Corporate Finance: Captive Insurance

Case Study

Fact Pattern

• A-Parent Co decides to cover its insurance needs with a wholly owned subsidiary and establishes a captive insurance company, A-Captive Co.
• A-Captive Co is located in British Columbia and licensed under the Insurance (Captive Company) Act.
• A-Parent Co has affiliates in Canada, as well as globally, which carry on active business in the US, Asia, and Europe.
• A-Subsidiary Co’s insure their risk with A-Captive Co, paying $2m premiums.
• A-Captive Co registers with the Province of British Columbia as an "international business".
• A-Captive Co is entitled to a full refund on provincial tax paid on corporate income on international qualifying business.

Illustration

Analysis

• A-Captive Co is carrying on a qualifying business: insuring property outside of Canada is a qualifying activity.
• As a registrant in the IB program, A-Captive Co can claim a refund of provincial corporate income taxes paid on income earned from insuring non-resident affiliates. (Income earned on insuring affiliates in Canada would be subject to federal and provincial tax.)
• A-Parent Co’s affiliates can generally deduct premiums paid to A-Captive Co as long as there is 1) bona fide transfer of risk; 2) the amount of the premium meets ‘reasonableness’ tests.
• Since A-Captive is located in British Columbia, no Canadian federal excise tax applies.
• The foreign affiliates may be subject to premium taxes; the actual tax will vary based on the location of risk.
• Captive Co can deduct loss reserves according to the rules in the Income Tax Act (Canada)
• Captive Co can flow earnings in the form of dividends to its parent free of tax.

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