INTM489445 - The Unassessed Transfer Pricing Profits Examples: Example 12 - Intragroup fronting

Facts

  • The group is a multinational insurer with an extensive network of insurance companies around the world.
  • A UK company in the group, Company A, has a substantial insurance business but does not have any expertise or experience in underwriting product X.
  • Product X is a core offering of the underwriting company resident in a low tax territory, Company B.
  • All of the underwriting function for product X is undertaken by Company B.
  • Company A fronts the insurance contracts relating to product X and the risk is 100% reinsured to Company B. Company A undertakes the necessary risk management activities to meet local regulatory requirements and provides contract administration assistance.
  • Company A receives a fronting commission for its activities from Company B which HMRC considers is less than the arm’s length amount.

Analysis

  • The provision is the fronting services provided by Company A to Company B.
  • There are unassessed transfer pricing profits because Company A is receiving less than the arm’s length reward for its services.
  • There is also an ETMO because although Company B recognises the full profits that correspond to the unassessed transfer pricing profits, it is located in a low tax territory.
  • Considering the TDC, Company A does not have the expertise to underwrite product X business and its function with regard to product X is restricted to the functions required to meet the local regulatory requirements. It is reasonable to assume that the fronting arrangement is designed to enable the producing company to underwrite UK risks and not to secure a UK tax reduction.
  • In considering whether it is reasonable to assume that the structure of the arrangements giving rise to the unassessed transfer pricing profits, are designed to avoid or reduce a charge to UK corporation tax, it is important to consider what reduction of tax would have been expected.
  • One way in which a tax reduction will arise in fronting arrangements, is if any of the profits of the overseas underwriter Company B would have been attributed to the UK fronter Company A if it had been treated as its dependent agent PE. The location of the key entrepreneurial risk-taking (KERT) functions is central to attribution under the authorised OECD approach. In this context the KERT function is generally the assumption of insurance risk which is performed by the underwriting company outside the UK. Therefore it is unlikely that the arrangements have been designed to ensure that Company A does not constitute a dependent agent of Company B.
  • Although there is additional profit to attribute to the UK activities so that Company A receives an arm’s length reward, it is reasonable to assume that the arrangements were not designed to achieve this outcome and that this is a straightforward transfer pricing error. Therefore the TDC is not met.
  • It should be noted that although the specific fact pattern in the above example points to there being no UTPP charge, fronting arrangements in general can be put in place for a variety of reasons, some of these will be designed to achieve a reduction of UK tax or tax mismatch. In particular arrangements where the UK fronter or other UK company provides underwriting services through subcontract arrangements with the non-resident underwriting company this can attract a UTPP charge.