UK-owned captive insurance companies will have less money to generate investment income under a tightening of UK taxation on controlled foreign companies (CFCs), Bermuda Insurance Management Association president Mr.

Dennis Higginbottom said yesterday.

Last week's UK budget, presented by chancellor of the exchequer Mr. Kenneth Clarke, included a move which would up the percentage of earnings CFCs (most captives are CFCs) must return to parent companies from 50 percent to 90 percent a year.

Several Bermuda captives have UK parents.

"Rather than being able to leave 50 percent of earnings with the captive on which it would earn investment income, the amount has been reduced to ten percent,'' said Mr. Higginbottom, also senior vice president of American International Company Ltd., a wholly owned subsidiary of American International Group, Inc.

"Half of a captive's earnings will no longer be sheltered and available for investment gains.

"Prior to this budget, there was a provision which said that if at least half of a CFC's annual earnings were repatriated to the UK in the form of a dividend to the parent company, the balance would not be subject to UK tax.'' The tightening brings the dividend requirement much closer to the US position of 100 percent, he noted.

Though all earnings by a UK parent company's captive are ultimately taxable, this move "accelerates the tax payment,'' Mr. Higginbottom said.

"(But) it is too early to tell what companies will do with their captives,'' he said.

The advantage of having the ability to shelter a portion from taxation is only one advantage of being a captive and certainly not the most important, he said.

Because the captive, usually a wholly owned subsidiary, is not located in the UK it is not subject to direct taxation.

The captive pays the dividend to the parent which is taxed by Inland Revenue, the UK equivalent of the US Internal Revenue Service.

There are practical impacts and the budget will not mean the end of captives, said UK broker Bowring Marsh & McLennan, cited in Lloyd's List.

Though the changes are unwelcome, they do not undermine the argument for captives as competitive alternative insurers, stated Bowring, which has offices here.

The broker also said: "The upside of this new environment in which captives must operate should encourage risk managers to return to fundamentals of what their captives are intended to do.'' A captive is an insurance company formed to ensure the risk of its parent corporation.

Bowring also said that if a captive is required to provide a tax benefit to be viable to the parent company then it has an unconvincing risk management basis.

And that "offshore locations may be less attractive under the new regime but kinder regulators will prevent an exodus to the mainland from Guernsey, the Isle of Man and other locations''.

TIGHTER TAXATION -- Mr. Dennis Higginbottom, Bermuda Insurance Management Association president.