Capturing the captives
On April 30, 2014 by way of the Provisional Collection of Tax (Income Tax) Order, Jamaica's income tax net expanded its reach to ensnare what has perhaps been until now one of the most effective offshore corporate income tax mitigation strategies deployed by big business: captive insurance.
In effect, the order imposes an obligation on the Jamaican taxpayer to withhold and account to the tax authority for 15 per cent of insurance premiums paid to non-resident (offshore) insurers.
The principal targets of this tax measure are large corporate groups who have invested in setting up their own insurance companies abroad for the purposes of self-insuring their own group risks, an insurance scheme known as captive insurance. Insurance companies based in Jamaica and registered with the FSC are exempt from the withholding obligation and as such, the very significant revenues that they relay offshore in reinsurance premiums are not affected.
A captive insurance strategy involves the creation by one or more non-insurance companies of a subsidiary insurance company which is set up for the purposes of insuring the risks of the group. The captive insurance company is typically incorporated in one of a number of "offshore" jurisdictions, such as Bermuda and St Lucia.
The set-up and ongoing regulatory compliance costs associated with the implementation of a captive insurance company are such that captive insurance schemes are generally only engaged by larger corporate groups with very substantial revenues and insurance requirements. The procedure for setting up a captive insurance company involves the preparation and submission to the insurance regulator of a business plan, feasibility study, revenue projections, management team structure and premium investment plan amongst other deliverables.
The Government's justification for seeking to capture the captives is probably driven by speculation that Jamaican corporate tax payers are using offshore captive insurance schemes primarily as a tax avoidance device, whereby captive insurance premiums are being shuttled into group-controlled offshore accounts as deductible expenses here in Jamaica and being received free of tax in the jurisdiction of the captive insurance company.
While it is true that captive insurance schemes may have tax mitigation benefits for their groups, it is certainly not the case that on the whole these structures represent nothing more than a tax sham. Genuine captive insurance schemes generate a number of positive effects including the expansion of society's insurance coverage generally by way of providing cost-effective insurance options for corporate risk coverage which may not otherwise be available.
Indeed, I have acted in a number of commercial transactions (both locally and abroad) where captive insurance was the only insurance option available to meet the related insurance requirements.
Any approach to the taxation of captive insurance schemes should consider not only the tax deductibility of the premiums from the perspective of the payer but also the regulatory compliance burden of the captive insurance company, including but not limited to capital and reserve obligations, investment limitations and reporting obligations which often partly or wholly offset the tax benefits of the scheme.
As it relates to the tax deductibility of captive insurance premiums, it should be noted that there are a number of internationally established legal principles which operate to set the parameters for what will be considered a genuine captive insurance arrangement.
For the premium payment to a captive insurer to be properly deductible as an insurance business expense, it must be demonstrated that the captive insurer is a valid insurance company properly licensed in its jurisdiction. In addition, the premiums being paid to the captive must be pursuant to a genuine insurance policy involving the demonstrable shifting and distribution of existing risk. The law in this regard is complicated suffice it to say that the insurance policy documentation confirming the insurance relationship between the insured and its captive insurer are very important to the legitimacy of the structure.
North America's revenue authority has adopted a clinical approach to the taxation of captives. Instead of attacking captives, the IRS has introduced "safe harbour" rules to regulate the captives while reserving the right to evaluate the captive insurance arrangements based on their individual facts and circumstances. This approach provides a mechanism whereby tax abusive captives may be identified and addressed while acknowledging and preserving the benefits being derived by genuine good faith operators of properly structured schemes.
Finally, for those Jamaican-based captive scheme operators who may be seeking a way to circumnavigate the recently introduced withholding obligation on captive premiums, it should be noted that the provisions of the Order anticipate efforts to exploit the reinsurance exemption by routing captive insurance premiums through a local insurer.
In this regard, the local insurer/reinsurance exemption is limited to circumstances where premiums are paid by a local insurer to a genuine international reinsurer and where the Commissioner is satisfied that the recipient of the premium is not acting on behalf of a captive insurance company.
Randolph Cheeks Jr is the founding principal of the boutique business law firm Cheeks & Company. He is a dual qualified corporate/commercial lawyer admitted to practice in Jamaica and the United Kingdom. His main areas of expertise are corporate/commercial transactions with an emphasis on corporate structuring and the law relating to information & communications technology. He may be reached by e-mail at email@example.com.