Legislation pending in Ohio would dramatically alter the state’s sales tax system, and could have a significant impact on insurance companies doing business in the state. Ohio House Bill 59 would extend sales tax to virtually all services. For the insurance industry, which deals almost exclusively with services and intangible property, the proposal has broad implications.
This bulletin highlights some issues that are likely to be of interest to insurance companies and others involved in the insurance business in Ohio. And where the bill is silent, or the implications for insurers are unclear, we point out those questions and the potential implications for insurers.
Background. Governor Kasich’s budget bill includes sweeping tax changes that will mean a fundamental shift in how state government is funded. The bill proposes to reduce taxes on income and investment, and increase taxes on consumption and spending. The proposed extension of the sales tax base to include services and transactions involving intangibles has implications for almost every person, business, and organization located, or doing business, in Ohio. The changes in the personal income and severance taxes likewise will impact a wide swath of individuals and businesses.
Currently in Ohio, the sales tax applies to most tangible goods, but to only a limited list of services specifically identified in statute. Existing law provides that where certain otherwise taxable services are provided among “related entities,” no tax is imposed.
Most services routinely purchased by insurance companies, such as actuarial and claims adjusting services, are not currently subject to the sales tax.
Analysis of the Tax Provisions in H.B.
The Proposed Expansion of the Tax Base
H.B. 59 expands the definition of a “sale” to include all transactions by which a service is, or is to be, provided. The term “service” means any act performed for another person for any type of consideration. Thus, virtually any activity for which a fee is paid will become subject to sales tax.
The bill specifically excludes from the tax a few services, most notably services rendered by employees to employers. However, all other services will be taxable. This includes services such as financial consulting, marketing, department collection, legal and accounting, and all other services for which any payment is made. The exclusion of residential rental transactions implies that commercial real estate rental transactions will also be subject to tax.
In addition to services, the bill also expands the sales tax to transactions involving digital goods and the licensing of intangible property. For example, electronic downloads of video clips, sound recordings and written materials will fall within the tax. In addition, payments for the right to use patents, copyrights, trademarks, and other intellectual property and rights will also be taxed.
Implications for Insurance Services
The bill appears to exempt insurance premiums from the sales tax. The exemption for transactions by which insurance is sold to a customer appears to mean that no sales tax is imposed on premiums paid for insurance by policyholders, certificate holders, or others such as employers who make contributions toward the premium for insurance for their employees. In informal discussions, state officials have confirmed that the bill is intended to exclude from the sales tax the purchase price of insurance.
It appears clear that the services of parties involved in marketing insurance products, such as fee-based financial planners, will be subject to the sales tax.
It is not clear from the legislation whether traditional commissions paid by insurance companies to insurance agents will be subject to the sales tax. Informal discussions with some state officials suggest that commissions will be subject to the sales tax. Based on the new paradigm — unless a service is specifically exempt, the sales tax applies — it seems reasonable to believe that the bill as drafted would impose the sales tax on agent commissions and any other form of compensation from insurers to agents.
The general rule is that the “vendor” — in this case the agent — is responsible for invoicing and collecting the tax. But there is some speculation that the tax debt anticipates having the insurance company self-report the tax on commissions and pay it directly to the State.
New Taxes on Services Used in Business
Under current law, transfers of tangible personal property and the selected services that are subject to tax are not taxed if they are acquired for the purpose of being resold. For example, a wholesaler does not pay sales tax on tangible products that it is going to sell to a retailer. However, under the bill, the definition of a “consumer” is revised so that a person who provides a service that is subject to the tax is deemed the consumer of all tangible property and all services purchased or consumed in the course of providing that service, and the resale exemption is specifically made inapplicable to those persons. And the bill specifically provides that an insurance company is the consumer of all services purchased for use “in connection with the performance of an insurance contract.”1 There is no further explanation in the bill about this.
