Prior to 2012, New York afforded surprisingly favorable tax treatment to life insurance companies that are not licensed to conduct business in New York ("unauthorized life insurers"), but that owned real estate investments in New York. The New York State Department of Taxation and Finance (the "Department") interpreted the New York Tax Law to provide that those insurers were subject to tax in New York as a technical matter, but that under the Tax Law's unique two-part franchise tax on life insurers, they would have no actual tax liability. In 2012, however, the Department changed its interpretation and adopted the view that unauthorized life insurers with real estate investments in New York may have a liability for tax in New York. This change has resulted in at least one area of uncertainty: How do unauthorized life insurers allocate income to New York for purposes of computing the franchise tax that is payable to New York?
Simply put, under the provisions of the New York Tax Law that apply to insurance corporations (Article 33 of the Tax Law), exercising its corporate franchise, employing capital, or owning or leasing real property in the state by any licensed or unauthorized insurer is, in itself, sufficient to make that insurer subject to the Article 33 franchise tax on income (or other amounts specified in the Tax Law)—which is the first part of New York's unique two-part tax on life insurers. Nevertheless, prior to the 2012 change in the Department's interpretation, unauthorized life insurers operated under what was in effect a tax exemption. Therefore, even though having real estate investments in New York would cause New York's taxing authority to attach to unauthorized life insurers, such insurers are not expressly subject to the separate tax on premiums imposed under Article 33—the second part of New York's tax on life insurers. As a result, because Article 33 "caps" the two parts of the tax at a percentage of taxable premiums, the Department had been of the view that because an unauthorized life insurer would have a premiums tax liability of zero, the cap on its combined tax under Article 33 would be zero (although the Department required such insurers to file returns with the state). In 2012, however, the Department changed its interpretation as to the applicability of the cap and, beginning with the 2012 tax year, requires unauthorized life insurers that own real estate investments in the state to compute and pay franchise tax on income or other amounts that are allocated to New York, although they continue to be exempt from the franchise tax on premiums.
As a result of the Department's change in position, some uncertainty has arisen with respect to the method that unauthorized life insurers must use to allocate income to New York for franchise tax purposes. The Tax Law generally requires all insurers to use an allocation ratio that is heavily weighted to the percentage of the insurer's total premiums that are derived from New York sources (plus a factor based on New York payroll, if any). Following the Department's changed interpretation, some commentators suggested that because these unauthorized life insurers would not be paying the premiums tax portion of the franchise tax, the Department would exercise discretionary authority to require such insurers to use an allocation ratio that is based on gross receipts, rather than premiums plus a payroll factor method that is generally required by the statute. In more recent discussions, however, representatives of the Department have indicated that they will expect unauthorized insurers that receive premiums from New York to use the required premiums plus the payroll allocation method, and that the Department will exercise its discretionary authority only in relatively rare cases.
New York state imposes a uniquely structured franchise tax on life insurance companies. Under Article 33, every domestic, foreign (non-New York) or alien (non-U.S.) life insurance corporation that exercises its corporate franchise, does business, employs capital, owns or leases property or maintains an office in New York is subject to a two-part tax. The first part is imposed by Tax Law section 1501(a) on the corporation?s allocated subsidiary capital, plus the highest of entire net income; business and investment capital; a portion of its entire net income plus certain compensation of officers and directors, as allocated to the state; or a minimum tax of $250. See Tax Law section 1502. The second part is a tax imposed at the rate of .7 percent on gross direct premiums received by any domestic, foreign or alien life insurance corporation on risks resident in the state, but only if the life insurance corporation is "authorized to transact business in this state under a certificate of authority from the superintendent of financial services" (an "authorized life insurer"). See Tax Law section 1510(b).
The two parts of the tax are combined, but the total tax to be paid is subject to a "cap" under section 1505(a)(2) of the Tax Law, which is based on the tax on premiums imposed by section 1510(b), at the rate of 2 percent. (There is also a "floor" imposed by section 1505(b) of the Tax Law of 1.5 percent of premiums.) It is important to note, however, that the cap under section 1505 applies only to "taxpayers subject to tax" under section 1510(b) of the Tax Law (i.e., authorized life insurers).
