Captive -- and Captured

MALCOLM FINNEY explains the continuing interest of the Inland Revenue in investigating offshore captive insurance companies.

FOR AS LONG as I can remember, offshore captive insurance companies owned by United Kingdom interests have been a prime target for investigation by one or more arms of the Inland Revenue. Such investigations have been premised upon the simple belief that captives are a hard-core tax avoidance device; as a consequence, they deserve to be 'attacked' one way or another.

The fact that after some twenty-five years of operation it has been clearly demonstrated that captive insurance companies perform a valuable risk management function does not seem to have cut much ice with the Inland Revenue. The mere fact that many United Kingdom owned captives have been located in a number of the world's offshore financial centres has been sufficient incentive for the Revenue to tilt its ever increasing weaponry directly at them.

The most recent addition to this weaponry are the provisions contained in Finance Act 2000 (section 104 and Schedule 31) referred to as the 'designer rate' tax provisions. These provisions have removed the ability of offshore captives to 'fix' the local rate of tax to be levied on their profits in their territory of residence. The intent of the captive when 'fixing' its local rate of tax was to do so in a manner which would then preclude the United Kingdom's controlled foreign companies provisions from applying. The Inland Revenue has identified four territories as chief culprits, namely Gibraltar, Guernsey, Jersey and the Isle of Man, which together probably account for in excess of 80 per cent of United Kingdom owned offshore captives.

But how and under what authorities can and does the Inland Revenue launch its investigations?

CTSA provisions

The introduction of the corporation tax self-assessment régime (effective for accounting periods ending on or after 1 July 1999) has opened up new channels down which investigations may now be launched. These new provisions are likely to make life considerably easier for the Inland Revenue to pursue captive profits than before.

Under the new CTSA provisions a much greater onus is now on the corporate taxpayer (e.g. the United Kingdom parent of the captive) to disclose information about its financial affairs than was the case in the past; each year the corporate taxpayer is under an obligation to file a corporate tax return which, inter alia, requires the taxpayer not only to calculate its United Kingdom tax liability but also to provide information appertaining to any controlled foreign companies (e.g. its captive) in which it possesses an interest (an interest broadly of 25 per cent or more).

This return thus represents an excellent starting point for any Inland Revenue investigation. Failure to provide accurate and timely information on the return is likely to result in, not only additional interest payments, but possible penalties as well. Not supplying clearly requested information on the return is not an option.

It has, however, to be borne in mind that although the parent company is required to make the return, no such obligation falls on the part of the captive vis a vis the United Kingdom (although, of course, there may be some requirements to be observed in the territory of location of the captive with respect to the filing of local tax information).

Unlike the pre-CTSA era, the Inland Revenue now no longer needs to justify any investigation into aspects of the return and thus the taxpayer may not be aware of precisely the nature of the Inland Revenue's interest at the onset of any investigation. This can make the structuring of answers to questions raised that much more difficult. Having said this, the astute should be able to quickly identify the likely area(s) of controversy.

Although there are time limits within which any enquiries about information on the return must be made, it is almost inconceivable that the Inland Revenue would miss such deadlines and therefore, in practice, this restriction is unlikely to be of help to any corporate taxpayer. Nevertheless, before responding to an enquiry in connection with the return, relevant dates should be checked.

Areas of interest

In general terms, and this has been the case for many years including the pre-self assessment era, the main areas of interest to the Revenue in its investigations are fourfold:

• the residence status of the captive;
• whether the captive trades in the United Kingdom;
• whether payments on the part of the parent company paid to the captive are insurance premium payments and, if so, whether they are tax deductible for United Kingdom tax purposes; and
• whether the controlled foreign companies provisions are in point.

It is important to appreciate that different parties will be involved to different degrees depending upon which of these four areas is in fact under enquiry.

The first two areas (i.e. captive residence and trading in the United Kingdom) relate to the possible United Kingdom tax liabilities of the captive itself. The second two areas (i.e. premium deductibility and the controlled foreign companies provisions) fall fairly and squarely within the province of the United Kingdom parent company.

Allowed or not?

It seems reasonably clear that enquiries pursuant to the lodgement of the return by the parent can extend to the latter two issues mentioned above which are clearly those of the parent. It is for the parent to be in a position to defend, inter alia, under the transfer pricing provisions the quantum of its deductible premium payments to the captive and to also defend its stance pursuant to the controlled foreign companies provisions. It is more than likely that all information and documentation relating to the premium deductibility issue will be in the United Kingdom with the parent. However, information and documentation relating to the controlled foreign company (i.e. the captive) will primarily reside with the captive, not the parent, in its territory of incorporation.

