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HMRC internal manual

General Insurance Manual

Reinsurance and other forms of risk transfer: tax issues: connected persons: captive reinsurance

In general, the problem of captive reinsurance is tackled in much the same way as any other form of captive insurance (see GIM11000+). And, as with captive insurance, the potential application of both the CFC and the transfer pricing legislation should be considered.

For instance, the reinsurer may be inadequately capitalised, in which case an arm’s length cedant would probably not enter into the transaction at all, or would expect to pay a lower premium than usual. And even where is it properly capitalised it may be charging over the normal premium. In either case the transfer pricing legislation may be relevant.

Captive reinsurance fronting

Apparently unconnected reinsurers shown on the FSA (regulatory) return may be captives for which the company is fronting. A fronting transaction is where the insurer acts as a mere conduit for insurance placed elsewhere.

This may be done, for a small turn, to conceal the link between a policyholder and a captive insurer, or to obtain the benefit of a double taxation treaty to which the retrocessionaire would not otherwise be entitled.

Fronting may also be used for types of business where there is a statutory requirement that the risk be insured with a domestic insurer, for example third party risks in motor insurance. Where information is obtained which makes it possible to identify a UK company or group that is using a UK-based insurer to front for a captive or an offshore insurer that is providing rent-a-captive or financial insurance facilities, a report should be made to the HMRC office dealing with the company or group in question.

In the past, fronting has sometimes been implicated in obtaining the benefit of a UK insurer’s entitlement to exemption from US Federal Excise Tax (FET). This US tax is (in particular) levied at 1 per cent on premiums paid in respect of US-situated risks to non-US reinsurers who are not trading through a permanent establishment in the USA and who would not otherwise be liable for US tax. There used to be a UK/USA double taxation treaty waiver for UK resident insurers, but this gave rise to US concern over possible conduit abuse. The 2001 US-UK treaty (effective in US 2004), uniquely among US treaties, contains a specific anti-conduiting rule in place of a qualified waiver that usually applies elsewhere. This rule operates a two-pronged test, both objective (if the income is paid on to a person with lesser treaty benefits than under UK/US) and subjective (for the purpose of obtaining increased benefits).

Where business which includes US risks is reinsured under an excess of loss policy the US business loses its identity as such and the FET exemption is unlikely substantially to affect the premiums paid to the reinsurer. On the other hand, where US business is separately reinsured to a substantial extent the UK insurer may be fronting the business for the reinsurer. Reinsurance of specific risks or of lower rather than upper layer of exposure is a particular tax risk. A US ruling in 2008 caused a particular problem for UK reinsurers, as it suggested that FET should be applied on a cascading basis. A UK reinsurer might commercially retrocede (say) into Bermuda and the risk might be retroceded further. The US Code places the primary responsibility for the tax on the payer of the premium, but this is relieved if under a closing agreement the foreign reinsurer accepts responsibility for administration, as is common. It follows that a UK reinsurer in this position may become liable if successive retrocessions are outside waiver.

See also GIM12070.