Insuring the Risks of Brother-Sister Corporations: … the Risks of Brother-Sister Corporations: Think Captive Reprinted from the Journal of Taxation of Financial Institutions By Irving

Insuring the Risks ofBrother-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.

Federal Claims, in allowing adeduction, provides this pro-tax-payer analysis of the risk shiftingoccurring with respect to brother-sister corporations:

As explained in Humana, thewholly owned subsidiaries haveno ownership interest in theparent’s captive insurer andhence would not suffer any addi-tional loss if payments by thecaptive insurer of future claimsagainst the subsidiaries exceed-ed the amount of premiums thecaptive insurer received. Forexample, because a $1,000 claimagainst a Kidde subsidiary paidby [the captive insurer] KICwould not result in a corre-sponding decrease in that sub-sidiary’s net worth, the risk asto that claim was shifted fromthe subsidiary, through Nation-al, to KIC.4

The court then provided a pro-tax-payer risk distribution analysis:

Similarly, when viewed fromthe perspective of that sub-sidiary, risk distribution alsotook place in that KIC distrib-uted the risk faced by that sub-sidiary in a pool with the risksof other entities in which the

Since 9/11, insurance coveragehas been harder to obtainand is far more expensive.

Fortuitously, both the courts andthe IRS have opened a door pre-viously considered problematic —brother-sister companies that aremembers of the same affiliategroup can deduct premiums paidto an insurer which is a sibling(even though the insurance com-pany insures no unrelated par-ties). Accordingly, it behoovesaffiliated groups to think captiveinsurance while seeking adequateand affordable insurance coverage.This article will analyze the devel-opments and the open questions.

BACKGROUNDOne of the most contentious areasin the tax law has been the debateover the definition of insuranceand the ability of a corporate tax-payer to deduct premiums paid toanother member of its affiliatedgroup. The IRS and some courtswere very rigid at first, for exam-

Irving Salem is a partner and Jocelyn Noll is anassociate at Latham & Watkins, New York.

ple denying a deduction in bothparent-subsidiary and brother-sis-ter arrangements and even wherethe capt ive had substant ia lamounts of outside business; how-ever, the pendulum has swung.1

Indeed, the Seventh and NinthCircuits, in the Sears and Amercocases, have expressed doubts as tothe importance of the risk shiftingand distribution requirements.2

In devaluing the significance of therisk shifting/distribution analysis,both the Seventh and the NinthCircuits suggest an alternativeapproach which seems to shift theburden to the IRS:

However, we also agree with theSeventh Circuit that discussionsof this area might seem lessabstruse if we asked ourselves asomewhat different question:Suppose we ask not ‘What isinsurance?’ but ‘Is there ade-quate reason to recharacterizethis transaction?’, given thenorm that tax law respects boththe form of the transaction andthe form of the corporate struc-ture. (Emphasis supplied)3

The most recent judicial decisionaddressing the brother-sister issueis Kidde Industries. The Court of

Insuring the Risks of Brother-Sister Corporations:

Think CaptiveRecent 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

May/June 2002 Vol 15 / No 5 I N S U R I N G B R O T H E R - S I S T E R C O R P O R A T I O N S

J O U R N A L O F T A X A T I O N O F F I N A N C I A L I N S T I T U T I O N S May/June 2002 Vol 15 / No 5

subsidiary did not have an own-ership interest.5

As described below, some recentdevelopments confirm the trendand make a captive arrangementwell worth considering.

would retain a note and value of$1.00 per share, bids were soughtfrom unrelated third-party insurers.However, they were expensive anda mutual insurer was formed toinsure the RIC against creditdefault risks.

In a recent follow-up PLR(2001210198), the IRS againresponded favorably even thoughthe 33 RICs consolidated into“no less than V Funds.” The PLRnotes the initial ruling was basedin part on the analysis in Rev. Rul.78-33 (1978-2 CB 107) whichinvolved 30 unrelated corpora-tions. In affirming the prior PLR,the diversity of the risks, not thenumber of insureds, was empha-sized: “[W]e note that the pro-posed transaction will not reducethe number of independent risksMutual accepts... .” As indicatedbelow, the emphasis on the num-ber of independent risks hasbecome a consistent theme.

