Following on from our earlier blog, the HMRC has published interim draft guidance which expands on how the Diverted Profit Tax (DPT) may apply to insurance arrangements, including a number of sector-specific scenarios.
The first example concerns a standard intra-group reinsurance arrangement with an offshore vehicle. The second example concerns a captive insurance arrangement.
In both cases, the question to be addressed is "whether or not, at the time of making the provision, it was reasonable to assume that the non-tax financial benefits referable to the insurance transactions outweigh the financial benefit of the tax reduction".
In the first example, the HMRC appears to accept that this test would ordinarily be satisfied, and hence the DPT would not apply. This is because the tax treatment of the premium etc is secondary to the regulatory capital and other benefits that would arise.
In the second example, the HMRC does however raise some potential concerns. The scenario described is relatively common, and deserves a little analysis. In the scenario, a global "widget" manufacturer has in place an insurance programme some of which is placed with an offshore (intra-group) captive. On the facts (more detail below), the HMRC concludes that the DPT would apply. The salient (fictitious) fact pattern that supports this (imaginary) conclusion is as follows:
- the functions performed by the captive are minimal;
- most of the underwriting and actuarial risk pricing is outsourced to a specialist insurance consultancy;
- assessment and management of the group's insurance risk is directed and performed by the group's parent;
- the captive employees just three people part-time (including a senior underwriter);
- the premium is on arms-length terms; and
- the group has sufficient liquid assets to cover the amount insured by the captive.
The HMRC appears to take these factors together to arrive at a conclusion that the test in that case would not be satisfied - ie there are no commercial motives for the transaction other than the tax saving.
Is this however the right conclusion? For instance, the fact that a business is capable of absorbing a loss (absent insurance) does not render the arrangements a sham It is of course entirely sound financial planning to guard against large exposures, whether or not the company could otherwise "afford" them.
Captive users and captive operators should nonetheless consider the extent to which their arrangements share any of the elements set out above, and to formulate their defences in the event of any HMRC challenge.
At a rate of 25%, a DPT charge on premiums payable to a captive would be an unwelcome surprise.