The Canada–Cayman Islands bilateral tax information exchange agreement opens further doors for Canadian-owned captive insurance entities.
June 24, 2010 was a historic day as the Cayman Islands Premier, W. McKeeva Bush, and the Canadian High Commissioner, Stephen Hallihan, signed a tax information exchange agreement (TIEA) between the two governments enabling both countries to exchange information relevant to the determination, assessment and collection of taxes. The TIEA, which has been effective since June 1, 2011, means Canada will now be able to request information from the Cayman Islands’ Tax Information Authority. The authority will provide information pertaining to ownership and banking records held by banks or other financial institutions. Although the Cayman Islands have always welcomed Canadian commerce to its shores, the TIEA is a vital step in attracting additional business from the Canadian multinational risk management market.
The Cayman Islands captive insurance industry is in an ideal position to capitalise on this development and become the new domicile of choice for Canadian-owned captives that carry on an active business. Not only does the Cayman Islands have a robust infrastructure and regulatory environment, but the TIEA provides a Canadian tax benefit that was previously reserved only for countries with which Canada had a tax treaty. Generally, the entry into force of the TIEA provides incentives for Canadian investment into the Cayman Islands through the repatriation of tax-free dividends to Canada. What does this mean? Cayman Islands resident captives are now afforded a level playing field in their competition for Canadian-owned captive business.
What has changed?
Prior to the TIEA amendments, a Barbados captive insurance company had an advantage over a Cayman Islands captive insurance company because Barbadian companies carrying on active business in Barbados could generate exempt surplus. As a result, dividends deemed to be paid from exempt surplus could be repatriated to Canada free of further Canadian tax.
Meanwhile, a Cayman Islands company that carried out active business in the Cayman Islands previously generated taxable surplus. Any dividends deemed to be paid out of its taxable surplus were subject to Canadian tax, to the extent where any Cayman Islands income or profit tax was paid, when received by the Canadian parent company. Since no corporate income or profits tax is levied in the Cayman Islands, those taxable surplus dividends would normally have been subject to Canadian tax at full rates.
Now that the TIEA has entered into force, a Cayman Island captive subsidiary of a Canadian parent corporation will be eligible to include certain active business income and deemed active business income in its exempt earnings and exempt surplus.
"The TIEA is a vital step in atracting additional business from the Canadian multinational risk management market."
Under Canadian income tax regulations, exempt earnings and exempt surplus includes, among other things, income from active business and income deemed to be from an active business carried on by a foreign affiliate in a designated treaty country (DTC) or a TIEA country. A DTC is defined as a country with which Canada has entered into a tax treaty. Barbados, for example, has been a traditional home for Canadian-owned captives because of its low domestic corporate tax rates and its tax treaty with Canada. However, a foreign affiliate resident in a country with which Canada has entered into a TIEA, such as the Cayman Islands, is now granted the status of DTC.
Income from an active business
Income from an active business includes insurance premiums earned by a Cayman Island captive from the insurance or reinsurance of non-Canadian third party risk provided that the Cayman Island captive employs more than five full-time employees. Furthermore, the portfolio investment income earned to support the third party non-Canadian insurance contracts ceded, as required for regulatory purposes, should be income from an active business.
Defining active business income
Certain types of passive income may also be deemed to be income from an active business. This includes insurance premiums earned from the insurance or reinsurance of related party non-Canadian risk by the Cayman Island captive from another foreign affiliate if, among other conditions, (i) the Canadian parent company maintains a qualifying interest in the Cayman Islands captive and the payor foreign affiliate throughout the year, (ii) the Cayman Islands captive and the payor foreign affiliate are resident in a DTC or a TIEA country, and (iii) the premium is deductible from the payor foreign affiliate’s active business income.
In these circumstances, there is no requirement for the Cayman Islands captive to employ more than five full-time employees. However, any portfolio investment income earned to support the related party non-Canadian insurance contracts ceded, as required for regulatory purposes, should also be deemed to be income from an active business.
"The TIEA is a vital step in attracting additional business from the Canadian multinational risk management market."
It is important to distinguish income derived from the insurance of Canadian risks by a Cayman Islands captive as it would be foreign accrual property income (FAPI) regardless of whether or not such income is earned in a DTC/TIEA country. FAPI is included in taxable earnings and taxable surplus. FAPI is taxed as if it was earned in Canada on an accrual basis. Thus, the Canadian tax benefits of the TIEA may be applicable only in circumstances where a captive foreign affiliate earns active business income or deemed active business income from the insurance or reinsurance of non-Canadian risk and not the insurance or reinsurance of Canadian risk.
