The growing number of onshore jurisdictions means it is increasingly tempting to domicile your captive close to home. But is this really a better option than offshore? US Captive investigates.
With ever more onshore jurisdictions available, the decision of whether to domicile your captive onshore or offshore is becoming harder to make. The convenience of a local domicile is alluring, but there are still some compelling reasons to opt for one of the offshore jurisdictions. It is a balancing act that every captive owner must face at some point.
“Captive domicile selection is typically one of the last decisions made in the captive establishment process, but it is very important,” says Anne-Marie Towle, senior vice president and senior consultant for the Global Captive Practice at Willis Towers Watson.
“When considering which domicile one should select for incorporation of a captive, many facets need to be analysed.”
One of these key considerations is the receptiveness of the regulatory environment. Domicile regulations should be acceptable to the parent company, insurers and reinsurers, as well as to the government in the parent’s own domicile, says Towle.
“Those exploring captives should be looking for domiciles with a well-established regulatory authority focused on captives, stability in the political and economic regime and a sense of regulatory compatibility with the business objectives of the captive,” she says.
Choosing to domicile your captive offshore can bring greater regulatory flexibility; offshore captives usually allow lower minimum capital requirements and may not require regulatory examinations. Some jurisdictions have developed an environment that is particularly supportive of certain types of captive.
"Achieving the most tax-efficient structure for a taxable corporate entity should be part of the captive strategy,” Anne-Marie Towle, Willis Towers Watson
“There are individual pockets of expertise,” says Jeffrey Simpson, director of law firm Gordon, Fournaris & Mammarealla. “Some states and some offshore domiciles have developed particular specialisations, but overall I think the level of regulatory sophistication onshore has caught up with the level offshore.”
Fiscal framework and tax planning
“There are US tax effects and consequences to being onshore and offshore at both state and federal levels and it is important to consider those in making your decision,” says Simpson.
“When you go offshore you pay federal excise tax on the premium—and that can be a material added cost of the transaction; if you are domiciling a captive outside your home state you need to be at least aware of the potential for self-procurement tax payable to your home state that wouldn’t be payable if your captive were in that state.”
Towle says you should first ask whether the domicile offers a menu of tax, legal ownership and capitalisation options. This enables the captive to be aligned with the sponsor’s overall legal, tax, and fiscal strategy.
“Second, how do the parent company’s tax authorities view each domicile? For example, achieving the most tax-efficient structure for a taxable corporate entity should be part of the captive strategy,” she adds.
Pros of staying onshore include lower costs for audit and legal fees, travel, and management; an absence of the tax risk or tax governance issues associated with the offshore structure; and the fact that valuable executive time is not required for meetings offshore for tax purposes. However, if you domicile your captive offshore, taxes on income are negligible.
Investment, capital and profits
Capital requirements, constraints on moving funds, and restrictions on the type of investment allowed, should also complement the sponsor’s overall strategy, says Towle.
“One financially efficient strategy used by many captives involves premium loan-backs. If a company is concerned about the opportunity cost of capital when forming the captive, your consultants will work with you and your tax advisors to properly assess this approach. A parent company’s financial strength will be important to the domicile regulators.”
Services and costs
Key questions to ask around this topic include: is there an appropriate range of professional services—auditors, bankers and lawyers, etc? Is it possible to find staff and board members of sufficient calibre? And what about set-up and running costs—how do these compare?
“For the long-term viability of the captive, the domicile needs to be politically and economically stable, with a good communications infrastructure. Access and logistics are also important,” says Towle. Captive domiciles impose regulatory, reporting, financial, and tax requirements on the captives within their jurisdiction.
Onshore jurisdictions assess a premium tax for direct or assumed premium written in the captive. Offshore jurisdictions tend not
to impose premium taxes but instead impose annual licence
“All captive jurisdictions require regular reporting of financial and operational activities and have an interest in the business plans of the captive insurance companies in their jurisdiction,” says Towle.
