The Organisation of Economic Co-operation and Development’s (OECDs) guidance introduced in 2015 shows a misunderstanding of the captive insurance industry, according to panellists at the European Captive Forum in Luxembourg.
Jenny Coletta, tax partner at Ernst & Young, explained that HMRC guidance to the UK’s Diverted Profits Tax, introduced in 2015 in response to the OECD base erosion and profit shifting (BEPS) project, says that if a multinational can’t buy insurance in the local market, then using a captive isn’t a commercially rational because you can’t find an open market comparable that would sell you that insurance locally.
According to a Coletta: “This is obviously a complete misunderstanding of the entire industry given that many groups using captives are doing so because they can’t use the local market due to capacity constraints or because it isn’t offering the solutions that they need."
She continued: “The misunderstanding of captives really goes to the heart of a lot of the tax authority challenges we’re seeing across the OECD."
Even though the BEPS project largely completed at the OECD in 2015, an initiative that the OECD is continuing to work on is the new Financial Transactions Transfer Pricing Paper, which, once finalised, will become a new chapter in the OECD transfer pricing guidelines. The guidelines are used by all member states and a lot of observer states.
The paper targets treasury-type arrangements, guarantees and so on but there is also a section on captive insurance. Coletta explained that it has been a long-term aim of the OECD to get out some guidance on the transfer pricing of captives.
Coletta questioned why it was necessary to put out more guidelines for transfer pricing specifically for captive insurers when there is already a lot of material in other OECD guidelines that enable tax authorities to challenge captives in the same way they can challenge other types of companies.
She stated: “[The OECD] seem to feel that they need to do something and that’s been largely driven by some of the member states. The transfer pricing paper asks if a captive really is a bonafide insurance arrangement, or is it just an offshore ‘money box’ with premiums just accruing and no real reason for that entity within it.”
“The draft doesn’t recognise some of the commercial reality and does not understand the captive industry. Thankfully, it was a discussion draft for public consultation.”
After the consultation comment date, over 1,200 pages of response was contributed to the industry and various companies.
Coletta noted that on the paper as a whole, “most of the commentators also made some comments on the captive section”.
Praveen Sharma managing director global practice leader, insurance regulatory and tax consulting at Marsh, also weighed in suggesting that the OECD’s consultation document didn’t recognise some of the commercial rationale and reasoning behind what a captive owner faces.
Sharma explained that the OECD kept asking if there should be some indicators that need to be introduced to judge whether a captive is a commercially viable proposition.
He said: “There is already legislation addressing the issue as to whether there is a contract of insurance and the captive would have to fulfil those accounting standards in order to justify its existence.”
According to Sharma, companies need to take a proactive approach, and make sure there is an objective for the captive.
On the topic, Coletta concluded that “there is a lot to do in getting that chapter right and getting the captive representation correct”.
She said: “I don’t believe captives should be singled out, but if the OECD want to do that, they need to get it right.”
A further draft of the consultation will be discussed by the OECD working party this month and then published in Spring next year.
According to Coletta, it is possible that there will be another consultation on the paper next year.
