17 January 2014

Rising scrutiny may lead to collective guilt

Considerable hype and press coverage in recent months, particularly around 831b and life insurer captives, has done more harm than good for the captive sector.

That is the view of Scott Geromette, partner at law firm Honigman, who tells Captive International that a quieter approach will benefit a sector that has largely been “self-sufficient and self-regulating” for years.

Geromette—who was recently made partner within Honigman’s Detroit office—says: “Historically captives have flown under the radar; not in the sense that they have tried to avoid regulation; rather they have been essentially self-regulating.”

“However, the huge growth in captives, captive domiciles and the more varied application of captives, from simple risk management tools to tax structures, has resulted in increased visibility and more discussions concerning captives.”

“This has led to increased scrutiny, specifically IRS tax audits and of 831b captives and pooling structures. It has also led to modifications in domicile regulation and heightened scrutiny within those domiciles.”

Geromette adds that the ongoing debate over the application of the Nonadmitted Reinsurance Reform Act, which was originally decried by some experts in the captive sector, has also resulted in putting the industry back on people’s radar.

“If captives are excluded under the NRRA it may be seen by some regulators as an opportunity to introduce their own captive tax laws.” It is an example of how highlighting issues can potentially be damaging to the captive sector, he says.

“Whereas in other spheres any press is good press; in the captive industry this is simply not the case”. He warns that, in light of the lack of general familiarity and understanding of captives, the industry is always at risk of being characterised by “a few bad apples”.

“Any time you make a shift away from the traditional purpose of captives, you lose that self-policing and self-regulating aspect. There is a danger with entities such 831bs—which can and often are credible captive entities under US tax law if established for proper purposes—that they may attract unwanted attention to the wider captive market from the tax authorities if they fail to satisfy scrutiny in an audit situation.”

The issue has been of particular concern due to the marked rise in 831bs in recent years. As Geromette explains, “the rise has been most evident in particular domiciles, raising more questions than it answers. For instance, why has growth not been as marked in the historic centres of captive excellence?”

Geromette warns that US captives can expect greater scrutiny in 2014. “The Administration has indicated that it is dedicating more manpower to audits and we have certainly seen an uptick. I would anticipate an increased risk of an audit. No one volunteers for these; they tend to be a painful process.”