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Some tax-exempt Sec. 501(c) organizations use offshore (non-U.S.) captive insurance companies for self-insurance purposes. Occasionally, unrelated exempt organizations form a captive insurance company to insure against common risks (for example, officers' and directors' liabilities). A recent IRS letter ruling suggests that unrelated business income tax (UBIT) could result if such a captive does not engage strictly in self-insurance activities.
The earnings and profits (E&P) of a foreign corporation generally are not taxed to a U.S. shareholder until repatriated through an actual dividend distribution. The rules of subpart F (Secs. 951-964), however, treat certain undistributed E&P ("subpart F income") of a controlled foreign corporation (CFC) as currently includible in a U.S. parent's income. Subpart F income includes insurance income, foreign base company income and certain other types of income. Foreign base company income includes foreign personal holding company (PHC) income, which includes passive investment income such as dividends and interest. Thus, a captive insurance company's premium income and passive investment income are generally treated as subpart F income.
The IRS has consistently ruled that exempt organizations do not recognize unrelated business taxable income (UBTI) when offshore captive insurance companies are engaged strictly in self-insurance activities. The Service has used a...