude from the definition of a financial account any

insurance contract, other than an annuity, with cash value of less than US$50,000 at

all times during the year

• Insurance-related definitions were simplified to replace most references to US

tax law with plain language descriptions and, where appropriate, references to

local law treatment

• Changes to the definition of cash value insurance contracts to add additional

exemptions to reduce the number of insurance contracts treated as financial accounts

• Insurance companies paying death benefits are no longer required to obtain

documentation on a beneficiary (other than the owner), unless the insurance company

has actual knowledge or reason to know that the beneficiary is a US person

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Background

On 17 January 2013, the US Treasury and the IRS

released the long-awaited final regulations under the

Foreign Account Tax Compliance Act (FATCA),

provisions of Sections 1471–1474 (also referred to as

the “chapter 4” provisions) of the Hiring Incentives to

Restore Employment (HIRE) Act (P.L. 111-147). (See

Tax alert 2010-467.) The final regulations reflect

comments received from a number of financial

institutions, including insurance companies, trade

organizations, foreign governments and other

stakeholders, regarding the proposed regulations,

which were published in the Federal Register on

15 February 2012. The final regulations are in excess

of 540 pages and incorporate many of the provisions

reflected in the intergovernmental agreements

(IGAs) that have been signed by the US and foreign

governments on FATCA compliance. (See Tax alerts

2010-1164, 2011-662, 2011-1185, 2012-310 and

Insurance alert CK0507.)

The final regulations attempt to limit the institutions,

obligations and accounts subject to FATCA to more

specifically target high-risk financial accounts

and address practical operational considerations.

To address the many comments they received, the

Treasury and the IRS established three avenues for

addressing the principal concerns regarding costs

and burdens associated with implementing FATCA

and the legal impediments to compliance in a number

of jurisdictions:

• Adopted a risk-based approach to implementing

the statute to address policy considerations

effectively and eliminate unnecessary burdens

• Collaborated with foreign governments to develop

IGAs that remove legal impediments

• Developed administrative approaches to simplify

the process for registering and entering into an

agreement with the IRS to minimize costs associated

with compliance

This alert provides an executive summary of key

provisions in the final regulations that apply

specifically to insurance companies. The final

regulations contain numerous rules that have broad

application to all financial institutions and many of

these provisions are discussed in Tax Alert 2013-165.

In the coming weeks, we will publish alerts to provide

more in-depth explanation of the broader rules

applicable to all financial institutions, with specific

focus on the rules directed at insurance companies

and their products.

These four changes, along with a number of other changes, are summarized in the following discussion:

Key changes

Changes in scope

With some notable exceptions, the FATCA regulations have been

modified to introduce new de minimis thresholds and narrow the

types of insurance contracts and business activities of insurance

companies that are in scope, all of which will reduce the number

of companies, accounts and customers impacted by FATCA.

Certain insurance and annuity accounts are no longer

considered financial accounts subject to FATCA due diligence,

reporting and withholding:

• Cash value insurance contracts with a value of less than

US$50,000 at any time during the calendar year. As a result,

most property and casualty, disability, accident and health,

and other non-cash value insurance that contains contractual

features, such as return of premium, should fall outside the

definition of a financial account. This de minimis threshold

should also cause many cash value insurance products in

emerging markets and offerings in lower cash value insurance

lines of business to be out of scope.

• Indemnity reinsurance agreements are now specifically

excluded from the definition of a financial account under FATCA.

• Certain immediate annuities that monetize retirement or

pension accounts using non-investment linked, non-transferable

immediate life annuities are no longer considered financial

accounts subject to FATCA.

• Term life insurance contracts with increasing premiums are

no longer financial accounts if coverage ends before age 90,

premiums do not decrease over time and there is no cash value

payable without terminating the contract. It appears this new

definition should resolve the issue regarding non-forfeiture

benefits on level premium term life insurance contracts.

The definition of retirement and pension accounts has been

modified so that more foreign plans and products are eligible for the

exclusion from FATCA, although the reporting requirements for

pension plans have been broadened. In many cases, retirement

and pension accounts will be excluded via Annex II of IGAs.

Insurance companies that have elected to be treated as a US

insurance company for federal income tax purposes under

Section 953(d), are considered foreign financial institutions

(FFIs) unless they are licensed to do business in the US. Since

most Section 953(d) companies are not licensed in the US, this

FATCA insurance alert 3

provision will treat them as a foreign insurance company for

FATCA reporting purposes, even though they file a US income tax

return. However, Section 953(d) companies, along with other

FFIs, may elect to report FATCA information in a manner similar

to a US withholding agent using IRS Form 1099-R.

