Financial Services Ireland

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Publication of final OECD BEPS reports – implications for the insurance sector

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On Monday, the Organisation for Economic Cooperation and Development (OECD) released the final reports under its Action Plan on Base Erosion and Profit Shifting (BEPS). These reports represent two years’ worth of intense effort, both on the part of the OECD working groups and by industry, advisors and other interested parties who provided over 15,000 pages of comments on the discussion drafts and participated in numerous public consultations.

Although final reports on the original 15 action points were released on Monday, work on some topics relevant to insurers, such as the multilateral instrument, interest deductibility and financial transactions, will carry on into 2016 and 2017. The work of insurers, advisors and other interested parties will also need to continue in respect of these areas, and as governments decide whether and how to implement the OECD recommendations.

While much of what was released on Monday was expected, the revisions to the transfer pricing guidelines in respect of risk and nonrecognition are concerning. Regarding defining risk and functions, the insurance industry will need to apply both the new guidance and the existing guidance set out in the OECD’s Report on the Attribution of Profits to Permanent Establishments (Part IV Insurance) (OECD Part IV). For the nonrecognition of transactions, the guidance includes a captive insurance example that has the potential to be construed more widely in regards to intragroup reinsurance arrangements. This guidance could have immediate legal effect in some territories, and therefore, we strongly recommend that insurers review their transfer pricing documentation.

Furthermore, captive insurance is negatively reflected in several other reports, and therefore it will be important to understand whether this could be applied to the insurance industry as a whole. This alert simply sets out the main headlines of the action points most relevant for insurers and is intended as a high level summary of key changes that have taken place; we will send a more detailed analysis in the coming days.

Aligning transfer pricing outcomes with value creation (Actions 810)

• The insurance industry was heavily involved in the consultation process on Actions 8 – 10 (specifically in respect of risk and nonrecognition) in view of the regulated nature of the insurance industry. The industry emphasized the need to recognize preexisting tailored guidance on the allocation of risk and capital in OECD Part IV.

• Positively, a footnote to the final report makes specific reference to “insurance businesses” and the need to consider the preexisting OECD Part IV guidance. However, this comment is made in the context of the need to take account of and make reference to Part IV as appropriate, with the implication that the revised transfer pricing guidelines contained in the report apply to all industries. This, therefore, implies a higher burden of compliance for insurers and could lead to inconsistent approaches by tax authorities.

• The report also confirmed that further work will be undertaken in 2016 and 2017 on the economically relevant characteristics for determining the arm’s length conditions for “financial transactions.” Based on previous announcements, we understand this will include reinsurance arrangements.

• There is much focus on functional analysis particularly in the context of assumption of risk, risk management and the forums within which decision making with respect to risk may be undertaken. This wording could be particularly challenging for companies with low head counts.

• The final guidance on nonrecognition includes a captive insurance example, which seems to imply that the transaction is commercially irrational since it is not possible to find thirdparty insurance in the local market. The example goes on to state that either relocation or not insuring may be more realistic alternatives. It is not clear how this example sits with the previous paragraphs, which state a number of times that nonrecognition does not necessarily arise simply because the same transaction is not observed between independent parties. In addition, the guidance refers to consideration of whether the group as a whole is left worse off on a pretax basis as a relevant pointer, which does not appear to be considered in the example. Based on this example, there would seem to be a risk that tax authorities could seek to apply similar arguments to disregard intragroup reinsurance as well as captive insurance arrangements. However, in previous forums, the OECD indicated that it recognizes a distinction between groups with captive insurers and the insurance industry as a whole where risk transfer is the “stock and trade.”

• Group synergies are discussed in the report, which may provide insurers with an ability to recognize the benefits of risk pooling.

• Overall it is disappointing that some key comments raised by the industry have not been reflected in the final report. It is not clear whether any remaining concerns will be reflected as part of the further work to be performed in 2016 and 2017. In the meantime, it should be noted that the final guidance can be implemented with immediate effect in certain countries and therefore groups should review their transfer pricing arrangements as soon as possible.

Permanent establishments (Action 7)

• The permanent establishment (PE) definition has been widened beyond the traditional authority to “conclude contracts” to include situations under the new drafting where a person “habitually plays the principal role leading to the conclusion of contracts that are routinely concluded without material modification.” This could potentially create multiple PEs where insurers use local sales teams to lead the negotiation of contracts with customers.

• The draft section on insurance agents collecting premiums has been completely removed and replaced with an acknowledgement by the OECD that it would be inappropriate to treat insurance differently from other types of business.

