[Congressional Record Volume 140, Number 80 (Wednesday, June 22, 1994)]
[Extensions of Remarks]
[Page E]
From the Congressional Record Online through the Government Printing Office [www.gpo.gov]


[Congressional Record: June 22, 1994]
From the Congressional Record Online via GPO Access [wais.access.gpo.gov]

 
    INSURANCE BROKER FOREIGN SOURCE INCOME CLARIFICATION ACT OF 1994

                                 ______


                        HON. BENJAMIN L. CARDIN

                              of maryland

                    in the house of representatives

                        Wednesday, June 22, 1994

  Mr. CARDIN. Mr. Speaker, I am today introducing the Insurance Broker 
Foreign Source Income Clarification Act of 1994. This bill is intended 
to clarify the treatment of changes in the international area included 
as part of the Omnibus Budget Reconciliation Act of 1993 as relates to 
their effect on U.S.-owned multinational insurance brokers and agents. 
The legislation is intended to treat U.S.-owned multinational insurance 
brokers and agents in a manner similar to that currently afforded to 
other similar financial services entities.
  The 1993 act that passed the Congress last year contained changes in 
the international area that inadvertently could negatively impact U.S.-
owned global insurance brokers. The changes could cause a broker's 
foreign subsidiaries to erroneously be treated predominantly as passive 
rather than active businesses.
  These changes could cause two negative results: first, U.S.-owned 
foreign insurance brokers could be subject generally for the first time 
to the pre-1993 act law Passive Foreign Investment Company rules; and 
second, U.S.-owned foreign insurance brokers may be subject to the new 
rules of the 1993 act applicable to earnings invested in excess passive 
assets of U.S.-owned foreign subsidiaries, section 956A. As a result, 
the unrepatriated active earnings of U.S.-owned foreign insurance 
brokers, directly or indirectly, may be subject to current taxation.
  Congress has never intended to tax financial services entities as 
PFIC's even though they may hold large client deposits. However, 
Congress has not always been careful and consistent in defining such 
financial services entities.
  Banks and insurance companies had a specific provision under pre-1993 
act law, which continues under the 1993 act, providing that their 
income is treated as active under the PFIC provisions and new section 
956A.
  In the case of securities brokers and dealers, the 1993 act adopts 
specific rules which provides for active treatment under both the PFIC 
provisions and new section 956A.
  Insurance brokers, like securities brokers, were not specifically 
treated as earning active income under the pre-1993 act law PFIC 
provisions, but generally were not subject to PFIC status. This 
occurred generally by satisfying the active income and asset tests, 
substantially due to the fact that goodwill and other active intangible 
assets were valued based on their fair market values under pre-1993 act 
law.

  The 1993 act substituted tax cost for fair market value in applying 
the PFIC asset test, thus eliminating the salutary impact of 
appreciated goodwill and other active intangibles, and potentially 
causing insurance brokers to be treated as PFIC's. A similar problem 
may arise under section 956A.
  Insurance brokers should continue to be treated like other financial 
services entities. The legislation I am introducing today would 
accomplish that result by recognizing the active nature of insurance 
brokerage and agency income. The effect of my legislation will be 
twofold:
  First, it will recognize the active nature of the insurance brokerage 
and agency business.
  Second, it will treat insurance agents and brokers in a manner 
comparable to their counterparts in the global financial industry; 
e.g., banks, insurance companies, and securities brokers and dealers.

