Tax Transparency and Self-Insurance: The Only Constant is Change

The Organisation for Economic Co-operation and Development (OECD) released the first Base Erosion and Profit Shifting (BEPS) discussion draft on the transfer pricing aspects of financial transactions and invited public input on the additional guidance concerning the application of Actions 8 -10 of the BEPS Action Plan. The plan addresses specific issues related to the pricing of financial transactions such as treasury function, guarantees and captive insurance.

According to the OECD, BEPS refers to tax avoidance strategies that exploit gaps and mismatches in tax rules to artificially shift profits to low or no-tax locations. The 15 actions in the plan aims to equip governments with domestic and international instruments to address tax avoidance, ensuring that profits are taxed where economic activities generating the profits are performed and where value is created.

The time has now come for captives of multinational companies to put forth their compliance with BEPS’ core principles of tax transparency. This is expected to trigger a landscape change in the management of captives today, which could also impact domicile choices. The “Tax Transparency and Self-Insurance: The Only Constant is Change” panel discussion produced an interesting session on how the BEPS proposed guidance will affect captives.

There are many commercial reasons for companies to establish captives, among them being cost mitigation and gaining access to reinsurance markets. On the flipside, questions have been raised when captives insure against certain risks that are deemed difficult or impossible to obtain coverage. Scepticism has been on whether an arm’s length price can be determined and the commercial rationality of such an arrangement.

The BEPS discussion draft emphasises that fronting arrangements are deemed controlled transactions where premiums received by a captive must be properly transfer priced. Fronting arrangements refer to a third-party insurer receiving a premium from the multinational enterprise’s (MNE) local entities and reinsures the risk to the captive in return for a fronting fee. BEPS’ Actions 8 – 10 states “assure transfer pricing outcomes are in line with value creation.”


Where the risk of recharacterisation of captives is concerned, the draft stresses the importance of understanding if arrangements are truly insurance and whether the captive has assumed and is capable of controlling the insurance risk contractually transferred to it.  It is made abundantly clear that the paragraphs in the OECD Transfer Pricing Guidelines (TPG), concerning analysis of risks, apply to insurance businesses in the same way as other businesses.

The plan also provides two examples that illustrate how a captive might not be carrying out insurance business. The first is its financial capacity to assume risk and pay claims followed by the scale availability of a captive insurer within an MNE to achieve significant risk diversification. The plan also seeks further views and inputs from industry experts to ascertain other areas where a captive can be deemed not carrying out insurance business.


The potential to use third-party pricing evidence for pricing premiums were also highlighted. Having said that, a detailed analysis was proposed to determine the need for and quantification of comparability adjustments.  An actuarial analysis was recommended as the best solution on the basis of the following elements:

  • A combined ratio designed to ensure that the captive covers anticipated losses, underwriting and administrative costs
  • An investment return based on the return of capital.

Captives are also advised to make adjustments to its capital levels compared to commercial insurers due to capital constraints for regulated insurers. Much consideration is also required on the rate of investment returns achieved by a captive to the extent that it is investing in related party investments. There are also two other specific scenarios that the draft of the plan has put forth for further deliberation.

Firstly, group synergies were proposed where MNEs can come together to pool insurance risks through their captives to help reduce overall premiums. A form of cash pooling, the benefit of lower premiums should be shared amongst the insured companies. The second scenario is on agency sales, particularly the role of a sales agent in an MNE that arranges the sale of insurance contracts.

It states that in instances where an agent sells highly profitable insurance on behalf of a captive together with its own products, the United Kingdom’s Her Majesty’s Revenue and Customs’ (HMRC) decision on Dixons Finance’s case forms the backbone of the draft. In this case, the ability to achieve a very high level of profit on the sale of insurance policies arises from the advantage of customer contact at the point of sale.

Thus, the captive should earn the benchmarked return for insurers insuring similar risks with the residual profit allocated to the agent. On 30 August 2018, OECD released its fourth round of BEPS Action 14 peer review reports on improving tax dispute resolution mechanisms. With findings from Australia, Ireland, Israel, Japan, Mexico, and more, over 130 targeted recommendations were obtained and will be followed up in stage 2 of the process.

More information on BEPS Action 14 can be found at