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LONDON-German insurers and reinsurers are being socked with huge unforeseen tax bills because German tax authorities have disallowed tax- free investment income from former subsidiaries in Dublin, Ireland.
Last week, the Hannover Re Group reported a record 60% increase in its 1996 after-tax profit to 108 million deutsche marks
($60.9 million). The group's stellar results would have been even better, however, had it not had a whopping 146% increase in its taxes, bringing them to a total of 118 million deutsche marks ($66.6 million) at the end of last year. That compares with 48 million deutsche marks ($27.1 million) in taxes for 1995.
Wilhelm Zeller, chairman of the executive board of Hannover Re, explained at a news conference in London last week that the tax bill resulted from a routine five-year tax audit by the German tax authorities for the years 1988 to 1992.
During this audit, the tax authorities disallowed tax-free investment income earned between 1989 and 1992 in a Hannover Re investment company run by one of the German banks in Dublin's International Financial Services Centre.
German banks encouraged German underwriters in those years to set up investment companies through the banks' Dublin subsidiaries in order to accrue investment income and lower costs, according to Mr. Zeller. He believes just about every
German insurer and reinsurer set up such companies under the banks' supervision, so the tax issue "is not just a Hannover
Re problem but a German insurance problem."
Indeed, Dublin's reputation as an offshore captive domicile was enhanced in the early years because it was the first region to attract German clients.Mr. Zeller said Hannover Re would oppose the tax authorities on this issue and believes other insurers already had started litigation against the ruling.
The tax authorities have claimed they disallowed the tax-free income because Hannover
Re didn't have its own office or personnel in Dublin during that period "but was using the offices of the bank," said Chief Finan-cial Officer and member of Hannover Re's executive board Herbert Haas.
The tax authorities now are arguing that these companies were only shells used for the sole purpose of saving on German taxation, he said.
But Mr. Haas noted that Germany's tax code at the time did not require companies to have a physical presence and "such an active company" in Dublin. Indeed, the German tax code was not changed until 1992 to require companies to establish offices and personnel in order to benefit from Dublin's regime, he said.
All these investment units were shut down in 1992, including Hannover Re's, after the change in the tax code.
Hannover Re's existing Dublin subsidiary, which satisfies today's tax code, is untouched by the latest audit, said Mr. Haas.
Mr. Haas said "it's difficult to assess how big the problem is" for the Germany insurance industry. But he thinks litigation will continue for years and end up in German's highest court before it is settled.
Banks imposed disclaimers at the time, so it may be difficult to sue them for the extra costs.
However, "there may be some liabilities" on the part of the banks depending on how they ran their businesses, said Mr. Haas.