GIM11060 - Captive insurers: taxation issues: possible approaches
There are a number of possible approaches to the taxation of captive insurers.
Residence
Few captives are UK resident (see GIM11020). Those that are may still exhibit risks, for example in relation to
- possible advantages of suggested mutual status (see GIM9140)
- the size of premiums charged to affiliates, and the related claims provisions.
It is also possible that a non-UK captive may be brought onshore. It may be incorporated in another jurisdiction but become resident in the UK by virtue of central management and control being exercised in the UK. This may be to avoid another EU country’s equivalent to the UK’s CFC legislation (INTM190000). Advice on ‘central management and control’ should always be sought from Business International.
Trading in the UK
The extent of the work performed by a captive insurer in the UK may suggest that it is trading in the UK through a branch or agency. Regulatory legislation refers to ‘effecting and carrying out’ contracts of insurance as a regulated activity, as distinct from ‘services business’ which is written from overseas and not through a permanent establishment. The distinction is similar to ‘trading in’ and ‘trading with’, and a company without authorisation (from the FSA, or under EEA ‘passporting’ arrangements) would be trading illegally and would resist strenuously the proposition that it was trading in the UK..
There is some (non tax) case law guidance. In Stewart v Oriental Fire and Marine, (1985) 1QB 988 the court looked at what the business consisted of and where it was carried out, where in fact the contracts were made. It held that the ‘effecting’ involved more than the executive decision to accept the business and comprehended the offering of the services, setting premium levels, negotiating terms and accepting risks. More recently, the House of Lords (Lord Goff) has confirmed that, for regulatory purposes and ‘effecting’ contracts, it is necessary to look at the business as a whole, rather than where contracts are formally made - Scher v Policyholders Protection Board [1994] 2 AC 257.
The domestic charge on trading in the UK may be modified or eliminated by a treaty with the company’s territory of residence. It may be that the charge only arises where profits arise through a permanent establishment, which is a stricter test than under domestic law. In practice, though, it is unlikely that an insurance company carrying on business in the UK would not possess a UK permanent establishment. See GIM10121.
Captives reinsuring risk into the UK are buying UK services, and this does not imply that the captive is trading in the UK.
Deduction of premiums
Wherever the captive is resident, contributions to the assets of captive insurance companies in the form of premiums will normally qualify for tax relief in the same way as any other payments for insurance. Provided the policy issued by the captive covers genuine risks for arm’s length premiums, and that the captive has sufficient resources to meet potential claims, a challenge to the deductibility of premiums solely on account of the relationship between the parties is unlikely to succeed.
Occasionally it may be that the payment is not made wholly and exclusively for the purposes of the insured’s trade: CTA09/S54, formerly ICTA88/S74 (1)(a), as where for example:
- negligible risks are insured against
- policies are taken out which the captive has no hope of honouring should the insured contingency actually arise
- premiums exceed the market rate, or
- insured losses may not be claimed.
In particular, to be an insurance contract there has to be a ‘significant’ transfer of insurance risk. This may not be present in the case of certain ‘finite’ or ‘financial’ reinsurance contracts. See GIM8000+.
Transfer pricing
The transfer pricing rules in ICTA88/SCH28AA may apply where there is a risk that the arrangements are not on an arm’s length basis. The question is not what the group would have paid for similar insurance to a commercial provider, but what on an arm’s length basis would be paid for the cover the captive can provide on the facts and circumstances of the case. This might reflect, for example, limited diversification and resources, limited experience (or use of an external manager) limited local regulation and spread of risk. However, the arguments are difficult and should not be undertaken without a strong risk pointer. See INTM430000+. The International Issues Manager and/or local Transfer Pricing Specialist should be consulted before opening enquiries.
Capital
In the early stages of a captive’s existence when resources are limited and there is a need to build up reserves speedily, it is also possible that the premiums are capital payments with a view to bringing into existence an asset of enduring benefit to business, namely a reserve fund to provide against future contingencies.
Controlled foreign companies
See INTM190000.