## Facts

- Four Japanese property and casualty insurers wrote primarily Japanese direct insurance and also assumed reinsurance, including reinsurance ceded by U.S. insurers and reinsurers.
- Each insurer sought U.S. reinsurance business through U.S. agents, including Fortress Re, Inc., a U.S. reinsurance underwriting manager.
- Each insurer entered into a separate, substantially identical management agreement with Fortress, differing mainly in net acceptance limits that capped Fortress’s authority to bind each insurer on any single risk.
- Under the agreements, Fortress could solicit, underwrite, accept or reject reinsurance on the insurers’ behalf (within limits), and cede reinsurance; Fortress regularly exercised authority to conclude reinsurance contracts for each insurer.
- Fortress was compensated through management fees and commissions; the insurers did not direct Fortress’s day-to-day underwriting decisions on individual transactions.
- The governing framework was the 1971 U.S.–Japan income tax treaty, under which Japan-resident enterprises are subject to U.S. tax on business profits only if the profits are attributable to a U.S. “permanent establishment” (PE), and the use of an independent agent acting in the ordinary course of its business does not create a PE.
- The IRS asserted deficiencies for 1986–1988 on the theory that the insurers had a U.S. PE through Fortress; a secondary dispute concerned certain 1988 adjustments tied to reductions in pre-1988 unpaid loss estimates on certain excess-of-loss reinsurance.
- The parties stipulated that the insurers were treaty residents of Japan; Fortress was authorized to bind them; Fortress was not a broker or general commission agent; and the dispute centered on whether Fortress was an “agent of an independent status.”

## Issues

1. Whether Fortress’s U.S. underwriting activities on behalf of the Japanese insurers created a U.S. permanent establishment for each insurer under the U.S.–Japan income tax treaty, or whether Fortress was an independent agent acting in the ordinary course of its business.
2. If a U.S. permanent establishment existed, whether 1988 taxable income had to include certain reductions in pre-1988 estimates of unpaid losses under certain excess-of-loss reinsurance contracts.

## Decision

- The Tax Court held that Fortress was an agent of independent status acting in the ordinary course of its business and therefore did not constitute a U.S. permanent establishment for the insurers under the treaty.
- Because there was no U.S. permanent establishment, the treaty barred U.S. taxation of the insurers’ relevant business profits, and the asserted deficiencies premised on a PE could not be sustained.
- The secondary unpaid-loss-reserve issue was not reached as a basis to impose U.S. tax on treaty-protected profits in the absence of a PE.
- The IRS conceded that no petitioner was liable for additions to tax under I.R.C. § 6661.

## Legal Principles

- Under the U.S.–Japan income tax treaty, U.S. taxation of a Japan-resident enterprise’s business profits depends on whether the enterprise has a U.S. permanent establishment and whether the profits are attributable to that establishment.
- A permanent establishment is not created merely because a resident uses an agent of independent status acting in the ordinary course of that agent’s business.
- Independent-agent status turns on both legal independence (freedom from the principal’s control over how services are performed) and economic independence (separate entrepreneurial activity and risk, not functioning as part of the principal’s enterprise).
- Contractual underwriting limits that function as risk constraints, without day-to-day operational direction by the principal, do not by themselves establish the control associated with a dependent agent.
- Broad authority to bind a foreign principal does not preclude independent-agent status when the agent operates as a separate business, is not owned or managed by the principal, and functions as a professional intermediary for multiple principals.

## Conclusion

The Tax Court concluded that the Japanese insurers did not have a U.S. permanent establishment through their U.S. underwriting manager because the manager was legally and economically independent and acted in the ordinary course of its own business; accordingly, the treaty prevented the United States from taxing the insurers’ reinsurance profits on the asserted permanent-establishment theory.


Taisei Fire & Marine Ins. Co. v. Comm’r of Internal Revenue, 104 T.C. 535 (1995)