Captives Face Uncertainty Over Future Tax Treatment.

Taxation of captive insurance companies faces several unknowns, mostly in the shape of initiatives by U.S. and international organizations bent on leveling the playing field and defining the constituents of competition, said attorney Thomas Jones, partner at the Chicago headquarters of the law firm McDermott, Will & Emery. He spoke at CAP 2000 in Southampton, Bermuda.

"These are fascinating times for captive-company taxation," Jones said. He pointed to several recent developments in U.S. tax law:

* An Internal Revenue Service "private letter ruling" allowed the application of U.S. generally accepted accounting principles by offshore captives, which Jones described as "a small victory."

* IRS field service advisers conceded that the combination of unrelated and affiliated business together create insurance for tax purposes.

* The U.S. Tax Court accepted the deductibility of conservative loss funding in the Utah Medical Insurance Association.

* The IRS is advocating a "line of business" theory of risk distribution, which argues that, for example, a life carrier that starts writing earthquake coverage isn't shifting risk.

Jones said companies forming captives also are concerned with the impact of moves by the Organization for Economic Cooperation and Development, the European Union and the G-7 group; the potentially adverse effect of President Clinton's budget proposals on captives; the future of pending legislation to close the "Bermuda tax loophole"; and proposed and temporary Treasury regulations, promulgated at the end of February and aimed at corporate tax shelters.