Recent changes to the Brazilian tax rules have significant implications for reinsurers which have established representative offices in Brazil.
Under the Brazilian reinsurance regulatory framework, the market comprises three different categories of reinsurer - local, admitted and occasional - each with different licensing and capital set-up requirements and each subject to different risk cession rules and taxation requirements. There are currently approximately 16 local reinsurers in Brazil, 38 admitted reinsurers and 82 occasional reinsurers. Lloyd’s of London has admitted reinsurer status.
In Private Letter Ruling (PLR) No. 62/2017 dated 20 January 2017, the Brazilian Tax Authority (RFB) ruled that representative offices established in Brazil by non-resident reinsurers (so-called admitted reinsurers) should be treated for tax purposes in the same way as a reinsurer incorporated in Brazil (i.e. a local reinsurer). This was primarily on the basis of the RFB’s decision that the representative offices of admitted reinsurers are to be considered a permanent establishment, and therefore subject to the same taxation applicable to local reinsurers. In the RFB’s view:-
“… the activities of representative offices do not have the character of mere brokerage, preparatory or ancillary services, but are characterized for tax purposes as equivalent to provision of services by local reinsurers.”
The local representative office of an admitted reinsurer is a service office, with all underwriting and claims handling being carried in the overseas office of the admitted reinsurer. Premium flows direct from the cedant insurers to the overseas entity and not via the account of the local representative. The practical effect of elevating the tax status of admitted reinsurers to local reinsurer is potentially very significant in terms of tax exposure.
Each corporate entity is structured differently and will have its own unique tax arrangements; however, by way of illustration, under the usual regime, local and admitted players have been paying tax on the following basis since the opening of the Brazilian reinsurance market in 2008.
- Local reinsurers pay 45% corporate income tax plus 4.65% PIS/COFINS (i.e. federal contributions for funding social security) on gross premiums. The corporate income tax is comprised 15% tax on net profit plus an additional 20% by way of social contributions (CSLL). Local reinsurers with net profit in excess of BRL240,000 (approximately USD75,000) pay an additional 10% tax.
- Local representative offices of admitted reinsurers pay 34% corporate income tax and are generally exempt from PIS/COFINS on service fees received from the admitted reinsurer. The corporate income tax is comprised 15% tax on a profit which is calculated on the ‘cost plus’ basis (usually 15%) plus an additional 9% for social contributions (CSLL), together with the 10% uplift for admitted reinsurers with net profit in excess of BRL240,000.
- The office of the admitted reinsurer which is based overseas is subject to the tax regime of the jurisdiction of domicile; however it also pays 2% on premium (which is calculated at 25% of a presumed profit of 8%) as withholding tax. There is also a 0.38% IOF tax on the exchange rate conversion.
The effects of the ruling are not entirely clear. In principle, it represents an 11% percent increase in the rate of corporate income tax for the local representative office of admitted reinsurers, plus the application of 4.65% PIS/COFINS. However, the ruling also raises difficult questions about application, not least because it anticipates taxing the local service office for the gross premium generated by admitted reinsurers even though, as set out above, these payments are not channelled through the account of the local representative and are normally taxed overseas.
The new ruling is also problematic because it is binding as of the date of its issuance and it is generally not subject to appeal. It is also potentially retrospective for five years, since it is not a new law but the clarification of an existing law. Furthermore, in the event the local representative offices of admitted reinsurers cannot calculate their profit under the rule on a retrospective basis (which is difficult since by its nature it is a service office) the default position is that it could potentially pay tax at a rate for ‘arbitrated profit’ of 45% on turnover, pursuant to a separate Brazilian tax regulation.
At the end of June 2017, a meeting took place between representatives from SUSEP, Fenaber and the tax regulator. Although no formal written decision has been made, there is some hope that these three entities may arrive at a consensus whereby the status quo prior to the publication of the PLR will be re-instated, however the timeline for any definitive solution is likely to be lengthy.
In the meantime, admitted reinsurers conducting business in Brazil have been advised to revisit their current activities, agreements, practices and guidelines to assess the scope of the powers of attorney of their representatives in Brazil vis-à-vis this PLR, in particular in the interests of narrowing down or limiting the scope of such powers (legal footprint, scale and scope of operations, assets and headcount in the ground in Brazil). The consensus is that this could assist reinsurers in any potential litigation.
The decision has done much to further shake the confidence of international investors in the Brazilian reinsurance market. Some admitted reinsurers may consider scaling down their operations and focusing their resources on other Latin American jurisdictions like Chile where doing business is much easier, and Argentina, which is under-going positive regulatory change. This recent tax development has also led to speculation that the three license model is coming under pressure. The recent IPO of the IRB may also change the dynamics in the sense that there may be greater emphasis on the free market, which would be welcomed by the international investment community.