Canadian insurers facing ‘affiliated’ tax grab

Canadian insurers facing ‘affiliated’ tax grab

While the battle is hotting up over US government plans to disallow the tax break given to domestic insurers ceding reinsurance to foreign affilates, over the border in Canada, insurers are facing the possibility of getting a massive backdated tax bill for premiums they have paid to offshore affiliates.

Canadian insurers are nervously awaiting the details of any proposed changes to federal rules signed into law in 2010, but it looks like they could be forced to pay hundreds of millions of dollars in back taxes and be forced to change their relationships with foreign parent companies.

The changes, now nearing enforcement, could require life and property/casualty insurers to pay tax on reinsurance arrangements with related businesses in other countries, retroactive to 2005.

As with the controversial US proposals, the tax would not apply to domestic reinsurance transactions nor when dealing with an arm’s length foreign reinsurer.

Unlike the US proposals, however, many insiders believe the Canadian tax grab to be an accident. Specifically, the 2010 amendments to the imported services provisions of the Excise Tax Act, GST Provisions, appear to be at odds with the broad public policy intent of value added taxation. 

But was it a case of serendipity for the state? There’s widespread belief that on realising the move would bring in some much needed revenue, the Canadian government is now reluctant to undo the error. Industry estimates put the tax take at C$1bn

Quoted in the Globe & Mail newspaper recently, Mike Firth, a tax services partner with PricewaterhouseCoopers, said that the rules went way beyond the problem they were originally meant to solve: “This appears to be a legislative accident,” he said. “And it’s still unclear what the legislation is supposed to produce when applied to reinsurance contracts. Taxpayers need certainty, and clearly there’s a concerning lack of certainty here.”

As things stand, all the filings Canadian insurers have made with the regulator since 2005 are wrong. And it will be a tough job unpicking those filings.

Tax specialists believe that a Canadian insurer is entitled to deduct the part of the premium that is not defined as “loading” from taxation. Loading is broadly defined in the legislation as the portion of the premium that is attributable to the non-resident’s cost of doing business and its margins.

However, advisers claim it is difficult to determine the value of the reinsurance contract that is attributable to the costs that are defined as loading. Also, the tax burden will be different for different types of insurance and different states in Canada.

But as an example, in Ontario a likely outcome will be an additional 13% tax on around 35% of the reinsurance premium, going back to 2005, plus penalty, plus interest.

For its part, the Canada Revenue Agency says it is reviewing the best way of defining loading.

Compared to the vociferous lobbies campaigning for or against the US tax reform proposed by Congressman Richard Neal and Senator Robert Menendez, Canadian insurers have been relatively acquiescent.

The Canadian Life and Health Insurance Association politely says the legislation “appears to have a wider scope re related-party, cross-border reinsurance arrangements than was intended by the Minister of Finance, based on his public statements, and we are working with officials to better explain how reinsurance contracts are structured and priced in order to help them understand why it would be appropriate to withdraw the parts of the legislation that are unintended with respect to these transactions”.

The Insurance Bureau of Canada told me simply: “We are still in the process of reviewing this file, therefore we do not have a position on this.”

According to a report in the Winnipeg Free Press, the legislation could mean a bill of up to C$1bn ($960m) for insurers. The legislation appeared in 2007 but its implications only recently dawned on insurers,

"In discussions I have had with affected insurers, most only became aware of the issue in 2012," Denis Brown of MSA Research wrote in an industry newsletter this April. "Like me, many did not take it seriously until December of 2012, always assuming that wiser heads at Revenue and Finance would intervene and fix the problem."

Insurance companies must pay their tax bills for 2012 by June 30, and face having their filings for the previous six years increased retroactively.  The Winnipeg Free Press quoted Joel Baker, president and CEO of MSA Research, as estimating the additional GST bill for 2012 alone could be up to C$200m, or more than C$1bn in total once retroactivity to November 2005 is counted.

Some in the industry are fatalistic. An industry source said, “Government is supreme, government decided to impose the tax retroactively, and that decision was part of the 2010 Federal budget, so essentially there is nothing that can be done.

“Government could of course revisit the legislation. But ultimately, the only recourse for global capital in response to this sort of behaviour is to exit Canada… If you want to be able to rely on the legislative framework in which you order your affairs – don’t come to Canada.”

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