Hong Kong Tax Alert: 9 January 2014

Commentary

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While captive insurance has been widely used as a risk management tool in advanced economies, its utilization in Asia and the Mainland remains relatively low.

We welcome the government’s proposal to introduce the incentive of the concessionary tax rate in order to attract more enterprises to set up captive insurers in Hong Kong, and to foster co-operation between the Mainland and Hong Kong.

Attracting a cluster of captive insurers to Hong Kong will help the development of other related businesses, including reinsurance, legal and actuarial services, making Hong Kong’s risk management services more diversified. This will in turn reinforce Hong Kong’s status as a regional insurance hub.

With a sound regulatory regime and availability of a wide range of professionals, Hong Kong is well positioned to establish herself as a domicile for captive insurers.

From a tax perspective, that the concessionary tax rate will only apply to the assessable profits derived from the business of insurance of offshore risks would make the proposal less susceptible to being exploited by Hong Kong taxpayers.

Furthermore, since captive insurance is a form of self-insurance within a group, the dealings between the captive insurer and its fellow group companies will be related party transactions. Where the captive insurer and the fellow group companies are located in different jurisdictions, those dealings will also be cross-border transactions.

As such, the insurance premiums charged would potentially be subject to examination by the relevant tax authorities under arm’s-length transfer pricing principles. This examination would typically include benchmarking the premiums charged and the service payments made by the captive insurer to any regional or global headquarters or other group companies, with similar charges made by unrelated third parties for comparable transactions. 

In this regard, it is also worth noting that the payment of premiums for captive insurance is being examined as part of the project, initiated by the Organization for Economic Co-operation and Development, concerning base erosion and profit shifting (BEPS) for cross-border transactions.

One of the aims of the BEPS project is to identify and address the issue of profits being unduly shifted to locations with favorable tax treatment in ways that erode the taxable base of a jurisdiction.