Base Erosion and Profit Sharing (BEPS): changes and implications for risk managers

Julia Graham, deputy CEO and technical director, Airmic
Julia Graham, deputy CEO and technical director, Airmic

Captive models must demonstrate a strong economic rationale, explains Julia Graham, Airmic's deputy CEO and technical director

Although the most serious shock waves from the 2008 financial crisis are behind us, businesses continue to operate in challenging times.

In the 2017 survey of Airmic members A Profession in Transformation, respondents ranked "Changes in legislation and regulation" as the fifth most "top of mind risk" (increasing to equal third in three years' time). Changes in laws and regulations can dramatically increase the cost of doing business and potentially decrease the attractiveness of using certain financing solutions, including captives.

Captive structures are not immune from scrutiny. Tax authorities have been looking at captives for examples of strategies designed to avoid or reduce the tax burden in their home country by moving operations or assets to lower tax jurisdictions.

The Organisation for Economic Cooperation and Development (OECD) consequently produced a plan with 15 work streams or action items to target any transaction or corporate structure that exploits tax rules to artificially move profits from low or no tax locations where there is little or no economic activity. 

In June this year, the Federation of European Risk Management Associations, FERMA, submitted an Information Paper to the OECD with the objective of presenting "draft guidance which would help the OECD and the national tax authorities to better comprehend the concept of captive insurance and reinsurance companies". The expectation of FERMA arising from this paper was support by the OECD for a proportionate level of scrutiny by the tax authorities as regards captive structures, and a corresponding reduction in the requests for information when assessing organisations using captives as part of their risk financing strategy.

The FERMA paper was welcomed and supported by Airmic as a FERMA member association.

However, the paper on its own and the reaction to it by the OECD, does not negate the need for captives to be manged through suitable business models. These models must evidence an economic rationale that stands the test of risk bearing with adequate pricing, capital, resources, documentation and governance. Governance including risk management, should have the characteristics of any good practices, including a framework with assigned responsibilities, defined risk appetite, documented processes and assigned controls.     

As often is the case with compliance, compliance with the OECD plan is not a question of ticking boxes. Compliance is about proportionality and sustainability. Captives with strong commerciality are most likely to be defendable against tax authority examination - developing a plan bespoke to a captive which embraces the most relevant OECD action items is good captive management practice - and in the majority of cases, business and governance common sense. 

Over the coming months Airmic will be preparing guidance for members on how to develop an operating model and as part of this, taking the views of members and business partners.