Going with an offshore captive might be concerning to you, whether due to different laws outside of the US, questioning its stability, or feeling nervous from the thought of it.
Thankfully, the short answer is no. Being part of an offshore captive is no cause for concern as long as you keep some important things in mind.
An offshore captive is a captive that is domiciled, meaning it’s based outside the country where the insured risk is located. For example, if your business is based in Florida and your captive is based in Bermuda, your captive is offshore because it is domiciled in Bermuda.
ReNu Insurance Group represents over 130 clients, many of which are part of offshore captives. We have more than enough experience ensuring that they are set up properly and in the best interest of the business owner.
After reading this article, you will have a good general understanding of the reasons why many top businesses choose to belong to offshore captives. Then, you will be better prepared to look more closely at the advantages and disadvantages of being part of an offshore captive.
Before reading on, check out our video that talks about captives being owned offshore:
Why do offshore-owned captives exist?
In the 1970s, in an effort to develop business in their countries, several offshore domiciles began offering opportunities for US-based businesses to set up insurance companies offshore, contingent on strict parameters. Most significantly, the captive management team (manager, lawyers, accountants, etc.) would have to live in the respective domicile.
When the offshore countries first began offering the captive option, the US did not have the regulatory framework to provide the same thing, and it has taken a while for the US to catch up.
Fortunately, some US states are now trying to compete with offshore domiciles. Vermont and Tennessee, in particular, have done an excellent job of taking the captive idea and promoting it, and this development is expected to continue. In the meantime, offshore domiciles are like the professors teaching, who usually teach at a university in the States but have chosen to teach a semester or two at a university in another country. Even though they’re teaching at a different school, they are still regarded as experts in their fields.
What does it really mean to belong to a captive owned offshore?
Belonging to an offshore captive means being part of a well-established network of vastly experienced experts in the field of captive insurance. Offshore captive domiciles have spent more than 50 years gaining substantial experience and establishing comprehensive services, flexibility, and strong networks to support captives. As a result, the vast majority of captives are still domiciled offshore.
Now, this doesn't mean there are briefcases of money being secretly exchanged between the United States and offshore domiciles. Captive consultants have created strong networks to be able to form captives on behalf of group members and others without contravening any domestic (US) rules.
How does the IRS view offshore-owned captives?
There are three potential ways for the IRS to tax an arrangement involving an offshore captive:
- tax the captive itself;
- impose a tax on the premiums paid on the transaction; and/or
- tax the owners of the captive.
Depending on the facts, one or two of these methods may apply, but never all three at the same time. Alternatively, the captive can elect to be taxed as a U.S. corporation for tax purposes under 953(d).
For a better understanding of how the IRS views captives, watch this video to understand their stance:
Taxing the offshore captive itself
The United States cannot tax a company that does not do business in the United States unless that company consents to it. A U.S. corporation with a non-U.S. owner has to pay regular U.S. corporate tax on its earnings. If the corporation distributes money from earnings to the non-U.S. owner, then the U.S. withholds 30% as a withholding tax (unless there is a treaty that provides for a lower rate.
Similarly, if a non-U.S. corporation does business in the United States, it is subject to both U.S. corporate tax and a branch profits tax. The branch profits tax requires a 30% withholding tax on a deemed dividend, putting the two arrangements on the same plane.
Imposing a tax on the premiums paid to an offshore captive
Premiums paid to a non-U.S. captive by a U.S. entity are subject to an insurance premium tax unless the non-U.S. captive is doing business in the U.S. or has made a section 953(d) election (or there is a treaty exemption.) Thus, absent treaty exemption, either the captive is paying an income tax or there is an excise tax on the premiums.
The excise tax rate is 4% on indemnity bonds and property and casualty insurance; the rate is 1% on reinsurance, life, sickness, or accident policies and annuities.
Taxing the captive owners
As just discussed, if a non-U.S. captive does not do business in the U.S. and does not elect under section 953(d), then it does not pay income tax. In those circumstances, there would be an excise tax paid on the premiums (unless there is a treaty exemption.) In addition, depending on the facts, the owners of the captive may also be taxed.
One word of caution to keep in mind: if you run into a captive manager who immediately suggests setting up a captive in any domicile, offshore or onshore, as a tax-saving measure, take a big step back. This is the worst advice you could receive, and it's dangerous.
Using taxes as the primary reason to set up a captive will get you in trouble with the IRS—your captive needs to do its job and primarily be an insurance provider. Business owners face penalties and fines for this issue.
953(d) election
To avoid being taxed in one of the three ways noted above, an offshore captive can elect to be taxed as a US business under section 953(d). This will result in the captive being treated almost the same as a US-based corporation for tax purposes while retaining its non-US designation.
The captive then pays U.S. corporate tax but is not subject to the branch profits tax or the insurance excise tax noted above. The 953(d) election is irrevocable. It is made by a separate filing that the IRS must approve and requires proof that the captive can make sure that taxes will be paid.
Note: While you’re here, check out our article that asks and answers the question: Does the IRS hate captives? That way, you can understand how the IRS views captive insurance companies.
What are the benefits and drawbacks of offshore captives?
Benefits
Business owners choose offshore captives because that’s where the most experienced regulators and captive managers are located. For example, Bermuda was the first domicile to establish the cell captives and the legislation to regulate them.
Recently, other domiciled, including those onshore, have added legislation to allow for segregated cells.
Drawbacks
With an offshore captive, the business owners have to play by two sets of rules. In addition to meeting all the requirements of the state where the business operates, the captive must follow all the applicable laws of the domicile where it is owned.
Also, one common rule among offshore domiciles is that an offshore captive must convene a meeting of its Board of Directors in its domicile at least once yearly. The domicile may also require a separate Board meeting in another part of the world, depending on the weather… which might not be such a drawback!
Know the pros and cons of captive insurance, whether they're on or offshore
While this article touched on the main aspects of offshore captives, there is much more to be said concerning the pros and cons of being in one. As always, it's important to do your due diligence and work with a reputable captive risk consultant who can help guide you through the process.
To find out more about the pros and cons of belonging to an offshore captive, you need to read, What are the general pros and cons of being a captive owner?
At ReNu Insurance Group, our insurance advisors are available to discuss any questions you might have.
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