Rev. Rul. 70-552

Advice is requested as to whether, under the circumstance described below, the taxpayer, a stock casualty insurance company, engaged in the business of reinsuring insurance contracts written by other insurance companies, is entitled to a deduction for commission expense under section 832(c)(1) of the Internal Revenue Code of 1954.

The taxpayer reinsures casualty insurance risks originally insured under contracts written by other insurance companies (hereinafter referred to as the "primary insurer"). The taxpayer is subject to tax under section 831 of the Code.

The reinsurance business of the taxpayer is conducted pursuant to a reinsurance treaty with the primary insurer, which upon execution remains in force for an indefinite period. Under the treaty terms, the taxpayer assumes responsibility for a specified portion of the liability incurred by the primary insurer under its policies of insurance or reinsurance in force, issued, or renewed while the treaty is in effect. The taxpayer's liability on the risks insured attaches simultaneously with that of the primary insurer.

The treaty further provides, in effect, that the taxpayer is to receive a pro rata share of the gross premiums received by the primary insurer, in accordance with the percentage of risk reinsured. However, the taxpayer is required to allow the primary insurer a ceding commission to provide for certain expenses incurred by the primary insurer including dividends, commissions, brokerages, and premium taxes, plus a profit element. This reimbursement for expenses incurred is accomplished by retention of the ceding commission by the primary insurer from the gross pro rata premiums to be paid over to the taxpayer so that only a net amount equal to the pro rata gross premiums on risks reinsured less the specified ceding commission is actually paid to the taxpayer.

The question presented is whether the taxpayer is entitled to a deduction for the amount of the ceding commission retained by the primary insurer as an ordinary and necessary business expense pursuant to section 832(c)(1) of the Code, and if so, in what taxable year is the taxpayer entitled to take the deduction. Correspondingly, a further question presented is in what year should the primary insurer take into account the ceding commission retained for purposes of computing its taxable income.

Section 832 of the Code provides, in substance, that the taxable income of an insurance company subject to tax under section 831 is gross income as defined in subsection (b)(1) less the deductions allowed by subsection (c).

"Premiums earned" computed in accordance with the provisions of section 832(b)(4) of the Code is one of the elements included in the gross income of an insurance company subject to tax under section 831 of the Code. Section 832(b)(4) of the Code specifically makes gross premiums written the starting point for computation of premiums earned, and accordingly, clearly contemplates that the gross contract premiums relating to the risks insured (or reinsured) have been received.

Further, section 832(c)(1) of the Code specifically provides that in computing the taxable income of an insurance company subject to the tax imposed by section 831, of the Code, there shall be allowed as deductions all ordinary and necessary expenses incurred, as provided in section 162 (relating to trade or business expense). In addition, section 832 of the Code, in effect, places casualty insurance companies on an accrual method of accounting with respect to their income and deductions. It follows that expenses are deductible by such casualty insurance companies for the taxable year in which all events have occurred that determine the fact of liability and the amount thereof can be determined with reasonable accuracy. See section 1.461-1(a)(2) of the Income Tax Regulations.

In the instant case, the taxpayer's liability on the risks reinsured comes into being at the same time as the primary insurer's liability. Accordingly, the taxpayer's right to receive a pro rata portion of the gross premiums written, and its obligation to pay the ceding commission agreed upon, becomes fixed at that time also. Further, the accrual of the foregoing rights and obligations and their treatment for Federal income tax purposes are not affected by the fact that the primary insurer "netted out" the ceding commission against the pro rata gross premium so that only a net amount was paid to the taxpayer. In computing taxable income, the taxpayer is required under section 832 (specifically section 832(b)(4) of the Code to take into account gross premiums written on risks insured without regard to whether such gross premiums written arose from direct insurance or from reinsurance, and to offset exclusions and deductions to which the taxpayer may be entitled from that starting point in order to arrive at "insurance company taxable income."

The payment of the ceding commission is an amount which the taxpayer is required to pay in order to obtain the reinsurance business from the primary insurer.

Accordingly, it is held that in the instant case the taxpayer is entitled to a deduction for commission expense equal to the amount of the ceding commission due the primary insurer as an ordinary and necessary business expense incurred, under section 832(c)(1) of the Code, in the taxable year in which the reinsurance coverage becomes effective. Correspondingly, in the same taxable year, the primary insurer, under principles of accrual accounting, must take into account the ceding commission due from the taxpayer on such reinsurance business.