Offshore Captives, Onshore Taxes:
The Best of Both
When establishing a captive insurance company, whatever one’s purposes, one of the first questions to be addressed is where the captive should be domiciled, either onshore or offshore. Ongoing additions to the possibilities onshore keep this issue at the forefront of that decision-making process. Despite the growing number of new domestic domiciles, many prospective owners still choose the option of being domiciled offshore, while also electing to remain a U.S. taxpayer. The interesting question is how and why this is an attractive strategy.
There are many reasons why captives choose an offshore domicile. Such domiciles have specialized in captives for many years and often have a greater depth of knowledge, expertise and financial sophistication. Minimum capital requirements can be lower, with greater discretion permitted regarding the ratio of capital and surplus to written premium, potentially increasing the volume of business which may be underwritten, as well as mitigating solvency requirements and specific ratios of premiums written to net assets. Additionally, State examinations and a generally more regulated environment apply in the onshore domain.
From a tax perspective, if a foreign entity meets certain criteria, it can elect under §953(d) of the Internal Revenue Code to be taxed as a U.S. entity. The election is commonly referred to simply as a 953(d). The 953(d) election allows an electing controlled foreign corporation (which would be the captive) to affirmatively elect to compute its U.S. tax liability as if it were a domestic corporation subject to the rules contained in Subchapter L of the Internal Revenue Code.
Who is eligible to make the 953(d) election?
A 953(d) election may be made:
• by a controlled foreign corporation (CFC),
• which would qualify as an insurance company under part I or part II of Subchapter L of the Code if it were a domestic corporation, and
• which either;• enters into a closing agreement and provides security for payment of taxes due (e.g. provides LOC in favor of IRS), or
• satisfies the office and assets test in Rev. proc. 2003-47 (usually satisfied by having a US bank account and/ or investment account).
The amount of the LOC, or the assets required under part c) above, is computed as 10% of the gross income in a U.S. bank account for a “base year” (as defined in Rev. Proc. 2003-47) or US$70,000, whichever is higher.
How to make the 953(d) election
Rev. Proc 2003-47 details how the election is made. The electing tax payer must file:
• an election statement;
• a list of U.S. shareholders (together with details including SSN or EIN as appropriate;
• Form 2848 (Power of Attorney and Declaration of Representative) or Form 8821 (Tax Information Authorization)
Once a 953(d) election is approved the captive will need to apply for an EIN which will require a Form SS-4 Application for Employer to be submitted to the IRS.
The 953(d) tax election is a one-off election and must be made by March 15 following the calendar year in which the election is to be in effect. If a 7004 extension is requested and filed by March 15, then the 953(d) election must be filed by September 15.
If approved, the election is binding from the first day in the tax year in which the election is made (including a short tax year) and to all subsequent years, as long as the requirements of Rev. Proc 2003-47 and section 953(d) are satisfied.
The whys and wherefores of the 953(d) election.
Once the 953(d) election is approved, the captive would file an 1120-PC tax return (if writing property and casualty business) or 1120-L tax return (if writing life business).
If the 953(d) election is not made, the captive remains a foreign corporation and all U.S. shareholders would be required to include in their gross income their pro-rata share of the captive’s Subpart F income under Sections 951-964 using Form 5471 and would be taxed under Subpart F on all undistributed income.
Shareholder dividends from a captive which has made a 953(d) election are generally treated as “qualified dividends” for individual shareholders and the electing captive would make the usual 1099 and 1096 filings. Shareholder dividends from offshore captives which haven’t made a 953(d) (and are domiciled in non-treaty countries), as well as Subpart F inclusions, are not treated as “qualified dividends” for individual shareholders.
Under Code § 4371 Excise Tax is calculated on premiums attributable to U.S. risks assumed with respect to U.S. persons or with respect to foreign persons engaged in trade or business with the U.S. If a 953(d) election is not made, then for property and casualty insurance policies the Federal Excise Tax imposed is 4% on premium paid or 1% on the reinsurance premium paid.
Where a captive is licensed in an offshore domicile and has made a 953(d) election and is deemed a “U.S. person” under Treasury Regulation Section 1.147-1T(b)(14) (usually meaning that it is not deemed a “specified insurance company” and is not licensed in any state), then a W9 may be completed and no withholding tax taken.
There are multiple advantages for a captive selecting an offshore domicile and choosing to remain a U.S. taxpayer. Making the 953(d) election allows the entity to avail itself of the special expertise and more relaxed regulatory environment of an offshore domicile while simultaneously enjoying tax advantages in the U.S. While making this election sounds, at first blush, like an involved process, it need not be burdensome when addressed early in the captive formation while following relatively few guidelines. The result can make a demonstrative difference in business written and in the annual tax situation of the captive and its shareholders.
Note: Atlas Insurance Management is not in the business of providing tax advice, and this article is intended only as an informative, general overview. Please consult a professional tax advisor regarding making a 953(d) election.
