ARCH CAPITAL GROUP LTD

Risks Relating to Taxation

We expect to become subject to increased taxation in Bermuda as a result of the recently adopted Bermuda CIT Act, and may become subject to increased taxation in other countries as a result of theimplementation of the OECD's plan on “Base Erosion and Profit Shifting.”

The OECD, with the support of the G20, initiated the “Base Erosion and Profit Shifting” (“BEPS”) project in 2013 in response to concerns that changes are needed to international tax laws to address situations where multinationals may pay little or no tax in certain jurisdictions by shifting profits away from jurisdictions where the activities creating those profits may take place. In November 2015, “final reports” were approved for adoption by the G20 finance ministers. The final reports provide the basis for international standards for corporate taxation that are designed to prevent, among other things, the artificial shifting of income to tax havens and low-tax jurisdictions, the erosion of the tax base through interest deductions on intercompany debt and the artificial avoidance of permanent establishments (i.e., tax nexus with a jurisdiction).

Legislation to adopt and implement these standards, including country by country reporting, has been enacted or is currently under consideration in a number of jurisdictions. As a result, our income may be taxed in jurisdictions where it is not currently taxed and at higher rates of tax than currently taxed, which may substantially increase our effective tax rate. Also, the continued adoption of these standards may increase the complexity and costs associated with tax compliance and adversely affect our financial position and results of operations.

In May 2019, the OECD published a “Programme of Work,” divided into two pillars, which is designed to address the tax challenges created by an increasing digitalized economy. Pillar I addresses the broader challenge of a digitalized economy and focuses on the allocation of group profits among taxing jurisdictions based on a market-based concept rather than historical “permanent establishment” concepts. In January 2020, the OECD released a statement excluding most financial services activities, including insurance activities, from the scope of the profit reallocation mechanism in Pillar I (referred to under Pillar I as “Amount A”). The OECD statement cited the presence of commercial (rather than consumer) customers as grounds for the carve-out, but also acknowledged that a “compelling case” could be made that the consumer-facing business lines of insurance companies should be excluded from the scope of Pillar I given the impact of regulations and licensing requirements that typically ensure that residual profits are largely realized in local customer markets. However, profits from “unregulated elements of the financial services sector” remain in scope but only where revenue exceeds €20 billion. The revenue threshold is expected to be reduced to €10 billion following future review of the operation of Amount A. The review of when to reduce the revenue threshold begins beginning seven years after the effective date of Amount A.

Pillar II addresses the remaining BEPS risk of profit shifting to certain in-scope entities in low tax jurisdictions by introducing a global minimum tax (15%), which would operate through the imposition of residence-based and source-based taxation (including potentially through the denial of certain deductions). In calculating whether the effective tax rate of an in-scope entity meets the minimum tax rate, certain deferred income tax assets and liabilities (“Deferred Tax Items”) reflected or disclosed in the financial accounts of an in-scope entity are taken into account. In October 2021, 136 jurisdictions agreed on a two-pillar solution to address the tax challenges arising from the digitalization of the economy. In December 2021, the OECD released Model Rules for implementation of Pillar II followed by the release of detailed commentary in March 2022, with the latest update to the commentary in December 2023. The OECD has released additional administrative guidance on the global minimum tax in February, July and December of 2023, June of 2024 and January of 2025 (with this latest administrative guidance introducing a new interpretation (with retroactive effect) for determining the treatment of Deferred Tax Items, which may affect the effective tax rate calculations of an in-scope entity following a grace period).

The members of the EU have either already adopted domestic legislation implementing the minimum tax rules, pursuant to the EU’s minimum tax directive, unanimously agreed by the member states in 2022 or have exercised their option to postpone implementation on the basis of certain exceptions available to countries that have a small number of multi-national groups to which the rules would apply. For many members of the EU that have adopted such rules, such rules are effective for periods beginning on or after December 31, 2023, with the “under-taxed profit rule” taking effect for periods beginning on or after January 1, 2025. Legislatures in multiple countries outside of the EU have also drafted and/or enacted legislation to implement the OECD’s minimum tax proposal. Given the OECD’s continued release of guidance regarding Pillar II, that only certain jurisdictions have currently enacted laws to give effect to Pillar II, that some jurisdictions have just recently enacted such laws, that jurisdictions may interpret such laws in different manners, and that certain elements of such laws are currently subject to challenge pursuant to legal proceedings, the overall implementation of Pillar II remains uncertain and subject to change, possibly on a retroactive basis.

On August 8, 2023, the Bermuda Ministry of Finance published its first Public Consultation announcing the proposed implementation of a new corporate income tax regime applicable to Bermuda businesses that are part of Multinational Enterprise Groups with annual revenue of €750 million or more. A Second Public Consultation was published on October 5, 2023 confirming, inter alia, a statutory corporate tax rate of 15% and a Third Public Consultation was published on November 15, 2023. The Bermuda CIT Act was enacted on December 27, 2023 and is effective for tax years beginning on or after January 1, 2025. The Bermuda Government announced in its Second Public Consultation that any new Bermuda corporate income tax regime would supersede existing Tax Assurance Certificates held by entities within the scope of the new Bermuda corporate income tax (such as those issued to us, referred to above under “—Taxation of Arch Capital. Bermuda.”). Given the potential for the new Bermuda corporate income tax to supersede existing Tax Assurance Certificates, it is likely that Arch will be subject to Bermuda tax for tax years beginning on or after January 1, 2025.

It is expected that the Bermuda CIT generally will prevent or mitigate the risk of other adopting countries from collecting “top-up” taxes from Bermuda companies to reach the 15% minimum rate, although the continued evolution of the implementation of Pillar II may in some cases mean that the Bermuda CIT does not avoid a “top-up” tax in all scenarios.

The adoption of the tax laws described above (in particular, the adoption of an “under-taxed profit rule” by certain countries in which we and our affiliates do business and the expected implementation of a corporate income tax regime in Bermuda) are expected to result in an increase to our effective tax rate and aggregate tax liability, which may adversely affect our financial position and results of operations, and is expected to increase the complexity and cost of our worldwide tax compliance. Although certain jurisdictions in which we and our affiliates do business have enacted an “under-taxed profit rule”, such rule is only expected to take effect for taxable periods beginning on or after December 31, 2024. Such tax laws may not be enacted or the form of such tax laws could change on a prospective or retroactive basis. The impact of any such changes is unknown, but such changes could have an adverse effect on our effective tax rate and aggregate tax liability and could increase the complexity and costs associated with our tax compliance worldwide.