With the release of the long-awaited base erosion and profit shifting (BEPS) action plan by the Organisation for Economic Co-operation and Development (OECD) in October 2015, the focus of the captive industry has been to understand what the impact of these measures is likely to be.
With the release of the long-awaited base erosion and profit shifting (BEPS) action plan by the Organisation for Economic Co-operation and Development (OECD) in October 2015, the focus of the captive industry has been to understand what the impact of these measures is likely to be.
Although considered by some as the next big challenge to the captive industry, there is still some uncertainty as to what the impact will be.
What is BEPS?
The primary objective of the BEPS package is to renovate international taxation rules and combat tax strategies aimed at artificially shifting profits to low- or zero-tax jurisdictions, and to promote fair and equitable tax treatments on an international basis. The BEPS package aims to achieve this by: taxing profits where value is added; improving substance arrangements; and improving tax strategy transparency globally.
The measures that are contained in the BEPS package are not altogether new. In essence, the BEPS package is attempting to bring together many of the recent international tax initiatives into one cohesive, global package that is ‘fit for purpose’ for an interconnected global economy. This should generally be regarded as a positive development.
Are captives affected by BEPS?
Although ostensibly a tax reform initiative aimed at large multinational corporations, the measures introduced by the OECD BEPS package represent a material challenge for the captive industry. Captives have been specifically referenced in BEPS documentation as potential vehicles for tax avoidance and very much in-scope for BEPS related scrutiny.
This—together with the fact that many captives are located in jurisdictions with lower corporate tax rates than that of the group headquartered, and that many captives are managed on an outsourced basis—means the common captive operating model may appear misaligned with BEPS expectations.
In practice, the areas in which a captive will likely be scrutinised are:
How can the industry respond?
Education is key to the captive response to BEPS. It is clear from the references to captives in the various BEPS releases to date that the OECD and tax community do not understand captives to the fullest extent. But nor should this be expected.
To the untrained eye, the value a captive generates can be fully deduced from the captive’s financial statements—reducing external premium spend and accumulating underwriting profits in the sometimes lower-tax jurisdiction.
In this context, it is unsurprising that captives are in the scope of BEPS scrutiny. However, the captive community will know that this is a binary view of what is a multi-dimensional risk management tool. The value created by a captive cannot be captured in solely quantitative or financial terms. The qualitative, strategic, sometimes nuanced or indirect benefits must also be factored in to the equation.
Quite simply, imagine the captive did not exist: would the risk department be able to influence risk management discipline in the same way? Would the same level of control and oversight of claims data be available? Would the group be in the same position to negotiate with the market?
The answer to each of these questions is likely to be ‘no’.
These are all legitimate examples of value created by the captive that an income statement will never detail, but which need to be put forward as part of the economic rationale for utilising the captive and aligned to profits generated.
This is not really anything new. Captive owners will appreciate that it is not uncommon for various departments within the group to occasionally query the value of the captive.
But in almost all cases, when educated on the numerous benefits that it provides the group, the challenge quickly disappears.
However, given the depth and breadth of the challenge BEPS poses to the captive industry, the community as a whole and at every level needs to respond to this challenge:
Lobbying efforts have already begun with some organisations seeking dispensations for captives. It remains to be seen how successful such efforts will be, and it could be argued that suggesting captives are a ‘special case’ may not be the best approach to take. Taxation frameworks are generally not accommodating to exceptions or special cases that could then be misused.
The important point is that the vast majority of captives will be able to rise to the BEPS challenge and demonstrate that the profit accrued in the captive is justified and based on quantitative and qualitative benefits.
Captives are set up for legitimate reasons and play a vital role in promoting good risk management discipline and risk governance. In many cases the captive is subject to more regulation, compliance and governance requirements than other parts of the group. These are arguments that need to be made.
Undeniably does BEPS represent a significant challenge to the industry, but it also represents an opportunity for captive owners and captive managers to highlight the strategic benefit captives provide, some of which may not be fully appreciated within the group, and for the industry as a whole to do likewise.
BEPS will compel the captive community to be more vocal in the articulation of the unique value that a captive strategy can provide, the positive effect it has on the risk management of multinational organisations and the important role it plays in the overall insurance landscape.
