831(b) ‘conspiracy’ bigger than Artex and Gallagher: LFDS lawyer


Owen Faulkner

831(b) ‘conspiracy’ bigger than Artex and Gallagher: LFDS lawyer

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The Arizona-based lawsuit Shivkov v Artex Risk Solutions is being followed with great interest by the captive insurance industry, perhaps with good reason. One of the lead lawyers involved in the case now claims the alleged conspiracy is larger than it seems. He explained why to Captive International.

The court case Dimitri Shivkov v Artex Risk Solutions could have significant repercussions for the captive insurance sector. With captive managers and promoters including Gallagher and Artex under fire for allegedly conspiring to sell and manage illegal tax shelter captive insurance strategies, the outcome of the case is being followed closely.

But its implications could be even wider than many imagine. One of the attorneys representing the plaintiffs in the Arizona-based lawsuit says he believes the conspiracy extends further than the named participants.

David Deary, along with attorneys Ralph Canada and Jim Flegle at Loewinsohn Flegle Deary Simon (LFDS), represents the plaintiffs in Dimitri Shivkov v Artex Risk Solutions. The case accuses the defendants of being part of a massive captive insurance strategy conspiracy.

The defendants are alleged to have disguised tax shelters as legitimate 831(b) captives and extracted money from their clients. Furthermore, the suit alleges that the defendants had entered into undisclosed, illegal business arrangements with each other and a nationwide network of investment, accounting, and legal advisors to refer clients to them.

“I believe the same type of conspiratorial conduct exists in a number of other major micro-captive management companies and those who worked with them,” says Deary.

“Each of the professional advisors involved in the design, marketing, sale, implementation, and management of the captive insurance company had specific roles and responsibilities that were crucial to the execution of their pre-planned scheme.”

The group of defendants includes Artex Risk Solutions, Artex’s parent company Arthur J Gallagher, TSA Holdings, PRS Insurance, Epsilon Actuarial Solutions, AmeRisk Consulting, and Provincial Insurance, along with various employees of the companies.

The Internal Revenue Service (IRS) ultimately determined that the captive strategies were illegal and abusive tax shelters, disallowed the tax benefits, and assessed the plaintiffs with substantial back taxes, interest, and penalties.

Now, the plaintiffs are seeking actual, consequential, incidental, punitive, and triple damages; rescission and disgorgement; pre- and post-judgment interest at the highest legal rate allowed by law; and all attorneys’ fees and costs in pursuing this matter.

Gallagher has hit back at the claims, suggesting the class action lawsuit has “no merit”.


Case background

Since 2003, LFDS has represented around 600 high net worth (HNW) individuals who participated in illegal and abusive tax shelters designed, marketed, sold, and implemented by a team of well-known accounting firms, law firms, and investment banks.

Deary was one of the first lawyers to represent individuals in lawsuits against firms in connection with supposed tax-advantaged investment strategies known as Son of Boss transactions.

In 2017, LFDS also represented Benyamin and Orna Avrahami in recovery efforts for damages from the promoters and professional advisors that had recommended the failed captive insurance structure to them.

“We’re not saying micro-captive insurance companies are illegal per se. They can be legal if they are designed, implemented, and managed properly.”  David Deary, Loewinsohn Flegle Deary Simon

Within the last year, Deary explains, he received a lot of calls from individuals regarding micro-captives, not only from Artex’s clients, but clients of “virtually every other major micro-captive management company”.

In Shivkov v Artex, the complaint alleges that Gallagher and Artex sold abusive tax shelter under the guise of legitimate 831(b) captives which were sold to HNW individuals.

From a general standpoint, Deary suggests, Artex did not distribute risk properly, particularly with respect to the way Artex set up and operated its reinsurance pool, Provincial.

“For example, Artex would issue insurance policies where the client-owned micro-captives would cover the first $250,000 in claims,” adds Deary. “Artex’s reinsurance pool would cover only the few claims that exceeded this $250,000 primary layer.”

Plaintiffs who paid premiums to Provincial did so at Artex’s direction to allegedly achieve risk distribution. Although Provincial’s pool had been in existence since 2002, there were apparently zero pool claims through 2010.

In 2011, there were 197 participants in the pool with 940 policies and total premiums paid of $51 million. The first claim to be approved for payment was $8,274 and represented the only claim paid for 2011. Each participant in the 2011 pool received a bill in May 2012 for its quota share percentage of the $8,274 claim. Most bills for each captive were under $100.

In 2012, total premiums for 245 participants in the programme were $65 million and approved pool claims were $210,615. In 2013, total premiums for 246 participants were $79 million and approved pool claims were $1.1 million.

Regarding other captives and policies arranged by Artex, the IRS also concluded that the deductions for purported captive premiums were disallowed because the transactions, among other things, lacked economic substance.

Instead, the IRS said, the transactions did not constitute insurance for purposes of federal tax law, and the the transactions were not ordinary. Accordingly, the IRS concluded that the deductions for purported captive insurance premiums and fees were disallowed.

It was decided that the economic substance of the arrangements was to drive clients to claim tax deductions for expenses that could not be properly justified, to subsequently avoid taxes with unsecured “borrow back” provisions, and to cycle back premiums to affiliated parties for those purported expenses.

The defendants are accused of having a financial, business and property interest in inducing the plaintiffs—as well as other clients—into entering into captive insurance strategies. To do so, they allegedly promised and assured the plaintiffs and defendants that the captive strategies complied with all applicable insurance and tax laws and would legally reduces taxes for them.


Doing it the right way

Following Shivkov v Artex, Deary hopes a clear message will be sent to the industry that the practices the defendants are accused of will not stand.

While 831(b) captives have existed since 1986, they have come under increased scrutiny from the IRS after being labelled a ‘transaction of interest’ in Notice 2016-66 in November 2016.

One of the advantages of an 831(b) captive is that earnings from premiums are not subject to federal income taxes, and only interest income is taxed. The maximum annual premium was originally $1.2 million, but this increased to $2.2 million on January 1, 2017.

The IRS argues such mechanisms could be abused, where 831(b) captives could be used as wealth transfer vehicles. This has been seen in high-profile US Tax Court cases such as Avrahami v Commissioner and Reserve Mechanical v Commissioner.

In light of Shivkov v Artex, Deary believes that there are legitimate business reasons for setting up 831(b) captives.

“That is what makes these cases particularly disturbing. Had Artex, for example, designed, managed and complied with 831(b) properly, it would be a legal captive insurance company,” he says.

“We’re not saying micro-captive insurance companies are illegal per se. They can be legal if they are designed, implemented, and managed properly.”

Deary hopes the lawsuit will help managers and promoters inform their clients to ask better questions and to understand fully how they are going to manage these companies and comply with 831(b) case law.

“These lawsuits are very beneficial for the captive managers that have legitimate captive insurance companies that they manage,” he adds.

“It should weed out all the renegades—the companies like Artex that don’t do things right. That may even mean less competition for the good ones.”

LFD, David Deary, Shivkov v Artex, Tax, 831(b) Artex, Gallagher, North America

Captive International