Rev. Rul. 2001-31 Eliminates Eco-nomic Family Test. Revenue Ruling2001-319 provides that the IRS“will no longer invoke the econom-ic family theory” enunciated in Rev.Rul. 77-316,10 citing the failure of

RECENT IRS POSITION FURTHER OPENS BROTHER-SISTER CAPTIVE DOORIn a flurry of recent activity, the IRSseems to have agreed with the broth-er-sister cases it has lost, and con-cluded that premiums paid to a bonafide insurance subsidiary insuringthe risks of brother-sister membersof the same affiliated group —regardless of the existence of out-side business6 — are likely to bedeductible. Chronologically, here-in follow the recent developments:

The IRS seems to have agreedwith the brother-sister cases

it has lost, and concluded thatpremiums paid to a bona fideinsurance subsidiary insuring therisks of brother-sister membersof the same affiliated group arelikely to be deductible.

IRS Concedes Pending Brother-SisterCases in FSAs. Somewhat surpris-ingly, in 2000, the IRS signaled achange in attitude by releasing anFSA which agreed to a 100% con-cession with respect to the brother-sister captive structure in the trans-action at issue, explaining:

[B]oth the United States Courtof Appeals for the Sixth Circuit[in Humana] and the UnitedStates Court of Federal Claims[in Kidde] have held that pay-ments to a captive insurer by itss i b l i ng sub s i d i a r y we r edeductible as insurance premi-ums...The court in Humanaexplained that brother-sistertransactions should be consid-ered insurance for Federalincome tax purposes, unlesseither the captive entity or thetransaction is a sham.7

PLR 20012109 Emphasizes Numberof Risks, Demphasizes Number ofInsureds. In a prior PLR (9624028,June 14, 1996), the IRS ruledfavorably on a captive utilized by33 unrelated regulated investmentcompanies (RICs). Each RIC was amoney market fund which heldsecurities used by numerous issuers.Seeking coverage to insure the RICs

1 The IRS initially took the position thatcaptive insurance arrangements were notinsurance for tax purposes because theinsuring corporation(s) and the captive sub-sidiary represented one “economic family,”and consequently there was no risk shift-ing or risk distribution. Rev. Rul. 77-316,1977-2 C.B. 53. Although no court fullyaccepted the economic theory, severalcourts denied deductions for premiums paidby affiliated corporations to captive insur-ance subsidiaries. See Clougherty PackingCo., 811 F.2d 1297 (9th Cir. 1987), aff’g84 TC 948 (1985); Beech Aircraft Corp.,797 F.2d 920 (10th Cir. 1986), aff’g 1984-2 USTC 9803 (D. Kan. 1984); Stearns-Roger Corp., 774 F.2d 414 (10th Cir.1985), aff’g 577 F.Supp. 833 (D. Col.1984); Carnation Co., 640 F.2d 1010 (9thCir. 1981), aff’g 71 TC 400 (1978); MobilOil Corp., 8 Cl. Ct. 555 (1985).

However, beginning with Humana,Inc., 881 F.2d 247 (6th Cir. 1989), over-

ruling in part 88 TC 197 (1987), the tax-payer began winning cases. In Humana, theSixth Circuit reversed the Tax Court andheld that, in respect to the sibling insureds,both risk shifting and risk distribution werepresent because payment of a claim by thecaptive insurer did not affect the balancesheet of sibling insureds and the losses werespread among the several separate corpo-rations within the affiliated group. Asthere was no evidence that the captive wasa sham or that the transactions lacked busi-ness purpose, the Sixth Circuit allowed thesibling insureds to deduct premiums paidto the captive insurer. Subsequent decisionsfollowed the Sixth Circuit’s analysis andallowed deductions for premiums paidpursuant to brother-sister arrangements.See Kidde Industries, Inc., 40 Fed. Cl. 42(1997); Hospital Corp. of America, TCM1997-482; Malone & Hyde, Inc., TCM1993-585, overruled by 62 F.3d 835 (6thCir. 1995) (holding that the wholly owned

insurance subsidiary was a sham and there-fore reversing the Tax Court’s finding ofrisk shifting).

