Although the possibility of obtaining insurance for a wide variety of tax liability risks is a well-established concept, insurance for transfer pricing risks have traditionally not been possible. Underwriters have given various reasons for declining transfer pricing risks, including the level of uncertainty relating to benchmarking studies and the aggressive approach of most tax authorities in respect of transfer pricing.
JLT Specialty recently hosted a successful tax insurance seminar where the insurability of transfer pricing risks was discussed. The question was raised whether transfer pricing risks are now insurable, whereas this was not typically the case only 18 months ago.
The short answer is YES, subject to certain limitations and on a case-by-case basis.
However, there appears to be a varied approach to the insurability of transfer pricing risks by different insurers. Some insurers still have very little or no appetite for these risks. In respect of those insurers that do consider these risks, two clear approaches have emerged:
- “Bottom up” approach;
- “Catastrophic risk” approach.
Bottom up approach
Under this scenario the insurer will take on more risk. For example, if a properly supported benchmarked price is 100, the insurer may be prepared to take on the risk of any additional tax cost arising due to the relevant Tax Authority adjusting the price from its original benchmarked value, either up or down, e.g. to 105 or 95 (depending on the facts).
Clearly this approach involves more risk for the insurer, which will be reflected in the price. We are aware of transfer pricing insurance policies, dealing with the pricing of financial instruments, which followed the “bottom up” approach. However, due to the inherent and sometimes still unacceptable risks attached to transfer pricing insurance, we believe this approach will only be possible in very select circumstances.
The approach that is currently gaining more mainstream acceptance among some insurers is the so-called “catastrophic risk” approach.
Catastrophic risk approach
In this case the insurer would only be liable if things go badly wrong. For example, if a properly supported benchmarked price is 100, the insurer would not insure any additional tax costs arising from an adjustment of the benchmarked price in the range of, let’s say, 100 to 115, alternatively 85 to 100. Insurance cover would for example only be provided for risks that relate to any adjustments of the transfer price to above 115 or below 85. In practice, this can be viewed as a large policy excess or retention.
Since the insurer will only be liable under exceptional circumstances, this should be reflected in the price of the insurance, although there is very little precedent at this time.
It may be possible to have a combination of both the “bottom up” and “catastrophic risk” approaches in one policy. For example, where the “bottom up” approach is followed for any adjustments higher than the benchmarked price of 100, but the “catastrophic risk” approach applies to adjustments lower than 100. In other cases, transfer pricing insurance may only be available for adjustments either higher or lower than the benchmarked price.
Insurers are changing their attitude to transfer pricing risks. However, we still believe underwriters remain wary of these types of policies due to the inherent risks involved, and would, at the very least, require proper and up-to-date benchmarking studies by reputable advisors before considering providing cover. These would then typically be reviewed by their own advisors to determine insurability and terms.
For further information, please contact Leon Steenkamp, Head of Tax Insurance, on +44(0) 207 558 3994 or email email@example.com