Non-resident insurers: scope of UK taxing rights: section 11 ICTA & Article 7 OECD Model: OECD Report on the Attribution of Profits: Step 1 - determining the activities and conditions of the hypothetical distinct and separate enterprise:
The starting point is that the assets representing provisions and surplus are primarily required to support the insurance risk assumed. Two approaches to asset allocation are discussed, plus a third ‘safe harbour’. Assets used in the insurance business and referred to here as investment assets are widely defined in the OECD Report and include assets which are not investment assets in the usual sense, but will be convertible to cash in the short term, such as reinsurance receivables. The meaning of assets here does not necessarily equate with assets which qualify as regulatory ‘admissible’ assets.
Capital allocation approach
This assumes that
- the investment assets support the whole business
- the sum of the attributable investment assets equates to the total investment assets, rather than the regulatory minimum
- allocation should be in proportion to the insurance risk assumed by each part of the enterprise
- there is no inherent reason to allocate to Head Office
- diversification benefits are recognised (so reduce to proportions of the whole, rather than the sum of the individual amounts).
As there are no agreed standards for insurance activity, ‘keys’ or proxies must be used Suitable keys might be technical provisions, premiums or regulatory parameters such as solvency margins, depending on the facts and circumstances. Alternatively, a hybrid approach might be used, borrowing from factors used in the thin capitalisation approach following.
Thin capitalisation (or adjusted regulatory minimum) approach
This seeks to determine the investment assets by reference to those assets which would be required by an independent company with similar activities, assets and risks in similar conditions, analogous to the thin capitalisation approaches applied to banks. This involves undertaking a comparability analysis, having regard to the size of the permanent establishment but also placing it in context of the size of the supporting enterprise, taking account of
- the capital of the enterprise as a whole
- the minimum amount of capital the host regulator would require for an enterprise carrying on similar activities in similar conditions
- the range of capital amounts of independent insurance enterprises required by regulators of enterprises carrying on similar activities in similar conditions (including the assumption that generally the establishment has the same credit rating as the enterprise as a whole), reflecting the fact that requirements are generally above the regulatory minimum.
Quasi-thin capital approach
This is the ‘safe harbour’ that looks at the regulatory minimum amounts. It may be encountered, but is not considered a suitable method in the UK.
Attribution of assets - resolving differences
Alternative capital allocation or thin capitalisation approaches may lead to international differences. The OECD Report lays down principles which need to be applied flexibly and according to the facts and circumstances to produce the best arm’s length result. The Mutual Agreement Procedure may be invoked to resolve differences - see INTM470010+. HMRC offices should refer cases to the Competent Authority in Business International.