Multinational companies, when analysing their insurance arrangements involving captives, should evaluate whether the premiums are commensurate with the level of risk assumed by the captive. In most circumstances, this would require an actuarial analysis of the risk- adjusted expected rate of return.


In this evaluation, consideration would need to be given to the captive’s capital base, its rating, if any, its infrastructure and the diverse nature of its business. Whether the premium charged by the captive is reasonable would very much depend on the nature of its business, the risk retained and the retrocession premiums it pays in turn to a third-party reinsurer for the transfer of its risk. In some circumstances, it might even be possible to work backwards from such retrocession premiums to establish what may constitute an arm’s-length arrangement.


Where a captive is involved in extended warranties or service contracts,


reinsurance arrangements, the UK courts held that Dixon’s reinsurance arrangement was not on an arm’s-length basis and, as a result, additional tax was payable. Although DSG Retail had engaged an accounting firm to prepare a transfer pricing report to support its position, the ‘comparable’ data put forward to the courts were considered to be inadequate. The case was settled for an amount understood to be in excess of £50 million.


In light of the Dixon’s case and the pressing need for tax authorities


to find sources of additional revenue, transfer pricing for captives is clearly something that multinational companies with such arrangements need to take seriously. An additional factor to consider is the increased interest of tax authorities to enter into agreements with each other to exchange information about the tax status of taxpayers under the Mutual Assistance Directive and International Tax Enforcement arrangements.


The following illustration presents a simplified example of a structure adopted generally by many multinational companies involving captives:


Illustrative transfer pricing arrangement involving a captive: MNE


Parent Co


as in the Dixon’s case, the evaluation will also need to take into account the method adopted to share its profits in line with the role the group entity plays in selling these warranties or contracts, meeting the ensuing contractual obligations to customers and bearing associated risks. This may involve considerations of what and how intangible assets— for example, brand and know-how—are employed in this part of the group’s commercial activities.


In all circumstances, multinational companies should ensure that relevant documentation is produced to justify the insurance arrangement involving a captive before the inception of the contract.


Conclusion Tax authorities are under increasing pressure to generate tax


revenues for their respective governments and they are more than likely to challenge transactions with captives using existing tax legislation to determine whether any additional tax is due. Consequently, multinational companies should conduct a thorough feasibility study not only to evaluate the need for a captive, its domicile and capital base, and the risk to be written and retained therein, but also the pricing philosophy that may need to be followed. Most importantly, multinational companies should ensure that all insurance arrangements with the captive are well documented and the pricing methodology fully justified using actuarial and third-party comparable data.


Treasury / Support Co


Interest & Fees Risk


Operating Companies


Premiums Captive Insurance Co Risk Retrocession Premiums Third Party Reinsurance Co


Praveen Sharma is global leader of the insurance regulatory and tax consulting practice at Marsh. He can be contacted at: praveen.sharma@marsh.com


Support Services & Funding


In the future, multinational companies must ensure that the rationale for either forming a new, or utilising an existing, captive in a particular jurisdiction is based on sound commercial principles. Any resulting tax benefits should be the ‘icing on the cake’ and not the cake itself.


emea captive 2011 15


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