German ambassador slams attempts to close reinsurance tax loophole

Klaus Scharioth, Germany’s ambassador to the US, has hit out at US attempts to tax related-party reinsurance between US-based firms and their foreign parents, saying they could violate elements of the German-US tax treaty.

In a letter to Sander Levin, chairman of the House Ways and Means Committee, Scharioth expressed the German government’s concerns about several proposals that aim to partially remove the tax-deductibility of reinsurance premiums paid to affiliates.

The initiatives include the so-called Neal Bill (HR 3424), a proposal by Representative Richard Neal to remove the tax-deductibility of reinsurance premiums paid to a foreign affiliate if the amount exceeds the industry average for third-party reinsurance. Scharioth also cited the Treasury Department’s proposal to limit deductions for affiliate reinsurance to 50% of written premiums.

“It goes without saying that the German government recognises the US government's right to combat tax avoidance and evasion,” Scharioth wrote. “But it is our view that the proposed legislation goes well beyond this objective and, as a result, will be in conflict with provisions of the German-US tax treaty.”

The Neal Bill in particular is designed to stem the flow of premiums to tax havens such as Bermuda. However, Scharioth said that such legislation would also affect companies reinsuring themselves with parents in non-tax havens such as Germany, thus putting German reinsurers at a competitive disadvantage.

Scharioth also believes that the proposals counter the so-called arm’s length principle in Article 9 of the German-US tax treaty, where related firms are taxed with respect to their commercial relations and transactions according to the same principles as unrelated parties.

The application of industry averages to related party transactions, as provided for under the Neal Bill, is … a clear departure from the arm's length principle, because it would disregard individual circumstances,” wrote Scharioth. “The same applies to the proposal put forth by the Treasury Department, which also represents a clear departure from the arm's length principle. 1ndustry averages have never been used to determine whether transactions between related parties were at arm's length.”

Furthermore, Scharioth asserted that the proposals would violate the German-US tax treaty’s prohibition on discrimination, which stipulates that a US company partly or wholly owned by a German company will not be subject to more burdensome taxation than that of other US companies.

Scharioth added that the German government was concerned about the proposals’ compatibility with World Trade Organisation principles, particularly, the General Agreement on Trade in Services.