Cross-border tax affairs are rarely clear cut. Subjective interpretation often means there is often no single ‘right’ answer – only competing analyses of the same facts. It is no surprise that tax positions are frequently contested by taxpayers and tax authorities (and between tax authorities fighting to tax the same profits).
Stepping in to meet this challenge is ‘specific’ tax risk insurance cover for MNE’s standalone and identified potential tax liabilities. While still in its infancy, the market has developed significantly in recent years on both sides of the Atlantic.
The origin has its roots in the warranties and indemnities (W&I) insurance used in M&A deals to protect against unknown risks that emerge after completion. Specific risk insurance complements W&I coverage of unknown risks by providing cover against those known risks that are revealed during due diligence.
While it emerged from the context of M&A transactions, particularly from private equity and real estate funds, now more than 50% specific risk insurance covers standalone, operational tax positions in the corporate market, unrelated to M&A – and this market is expected to continue to grow.
The list of potential tax liabilities for which insurance is available is long and includes transfer pricing and VAT disputes; differences of interpretation about interest deductibility and WHT of dividends; hybrid mismatches, CFCs and non-resident capital gains; and questions of debt versus equity.
Insurance can be provided at any stage in the life of a tax risk. A group may consider tax insurance at the time it decides to adopt a tax position, prior to any scrutiny from a tax authority. Alternatively, they may seek insurance after a tax authority enquiry has begun or even after litigation proceedings have started. The timing will affect the value of premiums as will other considerations such as the compliance history of the insured, length of the policy term or whether risks will be ‘zero-sum’ (such as determination of non-resident CGT or WHT) or have a sliding scale of outcomes, such as in employee misclassification risk, when some contractors, but not all, are determined to be employees.
Underwriters look for opinions on how a fiscal authority would approach a risk. Is the risk under consideration an area particularly prone to litigation? Is there a pattern of behaviour on the part of the tax authority in the relevant jurisdiction in relation to the tax risk? Underwriters will look at the risk through a practical lens, as well as a purely tax technical one.
Most insurers in the UK are Lloyds syndicates with S&P A+ ratings, backed up with the Lloyd’s guarantee and central fund safeguard. Alongside Lloyd’s syndicates, AIG and Liberty provide company markets. Investment in the market has increased capacity in the form of capital to provide underwriting cover and in tax technical expertise available to underwriters and brokers. Collectively, the market is now better positioned to offer cover for a range of complex tax risks. The policies cover not only the tax at stake, but also any interest and penalties incurred (provided they stem from civil litigation, not criminal procedures) along with defence and advisor costs.
Impact on negotiation strategy in a dispute: Where a group is insured for a specific tax risk, it will need to accept that it is surrendering negotiating power to the insurer who has taken on the economic risk. Insurers will want to review taxpayer correspondence and have significant control over the conduct of negotiations.
In one-off transactional disputes, the insurer may adopt a firm stance, but ongoing operational issues, such as VAT treatment or employment status, may prompt a more collaborative approach.
If tax authorities are aware that a tax risk is covered by insurance, it may influence how they approach a dispute. A tax authority may assume that insurance cover indicates a high risk or the insurer’s deep pockets and pursue the case more aggressively than it otherwise might have. Conversely, while having insurance shows a level of doubt on the part of the taxpayer, the tax authorities may conclude that an insured position has benefitted from the scrutiny of multiple advisers supporting the taxpayers, broker and underwriter and seeing the rigour of the analysis undertaken, may be more inclined to yield or settle.
Tax authorities may ask whether tax insurance is in place. If so, a taxpayer is obliged to disclose. As the market for specific tax risk insurance grows, it is safe to assume that this may become a standard question on the part of tax authorities.
Final thoughts: Tax risk insurance acts as a proxy to certainty or a tax ruling from a fiscal authority. For low-probability but high-impact exposures, insurance offers comfort that an adverse outcome will not hit the balance sheet and indeed release cash from provisions.
Note, however, that tax insurance is not a strategy to support aggressive tax planning. Insurers will not cover detection risk or a reportable scheme (anything formerly ‘DOTASable’), and Lloyd’s governance prohibits insurance of any such schemes.
While specific tax risk insurance remains in its infancy, the offering has evolved and, in the right circumstances, can be a realistic option worth considering in tax risk management.