“All captive jurisdictions impose financial standards which need to be met in order to maintain a licence in good standing as well. Captive licensure is generally related to the types of business being underwritten, in terms of both lines of business and relatedness to the captive’s owner.”
Besides the convenience of domiciling a captive closer to home, outward appearances are sometimes a consideration.
“Often a client chooses a domicile primarily because of optics,” says Sandra Fenters, president of Capterra Risk Solutions. “They may perceive that being onshore would be more palatable in the
eyes of regulators and other bodies that may scrutinise a captive.”
Simpson agrees: “An incentive to stay onshore is that there is a perception, at least, that there is a little less scrutiny from the Internal Revenue Service, and a little less stigma if you are onshore rather than offshore.”
Towle highlights several other factors to consider, including capitalisation and surplus requirements; quality of local infrastructure; availability of expertise; stability of the regulatory environment; flexibility as respects investment portfolio and ease of doing business in a suitably regulated environment.
Also important are the length of time already spent as a captive domicile; levels of experience in the business under consideration; and a track record of efficient financial outcomes.
A determining factor in the domicile selection process will be the determination of ‘home state’ status for the purposes of the applicability of self-procurement taxes, which are levied against insurance premium purchased outside the standard, licensed marketplace, adds Towle.
“If a company were to create a captive insurance company, underwrite risk, and collect premium, and if the state(s) in which the company has exposures determine that a self-procurement tax was applicable and that an ‘insurance’ transaction transpired, the state may seek collection of a tax. This determination has had an impact in the US in recent years to drive more onshore state formations versus offshore.”
Bringing it all together
The increasing number of, and expertise available in, US jurisdictions is making it harder to make the case for offshore.
“Newer onshore jurisdictions have become more sophisticated and a little more liberal as they have become more comfortable with what they are doing, so in that regard they have in many ways caught up with the offshore jurisdictions,” says Simpson.
“The offshore jurisdictions still have in some cases a concentration of expertise that is helpful—for example, if you want to do healthcare you probably go to the Cayman Islands and if you have a Fortune 500 reinsurance transaction you go to Bermuda.
“Other than those types of situation there is not much difference between onshore and offshore any more, and you can pick the managers and the service providers you want to deal with and work in the places they are comfortable working.
“Unless there is a particular kind of expertise that will be helpful to you, there is a lot to be said for the convenience of being onshore.”
With the rise in new captive formations or new jurisdictions in the US there has to be some clear benefit in leaving the US, agrees Fenters
“That benefit may be tax—some jurisdictions are tax-free—or areas of expertise; cost; service providers; or regulatory flexibility. The analysis of all these elements is fluid as the growth in the number of states that are creating captive-enabling legislation continues to increase.
“New domiciles go through growing pains—they initially grow rapidly then they have to tighten the belt in terms of regulation, and they learn as they grow.”
Ultimately, the key is to seek sound advice and consider all angles. Marsh, for example, has offices in every major domicile, and Derek Martisus, small captives sales leader, Marsh, regularly has to help clients make this decision.
“During our conversations, a prospective captive owner must understand the variables that make or break a domicile as it pertains to their business. The critical discussion points include: regulatory environment; service provider infrastructure; and cost and geographic proximity to their business.
“We focus heavily on the regulatory environment to ensure that we put our clients in a position to succeed. We must be concerned about the costs of running the captive, yet we do not want our clients choosing a domicile simply because capital requirements are low.
“If our clients are looking to make the 831(b) election, we would typically advise them to stay in the US as it’s simpler and there are plenty of great options onshore. Interest in offshore tends to occur when there are business ties to the particular region.”
The good news is that there are now many excellent options, both offshore and onshore. Never have there been more opportunities to give your captive the supportive environment it needs.
Willis Towers Watson, Insurance, Captives, North America, Risk management, Regulation, Legislation, Funds, Gordon Fournaris and Mammarealla