Choosing the optimal domicile for your new captive insurance company should be easy. Each location will have key differentiators separating them from other jurisdictions, so the choice should really come down to one’s own circumstances.
Choosing the optimal domicile for your new captive insurance company should be easy. Each location will have key differentiators separating them from other jurisdictions, so the choice should really come down to one’s own circumstances. However, when you consider that there are now in excess of 60 captive domiciles across the world competing (including 39 in the US), the ability to differentiate clearly and objectively becomes much harder.
When making such a decision the principal objective is often to focus on the differences, strengths and weaknesses of each domicile. However, before identifying the differences, some thought should be given to the similarities—the issues that are going to exist and that need to be addressed regardless of jurisdiction. Decisions made at this point may have a significant impact on the need to form a captive at all, let alone the captive strategy and choice of domicile. Failing to address these matters at an early stage may complicate operations further down the line.
Tax compliance is an area that is as much determined by the location of the captive as by its proposed activities. If we assume that the captive owner is a US corporation with international business interests then the two main alternatives are the forming of an onshore captive or an offshore captive.
Onshore captives
Thirty-nine US states have enacted captive legislation, the most recent being Texas. Vermont remains the largest domicile by some margin, although its dominance is likely to become eroded by the greater choice that is now available.
A captive established within the US is subject to taxation under the laws of the state of domicile as well as the federal tax authority (the IRS).
A captive is required to file an income tax return with the IRS in the same manner that any other corporation is required to do so. The biggest issue for determining the correct level of income tax to pay is often going to be the calculation of claims reserves, which will often require actuarial input to validate any provisions.
But for ‘micro’ captives, an 831(b) election can be used to exempt captives with less than $1.2 million of premiums from income tax on their underwriting income.
Although legislation can vary, captives would normally be subject to state premium taxes on premiums collected in the same way that general insurers are. This would certainly be the case if the captive was insuring risks within the same state of domicile (ie, the parent company and captive are in the same state). In many states that serve as captive domiciles, premium tax is capped at a maximum level.
Where a captive insures risks outside of the state, there may be a liability to additional taxes in the jurisdiction where the risk is located. If these risks are in the US, then Self-Placement Tax may be payable. If the risks are further afield, say in the UK or Germany, premiums charged in relation to those risks would be subject to local premium tax legislation.
In the case of Texas in particular, it would appear that the legislation was introduced in an attempt to persuade Texan corporations to redomicile their captive to Texas, rather than as a domicile of choice for global corporates. While this move could remove the liability to self-placement taxes, other state taxes may then become payable. When you consider the net impact of the tax changes together with the cost of redomiciliation, such a captive strategy may not be commercially viable to the owner.
Offshore captives
A US person may be subject to income tax on certain income earned by a “controlled foreign corporation” of which it is a significant shareholder. Therefore, profits from a closely-held captive domiciled in an offshore jurisdiction are typically subject to US income tax.
At the recent G8 summit in the UK, attendees agreed that combatting tax avoidance and evasion through the use of tax havens is a key target in order to ensure that countries are collecting all tax revenue due to them. Driven by increasing media scrutiny, there is a fear among many tax commentators that even the use of tax avoidance (legally minimising tax bills) is now considered unacceptable. This may have a long term impact on the growth of captive business in offshore jurisdictions—even though the insurance expertise that they offer often far outweighs any perceived tax advantages that may exist.
Consequently, many offshore captives owned by US corporations file a 953(d) election with the IRS, opting to be taxed as a US company. Ironically, that would then offer them the opportunity to make an 831(b) election to legally avoid tax on their underwriting income if their total premiums are beneath the $1.2 million threshold.
An additional tax concern for offshore captives is Federal Excise Tax. FET is payable when premiums for US risks are paid to non-US insurance companies. There are exemptions available for captives in jurisdictions where the US has signed double tax treaties, although in many of the traditional Caribbean captive domiciles no agreements have been signed. FET is also potentially payable on reinsurance premiums paid to non-US reinsurance captives.
Although in many offshore captive jurisdictions there are low or even no rates of corporate tax, there may still be tax compliance requirements and taxes payable. Ireland is an example of this, where although the rate of corporate income tax is 12.5 percent (considered low on a global scale), taxes must be calculated and filed annually.
Foreign Account Tax Compliance Act legislation is designed to identify funds that are remitted overseas but remain in the hands of US taxpayers, ensuring that all US taxpayers pay all of the taxes that are due. Although implementation has recently been delayed by six months, this additional legislation is only likely to add to the compliance costs associated with owning captives in offshore jurisdictions.
Overseas premium taxes
In many ways this is the constant issue, almost regardless of the location of the captive. In order to determine which overseas premium taxes are potentially payable, it is important to:
Identify the location of all risks insured by the captive;
Apply the national legislation that exists in that jurisdiction;
Calculate taxes based on legislation—exemptions may be available for certain risks;
Identify the taxpayer in each jurisdiction; and
Ensure that all taxes are collected and settled in accordance with local requirements.
Premium tax rates, legislation and compliance requirements vary enormously from country to country, so the need to use reliable information and to have access to expert advice remains critical. Tax authorities across the globe are stepping up efforts to collect more premium taxes and that fact, together with the need for corporates to remain tax compliant to avoid negative publicity, means that a robust and rigorous system of premium tax compliance must be built and maintained.
Non-tax issues
Moving away from the tax environment, again there are a number of issues that need to be considered, which are relatively consistent across all jurisdictions, before choosing a domicile. The newly formed captive will need to have a registered office, acquire resources to carry out the work, appoint directors, prepare and file annual accounts and tax returns, and hold board meetings.
If there is a requirement to hold board meetings locally and to appoint local directors, there may be an argument for domiciling the captive where the corporate is based. Directors’ time is valuable so unnecessary travel time could be avoided by doing this. Discipline can also be an issue. If all board meetings have to be held in the jurisdiction, then this must happen without exception. Failure to comply with what appears to be a simple requirement may complicate tax or licensing matters.
Choice of supplier is also key regardless of jurisdiction. More established jurisdictions may have larger infrastructures and more experienced personnel, but it is vital to build a successful working relationship with your supplier—something that is often easier in principle than practice.
Impact on domicile choice
If there is a clear captive strategy and a detailed operational plan that deals with tax, accounting, and financial and board matters, then the choice of domicile should be less daunting.
The strategy and operational plan will drive the decision to locate onshore or offshore, meaning that the choice of domicile will reflect the requirements of the captive owner rather than having to adapt the use of the captive to suit the domicile.
If you get all of the other elements of the plan correct, choosing your domicile should be the last decision you will have to make.
