www.policyschool.ca
TAX POLICY ISSUES
RELEVANT TO CAPTIVE
INSURANCE COMPANIES
IN ALBERTA
H. Michael Dolson
http://dx.doi.org/10.11575/sppp.v15i1.75075
RESEARCH PAPER
Volume 15:28
September 2022
Acknowledgements
This research paper is part of a series published by the Alberta Financial
Sector Research Partnership, a collaboration between the University of
Calgary School of Public Policy (Financial Markets Regulation Program)
andAlberta Treasury Board and Finance. The Research Partnership executes
research projects focused on identifying and evaluating mechanisms for
growing the financial sector in Alberta as a component of the province’s
economic diversification strategy.
1
TAX POLICY ISSUES RELEVANT
TOCAPTIVE INSURANCE COMPANIES
INALBERTA
H. Michael Dolson
Felesky Flynn LLP, Toronto
1
EXECUTIVE SUMMARY
Alberta now permits the creation of captive insurance companies. Captive insurance
companies insure their shareholders’ risks and sometimes those of their shareholders’
customers. Captives are licensed insurance companies controlled by a single firm or by
firms that are part of an industry association. While the cost savings captives can provide
are beneficial, national or multilateral tax policies can impact the viability of captive
insurance structures. This paper discusses the tax policy issues that may aect Alberta’s
captive insurance regime.
More than half of the world’s approximately 7,000 captives are located in the United States;
there are only an estimated 20 located in Canada. Most of the other captives are in
Caribbean low-tax jurisdictions or tax havens. Alberta cannot compete with Caribbean tax
rates and will therefore probably not be successful in attracting captive insurance business
if its regulatory policy treats captives like regular insurers.
Working in Alberta’s favour are recently enacted and proposed multilateral tax avoidance
measures which will result in higher costs for creating and maintaining a captive in a tax
haven jurisdiction. If the OECD’s Pillar II proposals come to fruition, they also require all
in-scope captives to pay a minimum 15 per cent tax rate regardless of residence.
This paper reviews the significant Canadian tax issues that aect captive insurance
companies, including GST/HST, federal excise taxes, provincial premium taxes and income
tax. It also breaks down the likelihood of attracting non-Canadian versus domestic captives,
looking at possible regulatory and tax policy structures and their likelihood of success.
Alberta will probably not attract captive insurance business from non-Canadian
multinational enterprises. However, the ability to insure or reinsure Canadian risks while
avoiding negative tax consequences and achieving potential tax and tax compliance
savings makes Alberta more attractive for captive insurance business from Canadian firms.
While there is a possibility that other provinces or the federal government could retaliate if
Alberta engages in aggressive inter-provincial tax competition, retaliation is unlikely unless
Alberta materially reduces or eliminates provincial income taxes for captives.
1
The author would like to thank Siobhan Goguen, QC, of Felesky Flynn LLP, Calgary, for her comments on an
earlier draft of this paper. Any errors that remain are the author’s responsibility.
2
1. INTRODUCTION
Alberta recently enacted legislation that will permit the creation of captive insurance
companies.
2
This legislation came into force on July 1, 2022.
3
Critical regulatory items, like
capital requirements, financial reporting obligations, and insurable persons or risks, are the
subject of a separate research paper on the captive insurance market published by the
School of Public Policy.
Captive insurers are licensed insurance companies that are controlled by a single firm or by
firms that are part of an industry association, which insure risks of their shareholders or, in
some instances, the customers of their shareholders. There are various non-tax reasons for
the creation of captive insurance companies that the author has canvassed elsewhere
(Dolson 2020), including the reduction of insurance costs through self-insurance or direct
access to the reinsurance market. Nevertheless, tax considerations can motivate the
creation and location of captive insurance companies, meaning that national or multilateral
tax policy choices will impact the viability of captive insurance structures and where
captive insurers are created. This paper explores tax policy issues that could impact the
success of the Alberta captive insurance regime.
2. REGULATORY POLICY VS. TAX POLICY
It is estimated that there are approximately 7,000 captives worldwide, not counting
separate cells of protected cell insurance companies (National Association of Insurance
Commissioners 2021). Of these 7,000 captives, slightly more than half are domiciled in the
United States (Business Insurance 2021a); popular American domicile choices include
Vermont, Utah and Delaware (Business Insurance 2021b). Most of the remaining captives
are domiciled in Caribbean jurisdictions like Bermuda, the Cayman Islands or Barbados,
while Luxembourg and Guernsey account for around half of all captives not located in the
United States or the Caribbean. It is estimated that there are only 20 captive insurance
companies organized in Canada.
The existence of many captive insurers in the United States — a relatively high-tax
jurisdiction — suggests on its face that regulatory or other non-tax concerns may be
significant factors in location decisions for corporate groups with captive insurers. This may
be somewhat deceiving, however. The United States has special tax rules for insurance
companies (especially life insurance companies) that may result in a lower eective federal
income tax rate for a captive than would apply to the parent;
4
these rules allow for a
dierent taxable income calculation than would be used for other corporations and could
result in very little tax being payable if there are increases in the insurer’s reserves.
Furthermore, many U.S. states, including Vermont, Delaware and Utah, do not impose taxes
other than premium taxes on insurance companies, regardless of the source of their
income. Thus, using a captive may allow for the shifting of taxable income from higher tax
states to a non-taxable entity.
2
Captive Insurance Companies Act, S.A. 2021, c. C-2.4.
3
Ibid., Section 84, read together with Order-in-Council O.C. 194/2002 dated June 1, 2022.
4
26 USC §831 (life insurers) and §832 (property and casualty insurers).
3
That is not to say that regulatory policy does not matter; the author’s experience is that
business location decisions in all industries are based on commercial, regulatory and tax
considerations. The clustering of captive insurers in, say, Bermuda or Vermont is a
byproduct of favourable tax policy, the presence of experienced insurance administrators
and other necessary infrastructure and favourable regulatory policy. Anecdotally, the
author understands from discussions with insurance administrators that one of the reasons
British Columbia’s captive insurance regime is relatively unpopular is that regulators adopt
an approach towards captives that resembles their approach to regular insurers.
5
Since
Alberta will likely not be able to compete with Bermuda on tax rates and may have
diculty competing with Vermont on tax rates if larger reserve deductions are allowed
forU.S. federal income tax purposes than for Canadian income tax purposes, Alberta will
probably not attract many captive insurers if it adopts a regulatory position like the one
inBritish Columbia.
3.  AN OVERVIEW OF SIGNIFICANT CANADIAN TAX ISSUES
FOR INSURANCE COMPANIES
To understand which tax policy opportunities may be available to Alberta in its eorts
toattract captive insurers, it is essential to review the tax rules applicable to insurance
companies. Because almost all captive insurers controlled by Canadian corporations are
resident outside of Canada, the tax rules necessarily include Canada’s foreign aliate rules,
which apply to all non-resident subsidiaries of a Canadian parent regardless of the
subsidiary’s business.
Equivalent tax regimes in foreign jurisdictions are outside the scope of this paper. Tax
policy decision-makers should nevertheless bear in mind that most foreign jurisdictions
have adopted tax regimes like the Canadian regimes described below. For example, the
United States imposes excise taxes on premiums paid to foreign insurers or reinsurers in
relation to domestic taxpayers or domestic risks.
