In recent years, there has been a rising degree of speculation surrounding the merits of the Tax Information Exchange Agreements (TIEAs), signed by various captive jurisdictions, and their alleged impact on the development of captive formations....
In recent years, there has been a rising degree of speculation surrounding the merits of the Tax Information Exchange Agreements (TIEAs), signed by various captive jurisdictions, and their alleged impact on the development of captive formations. The circumstantial evidence points at widespread misconceptions that have helped entrench what we consider to be a false perception on the actual impact of these instruments. Casting technicalities aside, this is a matter that should be assessed in the light of the factual evidence.
Today, it is a widely accepted fact across the profession that tax considerations must not be the driving force behind the design and development of any captive solution. Irrespective of wholeheartedly adhering to this line of thought, we are mindful of the fact that taxation remains a contributing factor to the process and that it must not be disregarded outright.
An objective assessment of the impact of tax vehicles on the development of captives should not avoid exploring the differences that lay behind two fundamental concepts, namely that of TIEA and the double taxation agreement (DTA).
It is worth pointing out that despite being conceived for alternative purposes, the potential for use and extent of the benefits that can be associated to both vehicles remain, by and large, misinterpreted as far as the captive sector is concerned. The absence of clear guidelines on this matter in the professional literature readily available has done little to shed light on the prevailing confusion, having on the contrary favoured the entrenchment of deeply rooted perceptions that are inherently flawed.
The origins of the TIEA can be traced back to the alleged intention of various jurisdictions to exchange information, and in doing so, to contribute to the goal of global transparency.
This behaviour ties in with the prevailing international framework in which the standards set out by the Organisation for Economic Co-operation and Development (OECD) emphasise the benefits that derive from good corporate governance and international cooperation on tax.
Broadly, TIEAs are bilateral agreements binding jurisdictions to cooperate on taxation matters through the exchange of information, these undertakings must be completed through the enactment of customary parliamentary proceedings at both ends before they can become legally binding. These instruments are used to great effect by those jurisdictions that are deemed neutral from a taxation perspective, ie, that do not levy direct and or indirect taxes.
Far from linking the rise in the use of TIEAs to autonomous jurisdictional decisions, the promotion of these instruments has been encouraged by the OECD as an avenue to remove from its ´black and grey lists´, or those jurisdictions whose taxation practices are deemed lacking in transparency.
The conclusion of minimum set numbers of TIEAs has therefore been imposed as a prerequisite to jurisdictional reclassification.
It goes without saying that a considerable number of these undertakings were concluded under a flurry of excitement following the publication of the OECD’s listings, pointing at jurisdictions that were yet to substantially implement internationally recommended taxation standards.
Key offshore captive domiciles were among those that signed several TIEAs as required to ensure prompt compliance with these guidelines, constructing their own TIEA networks to further their own needs.
As to the operational implications of TIEAs, for the actual exchanges of information to take place there needs to be a judicial request on a specific matter, duly issued on a jurisdiction and submitted through the agreed channels to the courts of another jurisdiction.
This request would be subject to a pre-existing case warranting the procurement of information, either on a physical or a corporate person domiciled in the other jurisdiction. Apart from the alleged intention to contribute to the enhancement of the jurisdictional transparency, this modus operandi helps to expedite the resolution of legal proceedings.
TIEAs also have the potential to open the gates to the removal of a captive domicile from the black list of a parent jurisdicition.
DTAs present an overly different proposition. In broad terms, these are bilateral instruments signed by two jurisdictions laying out which jurisdiction will tax a physical or corporate person receiving income from the other jurisdiction. These instruments have far-reaching implications when compared with TIEAs that, as previously stated, are limited by definition to the disclosure of information.
It must be pointed out that DTAs also contain clauses for the release of information that, while not as detailed as similar embedded on TIEAs, are equally effective in their contribution to the goal of promoting transparency.
Historically, DTAs have been well-tried bilateral instruments broadly used for the development and promotion of international trade and foreign investment. Today there are approximately 3,000 of these agreements signed between different jurisdictions across the globe. As is the case of TIEAs, the use of DTAs has not escaped a degree of controversy. Even making allowance for this, the benefits associated with their use are palpable and stand the test, from a conceptual perspective, at least.
First and foremost, DTAs are effective instruments to hinder dual taxation on profits at a corporate level.
Unlike TIEAs, these instruments can only be adopted by jurisdictions that are not neutral from a taxation perspective and therefore impose taxes, be it direct, indirect, or both. As obvious as it may sound, it is worth reiterating that a jurisdiction that is neutral from a taxation perspective (that levies no taxes) is unable to sign DTAs.
The critics of DTAs have drawn attention to the emphasis that these instruments put on the avoidance of double taxation to the detriment of tax avoidance in its broader sense, extolling praises on the allegedly superior nature of multilateral agreements. We would not dwell on these arguments as they are not central to our line of thought and bear little relevance to the needs of the discerning captive owner.
