ICA backs government's proposed MNE interest limitation rules

The Insurance Council of Australia (ICA) has offered support for the government’s proposed multinational enterprise (MNE) interest limitation rules and their potential application to insurers. However, it has some recommendations to help the industry.

In 2015, the Economic Cooperation and Development (OECD) outlined a framework in Action 4 of the Base Erosion and Profit Shifting (BEPS) program to limit interest deductions. Action 4 focuses on using third-party, related party, and intragroup debt to obtain “excessive” deductions or “finance the production of exempt or deferred income” and recommends an approach based on a fixed ratio rule, supplemented by a worldwide group ratio rule. The OECD recommended a fixed ratio test to limit net interest deductions to 30% of earnings before interest, taxes, depreciation, and amortisation (EBITDA), subject to caveats.

In a letter to The Treasury, ICA CEO Andrew Hall said it supports the implementation of the OECD BEPS Action Plan to address known weaknesses in the international tax environment. However, he argued that a different approach might be more appropriate when dealing with entities in the insurance industry. Specifically, the general insurance industry has an inherently volatile profitability profile, as seen in the impact of the catastrophic East Coast flooding from February to March 2022.

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“Given this profitability profile, [the] application of the fixed ratio rule (discussed below) to the sector would create a moving bar for interest deductions that inhibits the industry’s ability to plan, raise capital, and withstand the ongoing and increasing challenges posed by climate change,” Hall wrote on the letter. “Further, such a change would hinder the industry’s focus on helping the community reduce risk to be able to provide affordable insurance options to consumers and businesses.

“It would be reasonable for a country to exempt insurance groups from the fixed ratio rule and group ratio rule where no material risks are identified in that country and for these groups to continue to be subject to the existing thin capitalisation rules.”

The ICA has called on the government to consider the following:

• Insurance groups are subject to strict regulatory capital rules limiting their ability to excessively gear their operations;
• Insurance companies, as investors of premium income, are key providers of debt finance in corporate bonds and typically experience net interest income rather than net interest expense; and
• Insurers often have substantial EBITDA volatility due to the industry’s nature. Given the uncertainty around EBITDA due to that volatility, insurers might be forced to apply an alternative thin capitalisation test, such as the worldwide gearing or arm’s length debt test.

“Should the government reach the conclusion to retain application of the fixed ratio rules to insurers, we would be pleased to meet with Treasury to discuss options to limit unintended consequences for the insurance sector,” Hall said.