It appears that an insurer will pay sales tax on all services that it acquires in order to develop, offer and service its products. This would include actuarial services, claims adjusting services, and administrative services purchased from a third party. With respect to these services, the insurance company is the consumer of the service and will have to pay sales tax on the service.
As under current law, services provided by employees are not taxable to the employer.
In addition, every Ohio business, including an insurance company, that licenses a patent, copyright or other intangible for use in its business will now pay tax on the payments made for the use of the intangible property.
Under the current law, there is an exclusion from the sales tax for certain taxable services, such as electronic information services and employment services, that are provided to other members within a related group. This language is stricken from the bill. Combined with the provision rendering all services subject to taxation, it appears that all service transactions between the members of a related group are subject to the tax.
Thus, the members of a family of businesses that use a common service company to provide payroll, accounting, legal or other centralized services, and that uses a cost allocation or a charge-back system, will have to pay sales tax on those transactions within the group. Similarly, if intangible property is owned by one member of a related group and licensed to other members of the group, those transactions will be subject to the tax.
As a result, insurance companies that have shared services agreements among legal entities within the corporate family, or that have created separate legal entities to provide services to other entities within the organization, will be required to pay sales tax on those services. Common examples include a group of business entities with common ownership that has one member that provides payroll, accounting, collection and other services to the other members of the group, the cost of which is allocated to the other members; or a group of related business entities that lodge all of its intangible property, such as trademarks and copyrights, within a single member that licenses the use of the intangible property to the other members of the group. In both of these examples, these services will now be taxable to the member of the group who receives the services or the benefits of the service relationship.
Location of the Sale
In addition to statewide sales tax, Ohio’s counties and transit authorities may impose local sales taxes at various rates. Therefore, it becomes important to determine where a sale takes place for both state and local tax purposes so that the correct tax can be collected and paid.
Under existing law, there are some general guidelines as to where a sale takes place. As a general rule, the sale is taxed at the location where the tangible property is located or where the benefit of the service is received. There is no existing provision regarding where the sale of an intangible occurs.
Under the existing law, this rule — although inexact — generally works. However, with the inclusion of nearly all services and intangibles within the tax base, it will become more and more difficult to determine where a sale takes place and the correct tax, if any, to apply to the transaction.
In addition, with respect to insurance agent commissions it is unclear whether the policyholder, or the insurance company, will be the party liable for the tax.
Potential Retaliatory Tax Implications
Applying the sales tax to insurance related services may be considered by other states as a “burden” imposed on insurance companies by Ohio. Accordingly, other states may include Ohio’s sales tax when determining retaliatory charges imposed on Ohio-domiciled insurers.
Intangible Property Transfers
Another potential concern for insurance companies is the proposed expansion of the sales tax to sales and licenses of intangible property. Excluded from the definition of intangible property are “interest, gains, and dividends from sale of financial instruments” (broadly defined as stocks, notes, bonds, debentures, money market funds, mutual funds and negotiable securities). HB 59 appears to levy sales tax on the acquisition and liquidation of financial investments.
In fact, to the extent there are no gains, it appears the tax could apply to the price paid for the instruments themselves, as well as any service associated with the acquisition or disposition. The impact of assessing sales tax on the front and back end of every investment would make it difficult to generate any business income on assets held for short period of time.
Insurers are highly dependent on investment income as an ongoing, significant source of operating income. Subjecting investment transactions to a sales tax would have significant implications for insurers.
As a general rule, persons who provide services will have to register as vendors and will be required to charge and collect tax from their customers and pay the tax to the state. Consumers who are not charged the tax by their vendors will be required to register and to self-pay the tax directly to the state. As noted above, there is speculation that the Tax Department anticipates an exception to this general rule by requiring insurance companies to determine their own sales tax obligations for commission payments.
Next Steps in Consideration of H.B. 59
Hearings on H.B. 59 began in the Ohio House of Representatives in early February. The state’s budget must be approved by June 30.