7 September 2017Accounting & tax analysis

Avrahami got "almost everything wrong", says Capstone

The US Tax Court ruled against captive owners and jewellers Benyamin & Orna Avrahami on August 21 in a case long-anticipated by the captive industry.

Captive International previously spoke to a number of experts within the industry who all weighed in on one of the most long-anticipated cases.

Capstone Associated Services, a captive manager and alternative risk planning service provider, suggested that the Tax Court's opinion is a primer on pooly designed and weakly implemented alternative risk structures.

"If there were a captive team in place for the Avrahamis, it appears not to have evaluated or operated the planning to any meaningful degree," it said in a statement. "The so-called ‘captive program’ described by the US Tax Court was divorced from the fact situation presented, with the Court finding that the captive was devoid of adequate risk distribution and was improperly formed and managed. These are basic tenets of alternative risk planning."

Steven Lonergan, who manages Capstone’s Midwest and Great Plains region from Capstone’s Minneapolis office, commented: "While there are captives formed by unsophisticated managers that have some issues, this case is unusual in that the structure failed in almost every possible area. The Avrahamis and their advisors got almost everything wrong."

The Avrahamis' captive, Feedback, had attempted to satisfy the risk distribution requirement through a risk pool operated by Pan American Insurance, however, the risk pool only included terrorism risks, while other risk insured by Feedback were not pooled.

Furthermore, the court held that the Avrahami’s captive did not satisfy the risk distribution required of insurers. The Court further held that the operations of the Avrahami’s captive were not within the “commonly accepted notions of insurance.” Essentially, the court ruled that Feedback and Pan American both failed to operate as bona fide insurance companies, noted Capstone.

Coby Hyman, a tax attorney who focuses on captive operational issues in support of Capstone, commented: “The opinion highlights multiple questionable choices by the Avrahamis in operating their captive insurer. The Court noted that the insureds took out loans of approximately 65 percent of the captive’s assets that were insufficiently secured or were unsecured, with funds passing through shell entities back to the captive’s owners.

“Additionally, records produced reflected that the client’s lawyer, Celia Clark, directed the actuary (Rosenbach) to arrive at a dollar-specific premium that fit the client’s targets. The semi-retired actuary couldn’t articulate for the Court how the premiums charged by the captive were calculated and thus failed to follow generally accepted actuarial standards.

“The opinion commented that the possibility of a covered loss being triggered under the carefully designed terrorism risk pool was so low that the Avrahami’s actuary admitted that he did not know of any event in history that would have triggered coverage. Additionally, the St. Kitts domicile is a small domicile having little regulatory history or experience, unlike more common domestic or UK-controlled domiciles. Despite such, the captive operated at odds with the St. Kitts regulatory requirements in that the required pre-approval for loans was never obtained.”