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FATCA: US TAX TRANSPARENCY & CAYMAN CAPTIVES

The Cayman Islands Government (CIG) continues to make strides laying the groundwork for tax transparency for international business. Included in this groundwork, and likely having the most direct impact with US owned Cayman Islands captives, is the Foreign Account Tax Compliance Act (FATCA).

FATCA is actually US domestic legislation implementing a new tax information reporting regime. Noncompliance with FATCA could result in a 30% tax on US source withholdable payments made to foreign entities including Cayman Islands captive insurance companies. Withholdable payments include US sourced interest, dividends, gross proceeds, and certain other income including insurance or reinsurance payments. Well-advised and managed captives will be able to navigate and comply with the FATCA legislation and prevent the FATCA tax.

On August 13, 2013 the CIG announced it had concluded negotiations with the United States on a Model 1 intergovernmental agreement (IGA), and a new tax information exchange agreement (TIEA) which would supplant the current TIEA signed on November, 2001. These negotiations were a direct result of the Cayman Islands initiative to comply with FATCA. Under the US domestic FATCA legislation, each foreign entity would be required to comply directly with the Internal Revenue Service (IRS). However, FATCA allows an alternative method of compliance for foreign entities in countries which have an IGA with the US. Under the Cayman Islands Model 1 IGA, certain Cayman Islands financial entities will report the required tax information directly to the Cayman Islands Tax Information Authority which will then automatically exchange this information with the United States IRS.

It is expected that the IGA will soon be signed and officially released. The IGA will include an Annex II schedule. The purpose of the Annex II is to list out various entities which will have an alternative treatment under the IGA than under the actual US domestic legislation. Cayman Islands captive stakeholders are anxious to see whether Cayman Islands regulated captives are specifically included in the negotiated Annex II. Regardless of any potential Annex II inclusion much can be done now by captives to plan for FATCA as the final FATCA regulations were released in January 2013 and provide much of the foundation for FATCA compliance.

The FATCA regulations are indeed tax regulations and each captive will likely require expert assistance from a US tax specialist in order to comply. The specialist would be required to complete a comprehensive review of the captive, and certain related companies such as foreign holding companies, to determine their appropriate classification under FATCA. This comprehensive review, among other steps, would include a review of ownership documents, insurance and reinsurance policies, service contracts and other legal documents. This process would need to be completed timely to ensure every step in reducing exposure to the 30% withholding is made. Withholding on certain income is set to commence after June 30, 2014.

Typically the tax specialist will make the primary determination if the Cayman Islands captive will be treated as a Foreign Financial Institution (FFI) or a Non-financial Foreign Entity (NFFE). FFI’s, which includes a plethora of foreign financial entities including a specified insurance company that issues cash surrender policies and/or annuity contracts, will be required to implement a much more robust FATCA compliance program. Treatment as an FFI would require rigorous information reporting and potentially FATCA tax withholding on the FFI’s own financial accounts in order to prevent the 30% FATCA tax being applied to the FFI. Captives considered FFI’s will likely need continued expert assistance from its US tax specialist in order to comply while also relying on their captive insurance manager to implement many of the advised reporting and withholding requirements.

It would appear that most captives would not be considered FFIs and as such would be treated as an NFFE. NFFE’s would be required to certify this classification to its US withholding agents in order to prevent the 30% FATCA tax. Certain NFFE’s may be required to provide additional information on its US owners.

Tax transparency and new Cayman Islands captive formations

In September 2013, the CIG formally asked the United Kingdom to extend its membership in the OECD/Council of the Europe Convention on Mutual Administrative Assistance in Tax Matters (the convention) to the Cayman Islands.

In a CIG press release on the matter, the Minister for Financial Services, Wayne Panton, commented ‘Our formal request to join comes after many months of substantive discussions between Cayman and the UK, and it underscores our continued commitment to proactive participation in matters related to international tax cooperation’.

The actions of the Cayman Islands and other similar British overseas territories have not gone unnoticed. Recently, after the G20 Summit in St. Petersberg, UK Prime Minister David Cameron said, “I do not think it is fair any longer to refer to any of the overseas territories or crown dependencies as tax havens. They have taken action to make sure that they have fair and open tax systems.”

In a press release Rob Leadbetter, chairman of the Cayman Islands’ own Insurance Managers Association of Cayman, said, “It is wonderful to see acknowledgement by the UK Government that the standards not only met, but set by the Cayman Islands are recognised as being robust and exemplary”. Leadbetter added, “The Cayman Islands’ financial services industry, including captive insurance, has been built upon a philosophy of sound regulation and transparency and hearing this publically stated comes as a welcome validation of our efforts.”

It may be fair to say that new captive formations in the Cayman Islands may still be affected by the perceived tax haven reputation that is still portrayed in today’s media. Due to a perceived reputational risk with the Cayman Islands, captive owners may look for US domestic solutions. However, with public acknowledgement of the Cayman Islands’ tax transparency initiatives by world leaders and actual participation in government to government tax information reporting such as the conclusion of the FATCA IGA, it is hoped that the Cayman Islands will be known for clearly better business when it comes to captive insurance.

Summary

The Cayman Islands have undertaken many recent tax transparency initiatives including concluding the US FATCA IGA negotiations. FATCA has a potential significant impact on US owned captives and other captives with US source withholdable payments. Failure to comply with FATCA would result in a 30% withholding tax. Use of a US tax expert is likely in order to comply with the complex FATCA legislation. It is likely most captives will be considered NFFEs and thus not be required to partake in the rigors of the FFI compliance. Fortunately the Cayman Islands are beginning to garner the recognition for their involvement in tax transparency. As such the Cayman Islands remain a leading offshore captive jurisdiction and are ideally positioned to retain and attract US based captive business.