Upon the signing of the TIEA, the Premier stressed the agreement’s importance to active business income. “In regards to Canada specifically, I am also aware of an important result of our agreement,which will be favourable tax treatment under Canadian tax law for active business income earned by Cayman subsidiaries of Canadian companies,” said Premier Bush.
“I am sure this will be a welcome benefit, as many Canadian firms in the funds and private equity areas rely on the Cayman Islands’ stable, globally connected, tax-neutral platform to help reach their business goals. We look forward to more successful Cayman- Canada business for years to come.”
Why choose the Cayman Islands?
The TIEA presents a great opportunity to incorporate new captives in the Cayman Islands as well as re-domiciling from Barbados or similar DTC captive domiciles. The TIEA is not a double tax treaty, therefore a Cayman Islands resident captive will not be able to claim reduced treaty tax rates on any Canadian source income. However the Cayman Islands does not impose any income tax whereas Barbados imposes a tax of 1.75 to 2.5 percent on captive profits.
Treaty-based versus TIEA-based exempt surplus
Another benefit the TIEA has over a traditional tax treaty is the difference in residency requirements for Canadian tax purposes. A foreign affiliate must be resident in a DTC in order to have its active business or deemed active business earnings qualify as exempt earnings, which is a component of exempt surplus.
A foreign affiliate based in a DTC is subject to a two-pronged residency test. The first test is based on the common law residence of the foreign affiliate. Generally, a foreign affiliate is considered to be resident in the place of its central mind and management. Under the second test, a foreign affiliate must be considered a resident of the DTC for the purposes of its tax treaty with Canada.
"With its regulators, captive managers, law firms, and its reputation as a centre for excellence for international business, Cayman has all the expertise needed to assist Canadian companies with their riks management needs."
What about a foreign affiliate in a TIEA country? The nature of a tax treaty is different from that of a TIEA. Whereas the contracting parties to a tax treaty want to ensure treaty benefits are extended only to persons who meet the requirements of the residence article of the particular tax treaty, it is in the best interests of Canada—as a contracting party to a TIEA—for the TIEA to be as far-reaching as possible, in order to be able to obtain all information necessary for the proper enforcement of its tax laws. Once a foreign affiliate has been determined to be resident in a TIEA country under common law principles, it will be resident in that jurisdiction for Canadian tax purposes and can generate exempt surplus. Thus, a foreign affiliate located in a DTC is subject to a tougher residence test than a foreign affiliate in a TIEA country.
Local business climate
Access to the Cayman Islands and its tropical climate has never been easier. Currently there are two commercial airlines with direct flights from Toronto—a journey which is notably shorter than if one were to travel to Barbados. However, climate, travel, and the TIEA are not all that attract Canadian businesses. There are currently more than 730 captives with $58 billion in total assets in the Cayman Islands, making the Cayman Islands the second largestcaptive domicile in the world. And the Cayman Islands Monetary Authority (CIMA), the body mandated to regulate this large portfolio of captives, is ready to receive new Canadian business. CIMA was instrumental in drafting the soon-to-be implemented Insurance Law, 2010. The new law streamlines the regulation of captives through its new Class B sub-categories, while also providing a specific category for reinsurers.
The Cayman Islands is focused on transparency and integrity. At the time of the TIEA’s enforcement, the Cayman Islands had signed 23 TIEAs, though that number has since grown to 27 to include such countries as the US, UK, Ireland, Japan, France and Germany. More information on other tax information exchange agreements can be found at http://www.tia.gov.ky/
The Cayman Islands is already home to a significant number of Canadian banks, among other well established international financial institutions. With its regulators, captive managers, law firms, public accounting firms, and its reputation as a centre for excellence for international business, the Cayman Islands has all the expertise needed to assist Canadian companies with their risk management needs.
In summary, the TIEA has ushered in a favourable treatment of taxation in Canada for active and deemed active business income of those Canadian-owned captives domiciled in the Cayman Islands. Active and deemed active business income earned by Cayman Islands captives is now afforded equal Canadian tax treatment to its Barbadian counterparts. Now is the perfect time for multinational Canadian corporations to include the Cayman Islands in their risk management strategy.
Ian Bridges is tax director at PwC in Cayman. He can be contacted at: firstname.lastname@example.org
Kara Ann Selby is a partner in International Tax Services with PwC in Canada. She can be contacted at: email@example.com
TIEAs, Cayman, Canada, tax, captive, insurance, PwC