Location of risk

Apart from all but the longest-standing risk managers, many global corporate insurance buyers are experiencing their first hard market. The subsequent challenges of premium hikes and restricted coverages have inevitably led to more innovative global programme solutions for insurance buyers, captive owners and managers, as well as brokers and insurers. Compliance remains a high priority in multinational insurance, and to ensure informed decisions around alternative programme structures, it’s important to consider the varying consequences of such solutions and particularly those that may fall to the insurance buyer.

Within the insurance premium tax (IPT) team at TMF Group we have seen an influx in consultancy enquiries, many originating from financial lines business, where corporate insurance buyers, brokers and captive managers are faced with new or additional compliance challenges arising from increased use of non-traditional placements. Wider adoption of captive insurance to combat increasing premiums in the commercial market can in turn lead to the use of more non-admitted insurance – dependent on the location of the captive. We have also seen European corporates purchasing directors and officers covers stateside, where the attraction of lower rates must be considered against the reliance on non-admitted coverage, with US insurers not able to benefit from freedom of services cover afforded to European carriers with EU passporting rights.

As our area of specialism is IPT, at TMF Group we are not here to debate regulatory laws, but we are very aware that outside of Europe the onus of reporting and settling indirect taxes due on cross-border insurance transactions often falls to the local policyholder. Where such charges do not fall part of the usual accounting practices of a local insured entity, it’s paramount that the insurance buyer is fully aware of any compliance obligations on a territory-by-territory basis. Increased use of financial interest clauses continues to attract debate around whether the risk insured is in fact a true financial interest of the parent company, versus a mechanism to cover risks that are not able to be insured on a non-admitted basis.

While service providers and specialists can provide guidance and knowledge in this area on a programme-by-programme basis, it is prudent for the risk manager to consider some fundamental compliance elements that are key in the decision-making process around programme structure, and the buyer’s ability to fulfil any ensuing obligations.

The primary and key consideration surrounding IPT compliance is undoubtedly location of risk. Risk location, which isn’t always where the policy is bought or physical assets are based, is driven in Europe by EU regulation and precedent set by the Kvaerner case. The Kvaerner case, albeit now 20 years old, laid down some key principles for establishing the location of risk on multinational programmes. Global, or multijurisdictional policies with risks in EEA, will need to have premiums allocated across all jurisdictions and local taxes applied. This is required even where there is no local policy or premium payment. The local entity does not even need to know it is covered under the insurance. The interpretation of establishment was important and it was deemed to include subsidiaries, so subsidiaries covered under a single policy each create a location of risk.

In turn, this is key to ascertaining where IPT obligations will arise, i.e. the EU member state where the risk is located has the right to tax the allocated premium. Even under EU regulation, each territory can interpret and apply the rules differently, and when you move outside of Europe the rules again vary on a per-territory basis, as well as being dependent on the line of business being underwritten. For global and cross-border insurance the rules are complex, and subject to change. This can be highlighted by a couple of recent legislation changes and court rulings that we can briefly consider.

An example of increased scrutiny on the risk insured, in addition to location, was the subject of a recent First Tier Tribunal (FTT), in the UK. The ruling considered the insurance of a deductible under a construction all-risk (CAR) policy related to pipeline-laying projects in the North Sea. The contractor, Subsea 7, used its Isle of Man captive, Tartaruga Insurance Ltd, to insure against its obligation to settle the deductible in the event of a claim on the CAR primary policy. HMRC considered that the deductible policy being provided by the captive insurer represented a financial loss cover for the contractor, a UK-domiciled entity, and therefore pursued UK IPT on the full amount of the premium paid to the captive.

The FTT disagreed with HMRC’s view, instead determining that any claim under the CAR policy would contractually require a deductible payment, in turn leading to a claim under the deductible policy. Consequentially, an allocation of the premium must be made between the UK taxable and exempt risks. For those risks related to the buildings, and the liability element of the policy, those establishments, located further than 12 nautical miles off the UK’s coastline, should be exempt, and those within taxable. Interestingly, the FTT also accepted that in certain cases, the ships used by the contractor could be considered an establishment.

In Germany, the IPT Act was amended at the end of 2020, clarifying and amending rules on a number of issues. A key clarification to the location-of-risk rules within the Act concerns the ability to tax risks where a German policyholder obtains cover from an EEA insurer for risks located outside of the EEA. The Act makes it clear that premium related to such risk should be subject to German IPT, thereby creating a potential exposure to double taxation, with the premium potentially being taxed both in Germany, and the jurisdiction outside of Germany where the risk is located.

Moving outside of Europe, an example we could consider is the home-state ruling in the US. Applicable to non-admitted insurance, including surplus lines and self-procured insurance, the home-state rule identifies which US state has the right to tax the premium. Unlike the EU rules that require the premium to be allocated out, the home-state rule generally necessitates identifying the state where the ‘main policyholder’ has their residence or place of business. This state will then tax the whole premium.

To conclude, a comprehensive understanding of local risk location rules, as well as consideration of the corporate buyer’s local resource and accountancy functions to facilitate involvement in any locally required compliance activity, will be useful in then fully considering the various insurance programme structures. Not all structures would suit every corporate, and for the risk manager such considerations are very useful alongside the critical and more fundamental considerations of price, limits and coverage.

Contributed by Karen Jenner, portfolio director, business development, and Joseph Finbow, IPT assurance director, TMF Group