In Europe, the Kvaerner ruling set a legal precedent that companies must allocate premium to where the risk is located. Praveen Sharma examines the challenges and offers some helpful suggestions
Calculating premium for tax purposes is a major challenge for companies. Insurance premium tax (IPT) rates vary between countries: the US has 50 different regimes alone. The calculation can be huge and complex. It may be straightforward for a simple property programme, but much more difficult for liability programmes such as directors’ and officers’ liability (D&O).
Setting premiums on a ‘punish and reward’ basis may also be difficult. Additionally, transferring claims payments into a foreign country introduces another major tax consideration. In some countries, if a company wants to reimburse its foreign subsidiary, it could prove difficult. For example, Brazilian legislation will not allow nationalisation of foreign capital from insurance indemnities. Elsewhere, the authorities may treat the insurance payment as a new capital injection and tax it accordingly.
For many years, global insurance programmes have been structured in a way that in the present climate may be perceived to be inappropriate or inadequate. Local policies were arranged in jurisdictions where either compulsory or non-admitted insurance was strictly prohibited, such as employer’s liability or any risks located in the BRIC countries. Where either the conditions or the limits proffered by insurers on the local policies are inadequate, an umbrella or difference in conditions or limits (DIC/DIL) policy is arranged at group level, in most cases, with a non-admitted insurer(s) to cover the risks of all subsidiaries within the group.
Generally premium taxes are only paid on the local policies and either some or no premium taxes are paid on the relevant portion of the premium covering risks located in overseas territories (where non-admitted is not permitted) under the umbrella or DIC/DIL policies.
Is this approach strictly correct? Perhaps not wholly in the eyes of the tax authorities.
Premium related taxes
The 2001 European Court of Justice (ECJ) judgment on Kvaerner plc v Staatssecretaris van Financien was a landmark decision, as it clarified the circumstances under which premium taxes must be paid – particularly in the European Union, and emphasised the concept that location of risk rules must prevail. According to the judgment, notwithstanding which group entity arranged the master policy, paid the total premium or whether or not it was recharged to the overseas group companies, insurance premium tax must be paid, on the relevant portion of the premium, in the country in which the risk is located.
Depending on the class of risk, multinational companies should note that in addition to insurance premium taxes, there could be other types of taxes that they may be required to pay, such as excise tax, fire brigade charges, stamp duty and withholding taxes. The local insured may have to pay some of these taxes directly to the tax authorities, particularly if non-admitted insurers are used on the programme to cover the local risks, such as 4% federal excise tax in the US, 10% excise tax in Canada or 3% withholding tax in Australia.
Premium allocation methodology
How much premium related tax is payable depends on the premium allocation methodology applied by the multinational company and the global insurers. As mentioned above, notwithstanding which group company has arranged the global programme or paid the premium, the premiums should be allocated by reference to the location of risk.
Unfortunately, rules governing the location of risk vary and depend on the class of risk in question and the country in which it is located. Generally, for instance, property risk is located in the country in which it is physically situated. For liability classes of risk, it is generally regarded as being located in the country where the entity to which the policy relates is established.
There is no specific legislation for allocating global premiums. Some tax authorities have provided a basic guide – for instance, in the UK tax authorities have suggested that premiums for D&O could be allocated using headcount. The tax authorities generally expect the allocation methodology to be ‘just and reasonable’, and consistent with underwriting principles.
Many multinational companies and global insurers frequently take a simplistic approach to allocating premiums: for instance, a single factor is applied to allocating premiums, such as turnover for general liability policy. Multinational companies should review this approach and consider whether their current simplistic methodology is equitable or just and reasonable. Would it be more appropriate to apply a number of relevant factors, rather than one single factor, such as territorial or operational factors, claims history and capital employed, when allocating premiums for a particular class of risk? Whatever method is applied, multinational companies should document their allocation methodology and justification for any assumptions applied at the time of the annual renewal.
Whether or not premiums are allocated for determination of the premium related tax liability, the practice internally within multinational companies to recharge the premium (and related taxes) to the overseas group subsidiaries and associates varies greatly.
Whatever the internal reasons, multinational companies should note that, strictly speaking, tax legislation does not generally permit tax relief on premiums relating to risks located overseas. Conversely, the overseas entities would not be able to claim relief for their portion of the premiums unless the premium expense is incurred and shown as an expense in their respective tax computation.
Therefore, in order to ensure tax relief on premiums, multinational companies would need to recharge the respective portion of the premiums to their overseas entities covered under the global policy. However, if non-admitted is not permitted in a particular country, then it may be difficult to either recharge the expense or get tax relief thereon in that country.
Once a programme has been put in place, other tax issues do not generally become apparent until there is a large loss suffered by an entity – resident in a country where non-admitted is not permitted – and the loss is greater than the limits under the local policy. In such instances, the global insurer would normally pay the loss under the umbrella/DIC/DIL policy to the parent company.
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