                           Detailed Analysis


           a. Description of the Insurance Brokerage Business

       Insurance brokers act as intermediaries between clients 
     seeking insurance coverage and insurance companies who 
     underwrite insurance policies. Insurance brokers advise 
     clients on their needs and find the proper ``fit'' between 
     the client and an insurance company or companies, for which 
     services brokers charge a commission. Insurance brokers also 
     deliver claims adjustment services and provide risk 
     management and insurance company management services. In 
     short, insurance brokers are engaged in a financial services 
     business. As a consequence, they typically do not maintain 
     large investments in fixed tangible assets.
       Insurance brokers provide many services that are similar to 
     those provided by insurance companies and securities brokers 
     and dealers. Indeed, insurance brokers are recognized as 
     within the same ``financial services'' network as banks, 
     insurance companies and securities brokers. Thus, the foreign 
     tax credit regulations assign income from insurance brokerage 
     or agency services to the financial services income foreign 
     tax credit limitation ``basket.''
       As a regular business practice, insurance brokers 
     temporarily hold insurance premiums that are in transit from 
     clients to the insurers. They also may hold claim payments 
     and return premiums that are in transit from the insurance 
     companies to the insurers. These funds are held in a 
     custodial capacity. Such ``fiduciary funds'' typically are 
     subject to regulation, however, the nature of the 
     regulation depends upon the country in which the insurance 
     broker is based. For example, in the United Kingdom, the 
     Insurance Broker Registration Council rules govern the 
     treatment of fiduciary funds, designating the manner in 
     which such funds may be held and restricting the use of 
     such funds. These regulatory provisions, and the obvious 
     practical limitation that the funds are held only on a 
     short-term basis prior to being paid over, prevent any 
     repatriation of such funds to a U.S. shareholder.
       Additionally, insurance brokers often conduct directly, or 
     indirectly through an affiliate, related services, including 
     investment and financial advisory services, employee benefits 
     services, securities brokerage and dealer services, and other 
     financial-related services. These activities overlap 
     extensively with the brokers' counterparts in the financial 
     services industry, particularly with the activities of 
     insurance companies and securities brokers. Moreover, these 
     business activities (as is true for the brokerage business) 
     do not require maintaining significant tangible fixed assets, 
     although these businesses do require certain levels of 
     working capital.


                  B. Pre-1993 Act Law Regarding PFICs

       Any foreign corporation, including a controlled foreign 
     corporation, was treated as a PFIC under pre-1993 Act law if 
     it met either one of two tests which target foreign 
     corporations used as passive investment vehicles. Thus, a 
     foreign corporation was treated as a PFIC if either: seventy-
     five percent or more of its gross income is passive income 
     (the ``income test''); or its passive assets equal or exceed 
     fifty percent of its total assets (the ``asset test''). 
     Section 1296(a).
       For purposes of the PFIC asset test, a passive asset was 
     any asset that produced (or was held for the production of) 
     ``passive income.'' The asset test generally was based upon 
     asset fair market values.
       If a foreign corporation met either of those tests, any 
     U.S. person owning its stock was subject to rules that 
     accelerated income recognition or charged a deferred interest 
     ``penalty.'' Unless the U.S. person owning PFIC stock elected 
     to be taxed currently, the shareholder generally was subject 
     to ordinary income treatment upon receiving distributions 
     from the PFIC or upon disposition of the PFIC stock, and was 
     subject to an interest charge based upon the value of the tax 
     deferral. Section 1291.
       Congress recognized that active financial services 
     businesses inadvertently may be drawn within the PFIC rules. 
     Accordingly, Congress statutorily provided that corporations 
     in the banking and insurance business were generally not 
     subject to PFIC classification. This was effectively 
     accomplished through the definition of ``passive income,'' 
     e.g., for purposes of the income test and the asset test, 
     ``passive income'' did not include any income derived in the 
     active conduct of a banking or insurance business. Section 
     1296(b)(2). The fact that this statutory provision under pre-
     1993 Act law was limited to banks and insurance companies did 
     not impact U.S.-owned insurance brokerage companies that did 
     business outside the United States because of the substantial 
     goodwill and other active intangible assets taken into 
     account at fair market value in the PFIC asset test. 
     Accordingly, foreign insurance brokers under pre-1993 Act 
     generally were not treated as PFICs.
       In addition, it had been generally assumed that funds held 
     by insurance brokers to pay premiums, return premiums, and 
     claim payments did not count as assets of the insurance 
     broker for purposes of the PFIC asset test because they were 
     being held for customers of the broker either to be paid over 
     to the insurance companies or to be paid to the customer. 
     While this is not an issue on which the I.R.S. provided 
     guidance, its resolution generally was not viewed as 
     determinative of PFIC status due to the ability to value 
     goodwill and other active intangibles at fair market value.


                     c. changes under the 1993 act

       The 1993 Act contained two specific proposals that may 
     adversely affect the tax treatment of U.S.-owned foreign 
     corporations in the insurance brokerage business.
       First, the 1993 Act provides that, in the case of a 
     controlled foreign corporation (or any other foreign 
     corporation if the corporation were to so elect), the PFIC 
     asset test is based upon adjusted tax basis of the assets (as 
     determined for purposes of computing earnings and profits); 
     i.e., fair market value no longer may be used in the asset 
     test. The use of adjusted tax basis of assets rather than 
     fair market value substantially eliminates goodwill and other 
     active intangible assets from the asset test and may convert 
     active insurance brokers into PFICs.
       The second provision of the 1993 Act that may adversely 
     affect the insurance brokerage industry is new section 956A. 
     This provision requires a U.S. shareholder of a controlled 
     foreign corporation to currently include in income its share 
     of the corporation's accumulated earnings invested in 
     ``excess passive assets,'' defined as the extent to which 
     passive assets exceed twenty-five percent of total assets. 
     The determination of whether an entity has excess passive 
     assets is made by reference to the PFIC asset test, as 
     that test was amended by the above-referenced changes to 
     use the adjusted tax basis of assets rather than their 
     fair market value. This change, coupled with the 
     uncertainty as to the treatment of fiduciary funds, may 
     cause insurance brokers to be subject to section 956A 
     notwithstanding their clearly active nature.


