A New York State Division of Tax Appeals administrative law judge (ALJ) issued three determinations addressing the tax implications for unauthorized insurance companies, both life and non-life.1 Significant uncertainty has surrounded New York State’s taxation of unauthorized insurance companies since New York State amended its insurance tax provisions (Article 33) in 2003. The Department of Taxation and Finance (Department) even issued a technical memorandum in 2012 reversing its prior position on unauthorized life insurance company taxation. These ALJ determinations provide much needed clarity, although questions still remain.
Unauthorized non-life insurance companies: The ALJ determined that unauthorized non-life insurance companies are subject to the insurance franchise tax under New York Tax Law § 1501, and not the premium tax under New York Tax Law § 1502-a. Additionally, the ALJ determined that the insurance franchise tax “cap” does not apply to unauthorized non-life insurance companies. Finally, the ALJ determined that an alternative allocation method was appropriate in this case.
Unauthorized life insurance companies: The ALJ determined that the insurance franchise tax “cap” applies to unauthorized life insurance companies for tax years prior to 2012. The ALJ also interpreted the definition of life insurance company very broadly to include the petitioner, which insured non-life risk primarily, but also reinsured a small amount of life insurance risk.
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New York State Insurance Taxation Background
New York State enacted its insurance franchise tax in the 1970s, which operates much differently than traditional premium taxes. The insurance franchise tax generally mirrors New York State’s corporate franchise tax and imposes tax on an insurance company’s entire net income or capital (instead of just gross premiums). New York State’s insurance franchise tax also includes a premium tax component for certain companies.
Initially, New York State imposed its insurance franchise tax similarly on all types of insurance companies. New York State also provided a “cap” on the total amount of tax due, which was calculated using the premium tax component that looked to authorized New York State life insurance premiums.
In 2003, New York State amended its insurance tax regime and created a traditional premium tax in lieu of the insurance franchise tax for authorized non-life insurance companies, under New York Tax Law § 1502-a.2 New York Tax Law did not reference unauthorized non-life insurance companies expressly, which created uncertainty as to which tax applied to these companies.
The Department’s interpretation was that both unauthorized non-life insurance companies and unauthorized life insurance companies were subject to the insurance franchise tax. The Department issued several advisory opinions between 2003 and 2012 that addressed the insurance franchise tax as applied to unauthorized life insurance companies. The Department concluded that the “cap” effectively limited unauthorized life insurance companies’ insurance franchise tax liability to zero because they necessarily did not have any authorized premiums. However, in 2012, the Department issued a technical memorandum (TSB-M) reversing its interpretation for unauthorized life insurance companies prospectively, asserting that the “cap” does not apply to them. The Department also asserted that its position since 2003 was that the cap never applied to unauthorized non-life insurance companies.3
Unauthorized Non-Life Insurance Companies
Two of the cases involve unauthorized non-life insurance companies.4 The parties stipulated to several important facts, including that the companies
- were unauthorized;
- were non-U.S. companies and their effectively connected income was almost entirely from the partnership interests (no U.S. premium income);
- did not have any premiums from New York State, including orphan premiums; and
- were doing business for New York State tax purposes because they held partnership interests in partnerships that invested in commercial real estate in New York.
Sutherland Observation: Whether an unauthorized insurance company has sufficient nexus with New York State is a crucial threshold issue. Although the petitioners in these cases conceded nexus, it is unclear whether a limited partnership interest in a partnership that does not hold New York State real estate would create nexus. Further, many limited partnership interests qualify as portfolio investments and thus should not create nexus.
The petitioners argued that the premium tax provision must be read to include allnon-life insurance companies, authorized and unauthorized. Specifically, the petitioners argued that although the premium tax expressly encompasses authorized insurers, the provision does not expressly exclude unauthorized insurers.
The ALJ disagreed, stating that adopting the petitioners’ argument would require a finding that the legislature enacted a statute intending that it would be applied without regard to its express terms. Therefore, the ALJ determined that the insurance franchise tax, not the premium tax, applies to unauthorized non-life insurance companies. The ALJ also determined that the insurance franchise tax “cap” did not apply to non-life insurance companies because the “cap” expired with the 2003 amendments.
Sutherland Observation: The ALJ upheld the Department’s position that treats unauthorized non-life insurance companies significantly worse than authorized non-life insurance companies (subject to premium tax) and unauthorized life insurance companies (tax “capped” at zero prior to 2012). It is unclear whether the legislature intended this disparate treatment when it amended the New York State insurance tax regime in 2003.