It therefore becomes necessary when an enquiry relating to the controlled foreign companies provisions occurs to think very carefully as to how it should be handled. In particular, consideration would need to be given as to whether any specific documentation requested pursuant to an enquiry concerning the parent company's return could be regarded as within the parent company's 'possession' or 'power' to obtain (i.e. in such cases the parent would in principle be required to supply such information to the Revenue). The Inland Revenue's stance on this particular, albeit complex, matter seems to be crystal clear. Paragraph 2.3.7 of 'Corporation Tax Self Assessment Controlled Foreign Companies Guidance Notes' provides that:

However, this may, or may not, be the case. For example, the parent company pursuant to an enquiry from the Inland Revenue regarding its return and the controlled foreign companies provisions may request documents and/or information from its captive. The board of the captive may feel that, in the light of local legal advice, it would not be in the interests of the captive to provide the requested documents and information. It then becomes arguable that it would be unreasonable for the Inland Revenue in such circumstances to levy any penalties on the United Kingdom parent company for a failure to produce the documents and information. In such circumstances it would seem appropriate for the parent company to lodge an appeal against the request for the production of the documents and information. A thirty-day time limit to lodge any such appeal must be observed.

Section 20

It should also be borne in mind that there may be other routes down which the Revenue may go to obtain such information or indeed other information that may be desired. There is, for example, the infamous section 20 Taxes Management Act 1970 which does enable information to be obtained from third parties. These third parties who might be approached could include insurance/reinsurance brokers; fronting insurers; claims handlers; and loss adjusters. It is worth noting, nevertheless, that any third party who voluntarily provides information to the Inland Revenue (i.e. without a section 20 notice having been formally raised) about a third party client is likely to be in breach of its duty of confidentiality to the client and therefore before so doing would be wise to take professional advice.

The position with respect to the issues of captive residence and the possibility of a 'trading within the United Kingdom' situation appear to be quite different from those just discussed. It seems unlikely that these issues arise out of the parent company's return. As a consequence, the corporation tax self assessment provisions regarding the production of documents and information should not be in point. In addition, any such investigation would need to be justified on the part of the Revenue at its commencement.

If the Revenue thought that the captive might be carrying on a part of its trade in the United Kingdom, it is likely that consideration would need to be given as to whether a United Kingdom based branch/agency of the captive existed in the United Kingdom. In practice, in the Revenue's view, the captive's United Kingdom parent company, for example, may be perceived as such a branch or agency. It would thus no doubt wish to obtain relevant information from the United Kingdom parent company in this regard. Prima facie, again this would seem to be a matter for section 20, Taxes Management Act 1970 falling outside of the ambit of the corporation tax self-assessment provisions.

Double tax agreements

Whilst perhaps unusual, the ability of the Revenue to obtain information pursuant to a relevant double tax agreement should not be overlooked. Such agreements exist, inter alia, between the United Kingdom and Barbados, Guernsey, Ireland, Jersey, Isle of Man, Luxembourg and Malta. Territories where no such agreement exists with the United Kingdom include Bermuda, Cayman Islands, Cook Islands, Liberia, Panama and Vanuatu. Even where an agreement may be in point, its content should be checked to ascertain whether it contains an 'Exchange of Information' article and, if so, whether it could be used to obtain the specific information sought by the Inland Revenue.

There is no double tax agreement between the United Kingdom and Gibraltar. However, within the European Union (which includes Gibraltar) other provisions relate to the swapping of information among Member States and these are likely to be in point vis a vis Gibraltar, or any other Member State (e.g. Ireland and Luxembourg).

Conclusion

In summary,  the corporation tax self-assessment régime has greatly enhanced the Revenue's ability to undertake investigations into offshore captive operations. It is still important, however, to ensure that any requests for information and documents are in line with the legislative requirements including any time limits. Other potential sources of information available to the Revenue must not be forgotten.

Investigations can be long drawn out affairs. Often many taxpayers fail to attempt to put a strategy into place as soon as questions are raised. They willingly supply all sorts of information without first ascertaining whether this is, or is not, appropriate. In many cases the taxpayers' advisors are at fault for not offering more proactive and strategic advice early on. The name of the game is to think before acting.

Malcolm Finney is an independent international tax consultant specialising in investigation work and is author of 'Captive Insurance Companies: A UK Tax and Financial Analysis', available by e-mail at: malcfinney@aol.com.

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