Substance Over Form Revisited – The UPS Case And Captive Insurers

Corporate Counsel

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PUBLISHED ON: September 29, 2003

In the summer of 1999, the Tax Court (78 TCM (CCH) 262) ruled on a matter involving United Parcel Service and their restructuring of certain customer related insurance coverage transactions arising from the shipment of packages. UPS charged each customer an "excess value charge" or "EVC" on packages with a certain value and UPS was allowed by its tariff to remit the EVC’s to an insurance company as a premium for excess valuation cargo insurance on behalf of the customer.

After looking at various ways to deal with the EVC activity, which created a substantial flow of revenue, UPS decided to enter into an agreement with an unrelated insurer whereby UPS remitted EVC’s as insurance premiums to such insurer ("NUF", a subsidiary of AIG, was selected) on a monthly basis net of certain claims paid. Also as part of the arrangement, NUF would use a UPS owned Bermuda captive insurance company ("OPL" formed in 1983 by UPS) as a reinsurer and remit to OPL 100% of the amounts remitted to NUF from UPS less a small commission and certain costs. Immediately before the UPS-NUF-OPL arrangement was to become effective (1/1/84), UPS spun off OPL to UPS’ shareholders as a taxable dividend of one share of OPL stock for each UPS share. Thus, as of 12/31/83 (the date of the spin off) the shareholders of UPS were essentially the same as the shareholders of OPL.