Evolution of tax liability insurance: Forward-looking risks
In this interview, Paul Dickinson, head of tax at Themis Underwriting, talks to Dean Andrews, head of tax liability insurance at BMS Group, about forward-looking tax risks and the evolution of the tax liability insurance market in this space.
Dean: We understand that there is an increasing demand for tax liability insurance (TLI) solutions for forward-looking tax risks (Future Risks). Would you agree?
Paul: Yes, although the market remains primarily focused on insuring historic tax positions, we have insured a growing number of Future Risks. For obvious reasons, Future Risks might have a slightly elevated risk as compared to matters which have already taken place, but TLI policies can be adapted to cover such risks.
Dean: What sort of Future Risks do you most commonly see being insured?
Paul: They most frequently involve the application of a reduced rate of, or exemption from, withholding tax under a particular double tax treaty on dividends or payments of interest that are expected to be paid by a target to a parent company post-acquisition. These might often be insured in a historic context as well. However, we have also seen particular risks insured that arise from specific structuring steps as part of a merger or acquisition which are due to take place within a limited time frame post-completion.
Dean: When you are presented with a request for TLI terms for a Future Risk, are there any particular aspects that automatically mean that it falls outside of your risk appetite?
Paul: In general, we would apply the same test as we would for a historic position. In the case of withholding tax treatment for dividends or interest, we would examine the same points as if the risk had already arisen. These would typically focus on substance in the recipient company (Directors, employees, office space, balance sheet, ability to decide how to use proceeds received etc.) to ensure that it qualifies under the relevant treaty, in particular in light of recent EU case law around beneficial ownership.
The main difference compared to a normal TLI policy is that we would require undertakings from the insured in the policy as to future factual matters. Ideally, there would also be some factual background to be underwritten that has already taken place, for example, if the recipient company has been in existence for a while, it might already have a track record of holding tax residency certificates, board meetings or owning other investments.
Dean: It is helpful to know that the same underwriting principles apply to Future Risks, as well as historic risks. This marries with our experience, that it is the quality of the risk rather than the timing of the risk, that is crucial from an insurer’s perspective.
Dean: Have you seen Future Risks insured in the UK context?
Paul: Yes, in addition to insuring dividend/interest payments to be paid to a UK recipient, we’ve seen demand to insure a forward-looking component of certain historic risks. For instance, if an insured buyer is seeking cover for a historic IR35 or transfer pricing risk, as part of the same policy, it might also seek to cover the same risk for a limited period post-acquisition. One area that we will be interested to follow is the new UK notification requirements for ‘uncertain tax positions’ which takes effect for returns filed from April 2022.
Dean: How do you think that the new UK notification requirements for ‘uncertain tax positions’ might have an impact?
Paul: In general, we would not expect the issue to arise that often because insurers would not normally insure a position that is genuinely accepted as being uncertain. Helpfully, the rules clarify that if a tax treatment becomes uncertain after the date of a transaction (perhaps due to changes in case law which would not typically be excluded under a TLI policy), there would not be a requirement to revisit that year or accounting period.
However, if the tax treatment is ongoing, as it might be when a Future Risk in respect of a series of future payments is insured, then a notification would be required in the subsequent year or period if the position became uncertain. Another situation in which the new rules may be relevant relates to where the tax treatment contradicts a known HM Revenue & Customs (HMRC) position or published HMRC guidance.
HMRC guidance is not always completely up to date or fully aligned with case law, often because it takes time to update. A position may be supported by robust advice but arguably not be fully in line with current HMRC guidance. HMRC has sought to partially address this criticism by stating that opportunities to improve technical guidance will be explored.
Dean: Are there any important factors for insuring Future Risks?
Paul: Timing wise, TLI policies normally extend for seven years to cover statute of limitations. If payments are to be made over a number years, a longer tenor policy is likely to be attractive to an insured and Themis has often provided 10-year policies in such circumstances.
Head of tax liability insurance, BMS Group