13 December 2021ArticleAnalysis

Why choose Cayman?

The Cayman Islands is one of the largest and fastest-growing markets for captive insurance and re/insurance in the world. Why do companies choose Cayman to establish captives, leading institutional investors choose Cayman for collective investment vehicles, and multinational enterprises (MNEs) choose Cayman for subsidiaries?

Many commentators wrongly suggest that these decisions by some of the most sophisticated investment professionals in the world are simply some kind of tax play. The facts tell a very different story.

Cayman is a leading jurisdiction across a range of financial services sectors because it features a trusted and experienced legal system and world-class professionals. At the core of that system is Cayman’s status as a pure tax neutral jurisdiction which offers benefits to investors without causing tax harm. For Captives, that opens up a world of possibilities.

Tax neutrality fundamentals

At a fundamental level, tax neutral policies exist to prevent tax conflict or double taxation. Double taxation reduces capital available for investment, either directly (by reducing the proportion of profits available for reinvestment) or indirectly (by causing ownership to be artificially more dispersed, reducing the effectiveness of corporate control and hence lowering profitability). This has an adverse effect on innovation and, hence, on economic growth.

Implementing tax neutrality achieves this by allocating all of the taxing rights to the other country which is free to impose its domestic tax policy on the cross-border transactions with the tax neutral jurisdiction as it sees fit, without the need for a tax treaty.

Tax neutrality has been a foundational component of the Cayman Islands legal regime since it was established. Cayman has never imposed taxes on the income of individuals, companies, or capital. The absence of any direct taxes enables Cayman to be tax neutral in a straightforward, simple and transparent way.

It does not distort investment decisions because it cannot. And because Cayman-domiciled entities have no double taxation concern, they offer unparalleled efficiency by diminishing the need to pay tax accountants and lawyers to identify the most efficacious way to achieve tax neutrality.

Just because a jurisdiction is tax neutral doesn’t mean it’s a tax haven. Top tax neutral jurisdictions do not pose harm for tax evasion, aggressive tax avoidance, unfair base-shifting, or unfair tax competition. They have in place legislation, regulations, and automatic tax information-sharing arrangements that uphold the highest international standards for transparency, cross-border cooperation, and economic substance.

That’s how globally responsible tax neutral regimes distinguish themselves from many other international financial centres which are tax treaty investment hubs that rely on extensive double tax treaty networks.

Not-for-profits establishing captives: the Cayman tax neutrality advantage

As noted above, many observers incorrectly chalk up the attractiveness of the Cayman Islands as some kind of tax play. However, US not-for-profits are already exempt from US federal taxes so their priorities are less about tax and more about finding ways to reduce insurance costs to free up their capital for more important investments.

One of the top ways to do this is to establish an insurance captive—and the one of the top jurisdictions in the world to do that in is the Cayman Islands. Establishing a Cayman captive enables a US not-for-profit such as a hospital system to decrease its insurance premiums and more directly manage how any savings are invested. Cayman’s status as a pure tax neutral jurisdiction enhances the efficiency of this process and also poses no tax harm to the US.

A good example of this process in practice is the Western Maryland Health System (WMHS). In 2004, WMHS was facing spiking insurance rates and it chose to create a captive insurance company in the Cayman Islands. Its objective was to create some independence from commercial insurance to allow it to reduce costs. Nearly eight years later, a spokesperson for the company told the local newspaper that “WMHS has saved more than $9 million in insurance premiums since establishing the captive.”

Because WMHS had created this Cayman captive, it was able to realise millions of dollars in cost savings rather than paying them to a commercial insurance company. WMHS stated that it used some of those realised savings to pay for a risk management grant programme designed to elevate patient safety in its system.

WMHS’s experience—and it’s choice of the Cayman Islands—is not unique. The company’s spokesperson pointed out that “the majority of hospitals in Maryland have offshore captives, all of which are domiciled in the Cayman Islands, except for one that is in Bermuda.” In fact, it’s a common choice for large nonprofit organisations, which often include medical facilities.

Choosing to domicile a captive in Cayman but have it taxed in the US

US organisations choose to domicile captives in Cayman, in part, because our status as a pure tax neutral jurisdiction is a significant advantage. It means no additional layer of tax is levied on the captive insurance company’s profits or investments beyond what is owed to other jurisdictions. However, there are times when it is actually more advantageous to domicile a captive in Cayman while electing to have that captive taxed under US law, which is further evidence that the choice of Cayman is not driven by tax considerations.

A US company establishing a Cayman captive to insure risk within the US is establishing a Controlled Foreign Corporation (CFC) under US tax laws. Any foreign insurer or reinsurer providing coverage, bonds or contracts in the US would face a Federal Excise Tax of either 4 or 1 percent on each such policy.

At the same time, a part of the US tax code known as the subpart F regime levies US taxes on all income of a CFC. This includes underwriting and investment income and it does not allow those taxes to be deferred until the income is distributed.

Organisations that want the advantages of a Cayman-domiciled captive but prefer to be treated as a US company rather than a CFC, can elect to be treated as a US entity for tax purposes under §953(d). A captive that elects to be treated as a taxable US corporation under §953(d) is no longer considered a CFC and therefore is no longer subject to the Foreign Excise Tax imposed by the US.

The obvious question is why companies choose to domicile in a captive in Cayman yet be taxed as a US company rather than simply remaining in the US? The simple answer is that the Cayman Islands offers a more flexible regulatory regime that enables companies to pursue greater investment opportunities than they would by remaining entirely US companies.

For example, US insurance companies face a much more complex and restrictive regulatory regime in the US under federal law and the various state laws covering how they grow and invest. There may be greater limitations on how they can deploy their capital and which types of investment structures they can utilise. The Cayman Islands offers a more efficient regulatory regime while providing a stable and experienced legal system and a tax neutral regime that supports efficiency without posing tax harm.

Why Cayman?

Despite all of the evidence here about how Cayman’s role as a pure tax neutral jurisdiction provides advantages to captive re/insurers without posing tax harm, some critics may still ask “If it’s not about tax then why do investors choose Cayman?”

The Cayman Islands has become a premier global financial hub and a core node of international finance by combining good governance, a legal system derived from English law, global expertise, true tax neutrality and world-class infrastructure. It enables investors from many countries to pool their capital and deploy it cost-effectively towards companies and projects.

By facilitating the supply of capital at lower cost, it enables higher rates of innovation which benefit institutional investors and business while helping to drive global economic progress.

Cayman ranks in the top quartile of all countries on every World Bank metric of governance except “voice and accountability,” where it ranks just outside the top third. These governance metrics are drawn from “over 30 existing data sources that report the views and experiences of citizens, entrepreneurs, and experts in the public, private and NGO sectors from around the world, on the quality of various aspects of governance.”

A major advantage for Cayman is its legal system, which is based on English common law. Important legal concepts such as directors’ fiduciary duties, a company’s powers and capacity, limited liability of shareholders, and creditors’ rights and remedies are very similar to those under English common law and Cayman courts frequently refer to decisions of English courts.

Cayman’s final court of appeal is the Judicial Committee of the Privy Council, which offers international investors the comfort of a legal system with which they are generally familiar plus the legal security of an established body of law. In addition, Cayman has developed specialised legislation relating to financial services—including re/insurance—that reflects an innovative, pragmatic approach.

This approach has established Cayman as one of the world’s leading jurisdictions for captive insurance and reinsurance and is enabling significant growth. The more companies and institutional investors learn about the Cayman Islands, the more they want to establish a presence to begin to realise the benefits for their own business objectives.