Life insurance contracts purchased by a transferee for value

will be treated as financial accounts subject to FATCA.

A “local FFI” exemption is now available to insurance

companies. The deemed-compliant rules have been expanded

to allow insurers to qualify as local FFIs and FFIs with only

low-value accounts. There are significant restrictions on the use

of this deemed-compliant status, including a requirement that all

members of the expanded affiliate group do not have a place of

business outside of a single country (other than administrative

activities). It is not likely this will be of use to large insurance

groups, but it may provide limited market advantage to small,

local or web-based competitors. However, these entities will still

be required to perform a number of FATCA activities.

Changes in definitions

FATCA definitions impacting insurance companies have been

simplified and clarified, making the regulations easier to

understand. That being said, the definitions still leave room

for interpretation and judgment, and may prove difficult to

implement consistently for global organizations.

The definitions of “life insurance contracts,” “annuity contracts”

and “insurance companies” have been simplified and are now

based on plain-language definitions with references to local law,

when appropriate, instead of by reference to US tax law. This

should ease the understanding of FATCA for those with less

understanding of US tax laws.

New definitions are provided for “group annuity contract,” “group

insurance contract,” “immediate annuity,” “deferred annuity,”

“investment-linked annuity contract,” “investment-linked

insurance contract,” “life annuity contract” and, in some cases,

clarify the treatment of these contracts as financial accounts.

The cash value definition is modified to mean any amount that is

payable under a contract to a person upon surrender, termination,

cancelation or withdrawal or that can be borrowed under or with

regard to the contract. Cash value is a key factor in determining

if an insurance contract is to be treated as a cash value insurance

contract under FATCA. The exclusions from cash value were

modified to specifically exclude a death benefit payable under a life

insurance contract, a refund of previously paid premiums due to

termination of the contract and a return of an advance premium or

premium deposit when the premium is payable at least annually if

the amount held does not exceed the next annual premium payable

under the contract. However, policyholder dividends for term life

insurance contracts are no longer excluded.

These changes should go a long way in helping insurance

companies exclude a number of insurance contracts (other than

annuity contracts), which are otherwise considered cash value

products, from treatment as a financial account. Under the

proposed regulation rules, in many cases, these contracts met

the “technical definition” of cash value and were considered

financial accounts. This modification is welcome.

The depository account definition has been refined to include

certain typesof accounts offered by life insurance companies such as

a guaranteed investment contract or similar agreements to pay

or credit interest on amounts held with the company. Under the

proposed regulations, any amount held at interest by

a life insurance company was considered a depository account.

In addition, a new exception is provided to remove advance

premiums or premium deposit funds from the definition of a

depository account. These changes should help to reduce the

number of accounts held by life insurance companies that may

be classified as a depository account and, thus, reduce the

number of financial accounts.

The various rules relating to the aggregation of financial accounts in

Chapter 4 have now been coordinated to provide that, when

aggregation is required, it applies to all financial accounts held

by the FFI and any other member of the expanded affiliated

group. However, this is only to the extent that computerized

systems link the accounts by reference to a data element such as

a client number, EIN or foreign tax identifying number, and allow

the account balances to be aggregated. It is helpful that the same

standard is now applied whenever aggregation is required to help

ease the administrative burden of applying these rules.

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Aggregation is also required for accounts that a relationship

manager knows are directly or indirectly owned or controlled by

the same person or that the relationship manager has associated

with each other by an indicator, or for other business purposes.

Further, if the company chooses to treat the accounts of an account

holder as one obligation (i.e., as consolidated obligations) in order

to share information between them or to permit the treatment of

new accounts of pre-existing account holders as pre- existing

accounts, these accounts must also be aggregated. See also, the

discussion of the treatment of new accounts of pre- existing

account holders on p5.

The investment entity definition was broadened to include

asset managers and investment advisors. The broadening of

the definition of investment entities means that asset managers

and any entity that invests funds for customers will be FFIs. Other

provisions in the final regulations allow asset managers that

manage funds of various sorts to be “sponsoring entities” and to

register with the IRS to take on the participating foreign financial

institutions (PFFIs) responsibilities for these funds. The funds are

then sponsored entities. This approach is consistent with how asset

management companies actually operate and could reduce their

compliance burden.

The grandfathered life insurance and annuity contracts

definition for purposes of exclusion from FATCA withholding

has been broadened to include all life insurance contracts (and

payment on those contracts) payable no later than the death

of the insured and existing immediate annuity contracts that

are payable for a certain period or the life of the annuitant.

This provision applies to contracts outstanding prior to

1 January 2014 and should allow for the grandfathering of

most life insurance and immediate annuities.

