Micro-Captive Comment Letter

June 12, 2023 
VIA FEDERAL RULEMAKING PORTAL AT WWW.REGULATIONS.GOV  

The Honorable Lily Batchelder  

Assistant Secretary for Tax Policy  

Department of the Treasury  

1500 Pennsylvania Avenue, NW  

Washington, DC 20220  

The Honorable Daniel Werfel Commissioner 
Internal Revenue Service 
1111 Constitution Avenue, NW  

Washington, DC 20224  

Re: REG-109309-22 (2023 Micro-Captive Listed Transactions & Transactions of Interest)  

Dear Sir and Madam:  

MarksNelson Advisory, LLC (“MarksNelson”) welcomes the opportunity to provide comments in response to the Notice of Proposed Rulemaking, Micro-captive Listed Transactions and Micro-captive Transactions of Interest, published April 11, 2023 (the “Proposed Regulations”).1 MarksNelson is a business advisory firm that provides tax and consulting services to a broad range of clients throughout the insurance industry. MarksNelson represents numerous service contract reinsurers and has advised these reinsurers, third-party administrators, fronting carriers, and consumer good sellers regarding the disclosure requirements of Notice 2016-66.2 Accordingly, MarksNelson has a strong interest in this rulemaking because of the administrative burden associated with complying with Section 60113 disclosure requirements. Our comments focus on the Consumer Coverage exception in Proposed Regulation Section 1.6011-10(d)(2). 

1 88. Fed. Reg. 21547; REG-109309-22 (April 11, 2023) 
2 Notice 2016-66, 2016-47 I.R.B. 745 
3 Unless otherwise stated, all Section references are to the Internal Revenue Code of 1986, as amended  

MarksNelson appreciates the Treasury Department and IRS’ (“Treasury”) acknowledgment that Consumer Coverage transactions, as described in the preamble to the Proposed Regulations, do not represent the abusive transactions that concern Treasury. The Consumer Coverage exception is a welcome step forward and consistent with Treasury’s previous findings in Notice 2004-65 which stated, “examinations ha[d] revealed fewer abusive transactions than anticipated” and therefore were no longer subject to disclosure as a listed transaction.  

As Treasury has previously determined that consumer coverage transactions do not represent an abusive use of micro-captives that would subject the transactions to disclosure requirements, it appears inconsistent that the drafting of the Proposed Regulations would include a narrowly drafted exception for such transactions. Accordingly, this comment prioritizes our request that the Treasury reconsiders its approach to the Consumer Coverage exception and instead provide an exception that would only require the exclusive underwriting of consumer coverage in a micro-captive transaction.  

 I. Expanded Consumer Coverage Exception   

We propose that Treasury adopt a final rule that has as the sole criteria for the Consumer Coverage exception the underwriting of only consumer coverage type products. This approach is consistent with Treasury’s determination that these transactions are not abusive such that Section 6011 and the Regulations thereunder would not require disclosure of Sellers Captives that only insure insurance contracts sold in connection with the purchase of goods or services of a Seller. In addition to minimizing taxpayers’ compliance burden, this approach would also result in a more streamlined and efficient approach to tax administration that is consistent with the intent of the Section 6011 disclosure regime.  

It is not clear what criteria or other basis Treasury used to identify 50 percent as the appropriate minimum threshold in Proposed Regulation § 1.6011-10(d)(2)(iv)(A) (“Percentage Test”). While it provides some level of objective certainty, using this "proxy" to determine the purposed "abusiveness" of the transactions does not necessarily have any substantive connection to the economic realities of the transaction. Service contract purchasers and Sellers negotiate the consumer coverage's purchase price, representing an "arms-length" transaction. Because customers may negotiate every transaction with Sellers, the premiums reinsured to a Seller's captive are “governed” by the customer without regard to the tax implications of Seller's participation in the underwriting profit of the consumer coverage and therefore appears as an arbitrary standard.  

