Controlled Foreign Companies: exemptions - Exempt Activities Test ('EAT'): Insurance companies
The application of ICTA88/SCH25/PARA6(2)(b) (wholesale, distributive, financial or service business) is modified in relation to controlled foreign companies engaged in insurance business (as defined at (g) of INTM254890). The modifications are that -
- the gross trading receipts to be regarded as derived from connected or associated persons (see INTM254410) or persons who have a 25% assessable interest in the company (INTM254390) for the accounting period in question are those attributable, directly or indirectly, to liabilities undertaken by the company in relation to those persons or their property;
- the only receipts to be taken into account are commissions and premiums received under contracts of insurance, subject to the deduction of
i) so much of any commission or premium as is returned by the company to the payer; and ii)where any liability is reinsured by the company, in whole or in part, so much of the premium under the reinsurance contract as is attributable, directly or indirectly, to that liability, and
- certain types of premium received under ‘pooling’ arrangements are left out of account, see below;
- the extension to unconnected UK persons (for accounting periods beginning on or after 27 November 2002) does not apply to insurance companies that provide most forms of life assurance or insure ‘large risks’.
The term ‘indirectly’ in (a) and (b) above covers situations where the insurance of the risks of the associates of a controlled foreign company is ‘fronted’ through a third party. For example, the risks of the company’s United Kingdom parent may be insured with an independent insurer which in turn reinsures its liabilities with the company. The premium received from the independent insurer will be indirectly derived from an associated or connected person and should be treated accordingly.
The effect of the special basis of computing the trading receipts of companies mainly engaged in insurance is that a captive insurance company cannot satisfy the exempt activities test if 50% or more of its business is derived from carrying the risks of connected or associated persons. The computation of gross trading receipts (which are net of reinsurance premiums attributable to liabilities, see (b)(ii) above) will normally use the same income recognition basis as is applied in the calculation of chargeable profits. If, in any particular case, the accounting periods or basis of establishing receipts have been manipulated for non-commercial purposes, HMRC will consider the consistent application of the appropriate basis in the context of the requirements of the test.
Pooling arrangements - ICTA88/SCH25/PARA11(7)-(9)
Some insurance companies which are connected or associated with each other operate various types of group pooling and reinsurance arrangements. For example, a controlled foreign company insuring the risks of a third party might reinsure 20% of its risk with each of four associated companies (all controlled foreign companies) so that it was directly at risk only in relation to the 20% which it had retained. The premiums received by the associated companies in respect of the partial reinsurance will be receipts directly derived from a connected or associated person and will be treated accordingly for the 50% receipts test.
However, in limited circumstances premiums received by a company under pooling arrangements similar to that described above may be regarded as derived from persons not connected or associated with the company. The receipts to be treated in this way are those received under a ‘local reinsurance contract’ which are attributable to liabilities which -
- are undertaken under an insurance contract (other than a reinsurance contract) made in the territory in which the company is resident; and
- are not reinsured under any contract other than a local reinsurance contract; and
- relate either
i) to persons who are resident in that territory and are neither connected nor associated with the company, or ii) to property which is situated there and belongs to persons who are not connected or associated with the company.
A ‘local reinsurance contract’ means a reinsurance contract
- which is made in the territory in which the controlled foreign company is resident; and
- the parties to which are companies resident in that territory.
The territory of residence of a company for the above purposes is to be determined in accordance with ICTA88/S749 or ICTA99/SCH15/PARA5(2) (see INTM254400) where the company has no territory of residence under the ICTA88/S749 rules. In order to apply these statutory tests of residence a company should if necessary be assumed to be a controlled foreign company.
Excluded UK business - ICTA88/SCH25/PARA 11A and 11B
As noted above, the application of the exempt activities test was modified for accounting periods commencing on or after 27 November 2002 (see INTM254850). However, two types of insurance business have been identified which will not be subject to the additional class of persons with whom business is restricted.
The two types of insurance business identified are:
- the provision of most forms of life assurance business
- the insurance or reinsurance of large risks by insurance groups
The life assurance businesses covered by the exemption is the business of effecting or carrying out a contract of long term insurance which falls within the Financial Services and Markets Act definition (a non-taxation statute applicable to insurance companies). However, for the purposes of FA03/S200 [and SCH42] this definition is restricted to exclude protection business, or the reinsurance of protection business.
Protection business in this context means that either the contract has no surrender value or it is a contract that has no surrender value in excess of the single premium due. However, if a provision in the contract means that it can be converted so that this definition will no longer apply, then that is also accepted as falling outside the scope of protection business.
A contract will have no surrender value in excess of a single premium only when it is not capable of meeting this requirement from the outset, or could not reasonably be expected to meet this requirement. A single premium investment product will not fall within the definition of protection business simply because market fluctuations have reduced its current investment value to less than the original premium.
For the purposes of the second specific exclusion, the controlled foreign company must be a member of an insurance group. In this context, an insurance group is one whose ultimate parent would qualify as the parent of an insurance group as defined in section 1165 of the Companies Act 2006, or would do if it was a UK resident company. Section 1165 of the Companies Act is deemed to be extended for this purpose to include companies resident in Northern Ireland.
The Companies Act definition of an insurance group applies where:
- the parent company is itself an insurance company or
- the parent carries out no material business apart from managing its subsidiary undertakings and its principal subsidiaries are wholly or mainly insurance companies.
The second exclusion is also limited to certain qualifying business activities of the controlled foreign company. A controlled foreign company will only qualify for the exclusion if its main business is the effecting or carrying out of insurance business and 50% of whose gross trading receipts from that business derive from insuring or reinsuring large risks.
Large risk is defined using definitions found in general insurance law. This definition is the same as that used in the Financial Services and Markets Act 2000 (Law Applicable to Contracts of Insurance) Regulations 2001 (SI2001/2635) and that in turn is derived from the definition in Article 5 of the first EC Non-Life Directive. They are:
All cases of the following risks:
- Railway rolling stock
- Goods in transit
- Aircraft liability, Liability of ships
All cases of the following risks where the policies relate to a business carried on by the policy holder:
- Suretyship (broadly providing guarantees)
All cases of the following risks where the policy holder carries on a business which is not a small or medium sized enterprise (which is defined below):
- Land (motor) vehicles
- Fire and natural forces
- Damage to property
- Motor vehicle liability
- General liability
- Miscellaneous financial loss
A business is not a small or medium sized enterprise for this purpose if it passes at least two out of three arithmetical tests:
- a balance sheet total over 6.2 million euros
- turnover over 12.8 million euros
- number of employees over 250
These annual limits are reduced if the policyholder’s financial year is in fact less than a calendar year. The terms used in setting the limits are themselves defined by reference to the Companies Act 2006 or the Companies (Northern Ireland) Order 1986. Where it is necessary to convert accounts to euros, the exchange rate to use is the relevant London closing exchange rate for the last day of the period to which those accounts relate.
Special rules apply to address consolidated accounts or joint venture income, both of which can be used in aggregate when applying the arithmetical tests.