Swiss Re’s $2.7m VAT bill last year triggered fears of an explosion in retrospective tax bills, David Banks writes. Now rule changes throw up more hazards. We guide you though the minefield of European regulation.
When Swiss Re was judged to be liable for a €2m ($2.73m) VAT payment on a life portfolio transfer from its German subsidiary in October last year, the insurance world took notice. At first sight, it looked like Swiss Re could have avoided the tax, as there are so many tax-free options available to companies seeking to transfer portfolios; VAT exemptions cover pure reinsurance contracts, transfers within the same company and transfers of a going concern (TOGC).
Unfortunately for Swiss Re, German tax authorities are more stringent about those TOGCs; ‘going concerns’ cannot just be a piece of paper but need to involve staff and premises too.
For a while, there was mild panic in the insurance and reinsurance sectors. How many other companies would be hit by retrospective tax bills across the EU’s 27 member states? Yet, if the tax authorities were scrutinising the last few years of transfers, as predicted, they certainly have not found anything yet.
In fact, six months on, the rules have changed so much that there are now yet another set of pitfalls for reinsurers and cedants to consider.
Here we explain the key considerations when attempting to navigate the disorienting world of European VAT.
1. Exemptions from the rules
A portfolio transfer is exempt from VAT if it is either pure reinsurance, or a TOGC. Transfers within the same group that do not cross borders could also be deemed exempt from VAT.
Steptoe & Johnson tax partner Kassim Meghjee says: “In short, the legacy of the Swiss Re case … can be overcome with relative ease.”
2. Thinking ahead – pre-clearance
Several tax authorities across the EU provide a pre-clearance facility, which provides certainty of a transfer’s VAT-free status before it takes place. In the UK, the pre-clearance facility appeared to have been removed at the end of 2009, but this was later clarified as an “administrative mistake” by the UK tax office, which still offers pre-clearance.
3. The Swiss Re case
Swiss Re Germany Holding GmbH v Finanzamt München für Körperschaften in October 2009 resulted in VAT applying to reinsurance portfolio transfers under certain circumstances. The European Court of Justice decided the transfer of a portfolio of reinsurance contracts is neither a banking transaction nor a (re)insurance transaction.
This means that, under the current rules, VAT could become chargeable. But the case does not relate to the application of VAT to insurance or reinsurance transactions.
4. Shifting responsibility
Since 1 January 2010, it has become even easier for a company to transfer a portfolio to a reinsurer, because place of supply rules put the onus of VAT payment on the reinsurer not the cedant. Nowadays, it seems, the Swiss Re case would never have been heard. This poses fresh questions for reinsurers, especially the London run-off market. Lovells partner Greg Sinfield says:
“The change in the place of supply doesn’t make the VAT issue any less important. We see a lot of non-EU portfolios being directed to London and what used to be regarded as having no VAT consequences at all suddenly becomes very important. These are companies that have never had to think about VAT before and now it’s an issue.”
If it becomes difficult for insurers and reinsurers to find exemption from VAT, lower-tax domiciles outside of the EU, such as Bermuda, Switzerland, the Channel Islands and the Isle of Man, could benefit from European business.
Meghjee adds: “For transfers outside the EU, the implementation of the new place of supply rules should make the VAT analysis even simpler and thus make the transfer of businesses to more benign tax regimes outside the EU even more appealing.
5. Avoiding VAT, the easy way
When a TOGC seems tricky, there are other options. “For transfers within or into the EU, mitigation of the VAT-accounting burden is possible. The recipient should be able to argue, if all the relevant conditions are satisfied, that such a transfer is a TOGC. It would, however, be prudent for the EU-based recipient to get a ruling from its tax authority that the TOGC treatment does apply,” Sinfield says.
“Alternatively, it may also be possible to restructure the same transaction as primarily that of reinsurance, which is then followed by a disposal of the nominal residual business at much lower value. For transfers outside the EU, the implementation of the new place of supply rules should make the VAT analysis even simpler and thus make the transfer of businesses to more benign tax regimes outside the EU even more appealing.”
But Sinfield says applying the label of ‘reinsurance’ to a transfer should not be viewed as a “get out of jail free card”.
“I think the difficulty is that it is such an obvious device to avoid a VAT charge is that it is vulnerable to challenge under an anti-avoidance doctrine,” he says.
6. Retrospective VAT
In EU countries, tax authorities can look back up to four years depending on national rules if they wish to apply the precedent set by the Swiss Re ruling. The companies with the most to worry about are those cedants that did not gain pre-clearance. This might especially relate to companies in the 27 EU member states whose regulatory authorities did not initially provide deep scrutiny.
7. La différence across the EU
Rules of payment of VAT and its enforcement by the courts might ultimately be a Europe-wide decision, but what transactions are liable for VAT and the procedures followed by the authorities vary in each country.
In the UK, the transfer of portfolios as in the Swiss Re case would probably have escaped VAT even before 1 January 2010, because TOGC rules are less stringent. France has recently issued guidance on TOGC rules to provide clarity in a complex system.
8. Timescale of a TOGC
When TOGCs take place, it is usually expected that the going concern should be ‘kept going’ for a period before it is processed. The time required is not specified in rules, but the perception in the UK, for instance, is expected to be weeks rather than days. Sinfield says: “The thing that people overlooked is that the transferee has to carry on the business for a period. People used to trip up on that but I’m not aware of anyone being taxed as a result. However, the tax authorities might now be looking more carefully.”
9. How it could all change
Authorities may decide they need more money and tighten the rules on portfolio transfers. UK authorities could decide to follow Germany and require staff and premises to be transferred. Tax officials might also decide to tighten guidance on transfers being presented as reinsurance contracts. On the other hand, the International Underwriting Association of London is seeking to remove portfolio transfers altogether from VAT liability.
10. No precedents
In some cases, there is still doubt as to whether a cedant is providing value to the reinsurer in the form of a book of business, or whether the reinsurer is providing a service to the cedant by taking it on. Any future test case would need to establish whether tax was owed on the whole block of business, on the earnings from the business, or on the service rendered by the reinsurer. The rules on portfolio transfers are “still in transition”, Sinfield says. Reinsurers and cedants would be wise to stay alert. GR