Some courts have allowed both the par-ent and subsidiary insureds to deduct pre-miums paid to a captive insurance sub-sidiary when the captive received what thecourt considered to be a significant amountof premiums from unrelated insureds,despite a contrary ruling by the IRS in Rev.Rul. 88-72, 1988-2 C.B. 31. See OceanDrilling and Exploration Co., 988 F.2d1341 (Fed. Cir. 1993), aff’g 24 Cl. Ct. 714(1991) (44-46% from unrelated insureds);Sears, Roebuck and Co., 972 F.2d 858 (7thCir. 1992), aff’g 96 TC 63 (1991) (99.75%from unrelated insureds); Amerco, Inc., 979F.2d 162 (9th Cir. 1992), aff’g 96 TC 18(1991) (52-74% from unrelated insureds);The Harper Group, 979 F.2d 1341 (9th Cir.1992), aff’g 96 TC 45(1991) (29-32% fromunrelated insureds).

For a more comprehensive discussion of


the courts (specifically in Humana,Clougherty, and Kidde) fully toaccept the theory. The ruling, how-ever, cautioned that the IRS maycontinue to challenge certain cap-tive insurance transactions based onthe facts and circumstances, citingthe Sixth Circuit’s decision in Mal-one. At a tax conference shortlyafter the publication of Rev. Rul.2001-31, the tax press reported thefollowing comments of Robert A.Martin, an IRS official in the Officeof the Associate Chief Counsel(Financial Institution & Products)with a high degree of involvementin the new ruling:

Martin, who drafted the latest rul-ing, explained that the IRS hadsuccessfully invoked the eco-nomic family theory in casesinvolving wholly owned insur-ance subsidiaries without unre-lated insurance contracts. How-ever , the Serv ice was notsuccessful in applying the theoryto cases in which the sub insuredunrelated parties or in “brother-sister” captive situations.

According to Martin, the IRS willfocus on this fact-based approachfor transactions resembling thelast two situations. The Service

with unrelated insurers. The TAMsaid there was sufficient risk shift-ing and risk distribution, conclud-ing that the insurer qualified as aninsurance company under subchap-

ter L. Factors which the TAMfound important in analyzing theissue were:

1. There were no parental orrelated party guaranteespropping up Insurer;

2. Insurer was adequatelycapitalized;

3. Insurer’s premium to surplusratio was strong;

4. Insurer was formed in partbecause of significant disrup-tions in the market price ofworkers’ compensationinsurance;

In 2000, the IRS signaled achange in attitude by

releasing an FSA which agreedto a 100% concession withrespect to the brother-sistercaptive structure in thetransaction at issue.

will continue to view such factorsas guaranty and indemnity agree-ments, capitalization of subs,actuarially determined reserves,and whether premiums are pricedat arm’s length to gauge whetherpremiums paid to a sub aredeductible.

‘It’s a sliding scale,’ Martin saidof the analysis. ‘The closer itresembles a commercial, arm’s-length insurance transaction, thebetter you’ll be,’ he added.11

While unstated, presumably anoth-er of the factors the IRS will con-tinue to focus on will be whetherthe balance sheet of the insuredentity is affected by the captiveinsurer’s payment of a claim.12

Thus, the IRS is likely to apply abalance sheet test to disallow adeduction for premiums paid by aparent to a captive insurance sub-sidiary, particularly where there islittle or no outside business.

