Dean: There’s an increased global focus by tax authorities on the substance of the recipients of cross-border interest and dividend payments. Do you see a lot of enquiries in this area and what’s your view on the insurability of these risks?
Adam: We do see a lot of substance risk enquiries and have noticed a distinct increase in these enquiries following the ECJ rulings in the so-called ‘Danish Cases’ three years ago.
Questions of substance are inherently subjective and fact-based and, as a result, no two risks are exactly alike. Substance risks can certainly be insured with careful diligence. Insurability ultimately depends on the particular fact pattern of the situation at hand.
Dean: What factors do you take into account when assessing the insurability of substance risks?
Adam: We need to have a good understanding of how the company operates. Why was the entity established in the jurisdiction? Does its establishment there have a commercial rationale? Is there a wider investment platform in that jurisdiction?
The identity and experience of the directors is very important. Are they the real decision-makers or are decisions being made elsewhere? If so, where are these decisions made?
There are other considerations relating to the set-up of the entity. Does the entity have its own offices and bank account? What is the level of expenses incurred by the entity and the wider platform? Does the entity pay a meaningful amount of tax? What will it do with the proceeds – will these be reinvested or distributed to a parent? If proceeds are to be distributed, how soon will this take place?
Dean: In which jurisdictions are you seeing substance risks?
Adam: The majority of the substance risks that we see are risks in Europe, particularly in relation to payments from Spain and Denmark, but we have also seen quite a number of enquiries relating to Asian jurisdictions.
Dean: Are some jurisdictions more insurable than others?
Adam: Certainly! In assessing insurability we are keen to understand the approach of the relevant tax authority. Where a risk is in the EU, how a jurisdiction has interpreted the Danish Cases, for example, is key to our thinking.
The Spanish tax authority, in particular, has been very aggressive recently, challenging many payments made from Spain to Luxembourg. We would need to be extremely comfortable with the fact pattern to insure a substance risk relating to a payment made from Spain.
Dean: How do you anticipate ATAD 3 or the ‘Unshell Directive’ will affect your appetite for substance risks?
Adam: In a number of ways the new directive may actually be quite helpful. In setting a common definable threshold in the three tests for minimum substance, it may be that this becomes the pan-European benchmark for adequate substance.
Also potentially helpful is the exemption in the directive for alternative investment funds. A possible effect of this exemption may be that it becomes acceptable that alternative investment funds are generally treated as having adequate substance by EU jurisdictions even if they do not meet the three tests. Although, as drafted, it does not appear that intermediate holding companies held by investment funds are exempted under this carveout.
Dean: I see that the directive contains a reporting requirement if an entity fails any of the minimum substance tests. What effect would a requirement to report have on the insurance of a substance risk?
Adam: If an entity is required to report that it does not meet the tests then that may mean that insurance is more difficult. A failure to meet the minimum substance tests will likely mean an increase to the cost of insurance and, depending on the facts of the case, may mean that we would not be able to offer insurance.
Dean AndrewsHead of tax liability insurance, BMS GroupE: dean.andrews@bmsgroup.com
