5 March 2014Accounting & tax analysis

Can offshore domiciles deliver benefit to tax authorities?

There is a continued trend of scrutiny, and indeed reputational pressure, on many international corporates to ensure internal arrangements are transparent from a tax planning perspective, captives included.

While many international tax authorities grapple with keeping pace with globalisation, it is perhaps worth considering a perspective where an offshore captive (typically one domiciled in a country with a zero or low tax regime) is actually a benefit for local tax authorities.

Tax planning is a sensitive matter for many captive owners and while it is true that tax planning improves the financial viability of a captive, it is not, and should not, be the primary factor behind opting to establish a captive.

A captive should be neither tax-positive nor tax-negative, however the vast majority of captive programmes issue insurance policies to local business units with low deductibles and retentions—a strategy often cited as a means to improve risk management control.

There is an argument that optimising the amount of risk retention allocated to the local balance sheet and transferred to a captive may benefit both parties (tax authorities included) as the predictability of corporate tax revenues and expenses is improved.

Transferring the majority of risk (and premium) to an offshore captive domicile offers corporates limited opportunity to carry tax losses forward in the event of major catastrophe insured losses. this scenario actually benefits local tax authorities as the amount of upfront tax deduction given for premium is smaller than the tax credit on the loss, which would otherwise have been given by the tax authority if the captive did not reimburse its local business unit. an offshore domicile has limited opportunity to offset losses against other trading income within the group.

In addition, many tax authorities collect premium taxes on gross written premiums and, given that many captive programmes issue low deductible insurance policies, it represents another benefit for tax authorities.

That said, transferring premium to an offshore captive was beneficial for corporates when interest rates on assets were high, given the time delay between collecting premiums and paying claims. today this may no longer be the case.

An optimal captive programme that benefits both tax authorities (to reduce uncertainties over tax revenues) and corporates (to fund risk optimally) is one which considers:

• assessing the merits of establishing a captive in a domicile where other group operations are located;

• analysing local corporate balance sheet risk tolerance and appetite to understand the allocation of risk retained locally and that transferred to a captive;

• appreciation by local tax authorities that in the event of a major insured catastrophe loss an offshore captive may indeed reduce uncertainty over tax revenues.