USA RISK GROUP
“Many of these emerging domiciles realise they are never going to be a Vermont- sized domicile and that their most likely source of captives is businesses operating in their home state.”
state tax may not be imposed—is hardly set in the modern world of electronic communication, and the location of activity and risk in today’s business world has not been clearly tested in court.
Where exactly are policies that are ‘in the cloud’ from a Vermont manager, but immediately accessible by a company in Texas? Can a risk manager in Texas calculate premium allocations for company subsidiaries and send them to Vermont electronically to be issued from Vermont?
There is no doubt that the current captive environment is squarely in the grey. So, what steps can we take to reduce the likelihood of a non-domiciliary state trying to impose self-procurement taxes on risk located in their state being insured in another?
(a) The non-insurance approach. If the captive is not seeking federal deductibility of premiums, the captive can take steps, such as having parental guarantees, to ‘fail’ insurance tests. The argument here is that such a captive is merely a fancy bank account and any such transactions should not attract premium taxes.
(b) Use a fronting carrier—the carrier pays the taxes due to the states involved. Simple, but expensive.
(c) The mind and management test. This is the current default setting for many captives where the argument against other taxes being imposed is that the company is operating from its domicile, is issuing policies, writing cheques, holding its meetings, and carrying out management and board decisions in its domicile. In these circumstances, the non-domiciliary state has first to find out that risks in its state are being covered, and second, to establish that a tax is due under the self-procurement statute. Few states have paid much attention to this area, but as noted, the burgeoning expansion of captive domiciles has brought this untaxed sector to the fore.
(d) The home-state-as-domicile approach. If you are a New Jersey-based company, forming your captive in New Jersey can minimise many of the concerns arising out of the first
56 CICA | Forty years of captive leadership
two methods. There is a much smaller possibility of self- procurement taxes and the need to exercise caution over having insurance activity in the home state is greatly reduced.
Unfortunately for the successful captive states that have grown by attracting out-of-state business to their domiciles, (d) is probably the approach which reduces the uncertainty of premium tax expense in the future.
I can report that this approach is already gaining traction: we have new clients very deliberately seeking to form in their home state wherever practical, and we are even being approached by several existing captives about the possibility of redomestication.
The trend for home state formation is likely to continue, based on the current uncertain premium tax situation. However, large states such as California, Texas, Pennsylvania and Virginia have not joined the captive state list yet, so the choice of approaches remains out there for many businesses. No matter where or why the captive is formed, it is probably clear from these ongoing state issues that it needs to have a solid business purpose and that risk management goals need to be considered alongside tax considerations both nationally and at the state level. l
Gary Osborne is president of the USA Risk Group. He can be contacted at:
gosborne@usarisk.com
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