The Tax Cuts and Jobs Act has now been passed into law in the United States. It is the biggest tax reform in the United States since the 1980s and will have a significant impact on insurers in the US who will see their corporate tax cut from 35 to 21%. It is not all good news though; jurisdictions like Bermuda will see previous tax advantages reduced which is likely to have a negative impact on business. This article examines the potential effect of the tax reforms on Bermuda.
Bermuda has long been an attractive jurisdiction for financial services companies as the regulatory and tax advantages of Bermuda make it a natural jurisdiction for the (re)insurance industry. It has, however, been criticised at times for being a tax haven where international companies set up headquarters to avoid paying tax. This is referred to as the Bermuda loophole used by multinational insurers with US operations to invest premiums earned in the US. The so-called loophole works by insurers using that premium to purchase reinsurance from their affiliate companies in overseas jurisdictions such as Bermuda which benefit from tax advantages.
Insurers with affiliate companies in Bermuda (or similar jurisdictions) have been accused of taking advantage of the loophole to avoid paying tax on premium which would otherwise be subject to US tax. The loophole means that the insurer defers paying tax on the premiums they collect and are only taxed at low or zero rates on the US generated income whereas US insurers pay the full federal tax.
Level playing field
There are of course many sound and genuine commercial reasons why an insurer would want to do this as all insurers need to build up funds to pay claims. However, some US insurers have complained that this puts international insurers who benefit from the loophole at a competitive advantage vis-à-vis US headquartered insurance companies.
In a bid to even out the playing field, there has been a push by certain US insurers to try to close the loophole; a group of US insurers formed the Coalition for American Insurance and lobbied government to address the perceived competitive edge these multinational companies have over US insurers.
The recent reforms go some way to evening out the playing field. This is achieved first by applying a tax to payments made by US firms to overseas affiliates in places like Bermuda; premiums paid by US companies to their overseas affiliates will now be taxed at 5% per annum in 2018 increasing to 10% in 2019 and 12.5% by 2026. In addition, US federal corporate tax has been reduced from 35% to 21%.
Those who lobbied for the change will no doubt be pleased with the outcome since the reduction in US corporate tax will narrow the gap between the US and Bermuda thereby reducing the competitive advantage. Similarly, the tax on income transferred to overseas affiliates, whilst not designed to be discriminatory, will clearly have a negative impact on those insurance groups with US subsidiaries which pay premium to affiliate reinsurers in jurisdictions like Bermuda. It will also affect private equity firms and hedge funds that have overseas reinsurance operations into which they invest income.
Those in favour of the reform say that the previous tax regime had a negative impact on customers and hindered competition because the risk was not being spread in the usual way by reinsuring through third party insurers. Not surprisingly, international insurers with US operations have criticised the reforms saying that the increased cost of business may have to be passed on to customers through higher premiums.
Whether this will have a significant impact on Bermuda’s role in the financial services sector is yet to be seen. It seems unlikely that it would be fatal since Bermuda continues to benefit from tax advantages and a favourable regulatory regime. Bermuda has also played a large part in the (re)insurance world for many years and, as such, has developed a sophisticated environment for (re)insurance and investment which is built on far more than a tax loophole.
About the Author
Helena is experienced in advising on coverage issues under a wide range of insurance policies. She has also acted for insurers in a number of complex disputes.
She has spent time on secondment at large insurance and reinsurance companies in France, Germany and Bermuda and advises on policy wording and regulatory issues.
Helena speaks French fluently and many of the matters on which she advises involve cross-border issues. When not at work, Helena loves to travel and enjoys skiing in winter and trying her hand at different outdoor activities in summer.