Transfer pricing insurance for financial transactions

Until recently, we at LCN Legal weren’t aware that insurance was available in relation to transfer pricing risks. We thought you would be interested to read the following article, which was kindly contributed by Paul Dickinson, Head of Tax (International) at Themis, an underwriting agency gaining significant traction in the M&A insurance market owing to its experienced team. Themis seeks to position itself as the partner of choice for the global M&A community by offering a broad array of transaction solutions. In the case of Tax, this includes an ability to work on more complex and structured risks, such as those which involve accounting or valuation issues.

Within the M&A market, the use of insurance for standalone tax risks is now well developed both in the UK and globally. These are often insured either as part of Warranty & Indemnity insurance or as a standalone Tax Risk Policy because a buyer has identified a potential transfer pricing exposure in a target. Historically, there has been a reluctance to insure transfer pricing risks due to potential uncertainty over what might be considered arm’s length, but there is now an increased willingness to look at transfer pricing risks. Such risks may also be insured outside of the M&A context and we increasingly see them being obtained prior to winding up entities.

The most common transfer pricing risk we have seen to date, and one on which we have already underwritten policies both within the UK and Europe this year, has involved shareholder loans, specifically the risk of a potential transfer pricing adjustment to disallow the interest deduction in the borrower entity. Such loans are typically subordinated to secured bank debt, but they may also include more esoteric terms. However, there is increasing  scope to consider coverage of other transfer pricing related risks, including those relating to intellectual property or inter-company services.

As regards the underwriting process, we would typically first be presented with such risks when a client’s insurance broker provides a submission to us, normally accompanied by a contemporaneous transfer pricing report obtained on the client’s behalf from an advisor. That advice would usually be provided to us on a non-reliance basis, but should allow us to assess the risk and decide if we can offer insurance.

Within a day or two, we are normally in a position to provide an indication of pricing and terms to the broker for them to provide to their client. In terms of premium levels, those will vary depending on facts, advice, jurisdiction, quantum, etc., but we would typically expect them to be over 2% of the potential tax liability (plus interest and penalties). If we are selected as the underwriter, we would also charge an underwriting fee to cover the cost of our own advice. We will always endeavour to make the deal process as user-friendly as possibly; we have in-house expertise and will be guided by our advisors, but we will always be the ones making the decisions.

As part of our underwriting, we would also expect to review key documents such as the actual loan terms as evidenced by the intercompany loan agreements and related documents, the terms of other loans that might be senior to the one in question, and valuations or spreadsheets demonstrating ability to service the debt. As the members of our team at Themis have prior experience preparing transfer pricing reports from their time in practice, we are also happy to contribute our own views around the advice if we believe there are other factors that might be relevant. In terms of timing, it is feasible to underwrite such risks within a week from start to finish. Insurance brokers with tax expertise should be able to quickly assess whether a particular transfer pricing risk is insurable or not and reach out to potential insurers on your behalf.

Looking forward, we expect further risks to arise as a result of the February 2020 OECD Transfer Pricing Guidance on Financial Transactions, notably because of the increased focus on the Lender side of shareholder loans. Historically, the focus has been on the borrower, but increased analysis will now also be required in relation to whether the lender should have lent on the terms given, other options available to it and whether it has sufficient resources to manage the loan.

If you have any questions on the content of this article, please reach out to the team at Themis as follows:
Paul Dickinson
Head of Tax (International), Themis Underwriting
E: Paul.Dickinson@Themisunderwriting.com
Off: +44 203 794 4520
Mob: +44 7584 342 358
Web: www.themisunderwriting.com

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