A review of the information disseminated by various captive domiciles reveals that the number of TIEAs signed by a jurisdiction is usually portrayed as a key strength intrinsically relevant to the needs of captive owners. Interestingly, whenever the attention of a specific regional audience is sought, there is mention of the number of TIEAs signed between the captive domicile and the territories in that region as a means to convey the same subliminal message.
While the goal of global transparency promoted through the adoption of TIEAs is laudable, we are of the opinion that TIEAs fall well short of delivering a tangible outcome on that front. The presence of TIEAs has proven relatively innocuous to the general progression and development of captive propositions.
While these considerations are generic and can therefore be extrapolated to captive prospects across virtually any jurisdiction, we are keen to portray the case from a Latin American client´s perspective, on account of the singular nature of this market whose captive sector has borne witness to a remarkable dynamism in recent years. Our findings have been compelling.
It is widely known that most Latin American insurance jurisdictions are deemed ‘admitted’ territories as their legal frameworks establish that local paper must be issued by local insurers for all risks defined as ‘local’ under the law. It is also worth pointing out that despite this uniformity in the principles underpinning the insurance model prevalent across this vast economic space, the insurance laws vary considerably from country to country, leading, for example, to convoluted placement layouts such as the infamous ‘double frontings’ conceived to accommodate arcane reinsurance cession provisos.
Besides, with the sole exception of Panama whose laws contemplate the creation and incorporation of captives, there are no similar undertakings in the legislation of other jurisdictions across the region. Faced with this restrictive outlook, potential Latin American captive owners are forced to look elsewhere in their quest for a suitable domicile in which to set up and incorporate their captives.
For all the ongoing talk about regional integration, to date, an overwhelming majority of the captives emanating from Latin America must be domiciled offshore, much to the chagrin of the captive owners, a sympathetic observer would conclude.
Clearly, as Latin American captive owners are confronted with the tough realities of selecting a suitable offshore jurisdiction for the domiciliation of their structures, they must brace themselves for a process that at times can be complex and should be addressed with utmost caution and attention to detail, so that the key objectives are not missed.
Within the list of factors to be taken into consideration, the identification of a good DTA signed between the parent and captive jurisdiction should be paramount.
This, however, appears to be easily overlooked in the frantic search for a captive domicile not blacklisted by the parent’s jurisdiction. Such an omission on the part of captive owners can only be regarded with surprise, as a good DTA would not only deliver the selection of a captive domicile acceptable to the parent´s jurisdiction but also open doors to other corporate advantages.
Of special importance is the incorporation of a captive structure in a domicile that has signed a good DTA with the parent´s jurisdiction, which would facilitate the repatriation of the captive´s dividends to the parent company. DTAs make allowance for the selection of the domicile under which income or dividends can be taxed.
For ease of reference, we lay out the following example involving two hypothetical jurisdictions: namely jurisdiction A (captive) and jurisdiction B (parent).
Assuming that the tax rates on dividends are 5 percent for jurisdiction A and 30 percent for jurisdiction B, it would be possible under the terms of the DTA for the parent company to repatriate the captive dividends following payment of the 5 percent tax due to the tax authorities of the captive jurisdiction. Once this has been done, the tax authorities of the parent jurisdiction (B) would assume that the fiscal obligations of the parent company have been discharged and no further tax on dividends will be collected.
Failure to address those considerations previously laid out could have the potential to further isolate the captive from the rest of the parent setup, defeating the underlying intention to transform a captive into a profit centre that, apart from its main underwriting role, could contribute to the parent company´s bottom line when required.
As self evident and obvious as these propositions might sound, they are regularly by-passed by otherwise discerning captive owners across the region as little attention is usually given to the ostensibly superior nature of the solutions available through a DTA, vis-à-vis, those accomplished by relying on the modest merits of TIEAs.
Interestingly, the discerning captive owner will find that there are captive domiciles well suited to underwriting Latin American risks and offering access to a good network of DTAs signed with relevant Latin American jurisdictions. The Mexican case is emblematic as this jurisdiction has already signed DTAs with important captive domiciles. Other jurisdictions across the continent are following in Mexico´s footsteps.
As a closing remark, it is worth pointing out that the flexibility inherent in the redomiciliation proceedings among captive jurisdictions can be used to facilitate and expedite the transfer of Latin American captives towards those jurisdictions that offer attractive DTAs.
We may therefore conclude that there are no impediments hindering the potential re-configuration of the current scenario where a considerable portion of Latin American captive owners appear to have overlooked the advantages that could derive from a revision of the parent´s ability to benefit from the opportunities offered by DTAs. Those captive owners that open their eyes to this situation might be in for a terrific surprise.