Prior to 2012, the New York State Department of Taxation and Finance took the position that unauthorized foreign or alien life insurance companies had no liability for the franchise tax imposed by Article 33, even when such insurers owned or leased real estate in New York, because the cap under section 1505 of the Tax Law effectively eliminated their tax liability. This position was based on the proposition that because the insurers were not authorized to transact insurance in New York, they were not subject to tax on premiums under section 1510; thus, the cap would be zero. See, e.g., TSB-A-04(2)C, dated April 1, 2004. Therefore, because their cap was zero, neither part of the two-part franchise tax applied.
In reaching this conclusion, the Department recognized that unauthorized insurers may receive premiums from New York, when policyholders move into New York owning policies issued outside of the state (they are sometimes referred to as "orphan premiums"), but the lack of an insurance license was held to be controlling for purposes of section 1510 and, thus, for the section 1505 cap as well. The Department noted that the unauthorized life insurers were "taxpayers" within the meaning of section 1500 of the Tax Law and, therefore, were required by section 1515 to file tax returns with New York.
TSB-M-12(4)C—The Department's Change of Interpretation
In Technical Memorandum TSB-M-12(4)C (the "TSB") (Dated February 17, 2012), the Department reversed its position, noting that the cap and floor provisions of section 1505 of the Tax Law applied only to authorized life insurers—i.e., "taxpayers subject to tax" under section 1510(b) of the Tax Law. The Department reasoned that because unauthorized life insurers were not subject to tax under section 1510, the provisions of section 1505 had no application. In other words, unauthorized insurers would now be subject to tax under section 1501 of the Tax Law (the first part of the franchise tax) on their income or other tax base. Since they are not subject to the tax on premiums, there would be no cap on their overall tax liability.
Because the Department understood that the TSB represents a major change from its earlier interpretation, it limited its effect to taxable years beginning on or after January 1, 2012. The Department also noted that this change in its interpretation did not have an effect on unauthorized non-life insurers (i.e., insurance corporations that do not transact the business of life insurance). Non-life insurers ceased being subject to the two-part tax some years ago; authorized insurers became subject to a tax on premiums under Tax Law section 1502-a in lieu of the two-part tax, and unauthorized insurers continued to be subject to the tax on allocated entire net income or other tax base only. In addition, the cap that had applied to non-life insurers expired for taxable years on or after January 1, 2003. As a result, the Department's new position had no effect on unauthorized non-life insurers. The TSB did point out that unauthorized life insurers would be required to file CT-33-A, Life Insurance Corporation Combined Franchise Tax Return "if applicable." See New York Tax Law section 1515(f), which addresses combined reporting, and Instructions for Forms CT-33-A, CT-33-A/ATT, and CT-33_A/B, Life Insurance Corporation Combined Franchise Tax Return, 2012, which notes that when included in a combined group on Form CT-33-A, an unauthorized insurance corporation is not subject to the tax on premiums under section 1510, or the cap under section 1505.
Because of this change in position, an issue has arisen about the proper method for allocating an unauthorized life insurer's net income or other tax bases to New York. As previously noted, section 1504 of the Tax Law requires the use of an allocation method based on the percentage of premiums derived from New York (i.e., New York premiums, divided by premiums from all sources) multiplied by a factor of 9, and a New York payroll percentage. The sum of the premiums factor and the payroll factor is divided by 10, and the resulting number is the New York allocation ratio. If an insurer has no payroll in New York, the premiums factor would control. In the event that the tax authorities determine that the allocations factors described above do not "properly reflect the activity, business or income of a taxpayer within the state," Tax Law section 1504(d) grants the Department discretionary authority to direct an insurer to base its allocation on other factors, such as expenses, purchases, receipts other than premiums, real property or tangible personal property.
Applying this premiums and payroll allocation factor methodology to unauthorized life insurers has raised some uncertainty. An article entitled "An Analysis of New York's Position on the Tax Treatment of Unauthorized Insurers," published in the Insurance Tax Review, June 2012, at 793, indicated that the Department was of the view that unauthorized life insurers would not be permitted to use the premiums/payroll allocation method, but rather, would be required to use the "gross receipts" allocation method that is drawn from Article 9-A of the Tax Law, which applies to most other corporations. The apparent basis for this approach was understood to be that as unauthorized life insurers are not subject to the tax imposed on premiums under section 1510, it would be "distortive" to allow the use of a premiums factor for allocation purposes. In order to avoid this distortion, the Department was reportedly going to use its power under section 1504(d) of the Tax Law to require allocation based on its gross receipts.
