Seeking harmony

One thing that’s hard to argue against in the current political and economic climate is better financial regulation. The banking crisis revealed significant deficiencies in the way that cross-border financial juggernauts are supervised, and this must be addressed. But it has had a knock-on impact for other parts of the financial sector.

It now appears, for example, that insurance companies, who were not in large part directly responsible for the crisis, could be caught up in a new tax on financial transactions.

Meanwhile, as public debt soars, governments around the world are looking for ways to squeeze more revenue from tax receipts, and so-called ‘tax havens’ are high on the list of targets. What the G20 government will do next to tighten the noose on these places is not yet fully understood. It’s clear, however, that it will have an impact on captives.

UPPING THE PRESSURE

KPMG’s senior tax manager of financial services, Mike Allen, warns: “Revenue authorities are under pressure to raise tax revenues, and profitable multinational groups are a potential target.” In the UK, the tax authorities are reportedly intending to challenge the tax position of “corporate exiles”, he adds.

Authorities in the USA are also looking to increase the pressure on groups that operate overseas, particularly in low-tax territories.

“This is likely to extend to companies that the tax authorities consider are ‘exporting’ profits by way of captive structures,” Allen says. “Accordingly, groups should take care in execution when using captives.”

Cadwalader, Wickersham & Taft partners Jennifer Donohue and Adam Blakemore take a similar view. Since 2000, the UK government has focused on scrutinising captive insurance arrangements, particularly those perceived to be motivated by tax avoidance, they say. This hardening attitude is replicated in a number of other G20 jurisdictions and is unlikely to be relaxed in the near future.

“Notwithstanding the valuable risk management role fulfilled by captives,”

Donohue says, “national revenue authorities have not generally been persuaded that the commercial benefits arising from their use have been unrelated to the tax advantages of establishing these companies in low-tax jurisdictions or tax havens.”

In a UK context, changes to the Finance Act to remove the ability of offshore captive domiciles to fix the local rate of tax for captives has reduced some of the benefits of traditional captive locations, including Guernsey and Gibraltar, adds Blakemore.

“Similarly, legislation in France and Italy, by which transactions with counterparties in certain low-tax jurisdictions can be prescribed, is another example of an increasingly difficult environment within which offshore captives will need to operate.”

Accordingly, say Donohue and Blakemore, while the economic benefits arising from captives remain credible, the taxation environment may lead them to move away from traditional offshore centres and towards captives located within the European economic area, such as Ireland, Luxembourg and Malta.

On a more positive note, the drive towards a more comprehensive and global financial regulatory regime is likely to drive standards up wherever captives are located. Reform is already under way. Last April, as a result of a G20 initiative, the Organisation for Economic Co-operation and Development (OECD) drew up a list of tax havens and categorised them as either being on: the white list, or internationally compliant; the grey list, partial compliance; or the black list, not compliant.

The main offshore jurisdictions, like Bermuda, Guernsey and the Isle of Man, are all on the OECD’s white list. Switzerland and Luxembourg briefly appeared on the grey list but quickly got an upgrade.

TENOR OF REFORM

Further, the harmonisation of financial rules will lessen the “regulatory differences between jurisdictions as [captive domiciles] all seek to be deemed acceptable”, Marsh’s captive consulting leader Jonathan Groves says.

Airmic chairman and head of insurance and risk management for J Sainsbury Paul Howard adds: “The impact very much depends on the local regulatory body in your captive domicile. Our captive is in the Isle of Man and I know that they are extensively in dialogue with all of the major regulators and other bodies, in seeking to make their jurisdiction compliant with the general prevailing tenor of reform.”

Airmic’s technical director, Paul Hopkin, continues: “If financial regulation becomes truly and fully international, then it will not matter where you base your captive, because the regulatory regime, capital requirements and tax laws will be constants.”

There are compelling reasons to believe that, in the future, offshore domiciles will no longer be able or willing to compete for business on the grounds of their captive-friendly regulations or tax status.

These changes, however, are unlikely to hinder captive development or growth because the fundamental benefits of a captive will remain unchanged no matter where it is based.