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Tax liability insurance: An innovative alternative to APAs

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Tax liability insurance policies can help taxpayers eliminate TP risks

Dean Andrews and Martijn de Lange of BMS Group explain why tax liability insurance (TLI), an innovative tool which transfers tax liabilities to the insurance industry, are increasingly used as an alternative to advanced pricing agreements (APAs).

APAs remain popular 

Multinational enterprises (MNE) deploy different strategies to manage transfer pricing (TP) risks. Besides complying with the arm’s-length principle and documentation requirements, strategies may include (i) aligning TP models with business operations; (ii) fostering a transparent relationship with tax authorities; and (iii) refraining from taking aggressive positions. 

While these strategies help to reduce TP risks, they do not eliminate them. Therefore, it is not surprising that the use of APAs by MNEs has been on the rise. In its 2019 TP and International Tax Survey, EY concluded that 37% of the companies surveyed were using an APA to reduce tax risks. Also, more jurisdictions are rolling out APA programmes, making them available worldwide. 


Downsides 

Despite the popularity of APAs, there are certainly downsides of obtaining one. These have led to a decrease in the number of bilateral APA requests in some jurisdictions.



First, there is the length and costs of an APA process. Bart le Blanc of Norton Rose Fulbright notes, “MNEs should not underestimate the time and costs involved with an APA process. Submissions need to be well-prepared and clearly communicated. This takes time in cases with complex inter-company transactions. Other important factors are the level of experience within tax authorities or conflicting positions in bi- or trilateral APA processes. I have seen processes taking up to three years to complete, and MNEs find it challenging to deal with uncertainties for such a long time”.



Another downside is the growing uncertainty around APA processes' outcomes as tax authorities do not necessarily share the taxpayer’s views on what should be considered as 'arm's-length'. Harmen van Dam of Loyens & Loeff mentions, “Tax authorities often have conflicting views on technical matters such as the appropriate TP method (with tax authorities increasingly pushing the use of profit split methods) and comparability adjustments. Discussions also often evolve around MNEs paying their ‘fair share’ of taxes, which is a highly subjective concept.” 



A more recent concern revolves around reliability and reputational exposure. APAs may come under scrutiny at some point. MNEs have become extremely sensitive at this point, and le Blanc notes the following on the Dutch practice: “The Dutch tax authorities were a frontrunner on concluding APAs – and advance tax rulings – which contributed to bolstering the Netherlands as an attractive location for MNEs. However, in the current political climate, APAs have a negative connotation and are presumed to grant MNEs a ‘red-carpet treatment’ not equally available to small and medium-sized enterprises. The recent state aid cases have not helped in that respect and even jeopardised the ‘USP’ of APAs: providing certainty. In parallel, the Dutch tax authorities are imposing more stringent requirements before granting an APA request. All of this makes that MNEs are more reluctant to request an APA - also because transparency rules such as country-by-country reporting and DAC6 require disclosure of tax positions to the tax authorities already”.

Tax liability insurance as an alternative 

Considering these downsides, MNEs are looking for alternative strategies to provide certainty for TP risks. TLI offers such an alternative by transferring TP risks to an insurer. In exchange for a premium payment, the insurer covers the financial loss resulting from a tax authority's successful challenge of an insured TP position. 



Mark Hale of VALE Insurance Partners, a managing general underwriter focused on transactional risk says, “TLI can provide MNEs a quick and capital-efficient tool to transfer the risk related to identified, potential tax exposures. While historically this product is particularly focused on solving issues that arise in the context of merger and acquisition transactions, taxpayers that do not have the time or desire to pursue the APA process may be able to obtain a TLI policy to provide certainty for TP risks”. 



The possibility to insure TP risk has caught the attention of in-house tax professionals and tax advisors alike. "It is an innovative and welcome alternative to obtaining an APA. TLI's use to cover TP risk is quite new, but the product has proven itself with other types of tax risks. It could be a game-changer for dealing with TP risk,” said le Blanc.



A considerable benefit of a TLI policy is the short time frame to obtain certainty. Hale adds, “While more conventional methods for achieving certainty directly with tax authorities can take months or years, a TLI underwriting process can be completed in as little as a few weeks.”

Insurable risks

Until recently, insurer's appetite for TP risks remained limited to risks such as the interest rate on group loans and tax-deduction of service fees, but now there is an increasing appetite for more complex risks. For instance, TP risks related to the onshoring of an intellectual property (IP) portfolio. It will be interesting to see how insurers' appetite will evolve in the years to come, especially against the backdrop of the various tax reforms, including the OECD pillars, which are creating a whole new assortment of risks. 



“It is unclear what the effect of the various tax reforms will be on the possibility to obtain APAs, especially for those MNEs whose business models heavily rely on technology and digital presence. I can imagine that tax authorities hold on to their horses to sign off on new APAs. Yet, MNEs still need certainty on the TP aspects of their business models,” said le Blanc.

Conclusion

APAs remain an important tool for MNEs to eliminate TP risks but come with some critical downsides. TLI policies can help taxpayers eliminate TP risks without these downsides and are therefore increasingly used by MNEs. 





Dean Andrews

Head of tax liability insurance

E: dean.andrews@bmsgroup.com



Martijn de Lange

Managing director, Asia

E: martijn.delange@bmsgroup.com




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