6
The United States also has a controlled
foreign corporation (CFC) regime that includes imputation rules for passive income
(including income from insuring U.S. persons or risks),
7
as well as what is in eect a
minimum tax of 13.125 per cent for active business income earned by CFCs.
8
Thus, Alberta
may only be a suitable jurisdiction for the captive insurer of a U.S. multinational group
ifthere are non-U.S. risks to insure and the eective tax rate is high enough to avoid
minimum taxes.
5
British Columbia’s captive regime is governed by the British Columbia Insurance (Captive Company) Act,
R.S.B.C. 1996, c. 227.
6
26 USC §4371.
7
Ibid., §951 (imputation), §953 (insurance income) and §954 (foreign personal holding company income).
8
Through the combined operation of 26 USC §951A and §250 and §960(d). Under current law, this minimum
tax rate will increase to 16.406 per cent for tax years after 2025. There is a high-tax kick-out that applies
where the foreign tax rate is at least 90 per cent of the 21 per cent U.S. federal corporate tax rate: 26 CFR
§1.951A-2. This provision forms the U.S. global intangible low tax income (GILTI) regime, which is the subject
of various current legislative proposals and relevant to the OECD’s Pillar 2 initiative (discussed below) and
therefore may change.
4
A. GST/HST ISSUES
The supply of an insurance policy by a captive insurer resident in Canada is an exempt
supply of a financial service when made to a Canadian resident or when relating to
Canadian risks,
9
and a zero-rated supply when made to a non-resident in respect of non-
Canadian risks.
10
A captive insurer will therefore not be required to collect GST/HST when it
issues an insurance policy or receives premium income, but will also not be entitled to input
tax credits to the extent that it generates premiums from insuring Canadian risks.
11
Potentially more significant are the GST/HST compliance obligations. A Canadian-resident
captive insurer is a financial institution, a listed financial institution and a selected listed
financial institution for GST purposes.
12
As a financial institution, the captive insurer is
required to file an additional annual information return.
13
As a selected listed financial
institution, the captive insurer will be required to use the special attribution method to
compute net tax;
14
this will eectively force the captive insurer to calculate its net tax by
apportioning taxable supplies received and input tax credits available between participating
provinces and non-participating provinces in which the captive insurer operates.
B. FEDERAL EXCISE TAXES
Canadian resident persons or non-resident corporations carrying on business in Canada
who pay premiums in respect of Canadian risks to an insurer not authorized to transact the
insurance business in Canada must pay a 10 per cent premium tax.
15
This tax does not apply
to certain types of insurance, including life insurance and sickness or accident insurance,
and may not apply to a policy of any type if, in the Canada Revenue Agency’s (CRA)
opinion, the insurance is not available in Canada.
16
The federal excise tax, coupled with Alberta’s low corporate income tax rates, creates an
incentive for a Canadian multinational group to locate its captive insurer in Alberta if the
captive is insuring Canadian risks and adequate insurance is available through Canadian
insurers. Leaving aside the income tax consequences of insuring Canadian risks through a
non-Canadian captive, the federal excise tax means that the Canadian insured pay an
additional 10 per cent of the gross premium as tax if the premium is paid to a non-Canadian
captive. This can render many oshore captive insurance arrangements non-economical.
9
See the definitions of “financial instrument” and “financial service” in subsection 123(1) of the Excise Tax Act,
R.S.C. 1985, c. E-15 (the “ETA”) and section 1, Part VII, Schedule V of the ETA.
10
Section 2, Part IX, Schedule VI of the ETA.
11
As input tax credits are only allowed under 169(1) to the extent GST/HST is paid in respect of supplies
acquired in the course of commercial activities. The term “commercial activities” is defined in subsection
123(1) of the ETA as excluding a business making exempt supplies.
12
See the definition of “financial institution” in subsections 149(1) and 123(1) of the ETA, the definition of “listed
financial institution” in subsection 123(1) of the ETA and the definition of “selected listed financial institution”
in subsections 225.2(1) and 123(1) of the ETA.
13
Section 273.2 of the ETA.
14
Ibid., subsection 225.2(2).
15
Ibid., subsections 4(1) and (3).
16
Ibid., subsection 4(2).
5
C. PROVINCIAL PREMIUM TAXES
Provinces impose premium taxes on insurance companies that are licensed to transact
business in the province. For example, Alberta imposes premium taxes equal to three per
cent of gross premiums receivable for life insurance or accident and sickness insurance
(excluding reinsurance) transacted in Alberta, or four per cent of gross premiums
receivable for all other types of insurance transacted in Alberta (excluding reinsurance).
17
By comparison, Ontario imposes premium taxes equal to two per cent of gross premiums
receivable for life insurance or accident and sickness insurance transacted in Ontario,
3.5per cent of gross premiums receivable for property insurance transacted in Ontario
orthree per cent of gross premiums receivable for all other types of insurance transacted
inOntario (all excluding reinsurance).
18
Most or all provinces exempt reinsurance from
premium taxes.
Provinces also impose premium taxes or regulatory charges on insurance policies issued by
insurance companies not licensed to transact business in the province. For example,
Alberta requires the purchaser of insurance to pay a regulatory charge equal to 10 per cent
of the premiums paid to an unlicensed insurer.
19
While Ontario also imposes premium taxes
on the purchasers of unlicensed insurance in Ontario,
20
the premium tax rate is the same as
the rate payable by licensed insurers.
21
To protect their premium tax base, provinces have also enacted unfair discrimination rules;
some U.S. states have enacted similar laws. For example, if another jurisdiction imposes
taxes or fees on an insurer having its principal oces in Ontario that are higher than the
taxes or fees imposed on insurers organized under the laws of that jurisdiction, Ontario may
impose a retaliatory premium tax on insurers from that jurisdiction that transact business
inOntario.
22
Premium taxes are a potentially important tax policy lever since, all other things being
equal, a corporate group would choose to locate a captive in a jurisdiction with lower
premium taxes. However, the importance of this lever is diminished for Alberta because:
• Canadian provincial insurance premium taxes typically only apply to premiums
receivable for business transacted in the province, as compared to the United States
where insurance companies have traditionally been subject to premium taxes only in
their home jurisdiction. As a result, Alberta premium taxes may only be relevant to the
extent that the Alberta captive is insuring Alberta risks;
23
• Alberta does not have the power to control how other jurisdictions impose premium
taxes on premiums paid to an Alberta captive insurer in respect of business transacted in
that other jurisdiction; and
17
Subsections 87(1.1) and 88(1) of the Alberta Corporate Tax Act, R.S.A. 2000, c. A-15.
18
Subsections 74(1) and (4) of the Corporations Tax Act, R.S.O. 1990, c. C-40.
19
Paragraph 61(1)(b) of the Insurance Act, RSA 2000, c. I-3, as modified by section 2 of Bill C-16: Insurance
Amendment Act, 2022, Legislature 30, Session 3.
20
Subsection 2(2.2) of the Corporations Tax Act (Ontario).
21
Ibid., subsection 74.3(2).
22
Subsection 74(9) of the Corporations Tax Act (Ontario).
23
See, for example, the definition of “business transacted in Alberta” in paragraph 86(1)(c) of the Alberta
Corporate Tax Act or subsection 74(6) of the Corporations Tax Act (Ontario).
6
• Alberta’s ability to incentivize captive insurers to locate in Alberta through favourable
premium taxes for Alberta captive insurers versus other insurers, through subsidies to
compensate Alberta captive insurers for premium taxes paid elsewhere, or through taxes
and regulatory charges on premiums payable to non-Alberta insurers, risks other
jurisdictions imposing retaliatory premium taxes on Alberta insurers transacting business
outside Alberta.
