8 August 2018Accounting & tax analysis

Victories in small captive cases may embolden IRS to target larger captives

If the IRS continues to gain victories against small captives in the US Tax Court, it may be emboldened to target larger captives, according to Charles “Chaz” Lavelle, partner at Bingham Greenebaum Doll, speaking to Captive International at the VCIA annual conference.

“I think the IRS has always been very sceptical about all captives,” said Lavelle. “The prior litigation was against the larger captives, and the more recent litigation was against the smaller captives - I don’t think that implies that the IRS has agreed that anything the larger captives does is okay.”

Lavelle was tax counsel for two taxpayer victories in captive tax cases in the US court of Appeals: Humana v Commissioner, which ruled on the “brother-sister” issue, and Ocean Drilling & Exploration Company vs US, which decided the outside business issue.

If the courts develop new ideas around structures used by small captives they deem to be unsuitable, Lavelle anticipates the IRS may use the same logic against large captives - if the same facts are present in a case.

Lavelle also spoke at a panel, ‘Tax Reform: Where the Dust Settled’, along with speakers Tom Jones, McDermott Will & Emery; Jeffrey Webb, senior manager in the financial services practice of Deloitte Tax; and Bruce Wright, partner at Eversheds Sutherlands (US).

“Let’s make no mistake about it, if the IRS gets favourable opinions on these cases, they’re going to come back after the larger captives,” said Lavelle.

The panel examined the two recent small captive court cases - Avrahami and Reserve Mechanical, along with upcoming cases Caylor, Wilson, and Syzygy.

In both Avrahami and Reserve Mechanical, the taxpayer lost. In both cases it was determined there was no risk distribution and no insurance as commonly accepted.

Judge Holmes - the judge in the Avrahami case - will be the Judge in upcoming cases Caylor and Wilson. Caylor features a brother-sister arrangement, with no risk pool. And Wilson uses the same pool as Avrahami but has different experts and witnesses.

In the case of Syzygy, the IRS will be targeting a domestic captive, and seeks to tax both the insured and the captive.

Lavelle added that there are a lot of captives that have been docketed by the IRS, but none of them are set for trail at the moment, with maybe a couple that could be.

The panel also noted that the IRS’ Large Business & International Division has redirected its audit philosophy, focusing on specific issues (“campaigns”) rather than comprehensive general audits.