GIM10180 - Non-resident insurers: the scope of UK taxing rights: accounting periods beginning before 1 January 2003: section 11 ICTA & Article 7 OECD Model: attribution of the investment return: Method 1 and Method 2

Two main methods that have been employed in attributing the investment return to non-resident general insurers.

Method 1

UK Technical Reserves x (World wide investment return/World wide technical reserves)

Method 2

(UK Technical Reserves + solvency margin + ‘comfort margin’) x (World wide investment return/World wide assets)

The main criticism in treaty terms is that the methods appear to go beyond the separate enterprise principle in Article 7(2). By going in Method 1 for worldwide yield in the ratio of UK technical reserves to the world technical reserves, it is alleged that the Revenue is attributing income on shareholders’ funds that would simply not be available to the branch as a separate entity. However if the activities of the PE and of the rest of the enterprise are homogeneous, it can reasonably be argued that Method 1 gives an arm’s length result. But it may need to be adapted to take into account differing national regulatory requirements.

The argument against Method 2 is that the Revenue is seeking to give the business the attributes of a separate company with its own share capital and reserves and that also goes beyond the separate enterprise formula, since the hypothesis in Article 7(2) does not say that the branch is deemed to be a separate company and therefore must have a share capital. But whether or not it is a company, an enterprise looked at on a stand alone basis needs “capital” unless its activities are of the sort that do not require “capital”. A partnership or Lloyd’s syndicate needs “capital” although not in the form of share capital.

Although these approaches can be justified by reference to General Reinsurance v Tomlinson and the OECD Commentary, Inspectors should however be careful always to consider the actual circumstances of the branch activities. The total transfer of cash-flow as it arrives to Head Office is for example clearly a “dealing” with the enterprise of which the branch is a permanent establishment, which is different from the one that would exist at arms length. It is less obvious that the initial “underfunding” of a branch by Head Office is. The existence of the first situation clearly justifies the attribution of investment yield to the branch above what is shown in the branch books or regulatory return.

It is incorrect to refer to this investment yield as “notional” investment income. It is not notional. It is real, but has not been attributed by the company to the branch. It follows from this that it should not be possible to attribute to a UK branch more than the total investment return of the company as a whole, certainly as far as income is concerned. Where gains are concerned, theoretically there could be attributed to the UK gains which exceed the net figure of gains and losses for the company as a whole because what is properly attributable to the UK has a higher preponderance of gains compared with losses than the company as a whole or the rest of the entity. Method 2 could certainly have the effect of attributing to the UK more investment yield than is present in the company as a whole: a comparison with Method 1 would be useful in such a case. It might of course be the case that the entity of which the UK branch is part has been underattributed with investment return as a result of non-arms length dealings with other members of its group. If this is the case, then Article 9 of the OECD Model (the Associated Enterprises article) and possibly Schedule 28AA may also be in point (see the International Manual – INTM430000).