LAM12200 - International and cross border: Transfer pricing
The provisions of TIOPA10/PART4 apply as normal to life insurance companies. Transfer pricing aims to ensure that the profit arising in the UK is commensurate with the value added from UK activity when taking account of functions performed, assets used and risk assumed. Intragroup transactions should be priced on an arms-length basis which would be agreed between independent parties.
There are particular considerations to take into account for life companies in UK to UK transactions:
- intragroup recharges at cost: Where regulatory constraints mean that a mark-up on cost cannot be added between, for example a with-profit fund and a service company in the same group
- differential tax rates: Where income and expenses may be subject to different effective tax rates. This could be due to part of the expense being deductible in the FA12/S68 I-E computation as a management expense at 20% with income taxed at the normal CT rate of say, 17%.
The other specific area of transfer pricing risk relates to intragroup reinsurance. Reinsurance is a normal feature of the insurance market and is used as a capital management tool by the industry. The impact of reinsurance intragroup can often be to shift a share of the profits offshore and therefore it is an important area to review.
Further information on reinsurance is at LAM10000 onwards.
Intragroup recharges at cost
Insurance companies regulated in the UK have restrictions placed on their activities by the PRA and the FCA (or EEA equivalents). The PRA Rule book 9 ’Conditions Governing Business’ states that (for Solvency II firms) an insurance firm:
‘…must not carry on any commercial business other than insurance business’
This results in insurance groups (for example if they are covered by Solvency II) often being required to set up separate entities to carry out, for example, shared service activity which includes services to other group members. The insurance company would risk breaching the rule above if it was carrying out a service business alongside insurance activities.
In addition, many life insurance companies have with-profits funds where charges into the fund are subject to regulatory scrutiny, to ensure that policyholders are not being overcharged by shareholder companies.
Historically, many life companies charge for services into their life funds on the basis of cost, without any mark up for profit. Although this is not necessarily accepted as arm’s length in other circumstances, it has been generally accepted as the basis for charging into life companies. This is because the charging basis has been agreed with the regulator or been subject to some regulatory scrutiny or constraint and would normally be a charge into a with-profits or similar fund where the policyholder interests are predominant.
This was reflected when the transfer pricing provisions were originally introduced. During the passage of the Finance Bill through Committee Stage in 1998, the Paymaster General said:
“The right hon. Member for Wells referred specifically to the question of life insurance companies having to observe certain regulatory constraints. I want to give him a formal assurance again that the Government recognise that the special regulatory constraints to which life insurance business is subject can dictate the way in which a group’s activities are structured and the price of intra-group transactions. In such circumstances, the Inland Revenue is prepared to accept that recharging at cost is likely to be a normal commercial practice and will not seek to adjust the company’s tax liabilities on the basis that normal management services provided by another company should be appraised at more than cost. That is a specific assurance on the point he raised about a management company dealing with a life insurance company and providing services across the board.
… We sympathise with the life insurance industry, which should not be disadvantaged in any way by falling within the too narrow respects of the transfer pricing regime. Such measures are necessary to prevent tax avoidance.”
Hansard Finance Bill Standing Committee E, 9 June 1998 Afternoon Pt I
If there are concerns that the transfer pricing may not be appropriate, understanding the regulatory position is likely to be a good starting point. HMRC may challenge particular cases where the arm’s length position differs from the regulatory position, however such instances are likely to be fairly rare in practice, and should be based on a thorough analysis of the facts and circumstances of the case. It is not possible to provide an exhaustive list of such circumstances. Note that varying regulatory rules may apply for example to smaller insurers, Friendly Societies and mutuals.
Where a service company provides services group-wide, consideration may need to be given as to how the benefit of scale (often provided by the life company) should be taken into account in other recharges.
Differential rates of tax
Generally, a UK – UK transaction may be regarded as low risk where there is a limited risk of tax loss to the UK exchequer where both entities are within the UK CT net. This does not, however, relieve taxpayers from the obligation to self-assess on an arm’s length basis in accordance with TIOPA10/PART4.
However, as BLAGAB profits in the I-E calculation may be subject to tax at the policyholder rate, charges into the life company may be deducted at a different rate to the income in the service provider. Historically, policyholder and CT rates have varied with CT rates being higher than policyholder rates until financial year 2014. In FY 2017, CT rates at 19% fell below the policyholder rate which is linked to the basic rate of income tax of 20%.
The regulatory constraints on charges to the UK life company make any transfer pricing manipulation less likely and this tax rate differential should only be considered if there are reasons for concern.