FATCA insurance alert 5

Account holder due diligence and reporting of

financial accounts

The final regulations provide greater clarity on the obligations

and required documentation for account holder due diligence,

while reducing due diligence for certain types of accounts and

updating FATCA documentation and reporting deadlines.

Documentation of life insurance beneficiaries is reduced.

An individual beneficiary receiving a benefit under a cash

value life insurance contract, other than the owner, is presumed

to be a foreign person unless US indicia are present, or the

company knows or has other reason to know the individual

is a US person. Thus, most beneficiaries will not require due

diligence or documentation. This new provision applies only

to policies issued by FFIs. Under the proposed regulations, a

beneficiary receiving death benefits is an account holder of

a financial account. However, due to this presumption, the FFI

is not required to document the beneficiary unless it knows or

has reason to know that the beneficiary is a US person.

Certain group life insurance and group annuity contracts will

not require documentation until the payment to individual

participants. Group accounts will be treated as non-US

accounts until the date on which an amount is payable to an

employee or certificate holder or beneficiary, if the insurer

obtains a certification from an employer that no employee or

certificate holder is a US person. The group must cover 25

or more employees or certificate holders, all contract values

must be payable to employees or certificate holders and the

employees or certificate holders must be entitled to name

beneficiaries for the death benefits payable and the aggregate

amount payable to any employee or certificate holder or

beneficiary cannot exceed US$1m.

Grandfathering of policies is extended to 1 January 2014

and grandfathered accounts below a de minimis threshold

will not require documentation. An FFI is not required to

perform identification and documentation procedures for cash

value insurance or annuity contracts with a cash value less

than US$250,000 and which was in effect as of

1 January 2014 (pre-existing contracts) for individual or entity

accounts. The exception for each contract will cease at the end

of any subsequent calendar year in which the account balance

or value exceeds US$1m. Certain aggregation rules may apply

in determining the balance or value.

The definition of who is the holder of a financial account is

expanded, requiring documentation of additional individuals

in some cases. Insurance or annuity contracts treated as

financial accounts are considered held by each person who

can access the contract value (loan, withdrawal or surrender)

or change the beneficiary. If no person can access the contract

value or change a beneficiary, then the account is treated as

held by both the person named in the contract as the owner

and each beneficiary. When the obligation to pay an amount

under the contract becomes fixed, each person entitled to

payment is treated as a holder of the account. Election to report in manner similar to US life

insurance companies

FFIs may elect to report their insurance and annuity contracts in a

manner similar to the reporting that US life insurance companies

follow for domestic contracts. This election may allow some life

insurance companies to use systems and procedures already in

place at US-affiliated companies and centralize some of the

compliance process.

Treating new accounts as pre-existing accounts allows for limited additional documentation. “Consolidated accounts” is a new option that FFIs can elect to apply for treating new contracts related to existing customers as pre-existing contracts. In order to qualify, the contracts must meet certain aggregation and reason- to-know rules with regard to the new contract and any pre-existing contracts.

The valuation date for insurance and annuity contracts is the

year-end or most recent anniversary date, depending upon how

the company reports information to its account holders. For

immediate annuities without a minimum benefit and the value

of which is not reported to the account holders, the value to

be reported is the net present value, with adjustments using

assumptions to be provided by the IRS.

Form 8966 FATCA is the new form the IRS will release for FFIs

to report information regarding their financial accounts.

6

Withholding and withholdable payments?

Key aspects of withholding have been deferred, and in

conjunction with IGA agreements, fewer transactions are

expected to be subject to withholding. Withholding for cash

value life insurance and annuities has been simplified to treat all

payments as withholdable, regardless of their US tax treatment.

The scope of withholdable payments has been refined

to include insurance and reinsurance premium payments

and the definition of non-financial payments, which are

excluded from the withholdable payment.

Gross proceeds withholding has been deferred to 2017.

Gross proceeds from the sale of securities that produce interest

or dividends are treated as withholdable payments; however,

the requirement for withholding has now been delayed until

at least 2017.

Any distribution (including redemption) made to an account

holder with respect to a cash value life insurance or annuity

contract must be reported as a withholdable payment,

regardless of its US tax treatment. In other words, death benefit

payments, policyholder dividends, etc., must be treated as

withholdable payments even though they may not be taxable

income to the recipient.

The grandfathered obligations definition has been expanded

to include life insurance contracts in effect on 1 January 2014,

which are payable no later than upon death of the insurance,

including endowment benefits and immediate annuities for

life. These modifications should exempt a large percentage

of existing life insurance and immediate annuities currently

in force from future withholding under FATCA; however, the

contracts are still subject to the identification and reporting

requirements highlighted above. Moreover, a premium paid

with respect to a grandfathered obligation is treated as

a payment made under a grandfathered obligation and is

therefore grandfathered.

