In Matter of Stewart's Shops Corp., DTA No. 825745 (N.Y.S. Tax App. Trib., July 27, 2017), the New York State Tax Appeals Tribunal affirmed the decision of an Administrative Law Judge that a corporation operating a convenience store chain could not deduct on its corporate tax returns insurance payments made to its wholly owned captive insurance company, because the payments did not qualify as valid insurance premiums under federal income tax law.

Facts. Stewart's Shops Corp. ("Stewart's Shops") owns and operates over 300 convenience stores in New York and Vermont. In the face of increasing insurance costs for its operations, Stewart's Shops started self-insuring certain risks in 1992. In late 2003 to early 2004, Stewart's Shops decided to create a captive insurance company, Black Ridge Insurance Corp. ("BRIC"), to insure some of its self-insured risks. BRIC received authorization to operate as a captive insurance company licensed by the New York State Insurance Department ("Insurance Department"), and provided Stewart's Shops coverage for: (1) losses incurred within the threshold deductible amounts and in excess of the maximum losses covered by its outstanding policies with thirdparty insurance companies; (2) its self-insured risks and claims from periods before the formation of BRIC ("loss portfolio transfer"); and (3) other risks, including pollution, identity theft, and crime, for which it did not have any insurance at the time of the formation of BRIC.

In the months prior to the formation of BRIC, William Dake, Stewart's Shops' president, engaged in discussions with the Insurance Department's captive insurance group. Mr. Dake testified that, as a result of these discussions, he understood that insurance payments paid to a New York captive insurance company would be deductible for New York corporate tax purposes. However, an Insurance Department representative involved in the discussions with Mr. Dake testified that he could not recall representing that the payments were deductible.

BRIC filed annual statements with the Insurance Department, and was never contacted by the Insurance Department with any concerns about the annual statements. BRIC also paid New York insurance premiums tax on the insurance payments from Stewart's Shops. In response to a 2004 tax refund claim from BRIC related to payments received for the loss portfolio transfer coverage, in 2005 the Department issued a letter stating such payments were properly classified as taxable "premiums" for insurance company tax purposes.

In 2010 and 2011, the New York State Department of Taxation and Finance audited BRIC and Stewart's Shops. The Department concluded that BRIC was properly subject to the insurance company tax and therefore could not be included in Stewart's Shops' combined corporate tax returns. However, the Department disallowed Stewart's Shops' deductions for insurance payments to BRIC, concluding that, because the payments would not be valid deductions for federal income tax purposes, they could not be deducted for corporate tax purposes either.

Corporate Tax Law. For the tax years in issue, when computing a corporation's tax on entire net income ("ENI"), ENI was defined as being "presumably the same as" a corporation's federal taxable income. Tax Law 208(9). While the statute includes numerous adjustments and modifications to federal taxable income, none of the adjustments were relevant to Stewart's Shops' insurance payments to BRIC.

The ALJ Decision. The ALJ concluded that Stewart's Shops' insurance payments to BRIC were not deductible for corporate tax purposes. In reaching her decision, the ALJ closely analyzed federal case law to support her conclusion that BRIC did not provide insurance to Stewart's Shops under federal income tax principles, which require, among other things, evidence of risk shifting and risk distribution, and further rejected Stewart's Shops' contention that the federally established criteria for determining the existence of insurance was not controlling for New York purposes.

The Tribunal Decision. The Tribunal upheld the entirety of the ALJ's decision. At the outset, the Tribunal determined that the ALJ properly concluded that the insurance payments at issue were not deductible for federal income tax purposes, and that "[f]ederal law controls for the purpose of defining `entire net income'" unless there is a specific state departure (quoting Matter of Dreyfus Special Income Fund, Inc. v. N.Y.S. Tax Comm'n, 126 A.D.2d 368 (3d Dep't 1987)).

Stewart's Shops did not dispute that its insurance payments to BRIC did not constitute insurance premiums for federal income tax purposes, or that the Tax Law provided no explicit deduction for insurance premiums. Nevertheless, it argued that authorization of the deduction "may be inferred from the structure of the captive insurance laws . . . and the Legislature's intent to provide favorable tax treatment for captive insurance companies through those laws." Specifically, Stewart's Shops cited legislative history to support its position that the Legislature intended to tax captive insurance premiums only once, either under the general corporate tax regime (Article 9-A of the Tax Law) or under the insurance company tax regime (Article 33 of the Tax Law). As BRIC was classified as a captive insurance company under New York Insurance Law, it was statutorily required to file insurance company tax returns and, on such returns, it included the insurance payments by Stewart's Shops in its taxable base. Therefore, Stewart's Shops maintained that it was entitled to a deduction for those same insurance premiums on its corporate tax returns.

The Tribunal rejected Stewart's Shops' position and upheld the ALJ decision. The Tribunal stated that the burden to establish a right to a statutory tax deduction is on the taxpayer, and that a deduction "must clearly appear" in the taxing statute. In this case, Stewart's Shops was relying on a statutory inference to overcome the lack of an enumerated deduction under New York law, pointing to, among other things, the structure of the State's captive insurance company laws and portions of legislative history related to such laws. The Tribunal, however, concluded that, if anything, "the absence of express statutory language" in the Tax Law "indicates that the Legislature did not intend to create" the deduction claimed by Stewart's Shops.

Stewart's Shops contended that the ALJ's interpretation of New York law would lead to the "absurd result" that the insurance payments would be treated as insurance premiums under the State's insurance company tax regime, but not under the State's general corporate tax regime. While the Tribunal did not seem particularly convinced by this argument, it nonetheless pointed out that such inconsistency had been eliminated because the Department had previously indicated (and reaffirmed in its briefs to the Tribunal) that it would refund the insurance premiums tax paid by BRIC.

The Tribunal also rejected Stewart's Shops' claim that the Department was equitably estopped from denying the claimed deductions. While the Department had previously taken the position on audit of BRIC that the insurance payments were taxable premiums under the insurance company tax, the Tribunal concluded that such position did not address the deductibility of the insurance payments in calculating federal taxable income or ENI under the corporate tax regime. Further, the Tribunal rejected Stewart's

Shops' claim that the Insurance Department provided advice that the insurance payments would be deductible from ENI.

Additional Insights

The Stewart's Shops decision, which is subject to appeal by the taxpayer, is notable because it is the first Tribunal precedent examining the deductibility of insurance payments to a captive insurance company. The decision confirms that, because there is no specific provision in the Tax Law providing a deduction of insurance payments in calculating ENI, insurance payments to captive insurance companies will not be deductible unless they are properly classified as insurance premiums under federal income tax law.