Given the more limited scope of Alberta’s premium taxes, premium taxes are unlikely to
incentivize or disincentivize a corporate group to establish an Alberta-resident captive
insurer. Even eliminating premium taxes entirely would probably not have a material impact
on the competitiveness of Alberta as a residence jurisdiction for captives since most
insured risks will be located outside of Alberta. In any case, the Canadian income tax
regime disincentivizes insuring Canadian risk through non-Canadian captives far more than
eliminating premium taxes could ever incentivize businesses to insure Alberta risks through
Alberta captives.
D. INCOME TAX
There are three principal Canadian income tax concerns for captive insurance arrangements:
(i) whether the payment to the captive insurer is deductible by the payer in computing its
taxable income; (ii) whether any person resident in Canada is required to include an amount
in respect of the premium in computing its income, as foreign accrual property income
(FAPI) or otherwise; and (iii) the amount that may be deducted as policy reserves in
determining the income inclusion for any Canadian person who is required to include
amounts in income. All three of these concerns will be discussed in further detail below.
These income tax concerns are products of the federal Income Tax Act,
24
and thus are not
within Alberta’s control or legislative competence. Even if these items were within Alberta’s
control or legislative competence, Alberta likely would not wish to alter the operative
legislative provisions since they are primarily intended to prevent Canadian taxpayers
(including Alberta taxpayers) from shifting income outside of Canada. Nevertheless, an
understanding of these concepts is critical in appreciating the limits on Alberta’s ability to
attract captive insurance business through tax policy.
i) Payments for Insurance
Insurance premiums are deductible in computing income from a source that is business or
property,
25
but self-insurance, whether in the form of a reserve, a sinking fund or some
other accounting mechanism, does not give rise to deductible amounts.
26
The Federal Court
of Appeal has ruled that the distinction between insurance and self-insurance is that the
former involves a legally enforceable transfer of risk from the insured to the insurer, without
any guarantee or similar backstop of the insurer’s obligations oered by the insured.
27
24
Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.) (the “ITA”). All statutory references hereafter are references to
the ITA unless otherwise noted.
25
Pursuant to subsection 9(1).
26
Paragraph 18(1)(e).
27
Consolidated-Bathurst Limited v. R., 87 DTC 5001 (F.C.A.), at 5005-7, reversing in part 85 D.T.C. 5120
(Fed.T.D.).
7
Risk shifting ought not to be a significant impediment to the creation of a captive
arrangement in a jurisdiction like Canada, where the focus is on the parties’ legal
relationships and legal constructions and not on the “economic substance” of those
relationships.
28
There may be a trap for the unwary; for example, where a captive purports to
insure a parent’s risk but a third party (say, a reinsurer) requires the parent to guarantee the
captive’s obligations. Traps of this nature are easily avoided with proper professional advice.
ii) Imputation of Insurance or Reinsurance Income as FAPI
In tax-motivated captive insurance arrangements, the primary objective is for the captive’s
income from insurance or reinsurance income to be realized by a non-resident entity. If this
non-resident entity is a controlled foreign aliate of the Canadian parent, a related
objective is to avoid the captive’s insurance or reinsurance income being characterized as
FAPI that will be included in the Canadian parent’s income on an accrual basis regardless of
whether it is repatriated. Ensuring that the captive is resident outside of Canada, and that
the income of the captive is not FAPI, would allow for either a lengthy deferral of Canadian
corporate income tax or a total exemption from Canadian corporate income tax.
a) Residence of Captive Insurance Entity
Corporations incorporated in Canada are deemed to be resident in Canada.
29
Corporationsnot incorporated in Canada are resident in the place where central
management and control is exercised (which, without care and discipline, could be in
Canada even if not intended),
30
unless a bilateral tax treaty applies to override or
supplement this determination.
31
Residence is critical for two reasons. First, if the captive is resident in Canada, then its
income is subject to tax on a worldwide basis;
32
causing a captive’s income to be subject
totax in Canada rather than in a low-tax or no-tax jurisdiction would defeat the purpose
ofmany arrangements. Second, if the captive is a foreign aliate or a controlled foreign
aliate of a Canadian corporation, is resident in a designated treaty country,
33
has its
central management and control in that designated treaty country
34
and carries on an
active business in a designated treaty country,
35
the insurance or reinsurance income
28
See Shell Canada Ltd. v. R., [1999] 3 S.C.R. 622 (S.C.C.) at paras. 39, 45–46, reversing 98 D.T.C. 6177 (F.C.A.),
arming 97 D.T.C. 395 (T.C.C.). For recent examples of the Canadian courts giving eect to these legal
constructions as the framework for their commercial and tax outcomes (in various contexts), see CAMECO
Corporation v. R., 2020 D.T.C. 5059 (F.C.A.), arming 2018 D.T.C. 1138 (T.C.C.), leave to appeal refused (2021)
(S.C.C.); Alta Energy Luxembourg S.A.R.L. v. R., 2021 SCC 49, arming 2020 D.T.C. 5021 (F.C.A.), arming
2018 D.T.C. 1120 (T.C.C.); Loblaw Financial, infra note 49.
29
Subsection 250(4).
30
De Beers Consolidated Mines Ltd. v. Howe, [1906] A.C. 455 (H.L.).
31
In which case, subsection 250(5) will deem the corporation to not be resident in Canada.
32
Pursuant to subsection 2(2).
33
As defined in subsection 5907(11) of the Income Tax Regulations, C.R.C., c. 945 (the “Regulations”), and
subject to the limitation in subsection 5907(11.2) of the Regulations. A designated treaty country includes a
country with which Canada has concluded a tax information exchange agreement, and therefore includes
no-tax or low-tax jurisdictions like Bermuda, the Cayman Islands, the Bahamas or Guernsey.
34
The CRA’s position is that central management and control must be established in the designated treaty
country in order for the aliate to be resident in that jurisdiction for the purposes of the Regulations
regardless of whether the foreign aliate is deemed to not be resident in Canada for the purposes of the ITA:
Technical Interpretation 2000-0054455 dated October 23, 2001; Technical Interpretation 2007-0261551I7
dated October 19, 2010; Document 2009-0316641C6 dated May 1, 2009.
35
For the purposes of Part LIX of the Regulations.
8
generally will be added to the aliate’s exempt surplus that can be returned to Canada
tax-free.
36
Properly structured, residence in a designated treaty country can mean that the
captive’s insurance or reinsurance income from non-Canadian risks will never be subject to
corporate income tax in any country.
b) Foreign Aliate and Controlled Foreign Aliate Status
Status as a foreign aliate is a precondition to any dividends paid by a foreign corporation
being deductible when received by its Canadian parent.
37
If a foreign aliate is a controlled
foreign aliate, or is deemed to be a controlled foreign aliate, then the foreign aliate’s
FAPI will be included in the income of the Canadian parent when earned,
38
subject to a
deduction for the grossed-up foreign accrual tax paid by the aliate.
39
If a foreign
corporation is earning active business income and meets the conditions described above,
then it is desirable for the foreign corporation to be a foreign aliate so that exempt surplus
dividends can be received tax-free by the Canadian parent. If a foreign aliate is earning
income from property, it is desirable that the foreign aliate is not a controlled foreign
aliate so that Canadian tax is deferred until dividends are paid to the Canadian parent.
