GIM10220 - Non-resident insurers: the scope of UK taxing rights: accounting periods beginning on or after 1 January 2003: section 11 ICTA & Article 7 OECD Model: changes in FA 2003: “independent enterprise”

For all non-resident companies, section 11AA(2) (inserted by FA03/S149) sets out the “independent enterprise” hypothesis in Article 7(2) as a provision of UK law. Section 11AA(3) explains how the assumption is that the hypothesis should be applied where the question arises, as it does in particular for banks, whether, given a level of liabilities which bear interest and liabilities which do not (“equity capital”), what proportion of each would a stand alone enterprise hold. If the amount of interest bearing capital is higher than would be held at arm’s length, the costs associated with that loan capital are disallowed as representing a return on equity.

Section 11AA(5) provides for a power to make regulations to apply section 11AA(2) to insurance companies. The Non-resident Insurance Companies Regulations 2003 (SI2003 No.2714) came into force on 13 November 2003 and have effect in relation to accounting periods beginning on or after 1 January 2003. Section 11AA(5) recognises that with an insurance company, it is not a question of determining what proportions of the given total capital of a PE are equity and loan capital respectively, but more a question of determining, given a level of liabilities in the main technical provisions, what amount and type of assets an independent enterprise would hold.

Where unusually an insurance company’s PE has loan capital attributed to it, then section 11AA(3) will be applied to the PE’s capital in the same way as it is for any other company, and here credit rating may be relevant.

Regulation 3 of SI2003/2714 sets out the way that the independent enterprise hypothesis is to be applied to an insurance company. The hypothesis that the profits of the PE are those which an independent enterprise would have requires it to be assumed that the PE has free assets of the same amount that an independent enterprise engaged in the same or similar activities under the same or similar conditions, dealing wholly independently with the non-resident company, would have.