Warranty & extended service contracts (III)

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In Letter Ruling 9727014 the Service concluded that warranty supplements that covered repairs to a product after the manufacturer's warranty expired qualified as insurance contracts. The warranty supplements generally covered repairs made necessary by the failure of major systems or components of the product arising from defects in materials or workmanship but not from accidents or normal wear and tear.

Customers of the product could purchase the warranty supplement coverage from the taxpayer, which was the product's exclusive United States distributor. The selling dealer was the taxpayer's agent and the primary provider of repairs. Participating dealers collected premiums charged for the coverage and transmitted them, less a commission, to the taxpayer. The taxpayer was the sole obligor under the contracts.

The taxpayer proposed the creation of Newco1, whose sole or predominant business would be to issue and administer the warranty supplement program. It also proposed to create Newco2, which would provide indemnification coverage for Newco1.

The Service concluded that the warranty supplements qualified as insurance contracts. Risk shifting was present because Newco1 would be obligated to indemnify a contractholder for the economic loss arising from a failure under a covered system. In addition, the risk was distributed because Newco1 would accept numerous risks.

In contrast, Service officials concluded that "express limited warranties" that a manufacturer of consumer goods provided to consumers for its products did not qualify as insurance in ILM 200628018. Under this type of warranty a "manufacturer/seller is obligated to repair or replace a defective product if the defect occurs during a specified period of time.

The consumers bear no risk related to any defect in the product during the warranty period."211 Many manufacturers provide such warranties, at least in part, to satisfy legal requirements to provide products that are merchantable and fit for a given purpose.

The manufacturer "argued that the express limited warranties it provides to consumers should be considered insurance contracts purchased by the consumers when they buy [the manufacturers's] products." The Service officials, however, concluded that the risks covered by the warranties
were business risks reflected in the price of its goods sold, not insurance risks.

"The limited express warranty covers the goods sold for defects that likely existed in the goods at the time of sale. [The manufacturer] does not separately sell this limited express warranty—the manufacturer's limited express warranty cannot stand on its own." The Service officials
reasoned in part that "[a] warranty that covers the goods sold for defects that likely existed in the goods at the time of sale is not insurance in the commonly accepted sense."