The United States recently finalized its tax treaty with Chile, which is the first new U.S. tax treaty to enter into force in more than ten years. Does the treaty exempt insurance premiums paid to Chilean insurers from U.S. excise tax? It does not, but the answer is not that obvious, and it takes some work to understand why.
By way of background, the United States imposes an excise tax (“FET”) on insurance premiums paid to non-U.S. insurers on risks located in the United States, at a rate of 4% on direct non-life insurance, and 1% on direct life insurance or reinsurance. Some, but not all, U.S. tax treaties eliminate the FET for insurers who qualify for treaty benefits.
The technical analysis of how a tax treaty exempts insurance premiums from FET is a two-step process. First, tax treaties typically provide that the business profits of a qualifying foreign entity are not subject to U.S. tax. For tax treaty purposes, insurance premiums are treated as business profits, so that they are exempt from FET — if FET is within the scope of the treaty.
The second step needed to achieve FET exemption is to examine whether FET is within the scope of treaty. Tax treaties limit the type of tax that they cover, with most treaties only impacting income taxes and a limited number of excise taxes. Sixteen treaties include the FET in the list of taxes covered.
The Chilean treaty takes an unusual approach. It includes the FET in the list of taxes covered, which may lead one to think that the treaty includes an FET exemption. However, the Business Profits Article does not include a blanker exemption from FET. It only provides that FET may not exceed 2% of reinsurance premiums, and 5% of all other premiums.
The U.S. tax treaty with Chile does not include an exemption from FET, but the provision is in an unusual treaty article. International tax practitioners who may typically expect a treaty waiver if the FET is a covered tax may inadvertently – and incorrectly – conclude that the treaty waives the tax.