A corporation is a foreign aliate of a Canadian taxpayer if: (i) it is not resident in Canada;
(ii) the taxpayer’s equity percentage is not less than one per cent; and (iii) the combined
equity percentages of the taxpayer and all related persons is not less than 10 per cent.
40
Ifthe taxpayer owns shares of the non-resident corporation directly, the taxpayer’s equity
percentage in the non-resident corporation is the taxpayer’s percentage ownership of
aclass of shares of the non-resident corporation in which the taxpayer’s percentage
ownership is greatest.
41
In other words, if a taxpayer owns, together with all related persons,
10 per cent or more of the shares of any class of the non-resident corporation, the non-
resident corporation should be a foreign aliate.
42
A foreign aliate of a taxpayer is a controlled foreign aliate if: (i) the taxpayer controls
the foreign aliate;
43
or (ii) the taxpayer would control the corporation if it owned all of
theshares of the foreign aliate owned by non-arm’s-length persons, any set of up to four
arm’s-length Canadian shareholders of the foreign aliate and all persons who do not deal
at arm’s length with those other Canadian shareholders.
44
Even if a taxpayer does not
36
See the definitions of “exempt earnings” and “exempt surplus” in subsection 5907(1) of the Regulations.
Adividend that is deemed by subsections 5900(1) and 5901(1) of the Regulations to be paid from exempt
surplus is deductible from the income of a Canadian corporation that receives the dividend: paragraph 113(1)
(a).
37
As subsection 113(1) applies only to dividends received by a Canadian corporation from a non-resident
corporation that is a foreign aliate of the Canadian shareholder.
38
Pursuant to subsection 91(1).
39
Pursuant to subsection 91(4).
40
See the definition of “foreign aliate” in subsection 95(1).
41
See the definitions of “direct equity percentage” and “equity percentage” in subsection 95(4). For these
purposes, each series of shares is deemed to be a separate class: subsection 248(6). This deeming rule is a
trap for the unwary in many captive insurance arrangements, especially after the enactment of the tracking
aliate rules.
42
In instances where there are tiered foreign aliates, the “equity percentage” definition in subsection 95(4)
determines the Canadian taxpayer’s equity percentage using a percentage of percentage analysis.
43
For these purposes, “control” means de jure control, being ownership of enough shares of a corporation to
elect its board of directors: Duha Printers (Western) Ltd. v. R., [1998] 1 S.C.R. 795 (S.C.C.) at paras. 35–36,
reversing 96 D.T.C. 6323 (F.C.A.), reversing 95 D.T.C. 828 (T.C.C.); Buckerfield’s Ltd. v. M.N.R., 64 D.T.C. 5301
(Can. Ex. Ct.) at para. 10.
44
See the definition of “controlled foreign aliate” in subsection 95(1).
9
control a foreign aliate, the aliate may nevertheless be a controlled foreign aliate if
the taxpayer, together with four other Canadian shareholders and their non-arm’s-length
groups, controls the aliate.
The identification of controlled foreign aliates was complicated further by the tracking
aliate rules enacted in 2018, which apply where a taxpayer owns an interest in a foreign
aliate that tracks less than all of the assets or activities of the aliate.
45
At a high level,
these rules provide that a foreign aliate may be deemed to be a controlled foreign aliate
or part of the assets and activities of an aliate may be deemed to be assets and activities
of a notional separate corporation (which will itself likely be a controlled foreign aliate).
The tracking aliate rules are especially relevant to protected cell captive insurers or group
captive arrangements and eliminated many of the benefits of captive insurance
arrangements marketed to Canadian small and medium enterprises.
c) When Insurance Income Becomes FAPI
At the highest level, FAPI is a foreign aliate’s income from property, including interest,
rents, dividends, etc., as well as taxable capital gains, but excluding dividends from other
foreign aliates and taxable capital gains from the disposition of excluded property.
46
Taken
at face value, income of a foreign aliate from insuring or reinsuring risks would not be FAPI
because income from insurance or reinsurance would typically be income from business.
This superficial reading is incorrect because of the broad definition of income from
property used in the context of the foreign aliate rules.
47
Income from property not only
includes items of income typically characterized as being from a source that is property but
is also deemed to include income from an investment business and income that is deemed
to be income from a business other than an active business. This expansive definition is
important for captive insurance arrangements because both additions to income from
property are targeted in part at income from insurance or reinsurance. Balancing out the
expansive income from property definition is a relieving rule that deems income of a
foreign aliate that would otherwise be income from property to be income from an
activebusiness if the underlying payments were deductible by another foreign aliate
ofthe same taxpayer in computing its income from an active business.
48
An investment business of a foreign aliate includes, among other things, a business
ofinsuring or reinsuring risks unless the taxpayer can establish that: (i) the business is
conducted principally with arm’s-length persons;
49
and (ii) the aliate, or the aliate
together with certain other persons, employs more than five employees full time in the
45
Subsections 95(8) to (12).
46
See the definition of “foreign accrual property income” in subsection 95(1). The term “excluded property” is
also defined in subsection 95(1), and generally encompasses assets used in an active business carried on by
the aliate or shares of another foreign aliate that derive substantially all of their value from assets used in
an active business of that other aliate.
47
See the definition of “income from property” in subsection 95(1).
48
Subparagraph 95(2)(a)(ii), together with the definition of “income from an active business” in subsection
95(1). For greater certainty, the Canadian corporation must have a “qualifying interest,” as defined in
paragraph 95(2)(m), in both foreign aliates in order to avail itself of this relieving rule.
49
What it means to conduct business principally with arm’s-length persons was recently considered by the
Supreme Court of Canada in Loblaw Financial Holdings Inc. v. R., 2021 SCC 51, arming 2020 D.T.C. 5040
(F.C.A.), reversing 2018 D.T.C. 1128 (T.C.C.).
10
active conduct of the business.
50
If a foreign aliate is transacting insurance business with
persons other than other foreign aliates of the same taxpayer that are themselves
engaged in an active business, the foreign aliate will likely be carrying on an investment
business and generating FAPI if it does not satisfy both conditions.
Even if the foreign aliate is not carrying on an investment business, its income from
insurance can be deemed to be income from a business other than an active business and
therefore income from property. This will happen if the aliate earns income from insuring
or reinsuring risk in respect of persons resident in Canada, property located in Canada or a
business carried on in Canada.
51
To backstop these restrictions on earning active business
income from insuring or reinsuring Canadian risks, additional restrictions on insurance swap
transactions and a specific anti-avoidance rule may apply.
52
In summary, a captive insurer that is a foreign aliate of a Canadian taxpayer can generate
active business income from an insurance or reinsurance business if the income is derived
from other foreign aliates carrying on an active business or from other non-Canadian
risks if the captive employs more than five full-time employees. If the captive insurer
derives income from insuring or reinsuring Canadian risks, its income from insurance or
reinsurance will most likely be FAPI. If the captive insurer derives income from insuring or
reinsuring non-Canadian risks other than those of other foreign aliates carrying on an
active business, its income from insurance or reinsurance should be FAPI unless it has more
than five full-time employees.
iii) Loss Reserves
Unlike most taxpayers, insurers — including captive insurers and foreign aliates carrying
on insurance businesses — are entitled to deduct loss reserves,
53
and may also amortize the
cost of acquiring most types of insurance policies over the life of the policy.
