use the capital losses. Of course, directors must also weigh the related advantages and disadvantages of liquidating investments at a loss simply to fund the payment of the dividend.
Issues arise with a change to the investment portfolio similar to
cash, in that the board must understand what effects the change would have when meeting any requirements for outgoing letters of credit, ensuring compliance with its own investment policies, meeting the United States asset test, etc.
Tax considerations The tax treatment of the dividend is solely dependent on the status
of the captive and its shareholder(s) for United States income tax purposes. Cayman captives can be treated in a number ways under the United States Internal Revenue Code and Regulations. Based on the complexity of the applicable laws and regulations, it is highly advisable to obtain tax advice prior to the dividend declaration.
Depending on the ownership structure of the captive, the captive
“The opportunity to declare a dividend and reap
the rewards of sound risk and investment
management is key to the continued success of any captive programme.”
Regulatory compliance
considerations Cayman Islands’ captives are regulated by the Cayman Island
Monetary Authority (CIMA). As a regulator, CIMA has a legislated duty of care to the stakeholders of the captive. Any reduction in the total equity of the captive is equity that is unavailable to pay claims and thus could have an impact on a captive’s margin of solvency. Accordingly, CIMA must approve the payment of the dividend prior to its payment. The captive may have a set dividend policy in accordance with its business plan or may be in a position where the declaration of the dividend may constitute a change in the business plan and thus require specific CIMA approval. Fortunately, captives that have been diligent in their own analysis should be in an ideal position to present the merits of the dividend declaration.
Legal The company’s Articles of Incorporation must be complied with
when issuing a dividend, including the actual declaration. Further, careful attention must be paid to paying the correct shareholder. Sometimes there will be a holding or other related company that owns the stock of the captive and that does not have a bank account. Thus, appropriate documentation must be put in place to ensure that the payment of a dividend is made to the correct company via any appointed payee.
42 CAYMAN CAPTIVE
could be considered a controlled foreign corporation, where earnings are not deferred but rather taxed annually in the hands of the United States shareholder, or a non-controlled foreign corporation, where earnings are deferred and taxed when distributed. Additionally, and only available for controlled foreign corporations that are considered insurance companies for United States income tax purposes, a captive may make the previously mentioned Section 953(d) election. This irrevocable election classifies the foreign corporation as a United States corporation and following the election, the captive is taxed annually as if it were a United States insurance company, thereby transferring the liability of tax from the United States shareholder to the captive itself.
In brief, a dividend paid to a United States shareholder of a non-
elected controlled foreign corporation will be considered a return of previously taxed income to the extent the shareholder has previously taxed income and thus would not be taxable. Should the dividend exceed the previously taxed income, then the excess would be considered a return of capital. Should a United States shareholder’s dividend exceed both previously taxed income and paid-in capital, then the excess would be considered a capital gain subject to tax at the applicable taxable rate. A dividend paid to a United States person who is a shareholder of a non-controlled foreign corporation would be taxable upon receipt as a non-qualified dividend.
Dividends paid to a United States shareholder from a Section 953(d)
elected captive would be treated similarly to any United States source corporate dividend. Depending on the tax status of the United States shareholder, the dividend may be subject to the preferential dividend tax rate or perhaps be subject to the dividends received deduction.
Considering the different tax treatments of the dividend, it is
recommended again to obtain tax advice prior to the dividend declaration. This is especially significant due to the pending sunset of the ‘Bush tax cuts’, which would directly affect the tax liability of certain dividends and capital gains.
Conclusion The current trend of dividend declarations is likely to continue
while we slowly emerge from the post-recession era. It is vital for the board of directors to be aware and comprehend the various accounting, finance, regulatory, legal and tax considerations before declaring a dividend. The opportunity to declare a dividend and reap the rewards of sound risk and investment management is key to the continued success of any captive programme.
Peter MacKay is chairman, Ian Bridges is vice president and
Jennifer Reid is vice president at Global Captive Management. They can be contacted at:
pmackay@global.ky;
ibridges@global.ky and
jreid@global.ky
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