• Further guidance on attribution of profits relating to PEs will be released before the end of 2016, in anticipation of the multilateral instrument that will include these changes to the PE definition.

CFC rules (Action 3)

The final report removes much of the language on insurance income from the draft report, and now includes a new section outlining factors that could lead to an exclusion of reinsurance income from CFC rules, such as the arm’s length nature of the transaction, benefits from diversification and pooling of risks, the economic capital position of the group, and whether the CFC’s personnel have sufficient expertise to undertake/ write the insurance risks. Such insurance specific wording is welcomed in view of concerns previously raised by the industry.

Treaty abuse (Action 6)

Of relevance to life insurers is the Treaty Abuse report. While the report is titled as “Final,” there will be further OECD work specific to investment funds in 2016 and amendments will be made. With regard to collective investment vehicles (CIVs), the report restates the OECD view that the 2014 Action 6 drafting is suitable for addressing the potential treaty eligibility concerns of CIVs and that it reflects the conclusions of the OECD’s 2010 CIV report. The OECD’s previous Treaty Relief and Compliance Enhancement (TRACE) implementation package is referred to as the solution for implementing certain limitations-on-benefits (LOB) tests in practice. As such, the report has not materially changed with regard to CIVs, and we understand no further work will be performed in this area.

For noncollective investment vehicles the OECD indicates that further work is required in certain areas:

• NonCIVs funds in general — The OECD reiterates that it recognizes the economic importance of these funds and that they should be granted treaty benefits where appropriate. This is supported by the final report on hybrid mismatches (Action 2), which suggests changes to the Model Tax Convention that would clarify the treaty position of transparent vehicles. The report also points towards potential “derivative benefits” provisions to be introduced in 2016, i.e., provisions that would allow certain entities owned by nonresidents to obtain the treaty benefits that these residents would have obtained if they had invested directly.

• LOB rules — The US entered into public consultation on their LOB rules in 2015, and the OECD wants to consider whether any resultant changes, to be published in 2016, should be factored into Action 6.

• REITs — Updating the LOB commentary to include specific provisions for REITs that reflect previous OECD work on treaty issues for REITs.

• Pension funds — Updating the OECD Model Tax Convention to include a definition of “recognized pension fund” that qualifies as treaty resident. The UK life and pensions industry will be interested to note that the proposed definition includes entities and arrangements that operate exclusively to invest funds for the benefit of recognized pension funds.

Hybrids (Action 2)

• As expected and in line with the September 2014 report, the report issued confirms that countries remain free in their policy choices as to whether the hybrid mismatch rules should be applied to mismatches that arise under intragroup hybrid regulatory capital. The report states that, where one country chooses not to apply the rules to neutralize a hybrid mismatch in respect of a particular hybrid regulatory capital instrument, this does not affect another country’s policy choice of whether to apply the rules in respect of the particular instrument.

Interest deductibility (Action 4)

• Also as anticipated, the report recognizes that particular features of the banking and insurance industries mean that the recommended fixed ratio rule and the group ratio rules for interest deductibility set out in this report are unlikely to be effective in addressing BEPS involving interest in these sectors. As such, further work will be conducted, to be completed in 2016, to identify targeted rules to deal with the BEPS risks posed by banks and insurance companies.

• The report notes that countries may consider excluding entities in groups operating in the insurance sector from the scope of the fixed ratio and group rules, in which case they should introduce targeted rules addressing BEPS in these sectors. However, it notes that any such exclusion should not apply to a number of specific entities, including captive insurance companies.

• The report also highlights that it is crucial that any recommended interest limitation rules do not conflict with, or reduce the effectiveness of, capital regulation intended to reduce the risk of a future financial crisis.


During the past two years, the insurance industry has made considerable efforts to share information with the OECD working parties about insurance business models and the role of risk and capital in insurance. The final reports released,  reflect some of that effort, but the work of the insurance industry is far from finished. As we move into the 2016 project, and as governments begin to implement the OECD’s recommendations, the insurance industry will need to continue its knowledge campaign to help ensure that decision makers are well informed before making policy decisions that may impact insurers.

In other news, the UK tax authority HM Revenue & Customs (HMRC) released draft regulations to implement country-by-country reporting; as expected, these regulations follow the Action 13 recommendations. A penalty regime is introduced for failure to submit a report, or for inaccurate information where the inaccuracy is known at the time of the report or discovered later and not notified to HMRC.

Sandra Dawson

FS Partner, Tax
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