Notwithstanding the earlier reports, in a very recent conversation with representatives of the Department, they indicated that the Department will require the use of the statutory premiums/payroll factors (or the premiums factor only if there is no New York payroll) to determine the allocation ratio in most cases. In other words, if an unauthorized life insurer receives premiums that can be characterized as "New York premiums," it will be required to use the premiums/payroll or premiums-only method of allocation. The Department's representatives pointed out that the definition of New York premiums for purposes of section 1504 means "premiums written, procured or received on property or risks located or resident in New York." Unlike the provisions of section 1510 of the Tax Law, which applies only to premiums written by authorized insurers, section 1504 would require the use of "orphan" premiums received by an unauthorized insurer in determining its allocation ratio.
Calculation of Tax
As an aside, the instructions for Form CT-33, the New York Life Insurance Corporation franchise tax form, Line 31 requires the use of premiums subject to tax under section 1510 of the Tax Law, "plus any additional premiums on [life insurance, accident and health insurance and other policies] that were written, procured or received in New York on business that cannot be specifically assigned as located or resident in any other state or states that were not included in [the premiums subject to section 1510]." By definition, orphan New York premiums of an unauthorized insurer are not included in premiums subject to tax under section 1510; accordingly, those premiums would have to be included in "additional premiums." The instructions seem less straightforward than the statute; however, section 1504(b) refers to premiums "written, procured or received" on New York risks, whereas the instructions relating to the "additional premiums" refer to premiums "written, procured or received in New York" on risks that cannot be assigned to another state. In other words, the statute focuses on the situs of the risk, but the instructions focus on where the premiums were written, procured or received. As orphan premiums would not generally be written or received in New York, they would be includible in the apportionment formula only if they are "procured" in New York. The instructions to the Form could potentially be improved to reflect the provisions of the statute.
The Reinsurance Issue
Reinsurance presents additional issues. Many reinsurers are "accredited" in New York in order to allow New York ceding insurers to take credit for the reinsurance on their statutory financial statements for cessions to the reinsurer, but accredited reinsurers are not "authorized" in New York. See section 107(a)(2) of the New York Insurance Law (defining "accredited reinsurer" as an "assuming insurer not authorized to do an insurance business in this state"). As a result, beginning in the 2012 taxable year, accredited life reinsurers with real estate investments in New York may be required to pay the Article 33 tax for the first time. New York premiums include reinsurance premiums to the extent they relate to property or risks located or resident in New York. The instructions to Form CT-33, line 34, require including reinsurance premiums from insurance companies authorized in New York, to the extent allocable to New York. An accredited life reinsurer may also find itself with a surprisingly high allocation ratio for New York tax purposes. Total premiums for allocation purposes are net of reinsurance ceded, however. If New York premiums (orphan or reinsurance premiums) have been ceded or retroceded to a reinsurer, they would not be includible in New York premiums for allocation purposes. If, as a result of reinsurance, an unauthorized life insurer or reinsurer had what the Department viewed as an artificially low allocation ratio, the Department could use the discretionary authority under section 1504(d) to "effect a fair and proper allocation" of the unauthorized insurer's income from New York. This would likely be done on a case-by-case basis.
It is likely that unauthorized life insurers in New York are smarting from the recent change in the Department's interpretation of the franchise tax. Moreover, using premiums and payroll to allocate their income and to determine the tax due may cause some challenges for some unauthorized insurers. Nevertheless, this appears to be the current Department position. Then again, some unauthorized insurers with New York real estate interests may not have any premiums from New York sources, or any payroll in New York. In those cases, the insurers may have no New York allocation factor under the premiums and payroll formula, so such insurers should be aware that the Department may take a different position on allocation. In such case, an unauthorized life insurer may want to consider contacting the Department to determine whether under section 1504(d) of the Tax Law it should use gross receipts rather than premiums for its allocation methods. An unauthorized insurer in this posture could do this by seeking an Advisory Opinion or other guidance from the Department as to the proper factors to use.