The ABI’s Sarah Knight says the government must continue to help UK firms operate globally.

General insurers are used to dealing with the effects of bad weather but just recently they have been caught up in the storm raging around the state of UK competitiveness and the government’s consultations on the taxation of foreign profits. These are crucial issues, not least as the UK insurance sector is the third largest payer of corporation tax and suffers the highest levels of unrecoverable VAT of any financial sector.

There are a number of areas where a burdensome tax regime can impact on commercial decision making. Insurers need to hold capital to secure their liabilities – a basic regulatory requirement. If the tax regime creates complex barriers restricting what companies can do with that capital, it causes problems.

The current tax and regulatory rules also have a major impact on whether a company sets up a branch or a subsidiary to carry out overseas business and whether it funds expansion through shareholder capital or debt.

The tax impact of such measures can have even more significance on business planning during an economic downturn, and so it’s vital the government gets this right. Corporate decisions should not be clouded by the frictional costs and distortions that tax often creates and companies should be allowed to focus more on their commercial needs.

We believe that many businesses would like to stay headquartered in the UK. The government must work hard now to send a clear, positive message that it truly wants a competitive UK tax system and demonstrate why the UK is a good place for general insurers to do business.

It is in this context that the current consultations by the Treasury on the taxation of foreign profits was originally seen as a hugely beneficial change. It was a response to long-held concerns over the availability of double tax relief on remittances from overseas subsidiaries and the growing complications of the current controlled foreign companies regime.

The consultation proposed exemption from UK tax on participation dividends, a welcome move in helping UK firms operate globally. Concern has grown that the government is now more concerned about anti-avoidance around the use of capital than facilitating global business. This is a particular worry for general insurers who need a stable environment to plan and organise their commercial activities.

“The government must send a clear, positive message that it wants a competitive UK tax system and demonstrate why the UK is a good place for general insurers to do business.

Sarah Knight

The proposals contain a test which classifies capital as either active or passive. If it is deemed passive it is judged liable to tax. For general insurers, required to hold considerable levels of investment to meet future claims, this is a major problem. Also, regulation requires firms to set up complex corporate structures to allow them to sell insurance overseas and capital requirements vary.

The omission of branches from the consultation and the restriction of interest deduction for UK parts of worldwide groups have increased uncertainty about the value of change. Additionally, the removal of the general insurance losses provisions and the introduction of UK–UK transfer pricing, all point to a government which fears an immediate tax loss but fails to see that greater benefits can be gained through taking a longer term approach to tax strategy. This uncertainty has meant that many companies now prefer no change in the taxation of foreign profits to the risks and confusion that the current review is creating.

Continuingly focusing on short-term Exchequer protection can only continue to reduce the competitive position of the UK, especially at a time when other countries are eager to court UK business. However, it is not all bad news. The government and HM Revenue & Customs (HMRC) are consulting industry on many areas. The constructive, industry-focused approach on the EU VAT directive for financial services has seen the industry and HMRC working effectively together for positive change.

The acknowledgement by the Chancellor of the need to engage more closely with the insurance industry is a step in the right direction. The foreign profits consultation will be the test of how far in practice the government is willing to go to construct a competitive UK tax system that will provide for a modern and increasingly globalised industry. With Solvency II and IFRS 4 Phase II coming into view, we need more of this approach.

Sarah Knight is assistant director, financial regulation and taxation at the ABI