Reform of the German Insurance Tax Act: what policyholders can expect in 2021
A reform of the German Insurance Tax Act in 2021 may result in multinational companies facing double taxation on risks outside the European Economic Area (third countries). The law has been met with criticism, as the changes are tantamount to a premium increase for policyholders with business premises in third countries. In addition, the risk of regulatory compliance is exacerbated. We examine the changes to the Act and how financial interest cover (FINC) can be used to protect commercial interests.
The German Federal Government has passed a reform of the German Insurance Tax Act; the corresponding draft legislation was passed by the Bundestag on 29 October 2020. ‘The Act was promulgated in the Federal Law Gazette on 09.12.2020 and became effective one day later,’ explains Nadine Benkel, Assistant to the Management Board at Funk. The official goal of the reform is to achieve more legal certainty in the area of insurance tax law through explicit or clarifying regulations. In addition, the Federal Government wants to secure the insurance tax revenue in Germany.
Taxation for risks in third countries
The reform has implications for many areas, but especially for international insurance programmes in industrial insurance. The relevant question for taxation here is always: Where is the risk located? This question cannot always be answered unambiguously. If the insured risk is located abroad because the insurance contract (also) includes a subsidiary in a third country, it is necessary to determine what share of the total net premium is attributable to this risk within the framework of the allocation of insurance tax. In practice, different criteria come into play here, e.g. turnover or local market conditions, for which in turn the risk insured under the contract is decisive.
The modernisation of insurance tax law extends the taxation rights of the German tax authorities. This is because co-insured permanent establishments and risks of policyholders domiciled in Germany that are located outside the European Economic Area (EEA) or in a third country will be subject to German insurance tax in the future. Thus, the law may provoke double taxation for companies. Another component of the reform is that in a third country where no insurance tax exists, a (German) insurance tax will be due for the first time.
‘Depending on the legal situation in the third country, our clients will have to pay 19% insurance tax in Germany on top of local taxes in respect of DIC/DIL master agreements (difference-in-conditions/difference-in-limits insurance). This is tantamount to a premium increase,’ explains Nadine Benkel, summarising the changes. ‘The clarifying regulations for companies as tax debtors intended by the reform are not discernible here.’
DIC/DIL master policies offer protection in the form of condition and sum difference cover for the risks of subsidiaries abroad that are not adequately covered by the local policy.
Status quo in terms of the taxation of international insurance programmes
Up to now, location abroad within the context of DIC/DIL master agreements justified a 0% German insurance tax rate on the insurance premium. This practice was based on the fact that insurers are usually obliged to declare and pay German insurance tax. In respect of third countries, the policyholder is responsible for paying the local insurance tax – a duty that remains unchanged by the reform of the legislation.
Focus on regulatory compliance
The taxation of foreign risks exacerbates another risk for industrial companies: regulatory compliance. If a risk located abroad is taxed, this can create a potential conflict with the local supervisory law of the third country to the detriment of the companies. This is because taxation documents the insurance of a risk located abroad. However, the local insurance supervisory law of a third country often prohibits the insurance of risks located there from outside, i.e. by insurers that have neither their registered office nor a branch in the third country. As a result, an insurer providing cover for a subsidiary of the German parent company in the third country sometimes violates local supervisory law. As a rule, tax regimes in this context mainly target insurers. But companies can also come under the spotlight. There is a threat of penalties such as economic sanctions for the companies or even criminal sanctions for persons involved.
Financial interest cover as an alternative solution?
The law reform raises the question of how companies can protect themselves from possible double taxation. Avoiding double taxation through parallel devaluation of master cover and revaluation of local covers, however, seems very questionable. The revaluation of local covers may lead to a significant premium increase, which cannot be compensated by the possible saving of the premium burden in Germany.
Financial interest cover, on the other hand, represents a possible solution. Unlike a DIC/DIL master agreement, the financial interest cover model only serves to insure the parent company for its own interest(s). As with a traditional international insurance programme, FINC insurance also requires a local policy in the foreign country concerned. In this instance, the master agreement is concluded between the insurer and the parent company. The subsidiaries located abroad cannot be covered under the agreement and therefore do not have the status of insured entities. As such, the financial interest of the parent company in the value retention of the foreign subsidiary is insured – and the insurance premium is taxed at an insurance tax rate of 19%. No tax liability applies in the third country.
Different countries have different legal frameworks and different compliance requirements. As a consequence, some countries require the use of a local insurer, making them non-admitted countries (e.g. China or Brazil). With just a handful of exceptions, the central question of which countries constitute non-admitted markets cannot necessarily be answered unequivocally, with the status sometimes needing to be determined on a case-by-case basis (e.g. Hong Kong, Singapore and Vietnam). In order to ensure a high level of security and compliance, Funk has long recommended taking out financial interest cover for the aforementioned countries. We will be happy to advise you on the pros and cons.
Are subsidiaries considered permanent establishments?
The answer to the question of whether subsidiaries qualify as permanent establishments within the meaning of the reform of insurance tax law is legally controversial. Nevertheless, in practice – due to European and German case law – there is currently a broad interpretation according to which subsidiaries qualify as permanent establishments. In order to avoid tax compliance risks, according to current market observations, insurers have also decided on this broad interpretation and therefore also levy German insurance tax. However, the question of the definition of permanent establishments is not yet legally certain. Therefore, it cannot be ruled out that the interpretation will change over time in the course of test cases. If companies deviate from the interpretation and do not want to pay the insurance tax, a so-called declaration of exemption can serve as a remedy, with which companies exempt the insurers from the domestic or foreign tax authorities.
‘We are keeping track of developments and will provide our clients with full details regarding double taxation. We are also in close contact with insurers, meaning that we can respond quickly and offer comprehensive advice where necessary.’
Draft legislation met with criticism
Insurers and German business representatives have criticised the law, warning of colossal red tape for insurers and double taxation for policyholders. ‘We are critical of the modernisation of the Insurance Tax Act, especially given the already challenging situation on the industrial insurance markets,’ says Nadine Benkel.
Thus, many questions arise in the context of the reform of insurance tax law – not all of which have yet been clarified. As a partner you can rely on, Funk is closely monitoring the situation.