The withholdable payments definition has been refined to

identify what are excluded non-financial payments and what are

included payments. It is thought that “included payments”

must have a US source to be considered withholdable, but

this is not completely clear from the final regulations. Insurance

premiums and reinsurance premiums on all contracts and

amounts paid under cash value insurance and annuity

contracts (presumably if otherwise US source) are specifically

identified as withholdable payments. (Treasury noted in the

preamble that it did not find the application of Section 4371

excise tax a compelling argument to exclude premium

payments from FATCA.) This means that many US insurance

companies that do not issue cash value insurance or annuity

contracts that are treated as financial accounts are likely still to

have some obligations to apply the withholdable payment

rules to transactions with foreign counterparties, brokers

and reinsurers.

FATCA insurance alert 7

Implications and final observations

The final FATCA regulations contain many important

and helpful changes that should allow insurance

companies to simplify their documentation and

implementation processes; however, even with these

changes, the FATCA rules are complex and there are

still many unanswered questions. FATCA will impact the

information gathered from clients and distribution

channels and require changes to client onboarding and

monitoring processes in all geographies. As companies

move forward with their compliance efforts, care should

be taken to understand and comprehend fully the

numerous provisions of the final regulations and

how they impact specific insurance products and

insurance companies. The results are not always

intuitive or logical.

“The complexity will carry over to the insurance

company’s communications plan to employees, agents

and brokers to train them on the administrative and

systems changes required by FATCA and the impact to

policyholders.” This complexity is now more real than

ever. While we now have the final regulations, the

complex and time-consuming tasks of implementing

the necessary changes, mitigating the impact on

customers and complying with FATCA in a practical

and efficient manner are still ahead. The FATCA

statute and the new final regulations are complex and

will require ongoing analysis to understand and

mitigate the impacts on customers, business activities

and operational costs.

We will be issuing additional guidance in the coming

weeks to provide a more in-depth discussion of these

new provisions, as well as analysis of the operational

implications of these changes on the insurance industry.

In the meantime, we encourage you to reach out to

your Ernst & Young advisor for further information.

For additional information concerning this alert, please contact:

Contacts

Ernst & Young

Assurance | Tax | Transactions | Advisory

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Peter Frost EMEIA FATCA Insurance Tax Lead + 44 20 7951 5517 pfrost@uk.ey.com

Tracey Bowen-Lowe EMEIA FATCA Insurance Advisory + 44 20 7951 4591 tbowenlowe@uk.ey.com

Julian Skingley EMEIA FATCA Lead + 44 20 7951 7911 jskingley@uk.ey.com

Belgium Kris Volkaerts EMEIA Advisory + 32 2 774 96 70 kris.volkaerts@be.ey.com Koen Marsoul +32 2 774 99 54 koen.marsoul@be.ey.com Katrina Petrosovitch +32 2 774 61 22 katrina.petrosovitch@be.ey.com France Frédéri c Martineau EMEIA Tax + 33 1 55 61 13 35 frederic-c.martineau@ey-avocats.com

Vincent Natier EMEIA Tax + 33 6 07 70 85 35 vincent.natier@ey-avocats.com

Laurent Corbinea u EMEIA Advisory + 33 1 46 93 77 27 laurent.corbineau@fr.ey.com

Germany Petar Groseta EMEIA Tax + 49 6196 996 24509 petar.groseta@de.ey.com

Ralf Temporale EMEIA Advisory + 49 89 14331 22191 ralf.temporale@de.ey.com

Ireland Amanda Stone EMEIA Tax + 353 1 221 1160 amanda.stone@ie.ey.com Luxembourg Christophe Wintgens EMEIA Advisory + 352 691 830 402 christophe.wintgens@lu.ey.com Christian Daws EMEIA Tax + 352 661 995 196 christian.daws@lu.ey.com Netherlands Ton Daniels EMEIA Tax + 31 88 40 71253 ton.daniels@nl.ey.com Spain Héctor Vera Requena EMEIA Tax + 34 915 727 972 hector.verarequena@es.ey.com Switzerland Thomas Brotzer EMEIA Tax + 41 58 286 3412 thomas.brotzer@ch.ey.com UK Kathleen Moore EMEIA Advisory + 44 131 777 2497 kmoore3@uk.ey.com US tax Anthony Calabrese + 44 20 7951 5802 acalabrese@uk.ey.com

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