d. securities brokers' and dealers' activities are specifically treated 
                      as active under the 1993 act

       The Committee on Ways and Means (the ``Committee'') 
     observed during its consideration of the 1993 Act that when 
     the PFIC rules initially were enacted, Congress believed that 
     foreign corporations conducting active businesses as dealers 
     in stocks, securities and derivative financial products would 
     be excluded under both the asset and income PFIC tests. 
     However, the Committee indicated it had become aware that 
     foreign securities dealers did not always earn sufficient 
     gross income in the form of commissions to avoid the income 
     test and did not maintain sufficient levels of nonpassive 
     assets for the PFIC asset test. The Committee recognized the 
     considerable overlap between activities conducted by foreign 
     securities dealers and those conducted by banks.
       Accordingly, the 1993 Act included a provision to treat 
     foreign securities brokers and dealers under the PFIC rules 
     in the same manner as banking and insurance companies by 
     specifically providing that income earned in the active 
     conduct of the securities business is not passive income. In 
     this manner, securities brokers and dealers also are not 
     subjected to the new deferred earnings rules of section 956A.
       The securities brokers and dealers provision is based on 
     the policy that the PFIC rules and the deferred earnings 
     rules of new section 956A are not intended to apply to 
     corporations that actively engage in the business of 
     providing financial services to unrelated parties. See Ways 
     and Means Committee Print (May 19, 1993) at 266. In that 
     regard, the Committee recognized the significant and broad 
     activities of an active securities business, which include 
     purchasing and selling inventory securities, servicing 
     mortgages, investment banking, and providing financial and 
     investment advisory services, investment management services, 
     fiduciary services, trust services, and custodial services.


  e. u.s. owned foreign brokerage businesses should be treated in the 
             same manner as securities brokers and dealers

       The active nature of taxpayers engaged in the insurance 
     brokerage and agency business obviously demonstrates that 
     these are not the type of businesses which should be subject 
     to either the PFIC provisions or the excess passive asset 
     provisions of section 956A. The Congress has already 
     recognized that comparable financial services entities also 
     should not be subject to these provisions through rules, 
     under pre-1993 Act law or under the 1993 Act provisions, 
     applicable to banks, insurance companies, and securities 
     brokers ad dealers. A similar clarification should be 
     provided for taxpayers engaged in the insurance brokerage and 
     agency business.

  My bill would accomplish this result by providing that the term 
``passive income'' would not include any income derived from insurance 
brokerage or agency services, for purposes of section 956A and the PFIC 
provisions. The legislation would also provide that income earned on 
fiduciary funds held by an insurance agent or broker would not be 
passive income and that such funds would be treated as having a tax 
basis equal to their original purchase price.
  This change would provide insurance brokers with treatment comparable 
to that provided for securities brokers or insurance companies. 
Moreover, this change ensures that the practical effect of the tax 
rules comports with congressional intent. It would establish that any 
income derived from insurance brokerage activities would be treated as 
active income under both the PFIC rules and the deferred earnings 
provisions of new section 956A. Moreover, it would clarify that cash 
and cash equivalents amounts representing premium payments held by 
insurance brokers for their customer on a temporary basis to be paid 
over to insurance companies--and return premiums and claims payments 
held to be paid over to their customers--are active assets for purposes 
of the PFIC provisions and the new Section 956A rules, with a tax basis 
equal to their purchase price. This result correctly recognizes the 
active nature of these assets and the fact that they obviously are not 
available for repatriation to the United States.
  In the global marketplace, the activities of bankers, insurance 
companies, securities brokers, and insurance brokers comprise a single 
financial services network. Many times, the lines between these 
industries become blurred and, as a result, these businesses often 
compete directly with each other. By treating these businesses in 
comparable fashion, competitive advantages and disadvantages will be 
avoided.
  I urge Members to support prompt enactment of this legislation.

                          ____________________