Tax regime for insurance linked securities introduced

The Treasury has published new regulations designed to introduce a competitive regulatory and tax regime for insurance linked securities (ILS), which includes corporation tax exemptions to ensure that UK gets a share of this rapidly growing market

Insurance linked securities, sometimes known as catastrophe bonds, allow insurance and reinsurance firms to transfer risk to the capital markets when insuring against extreme risks, such as earthquakes and hurricanes.

Over $80bn (£61bn) of insurance linked securities have been issued to date, with over $10bn (£7.6bn) issued in 2017 alone, and research suggests it could reach an estimated $87bn (£67bn) by 2019.

The regulations will be laid before Parliament after summer recess and will come into force in the autumn of this year, and follow on from a consultation which closed in January.

They set out how to establish special vehicles to issue insurance linked securities, the legal framework, and the associated tax treatment.

The Treasury says that during the consultation process it became clear that subjecting the core insurance risk transformation activity carried on by the qualifying transformer vehicle (QTV) to corporation tax would result in an uncompetitive tax treatment, making it unlikely insurance linked securities vehicles would establish themselves in the UK.

Therefore, the government has decided that the insurance risk transformation activity of the QTV should not be subject to corporation tax. Furthermore, it was clear from the consultation that imposing a withholding tax on payments of interest made by the QTV would also make the UK less competitive than jurisdictions where insurance special purpose vehicles (ISPVs) are already established.

In the UK there is already no requirement to withhold tax on dividend payments, while a number of exemptions apply to withholding tax on interest payments. The government’s proposal here is to fully exempt from withholding tax debt and equity payments made from an ISPV to investors.

The government’s proposed approach therefore means that UK investors would be taxed as normal on their investment income, with overseas investors taxed according to the regime in their home country.

The tax treatment is strictly limited to QTVs and is contingent on regulatory rules being met and authorisation from the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA). The Treasury says the tax treatment under the regime will be fully switched off if a QTV is used to secure a tax advantage for any person.

Responses to the consultant have resulted in several other changes to the tax regime for insurance linked securities. The period allowed for distribution of assets from a QTV has been extended from 30 days to 90 days from the date on which all liabilities under the contract have been satisfied.

The condition providing for the tax treatment to be switched off if investors connected to the undertaking from which the risk was assumed held 10% or more of the securities issued by the QTV has been removed. The Treasury has also revised the approach to breaches of compliance, to ensure that the tax treatment is switched off only for most serious matters, such as penalties incurred for a return submitted with a deliberate inaccuracy or higher level penalties charged because of repeated failure to submit a return on time.

Stephen Barclay, economic secretary to the Treasury, said: ‘This new bespoke regime for Insurance Linked Securities will ensure the UK remains the most competitive insurance and reinsurance hub in the world.

‘This global business is evolving rapidly and we are determined to make sure we’re part of this evolution.’

Regulations implementing a new regulatory and tax framework for Insurance Linked Securities: response to the consultation is here.

The Risk Transformation (Tax) Regulations 2017 are here.

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