Now you own it, now you don't: IRS clarifies taxation of rent-a-captives

WHEN YOU rent a captive, is it taxed as if you own it? The IRS recently resolved that question in Revenue Ruling 2008-8. The ruling holds that if a rent-a-captive cell satisfies the tax definitional requirements of an insurance company, it will be treated as a standalone insurance company despite the cell’s lack separate legal status.

In a typical rent-a-captive structure, a sponsor forms a segregated account company (SAC) that consists of segregated cells plus US$1m of capital. The SAC effectively leases each cell to a user who conducts insurance business within the cell. The sponsor provides captive management services to the cell for a fee. Under applicable law, the cell has the licence to write related-party insurance risk or to reinsure unrelated risk. The SAC typically owns the cell’s common voting stock, while the cell’s tenant owns preferred stock. Preferred stock dividends track the cell’s net income. Each cell’s assets and liabilities are insulated from other cells and the sponsor.