A group of global insurance and reinsurance companies commented late last year on OECD proposals aimed at ensuring that multinationals pay a global minimum rate of tax, more commonly known within the tax profession as the Global Anti-Base Erosion" or "GloBE" proposals.
Since then, of course, the world has been thrown into a state of turmoil by the Covid-19 crisis. Nonetheless, the G7 Finance Ministers have reaffirmed a commitment to continue work on reforms to the global system of international tax. The OECD meanwhile has indicated that delegates continue to work full-steam ahead on proposals, and that there is actually a greater sense of urgency and impetus given the effect of the Covid-19 crisis on public finances.
A virtual meeting of representatives from over 130 countries that make up the G20/OECD Inclusive Framework is due to take place in July to discuss progress. This would be followed by an actual meeting to take place before G20 Finance Ministers and Central Bank Governors meet on October 15-16. A package of measures is expected to be adopted then according to the Director of the OECD's Centre for Tax Policy and Administration.
Given this, and the potentially far reaching nature of the proposals, it is worth highlighting some of the main points behind the industry group's comments.
They are of course very important to the insurance industry. But they also provide a striking example of the difficulties faced by the OECD in finding a solution that is workable and politically acceptable.
The OECD's "GloBE" Proposals
The OECD's GLoBe proposals emerged last year out of work originally started to address how best to tax the digital economy, but which has assumed a wider scope. This work followed the G20 and OECD's Base Erosion and Profit Shifting (BEPS) project, which was aimed at tackling tax avoidance and led to international agreement on a raft of measures. This is significant, since it illustrates the level of political commitment to reform.
The GLoBe proposals form the second of two proposals or "pillars" put forward by the OECD. Pillar One is primarily concerned with the allocation of new taxing rights to countries where consumers are located. Pillar Two concerns measures aimed at ensuring that all profit earned by multinationals is subject to some minimum level of tax.
The public consultation documentation published by the OECD on Pillar Two focuses on what is known as an "income inclusion rule". This would essentially allow countries to oblige require taxpayers that do not pay some sort of minimum rate of tax to pay a "top-up".
The Insurance Company Working Group response
The comments of the industry group focused on the proposed "top-up" and how it would be calculated. These comments were based on a number of observations about the insurance industry, and what clearly makes it different from other lines of business. At the same time, the industry group stressed that the approach it recommends would avoid the need for special provisions for the insurance industry, or a carve-out.
Three main points outlined by the industry group are summarised below.
Global approach using consolidated financial statements
Accounting standards, profit measures, tax rules and regulatory requirements vary widely from country-to-country. Calculating a "top-up" for each jurisdiction would produce anomalies and the risk of double taxation.
At the same time, it would hinder effective pooling and diversification of risk across geographical markets through internal reinsurance. This would restrict capacity in some markets, especially those prone to certain risks such as natural disaster (and ironically the submission notes, pandemics) and increase costs across-the-board, especially for risks such as catastrophe.
An approach that considers the consolidated global position of a group – what is referred to as a global blending approach – in determining whether a top-up is necessary, and how large it should be, would avoid this (and be significantly more practical for taxpayers and tax authorities alike). Using consolidated financial statements makes practical sense in this context.
The results of insurance businesses are played out over several years, especially in life insurance. Moreover, the insurance industry collect revenues (premiums and investment returns) upfront, but incurs its most significant (and unpredictable) costs later in the form of paid claims, sometimes much later (e.g. in life insurance).
This introduces significant volatility to results in the insurance sector. As an example, the industry group's submission notes figures in the OECD's Global Insurance Market Trends Report for 2018, which showed the largest ever global insured losses from man-made and natural losses of $144 billion. The performance of investments can add to this volatility (including in relation to bond yields). The current economic crisis provides the starkest illustration of this.
For these reasons, losses incurred in bad years need to be considered in conjunction with profits earnt in good years, so that a reliable picture can be obtained of what percentage of profit is paid as tax. What is known as the total effective tax rate should therefore be used, i.e. one that takes into account current and deferred taxes. In this respect, the submission notes that deferred tax assets (e.g. carry-forward losses) are used in measuring regulatory solvency capital for insurance companies (implying that a similar approach is reasonable and warranted for GLoBE).
US Tax Cuts and Jobs Act, and Similar
A key objective of GLoBe is that a minimum rate of tax is paid at least somewhere. Calculations for any "top-up" should therefore take into account instances where a jurisdiction has already imposed some form of minimum tax, such as the US Global Intangible Low Taxed Income (GILTI) rules imposed under President Trump's Tax Cuts and Jobs Act (TCJA). Although the industry group did not refer to it, the UK's diverted profits tax might be another example. This is particularly important in insurance because of the variation in accounting and tax rules from jurisdiction to jurisdiction. The industry group also makes the point that elements of GLoBe other than the "top-up" income inclusion rule (and there are other elements, albeit ones that have not been the subject of as much focus to date) should also not apply in these circumstances.
Insurance groups should keep an eye out for OECD updates, especially close to the virtual meeting of the OECD/G20 Inclusive Framework on BEPS scheduled for 1-2 July 2020, and the rescheduled in-person meeting in October.
In addition, insurance groups should contemplate a high-level review to evaluate what the financial and practical impact the proposals if enacted might have. A start to scenario analysis and planning might also be contemplated. Experience from the introduction of unilateral digital services taxes by a number of countries show that a wait-and-see approach does not leave enough time to act.
HL can assist with a review, not least because of the host of legal interpretational issues that may arise in applying measures that are finally implemented. We can also assist with scenario analysis, and advise on the tax and legal consequences of any restructuring or reorganisation that groups may consider in response to emerging issues.
Finally, Hogan Lovells can advise on tax and transfer pricing disputes already affecting insurance groups, including in relation to captives.
Authored by Graham Poole