Editor’s comment – Does offshore captive = reputational risk?

Tax is now very low on the list, yet all of a sudden, captives are facing increasing scrutiny as part of the general debate about corporate tax planning/avoidance/evasion. As corporates face the glare of media scrutiny and public opprobrium over their tax avoidance schemes, captives are being dragged into the debate. But it appears to be driven by concern over insurers using captives themselves, rather than the standard corporate-owned risk financing vehicle.

Nevertheless, it is a concern that captives are being identified by the media and others as a tax avoidance vehicle. And it is not that easy to explain why this view is misplaced, given the history of captives and their use. The secret is to explain the real reasons why captive are used, stressing the risk management function.

Captives are primarily used to centralise the risk financing objectives of the parent organisation, so that it becomes in effect the centre of risk, whether insurable or uninsurable. Above the deductibles of the individual units, the corporate risk retention can be directed centrally through the captive, so that risk management programmes and loss control measures can be implemented and seen to be cost effective from day one.

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And where the group has a number of operating units, or subsidiaries, the captive can be used to reward or penalise individual units, according to how they implement the group risk management programme, or individual loss control initiatives. Between the local deductible and the group deductible, there is scope for the captive to differentiate between units, rewarding loss control initiatives and co-operation with risk management programmes, and penalising those who do not co-operate, or who are showing greater losses than the norm.

Units can be penalised by raising the cost of insuring into the captive, or by increasing the local deductible. Equally, units can be rewarded with lower insurance costs.

The danger for some captive owners is that it will be difficult to explain why, despite all the protestations about tax not being at all important, captives are based in offshore domiciles such as Guernsey, Isle of Man, Bermuda, Cayman etc, regardless of how many tax information sharing schemes they sign up for.

No wonder so many US companies have switched their captives to onshore US domiciles. If the corporate tax debate goes on, will the next few years see a major move onshore?