“Under the OECD guidance, captive insurance transactions must be ‘accurately delineated’ as actual insurance arrangements.”
Sebastian Ma’ilei, Deloitte

The Organisation for Economic Co-operation and Development (OECD) published transfer pricing guidance for captives, for the first time, in February 2020. That guidance will form a new section of the OECD Guidelines, the de facto transfer pricing rulebook for revenue authorities in OECD countries.

This article will focus on the OECD’s 2020 material on captive insurance, as well as some of the wider international tax considerations that should be taken into account alongside transfer pricing.

The OECD guidance provides an overview of captive insurance, and focuses on the commercial rationale for captive arrangements, “accurate delineation” of such arrangements, and transfer pricing methods that may be appropriate to employ.

Documents matter

A key concept of the 2017 OECD Guidelines is “non-recognition”, whereby, in short, a tax authority can disregard a transaction if it is not commercially rational and replace it with an alternative transaction.

By definition, if transactions are observable between third parties, they must be commercially rational. In addition, however, per paragraph 1.122 of the 2017 OECD Guidelines: “Importantly, the mere fact that the transaction may not be seen between independent parties does not mean that it should not be recognised”.

The new guidance on captives describes various reasons as to why a multinational enterprise (MNE) may use captive insurance, including that a group may use a captive to provide insurance for risks that are difficult or impossible to insure externally, but that doing so can “raise questions” as to the arm’s length nature of the pricing of the arrangements, as well as to whether the arrangements are commercially rational.

It is therefore crucial that captive owners clearly document their commercial reasons for the existence and ongoing operation of their captives.

Genuine insurance transactions

Under the OECD guidance, captive insurance transactions must be “accurately delineated” as actual insurance arrangements in order to be respected as such for tax purposes.

This involves considering whether the conduct of the parties (ie, the captive and any companies of the multinational group purchasing insurance from the captive) is consistent with the contractual form of the transaction. If these do not align, the transaction could then be transfer priced, and therefore taxed, not based on what is in the written contract, but based on the behaviour of the parties.

In practical terms, for a captive this could involve a tax authority seeking to re-price the transaction as something other than insurance, including potentially disallowing tax deductions claimed by operating companies with respect to premiums paid to the captive.

For the transaction to be accurately delineated as insurance, six criteria, including functional “substance” and risk transfer, must be met.

These are as follows, per paragraph 10.199 of the OECD guidance:

  • There is diversification and pooling of risk in the captive insurance;
  • The economic capital position of the entities within the MNE group has improved as a result of diversification and there is therefore a real economic impact for the MNE group as a whole;
  • Both the captive and any reinsurer are regulated entities with broadly similar regulatory regimes and regulators that require evidence of risk assumption and appropriate capital levels;
  • The insured risk would otherwise be insurable outside the MNE group;
  • The captive has the requisite skills, including investment skills, and experience at its disposal; and
  • The captive has a real possibility of suffering losses.
“From a transfer pricing perspective, it is important that the captive does not outsource all of its operations.”
Jeremy Brown, Deloitte

We consider some of these criteria in more detail below.

  • First, how diversified is the captive? Diversification can be easily demonstrated for a traditional commercial insurance company, whether across geographies or lines of business. For captives, which are often established to insure a limited scope of risks within a particular business, this may not be so apparent.
  • Second, is the insured risk insurable outside the group? The guidance tells us that captives may exist precisely for this reason, which makes the inclusion of this criterion puzzling. Furthermore, if failing this test is used as grounds to delineate the transaction as something other than insurance, this would seem to be in conflict with paragraph 1.122 of the 2017 OECD Guidelines which, as noted above, states that a transaction need not be observable between third parties to be recognised for transfer pricing purposes.
  • Finally, does the captive have sufficient functional substance such that it has the “requisite skills” and “experience” per the guidance? From a transfer pricing perspective, it is important that the captive does not outsource all of its operations but, in particular, retains some level of underwriting and actuarial expertise, including robust oversight of such activities where they are outsourced to captive managers.

It is expected that some tax authorities will look to apply the above criteria in risk assessment and in tax audits. It is therefore essential that captives owners prepare documentation evidencing the above.

