The U.S. Tax Cuts and Jobs Act (TCJA), signed into law in December of 2017, could have more immediate implications for Bermuda insurers and reinsurers, according to analysis by Kroll Bond Rating Agency (KBRA).
In a recent report, KBRA discusses potential implications for Bermudian re/insurance companies regarding the implementation of the TJCA in the U.S., highlighting provisions to the Passive Foreign Investment Company (PFIC), the Controlled Foreign Corporation (CFC), and the Base Erosion and Anti-Abuse Tax (BEAT) as noteworthy.
Firstly, the TCJA made an amendement of the PFIC exception for insurance companies, ultimately applying a more objective test. Now, for the Insurance Company Exception to apply, the applicable insurance liabilities of a foreign P&C re/insurer must constitute more than 25% of the foreign company’s assets, or, at least 10% of the entity’s assets, if the dip below 25% is related to certain facts and circumstances. Although, exactly how this would work remain unclear, says KBRA.
According to KBRA analysis, as at the end of 2017, 14% of Bermuda P&C groups and independent Class 4 companies were below the 25% threshold, and, including companies that were only just above the threshold, the figure increases to almost 33%.
“This has the potential to drain capital from the Bermuda market as companies would need to return capital to shareholders to reduce assets in order to pass the new PFIC Insurance Company Exception requirements. It also has the potential to deter future U.S. investment in the Bermuda market as the PFIC Insurance Company Exception must be met each tax year,” says KBRA.
Essentially, warns KBRA, either of the above scenarios would be detrimental and negatively impact the global insurance and reinsurance industry. Capital is required, warns KBRA, and especially by Bermuda catastrophe reinsurance companies, in order to support increased natural catastrophe loss years, which appear to be on the rise as a result of climate change.
“Capital is also needed to support newly developed solutions for emerging risks where the liabilities initially may not be easy to quantify accurately,” explains the report.
However, insurers and reinsurers in Bermuda that reasonably believe that they will be negatively impacted by this tax law change have not been waiting for the final guidance to be published, says KBRA.
Alongside the PFIC provision, KBRA notes that Bermudian re/insurers are also tackling changes to the CFC provision made by the TJCA.
Regarding the CFC provisions, and of particular interest to the Bermuda market, the TCJA expanded the definition of a “U.S. 10% shareholder” to include persons that own 10% or more of the CFC by value, in addition to shareholders that own more than 10% of the CFC by vote.
At the same time, the TCJA broadened the attribution rules that apply in determining if a person is a “U.S. 10% shareholder”, and if a company is a CFC.
“These changes to the CFC rules generally make it more likely that a foreign company will be treated as a CFC and that each “U.S. 10% shareholder” that meets either threshold will be required to annually include in personal income its pro rata share of the CFC’s net income, even if no distributions of that income are made,” says KBRA.
The report warns that this could also reduce capital from the sector and/or put off new investments into the Bermuda marketplace.
Furthermore, the TCJA also introduces a BEAT that is applicable to corporations that are subject to U.S. income tax with three-year average gross receipts of at least $500 million, and that have also made related party tax deductible payments that equate to 3% or more of the corporation’s overall deductions for the year.
“KBRA reviewed the 10-K filings of U.S. publicly-traded Bermuda (re)insurance groups and found that all included the BEAT provision of the TCJA as a tax risk factor. The disclosures generally stated that the overall changes made by the TCJA would potentially increase the complexity, burden and cost of tax compliance with a resultant negative impact on their business, financial condition and results of operations,” says the report.
Concluding, that: “With perseverance, determination and creativity, participants in the Bermuda market are poised to overcome the obstacles foisted upon them by the TCJA – maybe not with the first solution(s), but eventually. Then, they can go about what they do best: finding innovative solutions to the tough issues facing the global (re)insurance industry. Quo Fata Ferunt.”