54
An insurer
with positive reserves must include an amount in its income.
55
The amount of the reserve that may be deducted or the amount of the negative reserve
that must be included in income, in all cases calculated net of reinsurance ceded, is
determined by formula.
56
The ability to deduct loss reserves means that an insurer will
typically only have taxable income where its net premium income exceeds administrative
costs and general expenses, amortized policy acquisition costs and loss reserves.
The 2022 federal budget proposed measures that will alter the calculation of insurance
reserves because of the transition to the new International Financial Reporting Standards
for Insurance Contracts (IFRS 17). Draft legislation to implement these proposals has
notbeen released and, in any event, a review of these proposals is beyond the scope of
thispaper.
50
See the definition of “investment business” in subsection 95(1).
51
Paragraphs 95(2)(a.2) and (a.23).
52
Paragraphs 95(2)(a.21), (a.22) and (a.24).
53
Paragraph 20(7)(c) and Part XIV of the Regulations.
54
Subsections 18(9) and (9.02).
55
Paragraph 12(1)(e.1) and subsection 1400(2) of the Regulations.
56
See subsection 1400(3) of the Regulations in relation to property and casualty insurers, and sections 307,
1401 and 1404 of the Regulations in relation to life insurers.
11
4. TAX INCENTIVES IN OTHER JURISDICTIONS
It is unclear to what extent tax incentives impact location decisions for captive insurers.
Some older research examining location decisions within the United States suggests that
there is little correlation between premium tax rates and the size of a state’s insurance
industry (Grace et al. 2004); many states have comparably low premium tax rates for
captives,
57
so there must be some other rationale for the clustering in Vermont, Utah and
Delaware. Nevertheless, considering that captive insurance arrangements are often tax-
motivated, tax rates may not always be irrelevant.
A. PREMIUM TAXES
Many or most Canadian provinces, including Alberta, impose premium taxes only on
insurance business transacted in the province regardless of where the insurer is resident.
Premium taxes therefore have limited importance as an incentive for insurance companies
in making location decisions, instead impacting the profitability of insuring risks located in
the province and, by extension, the decision to transact business in that province.
Not all jurisdictions impose premium taxes on business transacted in that jurisdiction; in
other instances, it may be unclear whether premium taxes can be imposed on captives and
so only the captive’s residence jurisdiction will impose premium taxes.
58
For taxpayers with
insurable risks in jurisdictions without local premium taxes, forming a captive in a jurisdiction
that does not impose premium taxes on premiums payable to an insurer headquartered in
that other jurisdiction means that premium taxes may never become payable.
This is probably why most oshore and onshore jurisdictions where captive insurers are
commonly located impose no premium taxes or very low premium taxes. Bermuda and
theCayman Islands do not impose premium taxes at all, Luxembourg does not impose
premium taxes on reinsurance and many U.S. states impose premium taxes on captive
insurers at very low rates.
59
A jurisdiction attempting to break into the captive insurance
space would likely need to adopt an equally favourable premium tax regime to be
competitive, and that favourable premium tax regime would need to be a permanent
feature of the legislation.
57
U.S. state premium tax rates as of 2017 have been compiled by Todd et al. (2017).
58
For example, the author’s understanding is that 15 USC §8201 is intended to permit the home state of an
insured risk to impose premium taxes, but in at least some states the courts have held that premium taxes are
not applicable to premiums paid to captive insurers. See Johnson & Johnson v. Director, Division of Taxation,
241 A.3d 318 (N.J. 2020) where the New Jersey Supreme Court confirmed this result under New Jersey law.
59
For example, Delaware’s premium tax rate on captive insurers is 0.02 per cent for direct premiums and 0.01
per cent for reinsurance premiums: Del. Code tit. 18 §6914(a) and (b). Vermont’s premium tax rate on captive
insurers is 0.038 per cent on the first US$20 million of premiums and decreases as premium revenue
increases: 8 V.S.A. §6014(a).
12
B. INCOME TAXES
Subject to FAPI-like imputation regimes in the country in which a captive insurer’s parent
entity is resident, the profits of captive insurers should be taxable only in the jurisdiction in
which the captive is resident. At least until such time as legislation implementing the
Organisation for Economic Co-operation and Development’s (OECD) two-pillar project is
implemented broadly (see below), income taxes are therefore an obvious lever that can be
used to attract firms.
Most oshore jurisdictions where captive insurers are commonly incorporated impose no
income taxes or impose income taxes at a very low rate. Bermuda and the Cayman Islands
do not impose income taxes at all, Barbados imposes income tax at an eective rate of
zero per cent
60
and Guernsey’s income tax rate is zero per cent if all insured risks are
foreign risks.
61
These are permanent advantages and not temporary concessions, absent
any change in law.
Onshore jurisdictions may attempt to compete by eliminating subnational income taxes.
For example, both Vermont and Delaware do not impose corporate income taxes on
captive insurers formed in those states.
62
Again, these exemptions from state income taxes
are not temporary or time-limited, absent a change in law. While a Vermont or Delaware
captive will still be subject to U.S. federal income taxes, the elimination of state income
taxes may be enough to make an onshore captive competitive, especially for more marginal
captives — the firm can save some tax while avoiding the costs and hassle of circumventing
excise taxes or imputation regimes that may apply when an oshore captive earns premium
income. Attracting marginal captive insurance business from within the United States is
worthwhile given the large volumes of insurance business transacted in the United States.
In Canada, British Columbia initially refunded all provincial corporate income taxes payable
by a captive insurer to the extent that the captive earned income from insuring foreign
risks.
63
The eect of this refund was that a B.C. captive insuring foreign risks would only be
subject to federal income tax, at a reasonably competitive rate (15 per cent).
64
However, this
incentive was repealed after September 11, 2017.
65
The termination of this tax incentive
appears to have been an outcome of the 2017 B.C. election campaign, during which the
B.C. NDP characterized the refund as a “shady give-away scheme” that did not produce
obvious benefits for B.C. taxpayers (Todd 2017). Following the repeal of the tax rebate, all
income of a B.C. captive is taxed at the combined B.C.-federal 27 per cent rate. It is unclear
what impact this income tax change had on captive formation in B.C.; as noted above, B.C.
is not viewed as a favourable jurisdiction from a regulatory perspective.
60
Section 43(3A) of the Barbados Income Tax Act, Cap. 73, as amended by section 7 of the Barbados Income
Tax Amendment (No.) Act, 2018.
61
Paragraph 2(2)(d) and the fifth schedule of the Income Tax (Guernsey) Law, 1975.
62
Del. Code tit. 18 §6914(d); 8 V.S.A. §6014(g).
63
Sections 17 and 18 of the British Columbia International Business Activities Act, S.B.C. 2004, c. 49.
64
Being the default 38 per cent rate in subsection 123(1), less the 13 per cent general rate reduction in
subsection 123.4(2), less the 10 per cent provincial abatement in 124(1).
65
Section 8.2 of the British Columbia International Business Activities Act.
13
5. THE CHANGING INTERNATIONAL TAX LANDSCAPE
Provided that Alberta can create a favourable regulatory regime for captive insurance,
recently enacted or recently proposed multilateral tax avoidance measures may have the
eect of making Alberta a more competitive location for captive insurers. At a high level,
these measures will have the eect of raising the costs of creating and maintaining a
captive in a tax haven jurisdiction like Bermuda or the Cayman Islands and will eectively
require all captives to pay tax at a minimum rate of 15 per cent regardless of residence.