Pricing the premiums

The new OECD guidance sets out which of its recognised transfer pricing methods might be appropriate for captive insurance transactions. A key challenge here is, of course, that unlike many other types of transactions considered in transfer pricing studies, captive insurance may not be easily benchmarked using commercial databases as information is not publicly available.

Likewise, third party comparable uncontrolled transactions may not be easily identifiable or even available at all given captive insurance transactions are typically intra-group.

Per the OECD guidance, the accepted methods include:

  • The comparable uncontrolled price method, which involves using uncontrolled transactions. An example of this would be a group operating company that purchased property insurance from both the captive and a third party insurer on the same terms, covering similar risks (eg, buildings of equivalent value in similar areas), and for the same or a similar price. This “comparable uncontrolled price” is then used to support the pricing of the intra-group transaction for transfer pricing purposes.
  • The transactional net margin method, which benchmarks the profitability of the captive (in this case by reference to a combined ratio and return on capital) against the profitability of third party insurance/reinsurance companies. However, captive owners must carefully consider whether third party insurance/reinsurance companies are really comparable to the captive, given their differences in scale and level of diversification. A further consideration is that third party insurers/reinsurers often seek to hold additional capital over and above regulatory requirements to achieve a rating benefit, which can distort their return on capital in comparison to that of captives.
“It is important to be able to explain to the tax authorities why the captive is used.”
Hannah Simkin, Deloitte

  • Performing an actuarial analysis of premiums paid. This is an application of an “other” transfer pricing method under the 2017 OECD Guidelines. Given the possible shortcomings of the other two accepted approaches, this could be the most suitable method.

An additional area covered with respect to pricing is “group synergies”. This refers to situations where the captive pools risks on behalf of other entities in the multinational group, and then accesses the reinsurance markets as a single buyer.

In this type of scenario, where this results in reduced overall reinsurance premiums for the group, the guidance stresses that these premiums savings should be passed on to the pool participants and not retained by the captive, with the captive retaining only a service fee to remunerate it for its functions performed.

Other key tax considerations

Alongside the transfer pricing treatment of captives, there are other direct tax considerations associated with a captive’s operating model design, such as its tax residence and whether a permanent establishment could be created as a result of remote decision-making.

For example, a captive incorporated outside the UK could be considered UK tax-resident if it is centrally managed and controlled from the UK. Where a captive is tax-resident outside the UK but supported by risk management functions in the UK, this could create a permanent establishment (a taxable presence) in the UK such that some of the captive’s profits may be subject to UK corporation tax.

Targeted measures, such as the UK’s diverted profits tax (DPT) which seeks to tax profits artificially diverted from the UK at a punitive rate, have prompted enquiries into some captive insurance arrangements where the captive is based in a low to no-tax jurisdiction. In line with the new OECD guidance on determining whether a captive arrangement is a genuine insurance transaction, it is important to be able to explain to the tax authorities why the captive is used, covering both the original setup and its continued use.

HMRC’s DPT guidance contains an example of a captive insurance arrangement where there are no commercial motives for the transaction other than the tax saving, concluding that a DPT charge should arise.

In addition, controlled foreign company (CFC) rules have now been implemented across the EU as a result of the EU’s Anti-Tax Avoidance Directive. The application of CFC rules, both in the EU and more widely, to the activities of the captive should be considered.


It is important that captives owners consider relevant tax developments in this area and, among other things:

  • Ensure that the commercial rationale for intercompany captive arrangements is kept under review and accurately documented.
  • Consider the delineation of the transactions under the OECD guidance: are they insurance?
  • Revisit the transfer pricing of intercompany insurance premiums and ensure that they can be supported using one of the OECD accepted methods.
  • Consider the existing operating model. Are operating guidelines required to manage any permanent establishment or tax residence risk? Have CFC rules been considered and is the group compliant with any relevant economic substance rules?

Sebastian Ma’ilei is a partner at Deloitte. He can be contacted at: smailei@deloitte.co.uk

Jeremy Brown is a director at Deloitte. He can be contacted at: jerebrown@deloitte.co.uk

Hannah Simkin is an associate director at Deloitte. She can be contacted at: hsimkin@deloitte.co.uk

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