There are a number of bills that have been introduced in the US Congress that, if enacted, could impact Cayman Island domiciled captives and/or their shareholders or affiliated group. Of course, as these proposals are subject to change, the discussion below is based on bills that have been introduced to date. Additionally, some of President Obama’s fiscal year 2010 budget proposals (the ‘Obama budget proposals’) could have such an impact, if enacted by Congress.
The Neal Bill
Earlier this year, Rep Richard Neal introduced a bill that would disallow deductions to certain non-life insurance companies for excess reinsurance premiums with respect to US risks paid to affiliated insurers not subject to US income taxation (the ‘Neal Bill’). The bill was proposed to limit a perceived competitive advantage non-US insurance companies may currently hold over US insurance companies. The Neal Bill, is substantially the same as a bill Rep Neal introduced last year and very similar to a discussion draft of a bill released for comment by the Senate Finance Committee in December 2008. To date, over 50 interested parties have submitted comments on the discussion draft, representing positions for and against it.
The Neal Bill disallows a US federal income tax deduction for certain premiums paid by a non-life insurance company to a non-US affiliate for reinsurance. For these purposes, an affiliate generally includes a member of a controlled group 25 per cent or more owned by one or more other corporations in the group with the parent owning at least 25 per cent of one member of the group. Premiums that are subject to US federal income tax in the hands of the reinsurer or that are taxable in the US under the controlled foreign corporation (CFC) rules, are not subject to disallowance under the Neal Bill. The amount of the premium deduction that is disallowed generally is computed by determining the amount by which a company’s ceded premium exceeds an industry average for ceded premiums paid to non-affiliated companies calculated by line of business. Although the bill, if enacted, would not impact a Cayman Island captive that has made a US Internal Revenue Code section 953(d) election or whose income is subject to US taxation under the CFC rules (ie, that certain of the captive’s US shareholders pay tax on their pro rata share of its income), it could negatively impact a global affiliated group that includes a Cayman Island captive with a non-US parent, which accepts cessions from a US-based sister captive.
Additionally, it is possible that the bill could impact group-owned Cayman Islands captives. Under this scenario for example, unless the bill is amended, a group that has a US-based risk retention group that cedes business to a Cayman Islands captive affiliate whose income is not taxed to shareholders under the CFC rules, such as a group comprised of US tax-exempt hospital owners generally insuring their own risks that are not required to recognise the captive’s income as unrelated business taxable income, may be affected.
The Levin Bill
Also earlier this year, Senator Carl Levin, introduced the Stop Tax Haven Abuse Act (the ‘Tax Haven Bill’), an expanded version of legislation introduced in the last Congress by Senator Levin; a companion bill was also introduced in the US House of Representatives. The Tax Haven Bill provides that: (i) a non-US publicly traded corporation, or, (ii) a non-US privately-held corporation with gross assets of US$50 million or more (including assets under management for investors, whether held directly or indirectly, at any time during the taxable year or any preceding taxable year) will be treated as a US domestic corporation for US federal tax purposes if the non-US corporation is “managed and controlled” primarily in the United States.
The Tax Haven Bill provides for regulations to be issued to guide the determination of whether management and control occur primarily in the United States, focusing on whether: (i) “substantially all” of the executive officers and senior management of the corporation who exercise day-to-day responsibility for making decisions involving strategic, financial and operational policies of the corporation are “located primarily” in the United States (treating individuals who are not executive officers and senior management of the corporation but exercise this day-to-day responsibility as executive officers and senior management for this purpose); and (ii) the assets of such corporation (directly or indirectly) consist primarily of assets being managed on behalf of investors, and decisions about how to invest the assets are made in the United States. Although the stated purpose of this provision was to address the situation where a non-US corporation is established as “a mere shell operation with little or no physical presence or employees in its country of incorporation”, with offshore hedge funds a particular target, the provision potentially casts a much broader net, much of which depends on the definition of “substantially all”, “located primarily” and other concepts included in the provision. Although if this bill were enacted in its current form it may impact some Cayman Island captives, if enacted with the gross asset trigger of US$50 million being reduced, it could potentially have a much broader impact. If, however, a captive’s income is being taxed under the CFC rules, there may not be a real economic difference for a captive characterised as managed and controlled in the United States under this provision. On the other hand, for Cayman Island captives whose income is not being taxed under the CFC rules (eg, a company which because of non-US or diverse ownership is not a CFC) the economic impact could be significant.
The Tax Haven Bill also contains a provision that would subject US source “substitute dividends” and “dividend equivalents” to the 30 per cent US withholding tax. For these purposes a “substitute dividend” is defined as a payment under a securities lending transaction or a sales-repurchase (“repo”) transaction1, where the transferor of the security is paid an amount essentially equivalent to a dividend distribution from the US corporation that issued the underlying security. A “dividend equivalent” is defined as a payment received under a notional principal contract (NPC)2 that references a dividend payment on either stock in a US corporation or property that is substantially similar to stock in a US corporation. If enacted, this provision would change the current rule that a payment to a non-US person under an NPC is not characterised as US source (ie, such payments are currently characterised as sourced in the domicile of the recipient)3 and accordingly not subject to the withholding tax. Additionally, the bill requires regulations to be issued to address certain perceived abusive situations where alternative arrangements are utilised to provide similar economic results as dividend payments, thereby creating ‘disguised dividends’. Similar provisions were included in the Obama budget proposals and very recently a similar provision with respect to “dividend equivalents” has been included in the Foreign Account Tax Compliance Act (the “Foreign Account Bill”) discussed below. If enacted, these provisions could impact a Cayman Island captive with NPC or similar investments or that has entered into securities lending or repo transactions.
Foreign Account Bill
The Foreign Account Bill provides for broad reaching increased reporting obligations. Certain of the bill’s provisions could impact US individuals that hold interests in Cayman Island captives. The bill requires all US individuals that hold interests in “specified foreign financial assets”, which in the aggregate are valued at greater than $50,000, to attach disclosure statements to their income tax returns. For these purposes, “specified foreign financial assets” include accounts at non-US financial institutions, stocks securities issued by non-US persons, any interest in a non-US entity and any other financial instrument held for investment. Additionally, the Foreign Account Bill adds a new penalty provision for non-compliance with these reporting obligations. Further, the bill requires “material advisors” to file disclosure statements with the Internal Revenue Service if they advise a US individual with respect to the direct or indirect acquisition of an interest in a non-US entity.
In addition to these legislative proposals, the Internal Revenue Service issued a number of pronouncements this year with respect to foreign bank account reporting, or FBAR, including an expansion of the definition of the foreign financial accounts requiring disclosure. In Notice 2009-62 released in August of this year the IRS indicated it intends to issue formal guidance clarifying the FBAR filing requirements and solicited formal comments regarding several issues, including: under what circumstances should a person with only signatory authority over a foreign financial account be relieved of filing an FBAR report; and whether an interest in a foreign entity, such as a corporation, partnership, trust, or estate, should be subject to the FBAR reporting requirements. The Obama budget proposals include further increased reporting obligations for US individuals as well as certain third party intermediaries.
On 13 October 2009 The Wall Street Journal quoted lobbyists and unnamed Obama administration officials as suggesting that the Obama budget proposal international tax provisions, specifically those dealing with deferral issues, had been ‘shelved’ because of opposition from multinational businesses. Subsequent reports qualified that conclusion and suggested that the proposals were simply accorded a lower priority, especially in the context of other pressing matters such as the health care debate. By contrast, in a statement released on 5 November 2009 Rep Neal predicted passage of the Foreign Account Bill by the end of 2009.