However, the ALJ determined that only the insurance companies’ income/capital from the partnerships were subject to tax.5
Sutherland Observation: Importantly, the ALJ recognized that an insurance company’s worldwide income and capital cannot constitute its tax base.
After determining that the insurance franchise tax applied, the ALJ next addressed the allocation method. The insurance franchise tax statute requires a two-factor allocation formula, which is 90% premium factor and 10% wage factor. The petitioners asserted that they must use the statutory formula, and that its worldwide premiums and wages represent the denominator of each factor. Because the petitioners had zero New York State premiums and wages, the allocation percentage would have been zero, and the petitioners would have been subject only to the minimum tax.
The Department’s assessment invoked an alternative allocation method, asserting that the statutory method failed to properly represent the petitioners’ New York State business activities because they had New York State source income and capital, but would pay no New York State tax on them. The Department instead implemented the corporate franchise tax allocation method (single receipts factor for 2007, and weighted receipts, property, and payroll factor for 2006), and used just the partnerships’ factors (applied to just the share of partnership income). The ALJ affirmed the Department’s use of alternative allocation and determined that its method was reasonable.
Sutherland Observation: The ALJ approved of the Department’s entity theory/separate accounting approach, which imposed tax on the petitioners’ share of partnership income/capital using the partnerships’ allocation percentages.
Sutherland Observation: The ALJ concluded that the legislature explicitly imposed the insurance franchise tax on unauthorized insurance companies, but then concluded that “it is not surprising that there is no explicit statutory allocation formula” for unauthorized insurance companies. However, it would seem that if the legislature knowingly chose to impose the tax on unauthorized insurance companies, it would have created an alternative allocation method if it felt the standard method was not proper.
The ALJ expressly stated that the statutory method is presumed appropriate for insurers with New York State premiums (e.g., authorized insurers), but alternative methods may be used if the taxpayer does not have any New York State premiums.
Sutherland Observation: The Department’s assertion that alternative allocation is proper whenever a taxpayer does not have any New York State premiums creates a rule of general applicability, which arguably violates the State Administrative Procedures Act.
Sutherland Observation: The petitioners stipulated that they did not have any New York State premiums, including orphan premiums (which arise when risk originally located in a certain state later moves into New York State). This stark fact pattern may not be realistic for many companies. Additionally, New York Tax Law defines New York State premiums very broadly, which encompass premiums not allocated to any jurisdiction. Therefore, many insurance companies may be able to assert that the Department cannot invoke an alternative allocation methodology—or at the very least that the statutory allocation method is presumed correct—because the insurance company has some New York State premiums even though it is unauthorized.
Life Insurance Companies
The third case mirrored the first two, except that the petitioner asserted that it was an unauthorized life insurance company. Although the petitioner insured health, property and casualty risk primarily, the petitioner also reinsured a small amount of life insurance risk.
The ALJ looked to the definition of “life insurance” under the Insurance Law, which provides that a life insurance company is any company that has the power to provide life insurance or annuities. Because the petitioner was permitted to reinsure life insurance risk, albeit outside New York State, it was a life insurance company under New York State law. Therefore, the “cap” applied to the petitioner, and it had zero insurance franchise tax liability (because it had zero authorized life insurance premiums), at least for these pre-2012 tax years.
Sutherland Observation: Based on the ALJ’s reasoning, an unauthorized insurance company should be able to qualify as a life insurance company for New York State tax purposes if it receives any life insurance or reinsurance premiums. The result is that the company would not have any New York State tax liability (at least prior to 2012).
The ALJ did not address whether the “cap” would apply to unauthorized life insurance companies beginning in 2012, when the Department reversed its position and began asserting that the “cap” does not apply.
Although these ALJ determinations provide some clarity regarding New York State’s taxation of unauthorized insurance companies, many questions still remain. It is unclear what activities create nexus for unauthorized insurance companies, whether the Department is permitted to use alternative allocation if the insurance company has some New York State premiums (including orphan premiums), and how the insurance franchise tax would apply to a non-alien company. Additionally, these determinations addressed only pre-2012 tax years, so the Department’s position that the “cap” no longer applies to unauthorized life insurance companies is left unresolved. Furthermore, these ALJ determinations are non-precedential, and it is uncertain whether they will be appealed to the New York State Tax Appeals Tribunal.