“There is an industry concern that any transfer pricing concerns will
be applied indiscriminately without any understanding of the special purpose
nature of captives.”
Effects in the US
The reporting requirements of Solvency II and potential impact of BEPS
also have an impact on US multinationals, but not to the same degree. US
multinationals can withdraw from a global captive strategy. The US market
continues to have significant opportunities from workers’ compensation
and employee benefit exposures for a captive to provide value.
Global captive growth from US-parented captives will continue and
can be expected to significantly increase in the future. The catalyst
will probably be a tightening insurance market but clearer guidelines
from the IRS, particularly in the 831(b) segment, may also contribute
to accelerated growth. Currently it is estimated that there are 6,977
US-parented captives including segregated asset companies.
Approximately 4,189, or 60 percent, are 831(b)s.
831(b) captives are not without controversy. Their growth has stalled
over the past two years due to the negative perception promulgated
by the IRS and US Tax Court cases. The IRS continues to target
831(b) captives as abusive tax schemes designating them a member
of their “Dirty Dozen” list.
As has been widely reported, the IRS was successful in two recent tax
challenges, Avrahami and Reserve Mechanical. While successful, these
should not be considered landmark cases. The judgments provide more
of an example on how not to structure a successful 831(b) captive.
The IRS and the Treasury Department appear to be challenging
captives with questionable tax structures. In spite of that perception
the Treasury Department actually increased the threshold to
$2,200,000 indexed for inflation in 2017. The IRS’s reporting
requirements in Notice 2016-66 are not particularly onerous for a
well-structured 831(b) captive. Proper governance and captives
being structured in accordance with case law and safe harbour
rulings apply to all captives, regardless of size.
Consequently, while the catalyst may be a tightening insurance
market, we can expect a significant increase in captives, particularly
in the 831(b) segment, from US-parented captives. It is estimated that
there are more than 50,000 small to medium-sized companies in the
US who could benefit from a captive who would qualify for the 831(b)
election. Captives currently have less than 1 percent penetration of this
Les Boughner is chairman of business insurance at Advantage
Insurance. He can be contacted at: firstname.lastname@example.org
ensure tax harmonisation, a term usually used to refer to the process
of removing fiscal barriers and discrepancies between tax systems
OECD members have attacked multinational corporations for
structuring their operations in a manner to minimise their overall
tax obligation. The term “transfer pricing” was created as a
reference for everyday inter-company transactions and mistakenly
linked with the concepts of “tax shelters” and “tax evasion”. The
lack of regulations for determining a correct transfer price for
any kind of international transaction within a group of companies
does create the opportunity for significant interpretation. This
is particularly the case within captives, where determining the
appropriate premium payable by a multinational parent to its
captive may be difficult.
As a result, in 2013 the OECD issued a report , Base Erosion and
Profit Shifting. The report implied that multinationals were using their
captives as tools for tax avoidance through shifting profits from highly
taxed countries to those with low or no income taxes. It concluded
that this should require greater transparency and oversight.
The OECD subsequently issued an “action plan” to combat BEPS,
that listed 15 specific actions. The basis of the plan is “taxation is at
the core of a country’s sovereignty”. When designing their domestic
tax rules, sovereign states may not take into account the effect of
other countries’ rules.
While international standards have sought to address this issue,
gaps remain, causing double taxation and the opportunity of BEPS.
The OECD believes that these anomalies must be addressed to
restore both source and residence taxation where cross-border
income would otherwise go untaxed, or taxed at very low rates. In the
area of transfer pricing, the OECD actions are specifically designed to
provide countries with the opportunity and capabilities to better align
their rights to tax with economic substance and activity. The OECD’s
proposed actions seek to put greater emphasis on value creation
than formulary apportionment of profits.
Similar to Solvency II, or perhaps because of it, there is an
industry concern that any transfer pricing concerns will be applied
indiscriminately without any understanding of the special purpose
nature of captives. To the OECD’s credit it recently issued a discussion
draft for BEPS Actions 8–10 requesting comments from interested
parties. It has segregated insurance and captive insurance as
separate from purely financial transactions and specifically identified
four questions, requesting comments from interested parties.
46 US Captive 2018 www.captiveinternational.com