A. OECD BEPS ACTION 5 MEASURES
One of the focuses of the OECD’s base erosion and profit-shifting (BEPS) project was the
elimination of harmful tax practices described in BEPS Action 5. According to the OECD
andthe Inclusive Framework, harmful tax practices include the shifting of income to nominal
or no-tax jurisdictions without carrying on substantial activities in those jurisdictions.
For captive insurers, the OECD’s concept of substantial economic activities includes
predicting and calculating risk, insuring or reinsuring risks and providing client services
(OECD 2015). To ensure that captive insurers established in a nominal or no-tax jurisdiction
are undertaking substantial economic activities, the OECD and the Inclusive Framework
required that these jurisdictions enact substantial economic activities laws. To meet
minimum standards, these laws must: (i) define the core income-generating activities
forinsurers; (ii) ensure that core income-generating activities are undertaken either by
theinsurer or in the jurisdiction; (iii) require that the insurer have a minimum number of
adequately trained full-time employees and incur adequate operating expenses; and (iv)
have a transparent compliance mechanism and an eective enforcement mechanism
(OECD 2019).The economic substance laws enacted by nominal or no-tax jurisdictions
tomeet the OECD’s minimum standards are broadly similar. To use Bermuda’s laws as an
example, a captive insurer must have a substantial economic presence in Bermuda,
66
whichmeans that it must:
• Be managed and directed in Bermuda;
• Undertake its core economic activities — which are prescribed to include predicting
andcalculating risk, insuring or reinsuring against risk, providing client services and
preparing regulatory reports — in Bermuda;
67
• Maintain adequate physical presence in Bermuda;
• Employ adequate full-time employees with suitable qualifications in Bermuda; and
• Incur adequate operating expenditures in Bermuda.
68
The government of Bermuda has issued administrative guidance that explains that
adequacy must be determined in context, having regard for the nature, scale and
complexity of the business (Government of Bermuda 2021). Core income-generating
66
Subsection 3(1) of the Economic Substance Act, 2018 (Bermuda).
67
These prescribed core economic activities are found in subsection 8(2) of the Economic Substance
Regulations, 2018 (Bermuda).
68
Subsection 3(2) of the Economic Substance Act, 2018 (Bermuda).
14
activities may be carried on by contractors rather than by the Bermuda entity’s employees,
so long as they are carried on in Bermuda; this will impact the number of full-time
employees and the amount of physical space required in Bermuda. What appears non-
negotiable is that the captive insurer has regular directors’ meetings in Bermuda, ensures
that all core insurance activities are carried on (by someone) in Bermuda and maintains
some physical presence in Bermuda.
All Bermuda captive insurers are required to file annually an information return disclosing
information that will permit the registrar of companies to verify compliance with the
economic substance regime.
69
Failure to establish substantial economic presence may
bedisclosed to the tax administrator for the jurisdiction in which the ultimate parent
entityis resident.
70
Failure to file the information return can result in penalties ranging
fromUS$7,500 to $250,000, and may result in a court ordering that the captive terminate
its business or be struck.
71
Providing false information in the information return is a
criminaloence.
72
Establishing and maintaining economic substance in Bermuda, the Cayman Islands or
asimilar jurisdiction imposes additional costs on the captive (in addition to the cost of,
forexample, holding regular in-person directors’ meetings in the residence country).
Ifthecaptive insurer is already outsourcing its insurance functions to residence-country
insurance administrators, those additional costs may be incremental. In contrast, if the
captive insurer was relying on employees of its ultimate parent entity to undertake its core
activities, the increase in cost may be material. Since onshore insurers are not subject to
economic substance minimum standards, onshore jurisdictions may be increasingly viable
even without the same opportunities for tax avoidance.
B. OECD PILLAR TWO (GLOBE) PROPOSALS
For large enterprises with captive insurers, the OECD’s proposed Pillar Two rules are
potentially significant as they may drastically reduce the income tax savings available from
maintaining a captive in Bermuda, the Cayman Islands, Barbados, Guernsey or other low-
income tax jurisdictions, sometimes referred to as tax havens (OECD 2021a). If enacted by
most OECD nations, the Pillar Two proposals would eectively force the ultimate parent
entity of a multinational enterprise (MNE) to pay tax at an eective rate of 15 per cent on
profits from every jurisdiction in which the MNE operates. If the ultimate parent entity
would be subject to tax on profits in its home jurisdiction at a 25 per cent rate, the GloBE
regime reduces the potential income tax savings by 60 per cent from shifting profits to tax
haven captive insurers.
73
69
Ibid., section.
70
Ibid., section 6.
71
Ibid., section 13
72
Ibid., section 14
73
Suppose an in-scope ultimate parent entity were subject to residence country tax at a 25 per cent eective
rate and a captive insurer in the group were subject to residence country tax at a zero per cent eective rate,
with the result that shifting income to the captive insurer would (absent Pillar Two) eliminate 100 per cent of
the tax payable on that income. If a 15 per cent minimum tax applies, then the rate reduction on the income of
the captive insurer is only 10 per cent (25 per cent – 15 per cent), meaning that the potential tax savings have
been reduced by 60 per cent.
15
A firm is within the scope of the GloBE regime if it is multinational — meaning that the
group has at least one entity or permanent establishment not located in the jurisdiction
ofthe ultimate parent entity — and has consolidated financial statement annual revenues
ofat least 750 million euros. Although some corporate groups with captive insurers may
not meet the revenue threshold, and others may not be MNEs because they are purely
domestic enterprises, it is reasonable to expect that many or most such corporate groups
will be in scope.
The core of the GloBE regime is the income inclusion mechanism, which causes the
ultimateparent entity to include in its income an amount that will generate sucient
residence country tax payable to increase the total tax on the undertaxed source country
to the 15 per cent minimum rate.
74
If the ultimate parent entity is not resident in a
jurisdiction that has enacted an income inclusion mechanism, then source countries
maydeny deductions for payments to entities in low-tax or no-tax jurisdictions to increase
the eective rate to the 15 per cent minimum rate. Finally, if a payer entity is resident in a
developing country and the payee entity is resident in a nominal tax jurisdiction, the source
country may impose withholding taxes on interest, royalties and other similar payments
toincrease the eective tax rate to nine per cent. The eective tax rate is calculated on a
jurisdiction-by-jurisdiction basis, so MNEs cannot avoid the potential application of the
GloBE rules by averaging the eective tax rates of its operating subsidiaries in high-tax
jurisdictions and captive insurers in low-tax jurisdictions. In computing the total income
forentities in a jurisdiction, MNEs may deduct five per cent of their total payroll costs and
five per cent of the carrying value of eligible tangible assets;
75
these substance-based
exclusions are unlikely to materially benefit captive insurers, which will typically have few
employees and minimal non-financial assets. Potentially more relevant for small captives is
a de minimis exclusion for entities in jurisdictions with less than 10 million euros of revenue
and one million euros of net income.
The United States has already enacted its global intangible low-tax income (GILTI) regime,
76
which is similar in many respects to the proposed GloBE regime, but its status as a
compliant GloBE regime is uncertain in its current form.
77
Most Inclusive Framework nations
have a more straightforward path to implementation than the United States, and all OECD
nations have agreed to enact GloBE-compliant legislation in 2022, with eect in 2023
(OECD 2021b). A multilateral convention will be developed in 2022 to allow for the
application of withholding taxes by developing nations, and this multilateral convention
orasecond multilateral convention may also be used to co-ordinate GloBE legislation
between countries.