TAM 200149003 Blesses Brother-SisterArrangement. In TAM 200149013,13

a domestic insurance company (the“Insurer”) provided workers’ com-pensation coverage only to its sib-ling operating subsidiaries. A por-tion of the insurance was reinsured

this history, see Emanuel Burstein, “Whatis Insurance?” The Insurance Tax Review25 (January 1997); Joe Taylor, “Myster-ies of the Term ‘Insurance’ Continue Fol-lowing Sixth Circuit Reversal of Tax Courtin Malone & Hyde,” The Insurance TaxReview 1723 (November 1995).

2 Amerco, 979 F.2d at 168. The SeventhCircuit in Sears was emphatic in its deval-uation of the significance of risk shiftingand risk distribution:

Much insurance sold to corporationsis experience-rated. An insurer setsa price based on that firm’s recentand predicted losses, plus a loadingand administrative charge. Some-times the policy is retrospectivelyrated, meaning that the final priceis set after the casualties haveoccurred. Retrospective policieshave minimum and maximum pre-miums, so the buyer does not bear

all of the risk, but the upper and low-er bounds are set so that almost allof the time the insured firm pays thefull costs of the losses it generates.Both experience rating and retro-spective rating attempt to charge thefirm the full cost of its own risks overthe long run, a run as short as oneyear with retrospective rating.(Emphasis supplied)

Sears, 972 F.2d at 862. 3 Internal citations in all quotations gen-

erally omitted. 4 40 Fed. Cl. 42, 46.5 Id.6 However, courts may be more inclined

to rule that premiums paid to a captiveinsurance subsidiary are deductible if thecaptive writes a significant amount ofunrelated business (see note 1, supra).Accordingly, if practicable, the captive

insurer should accept risks from unrelat-ed corporations, either directly or throughreinsurance arrangements.

7 FSA 200029010 (July 21, 2000).Similar FSAs are FSA 200125009 (June 22,2001); FSA 200125005 (June 22, 2001);FSA 200043012 (October 27, 2000); FSA200105014 (October 26, 2000).

8 May 25, 2001.9 2001-26 I.R.B. 1348.10 1977-2 C.B. 53.11 The Insurance Tax Review 9 (July

2001).12 The “balance sheet” approach was

originally put forth by the Ninth Circuit inClougherty, in connection with the court’sanalysis of the IRS’s economic family the-ory. See note 1, supra.

13 December 7, 2001.


5. Insurer was a fully regulateddomestic insurance companyunder the laws of State of C;

6. Insurer issued a separatepolicy to each sibling, andmaintained separate records;and

7. Insurer hired a number ofemployees in the year in issue,and hired more after that.

Perhaps most critically, while thenumbers of siblings and insuredworkers were undisclosed, theTAM noted the Insurer distributeda “large number of homogeneous,independent risks among itsinsureds.”

and b works with a joint pro-cessing faculty (sic) on the sameproperty). (Emphasis supplied)

Thus, the large number of inde-pendent risks is highlighted in dis-cussing all three judicial decisionsanalyzed in the FSA, and the num-ber of corporate siblings is onlymentioned with respect to one ofthe decisions.

SOME OPEN ISSUES

Is One Subsidiary Enough? Probably.There is no conclusive authoritydealing with the minimum numberof subsidiaries that would meet therisk distribution test under thebrother-sister analysis. Based onHumana, and the IRS’s acceptanceof the Sixth Circuit’s analysis, itseems clear that even a relativelysmall number of insureds, each ofwhom insure a significant numberof risks, can achieve risk distribu-tion. Although there were from 22to 48 brother-sister corporationsinvolved in Humana, the Sixth Cir-cuit’s language could be read broad-ly as blessing a much smaller group:

[W]e see no reason why therewould not be risk distribution inthe instant case where the captiveinsures several separate corpo-rations within an affiliated groupand losses can be spread amongthe several distinct corporateentities.15 (Emphasis supplied).