If Treasury chooses to pass on this opportunity for consistency with its previous pronouncements and finalize an exception consistent with its prior determinations, we request that the final rule include certain clarifications regarding the percentages used to determine qualification for the exception.  

II. Needed Clarifications for a Narrow Consumer Coverage Exception  

While this comment urges Treasury to remove the Percentage Test applicable to the Consumer Coverage exception, if the final rule retains the narrow approach utilized in the Proposed Regulations, there are certain clarifications needed to provide clarity to taxpayers and practitioners.  

Given the general terms of the language of Proposed Regulation § 1.6011-10(d)(2)(iv), Treasury could provide more clarity as to the mathematical operation of the language regarding the “unrelated commission percentage.” Our discussions with other industry professionals following the publication of the Proposed Regulations have indicated that there are various interpretations of what constitutes remuneration to be used in the numerator to determine the relevant percentages for the Consumer Coverage exception. We also encourage Treasury to publish finalized regulations that provide examples for taxpayers to rely on for a more definitive interpretation of the Treasury’s intent of the appropriate application of the Consumer Coverage exception rules as it relates to the unrelated commission percentage.  

More specifically, Treasury should provide more clarity as to the computation of the “unrelated commission percentage” identified in Proposed Regulation § 1.6011-10(d)(2)(iv)(B). It appears all products are included in the computation, but unclear as to what criteria taxpayers should use for “remuneration known by Seller.” Absent specific guidance on these items, taxpayers will not be able to reasonably determine whether a taxpayer’s fact pattern qualifies for the Consumer Coverage exception. Furthermore, as currently drafted, it is more than probable that two taxpayers selling the same type of coverage at the same price could reach different conclusions as to whether the exception does or does not apply and therefore treat similarly situated taxpayers differently.  

a. Identification of Products Included in Unrelated Commission Percentage  

The final regulations should provide more detail as to which products, “in the aggregate” are included in the unrelated commission percentage as “extended warranty, insurance, or other similar Contract[s]”. Based on the language as currently written, it appears Treasury intended that this language includes all products and services sold by a Seller in connection with the purchase of such product. For example, modern-day automobile dealerships not only offer extended warranties and service contracts but also fabric-protectant products sprayed on interiors and guaranteed against wear and tear, guaranteed asset protection products that provide coverage in the event the outstanding balance of a financing note exceeds the salvage value of a vehicle that is deemed “totaled”, and theft protection products installed on vehicles at the time of purchase that provide certain coverage in the event of offer not only vehicle theft. It appears that these products were intended to be included but reasonable minds may differ as to whether such products are “similar.”  

 b. The Meaning of “Remuneration Known by Seller”  

The Treasury should clarify that “remuneration known by Seller” is limited to products actually sold by the Seller whether or not actually reinsured to a Seller’s Captive and limited to net remuneration included in Seller’s or an affiliate of Seller’s taxable income.4  

In addition to Seller and Insured, a Consumer Coverage transaction typically includes other stakeholders that include third-party administrators that charge an administration fee, marketing agents that take a sales commission, and insurers that provide contractual liability insurance coverage guaranteeing performance to the purchasing customer. Given the nature of such programs, it is not uncommon for a Seller to have little, if any, knowledge of the various other stakeholders much less the amount to which they are compensated for their various efforts. To impose a requirement or potential duty on the taxpayer to determine what remuneration is being paid to third parties would not only be extremely difficult but very time-consuming to accumulate data to support that determination, etc.  

Accordingly, Treasury should provide for a clarification that limits the remuneration to the amount retained in Seller’s or an affiliate of Seller’s taxable income for which remuneration a Seller must know of under Proposed Regulation Section 1.6011-10(d)(2)(iv)(B). This approach would provide additional clarity and certainty as to the appropriate amount of remuneration to include for purposes of determining the “unrelated commission percentage”  

MarksNelson  

Mr. David Kaseff Partner-Insurance Tax dkaseff@mnadvisors.com 

Mr. Ian Osler Manager-Insurance Tax iosler@mnadvisors.com