74
Under the current Pillar Two proposals, the residence country in which an undertaxed controlled foreign
company is resident would have the option of heading o the income inclusion for the ultimate parent entity
by imposing a qualified domestic minimum top-up tax (QMDTT) to bring the eective tax rate on the income
of those controlled foreign companies to 15 per cent.
75
These rates will initially be 10 per cent of total payroll costs and 10 per cent of the carrying value of eligible
tangible assets but will be decreasing to five per cent over 10 years.
76
26 USC §951A.
77
The U.S. Treasury’s FY2023 budget proposals and H.R. 5376 Build Back Better Act would amend the GILTI to
make it a Pillar Two-compliant regime. The Build Back Better Act appears unlikely to pass the Senate and it is
unclear whether the FY2023 budget proposals will be enacted.
16
Although the application of the GloBE rules will vary between countries based on the
legislation ultimately enacted, captive insurers earning base-eroding premium income are
precisely the types of entities targeted by the GloBE proposals. If an MNE group is in scope,
it is likely that a tax haven resident captive insurer will generate tax liabilities; any captive
small enough to escape using one or more carve-outs is probably not economical because
of the economic substance rules. It appears that only MNEs with less than 750 million euros
of consolidated revenue, but that are nevertheless large enough to operate a captive
insurer with economic substance, will fully realize the benefit of tax haven residence for
their captives.
6. IMPLICATIONS AND OPPORTUNITIES FOR ALBERTA
Recent domestic legislative amendments and international tax proposals have restricted
the opportunities to use captive insurance and increased the cost of the captive insurance
arrangements that remain. The Canadian tracking aliate rules have brought many
industry association-sponsored group captive arrangements into the FAPI web. Economic
substance legislation — assuming it is enforced in a manner consistent with its purpose —
will increase the costs of maintaining an oshore captive insurer. The GloBE proposals, if
enacted as agreed upon by the Inclusive Framework members, will increase the eective
tax rate on tax haven captive insurance profits from zero per cent to 15 per cent, thereby
making the costs of maintaining an oshore captive less palatable for many MNEs.
A. DOMESTIC CAPTIVE INSURANCE OPPORTUNITIES
Attracting captive insurance business from Canadian firms that have non-tax reasons for
captive insurance may not require much further action by Alberta, provided a favourable
regulatory regime is created. The combined federal-Alberta general corporate rate (23 per
cent) is lower than the rate in any other province and close enough to the GloBE minimum
rate (15 per cent). It is not certain that interprovincial income shifting through captive
insurance would be prevented under existing law, as the courts in common-law provinces
have held that general provincial anti-avoidance rules do not apply to these sorts of
arrangements.
78
This is especially true where the captive insurance arrangement is
commercially motivated and not tax motivated.
The opportunity to reduce or avoid non-tax costs through an onshore captive may be an
attractive financial proposition for Canadian firms. Using an Alberta captive would avoid
the need to: deal with oshore legal regimes that can be slow and cumbersome; establish
central management and control in an oshore jurisdiction; satisfy foreign aliate
compliance requirements; avoid the creation of FAPI; satisfy economic substance rules; and
manage GloBE reporting. Further, an Alberta captive could be used to insure Canadian
risks directly without incurring federal excise taxes or pay a toll charge to a fronting insurer
in Canada, and an Alberta captive could insure or reinsure Canadian risks without
generating FAPI.
78
See, for example, R. v. Husky Energy Oil Inc. (2011), 514 A.R. 181 (Alta. Q.B.) at paras. 72–73, armed [2012] 11
W.W.R. 282 (Alta. C.A.), leave to appeal refused March 7, 2013 (S.C.C.); Canada Safeway Ltd. v. Alberta (2012),
352 D.L.R. (4th) 566 (Alta. C.A.), arming [2011] 10 W.W.R. 526 (Alta. Q.B.), leave to appeal refused (2013),
447 N.R. 400 (note) (S.C.C.).
17
If Alberta is going to pursue domestic insurance business through captives, one possible
concern was that other provinces would rely on retaliatory premium taxes to protect both
their premium tax base and their income tax base. Prior to 2022, Alberta’s regulatory
charge on unlicensed insurance was far higher than premium taxes imposed by other
provinces on unlicensed insurance and would eectively preclude a captive insurer licensed
in another province insuring risks in Alberta. An Alberta captive would have been similarly
unviable as a direct insurer for domestic risks if subject to retaliatory premium taxes,
although still viable if reinsuring domestic risks via a fronting insurer. Reducing the
regulatory charge on unlicensed insurance to a rate consistent with other provinces
reduced the risk of retaliation by other provinces via premium taxes; it appears that the
Alberta legislature was aware of this concern and responded by reducing the regulatory
charge on unlicensed insurance.
If Alberta wanted to use tax policy to aggressively court domestic captive insurance
business, a temporary or permanent reduction or elimination of provincial income taxes on
captive insurance profits of Canadian-controlled captives could be considered. The federal
corporate income tax rate (15 per cent) is the same as the GloBE minimum eective rate. If
Parliament enacts the GloBE proposals, then, subject to taxable income calculation
dierences, eliminating provincial income taxes would place Alberta captives and oshore
captives on an even footing for Canadian MNEs even before accounting for non-tax
savings. However, there is no obvious economic eciency, fairness or tax simplification
justification for a provincial income tax reduction or elimination. Furthermore, businesses
with permanent establishments in Alberta would have an incentive to shift income from
operating entities to captive insurers to eliminate provincial income taxes; Alberta would
therefore risk eroding its own corporate income tax base.
Other provinces or the federal government could retaliate against a reduction or
elimination of provincial income taxes for captives in two ways. First, subject to the
requirement to maintain a common tax base under tax collection agreements and not
deviate without the consent of the minister of Finance,
79
provinces could amend their
provincial income tax laws to deny deductions for insurance premium payments to Alberta
captives. Second, the federal government could, at the behest of one or more provinces,
restrict the provincial abatement to not apply to Alberta captives. Both alternatives for
retaliation would require meaningful eort and would probably not be considered unless
the revenue losses for one or more other provinces was significant.
While it is theoretically possible that other provinces could retaliate by creating their own
special tax regimes that would not tax income earned from Alberta sources, this is less
plausible for non-Quebec provinces because doing so would require the consent of the
Department of Finance. Although the federal government is not obligated to administer
provincial corporate income taxes to protect Alberta’s tax base,
80
it is doubtful that the
federal government would want to be perceived as facilitating interprovincial tax
competition, even if retaliatory.
79
See, for example, section 3.4 of Annex B to the Memorandum of Understanding Concerning a Single
Administration of Ontario Corporate Tax between Canada and Ontario.
80
As, for example, paragraph 3.4(b) of Annex B to the Memorandum of Understanding Concerning a Single
Administration of Ontario Corporate Tax between Canada and Ontario only prevents Ontario from adopting
tax programs that impact the tax base of other provinces that have tax collection agreements with Canada.
