An opportunity for upstream stimulus


Peter MacKay, Ian Bridges and Jennifer Reid

An opportunity for upstream stimulus

Before considering buy-backs and dividends, captives need to fully understand the implications of returning funds to their parent companies, say Peter MacKay, Ian Bridges and Jennifer Reid.

Earlier this year, the National Bureau of Economic Research announced that the most recent economic recession actually ended in June 2009. While the economic statistics may support this conclusion, in the days of stimulus packages, low investment returns and expiring tax cuts, cash is still king. With the spotlight remaining on cash and liquidity, many have turned their attention to their captive, eyeing its balance sheet and wondering if the captive’s liquidity could be put to better use in the hands of the captive’s owner. The captive owner may see the liquidity as an opportunity to support capital projects, business expansion or perhaps to simply support continuing operations.

Luckily for Cayman captive owners, there are a number of opportunities to access investments in their captive without sacrificing the longevity of the captive programme. Loan backs, return premiums, return of additional paid-in capital and policyholder or shareholder dividends are all considered viable options, each with their own merits. Experience indicates that cash dividends paid to captive shareholders ranks high on the list of options. Having witnessed a notable rise in cash dividends declared, and expecting this trend to continue through this fiscal year, this article will focus on discussing the shareholder dividend option in greater detail.

Ensuring that captive owners and the captive’s board of directors are aware of the process and fully understand the many operating, accounting, regulatory, legal and tax considerations before the dividend declaration can, excusing the pun, pay dividends in the future.

Accounting and financial considerations

To trivialise the first step of any cash dividend declaration would simply be to ensure there is the fiscal ability to pay the dividend. While this may be easily articulated, it should nevertheless be scrutinised. While one may first look to the asset section of the balance sheet, focus should move down the page to the shareholder’s equity and, more specifically, the retained earnings. Without sufficient retained earnings, further discussion would be pointless. Assuming your captive has reaped the benefits of past underwriting profits and investment yields, we can assume your captive is ready to calculate an appropriate dividend.

"The board does not want to be fuond in a situation where a taxable dividend is declared only to realise a non-deductible contribution is required shortly thereafter to support the programme."

When examining the retained earnings, the board should clearly understand the calculations and assumptions made to derive this figure. Are the retained earnings based on audited year-end financial statements or perhaps a mid-year set of management financial statements? Are insurance reserves adequate and based on a recent actuarial report? Is the actuarial report based on the most recent loss history and loss trends? It is extremely important that the board understands the possible effect any recent unfavourable loss trends may have on future actuarial loss estimates. Sufficient surplus today may be insufficient by the end of the fiscal reporting period.

While retained earnings may be the key balance in a captive’s ability to pay a dividend, the board must further consider the impact that the dividend would have upon the overall capital of the captive and ensure its continued successful operation. The board must continue to understand the current level of risk retained in the captive, coupled with the additional level of risk to be retained in future years. Not all premium-to-equity ratios work for all captives. It would be advisable for the board to seek the input of its risk managers, actuarial advisors and captive managers in forecastingits future operations and in identifying the ideal level of total equity. The board does not want to be found in a situation where a taxable dividend is declared only to realise a non-deductible contribution is required shortly thereafter to support the programme.

Undoubtedly, at some point in the infancy of the process, the question of whether there is simply enough cash to pay the dividend will arise. In order to provide a definitive response, one cannot just examine the most recent bank statement. The captive must clearly identify the free cash position, or rather the cash available that is otherwise not encumbered. Is the cash being held for the benefit of loan-to-value ratios in order to satisfy a letter of credit? Is the cash being held to satisfy other stakeholders such as the Internal Revenue Service to meet the United States asset test under the Internal Revenue Code Section 953(d) for elected captives? Also worthy of mention is the access limitation to funds should the funds be held in a 114 trust.

Perhaps equally important is future cash flow requirements. Are losses maturing or in need of payment? Will the reduction in cash have a material impact on the asset mix such that it could put the captive out of compliance with its own investment policies? Accordingly, the board must pay close attention to current and longterm cash flow needs.

