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HMRC internal manual

General Insurance Manual

Reinsurance and other forms of risk transfer: tax issues: transactions between connected persons: parent funding subsidiary

A parent may put additional finance into its subsidiary by entering into a stop-loss reinsurance treaty (GIM8090).

This may be done initially for non-tax reasons. If the subsidiary’s solvency margins or capital requirements are based on exposure net of reinsurance the parent does not need to put so much capital into the subsidiary. There may also be a hidden subsidy if the premium charged is less than the arm’s length rate. The difficulty here is that stop-loss protection on the scale needed is difficult to obtain in the open market, so both sides may experience problems in finding comparable unconnected transactions.

An independent underwriter would use a methodology known as burning cost in such situations, which analyses the ratio of the reinsurance losses incurred to the ceding company’s subject (inward) premium. Intra-group stop-loss arrangements are higher risk where they are entered into after the subsidiary has incurred substantial losses, in which case there may be grounds for denying a deduction for any amounts paid under ICTA88/S74 (1)(e), re-enacted as ITTOIA05/S34 (1)(b) and CTA09/S54 (1)(b). In the past most such cases have been settled on transfer-pricing lines.