GIM11050 - Captive insurers: taxation issues

There is little doubt that there is usually a cost saving from establishing a captive in certain offshore territories rather than in the UK due to the different regulatory regimes. Generally, however, there is also a substantial cost saving in terms of tax (see ITH1702).

Most businesses will find it prudent to reserve against contingencies, but the creation of reserves, where that is possible under relevant accounting standards, may not be recognised for tax purposes as allowing a deduction in computing profits. Instead an insurance premium paid to a captive may allow a tax deduction, and the corresponding receipt, kept in the group, may escape UK rates of tax if the captive is offshore in a low tax territory. Even if the captive were to be located on-shore there could still be a tax advantage. This is because an insurance company will normally obtain a deduction for its technical provisions (see GIM6000+), whereas the insured may not obtain a deduction for the contingent liabilities represented by those claims if it chose to carry the risks itself.

The investment income and gains arising on the premiums paid together with that on any funds used to capitalise the captive are also accrued offshore and taxed at low rates assuming a tax haven is used as the domicile of the captive. The company may, after a few years, take on the characteristics of a moneybox company, at best deferring UK taxation until a dividend is paid, at worst avoiding it altogether by profit importation or upstream loans.

Where the existence of a captive comes to light, enquiries should therefore be directed to establishing whether the commercial arrangements make sense. These would include basic information such as the nature of the risk, the premiums payable, the cover obtained, reinsurance details. It will also be useful to review the company’s other insurance arrangements.

Residence, trading in the UK, premium deductibility, and transfer pricing may all offer the opportunity to tackle the tax issues surrounding captives. However, the most common approach is likely to be through the application of the controlled foreign companies legislation ( GIM11070).