Six Reasons to Start a Captive Onshore
Although there are significant business advantages to an offshore captive, there are equally strong arguments for onshore captive formation.
Here are six reasons why an onshore captive may be the best choice for certain firms:
1. Government Restrictions on Lines of Coverage – Certain risks cannot legally be insured by offshore captives. For example, the Department of Labor (DOL) requires that corporations use an onshore captive to insure employee benefits regulated under the Employee Retirement Income Security Act (ERISA).
2. Access to Federal Programs -- Some benefits offered through federal government programs or laws are only available to onshore insurers. Two examples are the revised Terrorism Risk Insurance Act of 2002 (TRIA) and the formation of risk retention groups under the Liability Risk Retention Act.
3. Potential Tax Liabilities -- While offshore domiciles are associated with tax benefits, they could actually result in higher taxes. For example, premiums paid to an offshore captive may be subject to the Federal Excise Tax (FET), unless it elects to be taxed as a US insurance company. When applicable, FET is charged at a rate of 4% or 1% for direct and reinsurance premiums -- a much higher rate than the premium tax charged by onshore captive domiciles.
4. Higher Cost of Operation – Operating expenses can vary significantly from one domicile to another. It is not unusual for the cost of services such as captive management, audit and legal fees, and other expenses to be as much as 10-20% more in some of the more established offshore domiciles.
5. Limited Accessibility and Ease of Operation -- Depending on the location of the captive’s parent and management, it is often time-consuming and costly to travel to many offshore locations (although the same can be said for the two leading US domiciles, Vermont and Hawaii).
6. Negative Reputation or Perception -- Whether real or not, there is still a tax haven or tourist destination stigma attached to many offshore jurisdictions. Firms need to consider the public perception of the captive’s locale based on their own internal philosophy and industry particulars.
The bottom line is that there is no one “right” domicile for every firm. Every prospective owner should perform a Domicile Analysis as the cornerstone of its Captive Feasibility Study. Only when all variables are considered in light of each firm’s unique situation can the best choice be made.
Wilmington Trust neither claims to nor provides legal or tax accounting services. Clients should consult professional tax and legal advisors regarding favorable tax treatment of any particular strategy.