In Malone, the Tax Court accept-ed risk distribution with respect toeight brother-sister corporations,suggesting that the above-quotedlanguage from the Sixth Circuitdid not foreclose “the ability of afew insureds with many differentinsurable risks to demonstratethat they also had achieved riskdistribution” (emphasis supplied):

We conclude that petitioner hasdemonstrated the presence of

FSA 200202002 Expresses Doubt inDubious Brother-Sister Arrangement;Quantum of Risks Again Emphasized.Lastly, FSA 200202002,14 againemphasizing a facts and circum-stances approach, expressed seri-ous reservations over a brother-sis-ter captive arrangement. Only twosubsidiaries were involved andonly a few properties (two plants,one of which was operated joint-ly). The FSA, after reviewing thecase law on brother-sister insur-ance, expressed concern over:

1 The few entities and fewproperties insured (oneinsured accounted for 86-88% of the captive insurer’spremium income, and thatsame insured’s single process-ing facility accounted for the“vast majority” of the riskstransferred),

14 January 11, 2002.15 Humana, 881 F.2d at 257.

In PLR (200121019 the IRS againresponded favorably even though

the 33 RICs consolidated into anunspecified number of funds.

2 The dilution of the insurancecoverage allowed by thecontract if subsequentinsurance were issued toanother insured,

3 The retroactive change madeto the policies; and

4 The investment of 97.5% ofthe premium by the insurer inaffiliates of the insured.

The FSA, however, could be viewedas supportive of many brother-sis-ter arrangements. While reviewingthe brother-sister judicial deci-sions, the FSA emphasizes the num-ber of properties insured, ratherthan the number of insureds:

Similarly in the present case, weexpect that with only the work-ing operations of OperatingSubsidiary 1 and 2, InsuranceSubsidiary was unable to achieveadequate r isk distr ibutionwhich, as discussed previously,incorporates the concept of thelaw of large numbers. The inher-ent risk distribution in the pre-sent case is much more limitedthan the three brother-sistercaptive insurance cases that theGove rnmen t ha s l o s t . I nHumana, supra, during the yearsunder consideration the tax-payer operated an average of 77hospitals with 12,558 patientbeds for which it needed liabil-ity coverage. In HCA v. Com-missioner, the taxpayer operat-ed an average of 160 hospitalswith an average of 26,574patient beds for which it need-ed similar coverage. In KiddeIndustries, Inc., supra, the tax-payer was a broad based decen-tralized conglomerate with 15separate operating divisions and100 wholly owned operatingsubsidiaries for which it neededworkers’ compensation, auto-mobile and general (includingproducts) liability coverage. Incontrast , the present caseinvolves risks of two insuredsand two working operations(one of which consists of the a


risk distribution in this case.Although at most only eightsubsidiaries, as compared withbetween 22 and 48 subsidiariesin Humana, participated in thereinsurance agreement, worker’scompensation, automobile lia-bility, and general liabilityclaims involve diverse risks andpotentially represent thousandsof individual loss events.16

(Emphasis supplied)

Conve r s e l y , ba s ed on FSA200202002, risk distribution willbe a problematic issue when thereare only two subsidiary insureds,and each of whom are insuring asmall number of risks located inthe same area.17

An intr iguing quest ion i swhether a captive subsidiary insur-er which insures only a single sub-sidiary that has a large number ofindependent risks can achieve riskdistribution. The Tax Court hasaddressed this issue, in dicta, inGulf Oil,18 in which the courtsaid “risk transfer and risk distri-bution occur only when there aresufficient unrelated risks in thepool for the law of large numbersto operate,” and that “a singleinsured can have sufficient unre-lated risks to achieve adequaterisk distribution.”19This languagewas quoted by the Tax Court inMalone, in support of its conclu-sion that risk distribution waspresent.20

stated that, “[g]enerally, the morepolicies that the primary insurerwrites, the more predicable itsunderwriting results will be.”25 Inorder to get a better understandingof the parameters of “large num-

bers,” one is required to understandsome statistical nightmares (forexample, “The Central Limit The-orem”), an adventure beyond thescope of this article.

