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HMRC internal manual

General Insurance Manual

Reinsurance and other forms of risk transfer: financial reinsurance and alternative risk transfer (ART): tax treatment

The absence of clear-cut accounting and regulatory guidance can make the correct tax treatment of reinsurance, financial reinsurance and ART products generally difficult to determine. The starting point for their tax treatment is in accordance with normal trading income principles. That is, the profit or loss for tax purposes is the profit or loss of accounts drawn up in accordance with UK generally accepted accounting practice (GAAP) disclosing a true and fair view of the company’s results, subject to any specific tax rule of law (FA98/S42, re-enacted as ITTOIA05/S25 and CTA09/S46). This principle is, however, rather more difficult to apply in this area than in some others.

First, it cannot be assumed that the accounting treatment actually applied to financial (re)insurance transactions necessarily accords with the ABI SORP (Statement of Recommended Practice). In the past, financial (re)insurance and ART has been used to distort profit figures and balance sheets, and to mislead shareholders, members of Lloyd’s syndicates, regulators and fiscal authorities (see GIM8220). This remains a high risk area. Particular risk areas are complexity (which may be tactically and unnecessarily exaggerated, in other words obfuscation) and a tendency for the primary contract to be supplemented by side letters or subsidiary agreements. Although FRS5 (see GIM8270) makes it clear that the effect of such side letters is to be taken into account, it can be difficult for an auditor to be sure that all the relevant material has been made available.

Secondly, the issue may turn on the distinction between capital and revenue account, and this is a question of law rather than accountancy, for the reasons explained at BIM30000+. Capital expenditure may also be disallowable by virtue of ICTA88/S74 (1)(f), re-enacted as ITTOIA05/S33 and CTA09/S53. This will only be relevant where the contract is accounted for as giving rise to premiums taken to the profit and loss account, and not where FRS5 requires the contract to be accounted for as an asset or liability.

Thirdly, the use of such words as ‘significant’ and ‘material’ in the accounting guidance affords ample scope to account for contracts as insurance where there is very little risk transfer. As a result the figure of accounting profit may be less than the ’full amount of the profits’ for the year within in the meaning of ICTA88/S70(1), re-enacted as ITTOIA05/S7 (1) and CTA09/S8 (3).

Fourthly, in some contracts there is a significant transfer of timing risk, but no transfer of underwriting risk. The question then becomes one of whether the contract is really one of insurance at all (GIM8290).

It is thus difficult to lay down clear rules for the tax treatment of financial insurance and reinsurance. Where it is clear that a contract involves a significant transfer of both underwriting and timing risk, and premiums and claims have been treated as revenue items in the accounts, the accounts should be followed for tax purposes. For example, ordinary loss portfolio transfers.

Where the product is a derivative contract falling within FA02/SCH26 (which will be the case with weather derivatives in particular), that should be enough to determine the tax treatment (GIM5140).

GIM8310 offers guidance on enquiries.