18
Eliminating provincial income taxes for captive insurers while only imposing premium taxes
on Alberta risks would not raise tax revenue for Alberta. An industry-specific tax reduction
or exemption likely would not be ecient, and a base-eroding tax reduction or exemption
for large businesses cannot be justified by equity considerations. Tax elimination for captive
insurers could probably only be justified if the government of Alberta had a pressing or
substantial reason for wanting to subsidize a captive insurance industry or the insurance
industry more generally. Tax reductions for captive insurers short of an exemption might be
justifiable if the government of Alberta believed that it could raise incremental revenue and
might also be justifiable if there were pressing or substantial reasons for an industry
subsidy. At the same time, the need for an industry subsidy is undercut by the fact that
economic substance requirements will raise the cost of oshore captive insurers and may
incentivize multinational groups to move captives onshore.
Other than a rate reduction, there are limited opportunities to use the tax system to
incentivize the location of captive insurers in Alberta. Captive insurers are unlikely to have
material capital expenditures or to have a meaningful workforce, so traditional tax
expenditure options like investment tax credits are unlikely to provide strong incentives.
Departing from the federal income tax base to allow for larger reserve deductions or to
allow investment tax credits based on notional investment are tantamount to a rate
reduction, without the benefit of simplicity.
B. INTERNATIONAL CAPTIVE INSURANCE OPPORTUNITIES
Using tax policy to attract international captive insurance business will likely prove more
dicult, if for no other reason than Alberta lacks the captive insurance infrastructure
available in oshore jurisdictions like Bermuda or onshore jurisdictions like Vermont. Non-
Canadian firms that are not large enough to be within the scope of the GloBE rules would
have the option of paying zero per cent in a tax haven jurisdiction; even if Alberta were to
exempt captive insurers from provincial income tax, the cost savings of not having to
comply with economic substance legislation would probably not justify the loss of tax
savings. Captive insurers that are part of MNE groups that are within the scope of the
GloBE rules would be subject to the 15 per cent minimum tax, but these captive insurers
may be generating large enough profits that the eight per cent spread between the
eective tax rate in a tax haven and the combined federal-Alberta 23 per cent corporate
tax rate would result in a substantial incremental tax cost.
Alberta does have some advantages relative to other jurisdictions, however. The combined
federal-Alberta 23 per cent corporate tax rate is lower than in many OECD and non-OECD
jurisdictions,
81
and Alberta’s non-imposition of premium taxes on risks located outside of
Alberta is competitive with premium tax regimes in tax havens. Unlike most tax haven
residents, Alberta captives will be able to avail themselves of Canada’s expansive tax treaty
network. As a resident of a high-tax jurisdiction, an Alberta captive insurer may be outside
of the scope of controlled foreign company rules in many OECD countries and therefore
attractive to MNEs that need captive insurance but cannot otherwise avoid the application
of a FAPI-type regime.
81
However, the 23 per cent rate is only slightly below the OECD average (whether using the GDP-weighted
average or simple average), so Alberta’s corporate income tax rates would be most competitive relative to
countries that are well above the OECD average: see Bazel and Mintz (2020).
19
Assuming that adequate captive insurance infrastructure can be developed, Alberta would
likely need to either eliminate or substantially reduce the provincial income tax rate for
captives to be internationally competitive. Any reduction may need to be applicable to all
captives and not only to captives insuring non-Albertan or non-Canadian risks and may also
require economic substance. Ring fencing from the domestic economy, especially with no
requirement for economic substance, could result in any tax reduction for Alberta captive
insurers being branded as a harmful tax practice by the OECD.
82
If this were the case, then
the federal government may be obliged to deny the harmful tax benefits.
Even if Alberta were to eliminate the provincial income tax on captive insurers, it is unclear
whether this would provide enough of an incentive to locate non-Canadian captive
insurance business in Alberta. MNEs would have no reason to believe that Alberta would
betax competitive over the long term; a federal corporate tax rate increase or a change in
government in Alberta followed by a provincial tax rate increase or a repeal of the captive
insurer tax exemption would leave an MNE worse o than if its captive were resident in a
tax haven. Unlike most tax havens, it is doubtful that Alberta could secure the sort of all
political party buy-in to the concept of tax exemptions for large MNEs that would oer
assurance of stable tax treatment.
Again, provincial income tax reductions or exemptions for base-eroding income of non-
Canadian MNEs is dicult to justify on revenue raising, eciency or equity grounds.
Thereare also few tax expenditure options short of a rate reduction or a disguised rate
reduction that would incentivize non-Canadian MNEs to locate captive insurance business
in Alberta. Like domestic captive insurance business, the government of Alberta would
need good reasons to want to attract non-Canadian captive insurance business to justify
any tax expenditure.
In summary, there is probably limited opportunity for Alberta to attract captive insurance
business from non-Canadian MNEs. Alberta could reasonably expect greater success in
attracting captive insurance business from Canadian firms, given the potential tax
compliance savings and the ability to insure or reinsure Canadian risks without adverse tax
consequences. Retaliatory measures by other provinces or the federal government would
be unlikely unless Alberta were to reduce or eliminate provincial income taxes for captives.
82
For a discussion of what constitutes a harmful tax practice, see OECD, supra note 73 at 13–14.
20
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Investment and Growth Challenge.” University of Calgary School of Public Policy.
Business Insurance. 2021a. “Share of Captives Worldwide.” Accessed January 14, 2022.
https://www.businessinsurance.com/article/20210101/STORY/912338863/Business-
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———. 2021b. “Counting Captives.” Accessed January 14, 2022.
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Dolson, H. Michael. 2020. “A Comprehensive Review of Captive Insurance Companies.”
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Grace, Martin et. al. 2004. “Insurance Premium Taxes.” Paper presented at the
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National Association of Insurance Commissioners. 2021. “Captive Insurance Companies.”
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https://content.naic.org/cipr_topics/topic_captive_insurance_companies.htm.
OECD (Organisation for Economic Co-operation and Development). 2015.
Countering Harmful Tax Practices More Eectively, Taking into Account
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———. 2019. Harmful Tax Practices—2018 Progress Report on Preferential Regimes:
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———. 2021a. “Tax Challenges Arising from the Digitalisation of the Economy –
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theeconomy-global-anti-base-erosion-model-rules-pillar-two.htm.
———. 2021b. “Statement on a Two-Pillar Solution to Address the Tax Challenges
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https://www.oecd.org/tax/beps/statement-on-a-two-pillar-solution-to-address-the-
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Rankin, Eric. 2017. “B.C. Tax Rebates for Big Banks and Big Business Heat Up Election.”
CBC News. Accessed January 29, 2022. https://www.cbc.ca/news/canada/british-
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Todd, Matthew B. et. al. 2017. “Retaliation Guide.” Prepared for National Association
of Insurance Commissioners.
21
ABOUT THE AUTHOR
H. Michael Dolson is a tax lawyer and partner with Felesky Flynn LLP, a renowned Canadian
tax law boutique. With an emphasis on corporate and international tax planning, Mike advises
public corporations, owner-managers, First Nations and public sector entities on income tax
and GST matters. After spending the first 12 years of his legal career in Edmonton, Michael
recently relocated to Toronto and opened Felesky Flynn LLP’s Toronto oce. Michael is ranked
by Canadian Lexpert® and The Best Lawyers in Canada™ as a leading tax lawyer and was named
the Best Lawyers® 2022 Tax Law “Lawyer of the Year” in Edmonton. Michael graduated with a
law degree from Western University in London, Ontario in 2009, and with an LLM in tax law from
New York University in 2014. He currently serves as a Governor of the Canadian Tax Foundation,
is a former lecturer in corporate tax at the University of Alberta, and has published a number of
articles in reputed industry publications.
22
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