Be Careful to Do What You Said YouWere Going to Do. Both the courtsand the IRS have identified factorsthat may indicate that the transac-tion is a sham and thus not trueinsurance. In Malone, the factors theSixth Circuit pointed to in deter-mining that the transaction was asham were that the insurer sub-sidiary was thinly capitalized, it waspropped up with parent guarantiesand a hold harmless agreement with

In Malone, the factors the Sixth Circuit pointed to in

determining that the transactionwas a sham were that theinsurer subsidiary was thinlycapitalized, it was propped upwith parent guaranties and ahold harmless agreement withthe unrelated primary insurer,and it was loosely regulated bythe jurisdiction in which it wasincorporated.

The IRS had a chance to rejectthe single insured case, but blinked.There was apparently only onesub s i d i a r y i n su r ed i n FSA200125009, in which the IRS con-ceded the deduction of premiumspaid by a subsidiary (“a domesticcorporation”) to its sibling sub-sidiary insurance company. Theanalysis by the IRS did not, how-ever, address the issue of risk dis-tribution beyond stating that riskdistribution is a requisite elementof insurance; moreover, FSAs haveno precedential value.

A classic single sibling casewould involve an insured like“Hertz.” Assuming that thousandsof automobiles rented throughoutthe country by Hertz were ownedby a single entity, such entityshould be able to deduct premiumspaid to a bona fide sibling captive.However, whereas reliance on thenumber of risks, not entities orinsureds, seems eminently sound,it may take some time to fully clar-ify the issue since language (onemight suggest is merely “loose”)referring to the number of eitherentities or insureds can be foundin the case law,21 IRS publica-tions,22 a Joint Staff document,23

and certain non-tax descriptions ofinsurance.24

Assuming one entity is accept-able, that still leaves open the ques-tion of how many risks must theentity insure in order to meet thelaw of large numbers. It has been

16 TCM 1993-585 at 93-3084.17 Query, if the two plants in FSA

200202002 were split among 30 corpora-tions, would the result be different. Avery close question.

18 89 TC 1010 (1987), reversed in parton other grounds, 914 F.2d 396 (3rd Cir.1990).

19 Id. at 1025-26. 20 TCM 1993-585, at 93-3084. 21 Kidde, 40 Fed. Cl. at 46 (risk distri-

bution took place because the subsidiary’srisk was placed in a pool “with the risks

of other entities”) (Emphasis supplied);Humana, 881 F.2d at 257 (risk distribu-tion was present where “the captive insuresseveral separate corporations and losses canbe spread among the several distinct cor-porate entities”). (Emphasis supplied)

22 FSA 199915004 (April 16, 1999)(risk distribution is accomplished “wherethe risk is distributed among insureds oth-er than the entity that incurred the loss.”)(Emphasis supplied)

23 Staff of the Joint Committee on Tax-ation, Tax Reform Proposals: Taxation ofInsurance Products and Companies (JCS-

41-85), 60 (September 20, 1985) (risk dis-tribution occurs when there is a “group ofa large number of individual insureds whoshare a similar type of risk of loss”).(Emphasis supplied)

24 See R. Riegel & J. Miller, InsurancePrinciples and Practices (6th ed. 1976)(referring to insurance as an arrangementin which risks of individuals are combinedin a group).

