Captive owners: Worried about BEPS implementation?

Captive owners: Worried about BEPS implementation? | Corporate Risk & Insurance

Captive owners: Worried about BEPS implementation?

Too often, one bad apple spoils the whole bunch. That’s the reality facing captive owners in 2018, as risk managers prepare their captives for increased scrutiny from tax authorities.

There are now more than 7,000 captives operating across the globe, but implementation of the Organisation for Economic Co-operation and Development’s (OECD) base erosion and profit sharing (BEPS) project has put managers on high alert.

Captives have quickly become a go-to in risk managers’ toolkits. The range of benefits from owning captives runs from having better access to capital and increased flexibility to greater specialisation of coverage for non-traditional risks such as cyber, supply chain, and employee benefits. “If the insurance market is unable to cover extreme risks such as hurricanes, a captive is an extremely useful tool for a company,” says Derek Bridgeman, advisory practice leader, EMEA APAC, Marsh Captive Solutions.

None have taken better advantage of those opportunities than companies in communications, media, technology, and financial institutions, says Marsh’s annual report on the captive landscape. Growth in captives underwriting employee benefits and cyber risk within those industries has increased by nearly 20% in the past year alone.

In the past decade, the number of captives worldwide has increased by 40%. Most of the largest companies in the world have captive operations, and their popularity is beginning to spread to SMEs now, too. Last year, small captives made up the majority, constituting 44% (Marsh).

Despite their growing popularity — or perhaps because of it — the act of having a captive could constitue a risk in and of itself. “Despite the industry’s efforts, there remains a stigma associated with captives that tax avoidance is a key driver in any captive program,” says Bridgeman.

Following public controversy of some high-profile leaks (Panama papers, anyone?), the G20 asked the OECD to come up with a plan of action to combat base erosion and profit sharing. Despite efforts by captive owners to dispel the notion that captives exploit tax regulations to artificially shift profits and dodge corporate tax, the OECD included specific reference to captives in its October 2015 final report. “Sensitivity to tax compliance has never been higher as the ‘paradise papers’ revelations attest to, so ensuring that the captive does not represent a risk is obviously very important for risk managers,” says Ciaran Healy, director of consulting with Willis Towers Watson’s global captive practice.

To date, more than 30 countries have signed up to the recommendations. As a result, captive owners are more worried about falling under public scrutiny now than ever before. Captive Review’s survey of captive owners released last month reported a significant rise in the number of owners expressing concern over BEPS scrutiny. Last year, only 29% of owners listed BEPS scrutiny as a primary issue, but this year, 47% indicated it as a top risk.

Specifically, captive owners are worried about their captives being misunderstood. Before BEPS, the tax authority was responsible for finding fault in captives, but the new guidelines require owners to prove that their captive is operating correctly and that it has a rationale for existing. That’s created a huge burden administratively. “The challenge for risk managers is that without specific guidelines on how captives should be structured,” says Bridgeman, “they are expected to document the commercial rationale and undertake a health check and comparison to best practices within the captive industry.”

Fairly or not, the guidelines add an extra layer of risk to captive owners should they fail to properly justify their captive.  “The role a captive plays in an organisation’s risk management arrangements can sometimes be misunderstood by those less familiar with the concept,” says Healy, “so a key objective for risk managers and the entire industry, is to educate and inform all stakeholders, just how valuable captives are.”

Risk managers’ reported insecurity over BEPS scrutiny could be rooted in national tax authorities doubling down on their efforts and increasing their enquiries into captives as they begin implementing the recommendations. “We expect increased activity from tax authorities in the coming year as the final aspects of the BEPS package are finalised, so addressing the issue early will be important,” says Healy.

"For most captive owners, BEPS is not something to be fearful of,” he says, “although it is something to prepare for.”