Sandy Markwick, Winmark Tax Director Network
Cross-border tax affairs are rarely clear cut. Subjective interpretation often means there is often no single ‘right’ answer – only competing analyses of the same facts. It is no surprise that tax positions are frequently contested by taxpayers and tax authorities (and between tax authorities fighting to tax the same profits).
Stepping in to meet this challenge is ‘specific’ tax risk insurance cover for MNE’s standalone and identified potential tax liabilities. While still in its infancy, the market has developed significantly in recent years on both sides of the Atlantic.
The origin has its roots in the warranties and indemnities (W&I) insurance used in M&A deals to protect against unknown risks that emerge after completion. Specific risk insurance complements W&I coverage of unknown risks by providing cover against those known risks that are revealed during due diligence.
While it emerged from the context of M&A transactions, particularly from private equity and real estate funds, now more than 50% specific risk insurance covers standalone, operational tax positions in the corporate market, unrelated to M&A – and this market is expected to continue to grow.
The list of potential tax liabilities for which insurance is available is long and includes transfer pricing and VAT disputes; differences of interpretation about interest deductibility and WHT of dividends; hybrid mismatches, CFCs and non-resident capital gains; and questions of debt versus equity.
Insurance can be provided at any stage in the life of a tax risk. A group may consider tax insurance at the time it decides to adopt a tax position, prior to any scrutiny from a tax authority. Alternatively, they may seek insurance after a tax authority enquiry has begun or even after litigation proceedings have started. The timing will affect the value of premiums as will other considerations such as the compliance history of the insured, length of the policy term or whether risks will be ‘zero-sum’ (such as determination of non-resident CGT or WHT) or have a sliding scale of outcomes, such as in employee misclassification risk, when some contractors, but not all, are determined to be employees.
Underwriters look for opinions on how a fiscal authority would approach a risk. Is the risk under consideration an area particularly prone to litigation? Is there a pattern of behaviour on the part of the tax authority in the relevant jurisdiction in relation to the tax risk? Underwriters will look at the risk through a practical lens, as well as a purely tax technical one.
Most insurers in the UK are Lloyds syndicates with S&P A+ ratings, backed up with the Lloyd’s guarantee and central fund safeguard. Alongside Lloyd’s syndicates, AIG and Liberty provide company markets. Investment in the market has increased capacity in the form of capital to provide underwriting cover and in tax technical expertise available to underwriters and brokers. Collectively, the market is now better positioned to offer cover for a range of complex tax risks. The policies cover not only the tax at stake, but also any interest and penalties incurred (provided they stem from civil litigation, not criminal procedures) along with defence and advisor costs.
Impact on negotiation strategy in a dispute: Where a group is insured for a specific tax risk, it will need to accept that it is surrendering negotiating power to the insurer who has taken on the economic risk. Insurers will want to review taxpayer correspondence and have significant control over the conduct of negotiations.
In one-off transactional disputes, the insurer may adopt a firm stance, but ongoing operational issues, such as VAT treatment or employment status, may prompt a more collaborative approach.
If tax authorities are aware that a tax risk is covered by insurance, it may influence how they approach a dispute. A tax authority may assume that insurance cover indicates a high risk or the insurer’s deep pockets and pursue the case more aggressively than it otherwise might have. Conversely, while having insurance shows a level of doubt on the part of the taxpayer, the tax authorities may conclude that an insured position has benefitted from the scrutiny of multiple advisers supporting the taxpayers, broker and underwriter and seeing the rigour of the analysis undertaken, may be more inclined to yield or settle.
Tax authorities may ask whether tax insurance is in place. If so, a taxpayer is obliged to disclose. As the market for specific tax risk insurance grows, it is safe to assume that this may become a standard question on the part of tax authorities.
Final thoughts: Tax risk insurance acts as a proxy to certainty or a tax ruling from a fiscal authority. For low-probability but high-impact exposures, insurance offers comfort that an adverse outcome will not hit the balance sheet and indeed release cash from provisions.
Note, however, that tax insurance is not a strategy to support aggressive tax planning. Insurers will not cover detection risk or a reportable scheme (anything formerly ‘DOTASable’), and Lloyd’s governance prohibits insurance of any such schemes.
While specific tax risk insurance remains in its infancy, the offering has evolved and, in the right circumstances, can be a realistic option worth considering in tax risk management.
Sandy Markwick, Winmark Tax Director Network
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