25 R. Michael Cass et al., ReinsurancePractices 35 (2nd ed. vol. 1, 1997).

26 62 F.3d at 840.


the unrelated primary insurer, and itwas loosely regulated by the juris-diction in which it was incorporat-ed.26 The IRS has cited these factorsand identified several more, in FSA200043012:

In addition to the factors setforth in Malone, other factorsconsidered in determiningwhether a captive insurancetransaction is a sham include:whether the parties that insuredwith the captive truly faced haz-ards; whether premiums chargedby the captive were based on

there has been risk distributionand risk shifting...[if the parentcorporation] changes its corpo-rate structure and that changeinvolves risk shifting and riskdistribution, and that change isfor a legitimate business purposeand is not a sham to avoid thepayment of taxes, then it is irrel-evant whether the changed cor-porate structure has the sideeffect of also permitting [the par-ent’s] affiliates to...deduct pay-ments to a captive insurancecompany under the control ofthe...parent as insurance pre-miums. (Emphasis supplied)30

Thus, provided that the require-ments discussed in the precedingsubsection are met, courts shouldrespect the form of a brother-sis-ter captive insurance arrangement.

CONCLUSIONCurrent developments — includ-ing the demise of the economicfamily test and the emphasis on thenumber of risks transferred —should embolden taxpayers toexplore brother-sister captiveinsurance arrangements. Whilethe IRS will scrutinize the facts andcircumstances, large affiliatedgroups with numerous subsidiariesand risks should be able to deductpremiums paid to a bona fideinsurance subsidiary even thoughit is a sibling and insures no out-side risks. Further, the number ofsubsidiaries, while still an openquestion, need not be very signif-icant — indeed, could be a singlecorporation — if one or more sib-lings has a large number of inde-pendent risks (e.g., workers’ com-pensation) which are effectivelybeing pooled. ■

commercial rates; whether thevalidity of claims was estab-lished before payments weremade on them; and whether thecaptive’s business operationsand assets were kept separatefrom its parent’s.

Additionally, favorable IRS opin-ions normally mention that busi-ness reasons prompted the use ofa captive.27 Generally, meetingthe business purpose requirementshould be a non-issue today. Forexample, an article in the WallStreet Journal of January 9, 2002,“Workers’ Compensation Insur-ance Now Harder to Get,” quotes

27 For two recent articles that plumb thedepths of “business purpose,” see StephenBowen, “Whither Business Purpose?” Tax-es 275 (March 2002); David Garlock, “IsThere Any Substance to the Sham Trans-action Doctrine?” Tax Management Mem-orandum 83 (2002).

28 Gregory, 293 U.S. 465 (1935).29 88 TC at 213.30 881 F.2d at 255-56.

Generally, meeting the businesspurpose requirement should

be a non-issue today.

a managing director of Marsh Inc.as saying: “The entire market thatprovided workers’ compensationcatastrophe insurance has driedup.” Another article, also in theWall Street Journal, on February26, 2002, “Property-CasualtyInsurers’ 4th-Period Charges ToBoost Claims Reserves Don’t FazeInvestors,” further confirms theneed to consider alternative waysof obtaining necessary insurancecoverage: “You pick up the paperevery day and everyone is talkingabout 30% rate increases, 100%rate increases.”

The facts and circumstancestest is a sort of Gregory28-typeanalysis — did the taxpayer in factdo what he said he did, namely,was the risk of loss in fact trans-ferred to a separate and distinctentity which functioned like a nor-mal insurance company, and wasthere a business purpose for thearrangement? If this test is met,presumably the transaction willalso meet the test suggested by theSeventh and Ninth Circuits (thatis, “no adequate reason to rechar-acterize this transaction”).

Will Courts Respect the Form of theBrother-Sister Transaction? A con-cern that prompted the Tax Courtin Humana to extend the analysisand the holdings of the parent-sub-sidiary cases to the brother-sisterarrangement at issue was that afailure to do so “would exalt formover substance and permit a tax-payer to circumvent our holdingsby simple corporate structuralchanges.”29 In overturning the TaxCourt, the Sixth Circuit rejectedthis rationale:

Such an argument provides nolegal justification for denying thededuction in the brother-sistercontext. The legal test is whether

Documents

Insuring the Risks of Brother-Sister Corporations: … the Risks of Brother-Sister Corporations: Think Captive Reprinted from the Journal of Taxation of Financial Institutions By Irving