Tax Risk and Transfer Pricing Tax Insurance: Insights from Industry Experts

In a recent webinar hosted by Aon in collaboration with Copenhagen Economics and Acquinex, a panel of tax and transfer pricing experts discussed the growing importance and intricacies of tax insurance policies, particularly in the context of transfer pricing. The session provided valuable perspectives from brokers, underwriters, and transfer pricing specialists on how companies can manage and mitigate these complex tax risks.

What is Tax Insurance and How Does It Differ from W&I Insurance?

Ted Wigelius from Aon, with previous extensive experience as a tax lawyer focusing on mergers and acquisitions (M&A), clarified the distinction between tax insurance and Warranty & Indemnity (W&I) insurance. While W&I insurance covers unknown risks under the warranty catalog in a Share Purchase Agreement (SPA), a tax insurance policy specifically addresses identified potential tax risks. These tax risks can arise within and outside of M&A contexts, the later such as in daily corporate operations or planned restructurings. Tax insurance solutions for transfer pricing related risks are most commonly originated from outside an M&A context, considering that such processes usually require more time in underwriting.

Emelie Wallon, also tax lawyer by background who has covered the Nordic Tax insurance market for Aon since 2021, continued to explain that tax insurance protects companies from losses arising when tax authorities challenge a chosen tax treatment. It covers not only the tax at risk but also defense costs, late interest fees, penalties when insurable under local law and gross-up. This insurance solution is particularly suitable for risks rated as low to medium probability but with potentially high financial impact, with coverage amounts ranging from €1 million to over €1 billion for one specific tax risk.

Transfer Pricing Risks

Transfer pricing risks pertain to cross-border transactions within multinational groups, often linked to restructurings, licensing agreements, or intra-group services. Georg Dettmann from Copenhagen Economics emphasized that he sees tax insurance as a valuable tool in relation to uncertainties regarding the applicable interest rates on intercompany loans, the remuneration charged for routine entities and when there is a risk that tax authorities deem that profit potential has been shifted to another jurisdiction (exit taxation).

“From a broker’s perspective we have seen inquires regarding all these intra-group transactions flows, with interest rates on shareholder loans related risks being one of the few that has been possible to insure within the timeframe required for a M&A transaction,” said Ted Wigelius, Tax Insurance, Aon M&A and Transaction Solutions.

Given the complexity of transfer pricing, due diligence reports alone are often insufficient for insurers. Instead, a detailed tax memo from e.g. Copenhagen Economics with supporting arguments and risk assessments is typically required to evaluate the insurability of transfer pricing risks.

Underwriting Transfer Pricing Tax Risks

Tom Pygall, an underwriter with over 20 years of tax experience, highlighted the challenges insurers face when underwriting transfer pricing risks. Insurers seek to avoid "execution risks," where documentation or commercial realities do not align, potentially leading to uncovered losses. To mitigate this, insurers often charge a pre-underwriting fee to conduct a thorough risk assessment before committing to non-binding indications. This fee allows insurers to gain comfort on the risk and limit the risk that the risk profile, and hence the non-binding terms, would change upon a deeper review.

Additionally, for transfer pricing risks with forward-looking elements or transfer pricing risks under audit, insurers may impose a monitoring fee. This fee covers ongoing review of compliance documents to ensure adherence to policy terms over multiple years, reflecting the long-term nature of transfer pricing risks.

Market Trends and Practical Applications

The webinar panel noted an increasing demand for transfer pricing insurance, driven by heightened tax authority scrutiny and the financial stakes involved. Tax insurance is seen as a valuable tool not only in M&A but also for managing ongoing operational risks or historical risks related to e.g. intra-group transactions and licensing arrangements etc.

”The more complex transfer pricing risks we have managed to facilitate insurance solutions for have all been outside M&A context,” pointed out Emelie Wallon, Tax Insurance Broker, Aon M&A Transaction Solutions

Premiums for tax insurance vary depending on risk complexity, ranging generally from 1-5% of the insured amount in Europe and the Nordics, with transfer pricing risks commanding higher premiums of 3-7% due to their complexity.

Conclusion

Tax insurance, particularly for transfer pricing risks, is emerging as a critical risk management instrument for multinational companies. By transferring potential tax liabilities to insurers, companies can protect themselves against costly disputes and uncertainties inherent in cross-border tax arrangements. The collaboration between brokers, underwriters, and transfer pricing experts ensures that these complex risks are carefully assessed and appropriately covered.

This webinar underscored the importance of detailed documentation, expert analysis, and clear communication between all parties to successfully navigate the evolving landscape of tax risk insurance.