Liquidation of investments to pay dividends is commonplace, as one might imagine. If there are constraints on cash then liquidating investments is the next logical step. Once again, the board must also be aware of the effects liquidating all or part of an investment portfolio could have on the captive. Should the identified assets be above water, then the sale would crystallise and thus accelerate any unrealised gains that may trigger a taxable capital gain to either the captive or its owners. On the other hand, should a captive have capital losses carried forward that are set to expire, then it may be advantageous and prudent tax planning to sell the investments touse the capital losses. Of course, directors must also weigh the related advantages and disadvantages of liquidating investments at a loss simply to fund the payment of the dividend.

Issues arise with a change to the investment portfolio similar to cash, in that the board must understand what effects the change would have when meeting any requirements for outgoing letters of credit, ensuring compliance with its own investment policies, meeting the United States asset test, etc.

Regulatory compliance considerations

Cayman Islands’ captives are regulated by the Cayman Island Monetary Authority (CIM A). As a regulator, CIM A has a legislated duty of care to the stakeholders of the captive. Any reduction in the total equity of the captive is equity that is unavailable to pay claims and thus could have an impact on a captive’s margin of solvency. Accordingly, CIMA must approve the payment of the dividend prior to its payment. The captive may have a set dividend policy in accordance with its business plan or may be in a position where the declaration of the dividend may constitute a change in the business plan and thus require specific CIMA approval. Fortunately, captives that have been diligent in their own analysis should be in an ideal position to present the merits of the dividend declaration.


The company’s Articles of Incorporation must be complied with when issuing a dividend, including the actual declaration. Further, careful attention must be paid to paying the correct shareholder. Sometimes there will be a holding or other related company that owns the stock of the captive and that does not have a bank account. Thus, appropriate documentation must be put in place to ensure that the payment of a dividend is made to the correct company via any appointed payee.

Tax considerations

The tax treatment of the dividend is solely dependent on the status of the captive and its shareholder(s) for United States income tax purposes. Cayman captives can be treated in a number ways under the United States Internal Revenue Code and Regulations. Based on the complexity of the applicable laws and regulations, it is highly advisable to obtain tax advice prior to the dividend declaration.

"The opportunity to declare a dividend and reap the rewards of sound risk and investment management is key to the continued success of any captive programme."

Depending on the ownership structure of the captive, the captive could be considered a controlled foreign corporation, where earnings are not deferred but rather taxed annually in the hands of the United States shareholder, or a non-controlled foreign corporation, where earnings are deferred and taxed when distributed. Additionally, and only available for controlled foreign corporations that are considered insurance companies for United States income tax purposes, a captive may make the previously mentioned Section 953(d) election. This irrevocable election classifies the foreign corporation as a United States corporation and following the election, the captive is taxed annually as if it were a United States insurance company, thereby transferring the liability of tax from the United States shareholder to the captive itself.

In brief, a dividend paid to a United States shareholder of a nonelected controlled foreign corporation will be considered a return of previously taxed income to the extent the shareholder has previously taxed income and thus would not be taxable. Should the dividend exceed the previously taxed income, then the excess would be considered a return of capital. Should a United States shareholder’s dividend exceed both previously taxed income and paid-in capital, then the excess would be considered a capital gain subject to tax at the applicable taxable rate. A dividend paid to a United States person who is a shareholder of a non-controlled foreign corporation would be taxable upon receipt as a non-qualified dividend.

Dividends paid to a United States shareholder from a Section 953(d) elected captive would be treated similarly to any United States source corporate dividend. Depending on the tax status of the United States shareholder, the dividend may be subject to the preferential dividend tax rate or perhaps be subject to the dividends received deduction.

Considering the different tax treatments of the dividend, it is recommended again to obtain tax advice prior to the dividend declaration. This is especially significant due to the pending sunset of the ‘Bush tax cuts’, which would directly affect the tax liability of certain dividends and capital gains.


The current trend of dividend declarations is likely to continue while we slowly emerge from the post-recession era. It is vital for the board of directors to be aware and comprehend the various accounting, finance, regulatory, legal and tax considerations before declaring a dividend. The opportunity to declare a dividend and reap the rewards of sound risk and investment management is key to the continued success of any captive programme.

Peter MacKay is chairman, Ian Bridges is vice president and Jennifer Reid is vice president at Global Captive Management. They can be contacted at:; and

Captive International