United States

New York: Payments Made to Captive Insurance Subsidiary Not Deductible in Computing Entire Net Income

Aug 14, 2017
From KPMG TaxWatch

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Recently, the New York Tax Appeals Tribunal held that a taxpayer was not entitled to deduct premiums paid to a captive insurance subsidiary in computing New York entire net income for the tax years at issue (2006 through 2009). In reaching this conclusion, the Tribunal upheld an earlier decision in which an Administrative Law Judge (ALJ) had reached the same conclusion. For federal tax purposes, the captive insurance subsidiary was included in the taxpayer’s federal consolidated group and the amounts paid as premiums were eliminated as intercompany transactions on its consolidated returns. For New York tax purposes, the captive insurance subsidiary was not included in the taxpayer’s combined New York reports, but filed and paid insurance tax under Article 33 of New York’s Tax law.   On audit, the Division disallowed the amounts paid to the captive insurance subsidiary for two reasons: (1) they were not allowable deductions under federal tax law and (2) were not “premiums” paid for bona fide insurance. After an ALJ held in favor of the Division, the taxpayer appealed.

Before the Tribunal, the taxpayer made numerous arguments in support of its position. In sum, although the payments were not deductible for federal tax purposes and there was no standalone New York deduction for such payments, the taxpayer essentially argued that New York’s overall captive insurance regime was intended to provide favorable tax treatment for captive insurance companies and the legislature’s intent would be frustrated if the deductions were not allowed. The Tribunal disagreed. There was no provision of New York law that specifically authorized a deduction from entire net income for captive premium payments and the Tribunal declined to infer that such a deduction existed. Under the rules of statutory construction, it is presumed that the legislature is aware of existing tax law when it adopts new legislation. Thus, the legislature knew that federal law controls for the purposes of defining entire net income and that premiums paid in such a captive insurance arrangement would not be deductible in computing federal taxable income. Had the legislature intended to provide a deduction for such premiums, in the Tribunal’s view it would have expressly done so.

The taxpayer also asserted on appeal that the ALJ’s conclusion reached an absurd result because the payments were classified and taxed as “premiums” for purposes of the insurance tax law under Article 33, but could not be deducted as “premiums” in computing entire net income under Article 9-A. The taxpayer argued that the statutes must be read “in pari materia” and that premiums should be treated the same under both Article 33 and Article 9-A. The Tribunal again disagreed. The rule that permits the meaning of a statute to be determined from its construction in connection with another statute may be invoked only where the statute under consideration is ambiguous. Here, there was no ambiguity in New York law with respect to the deductibility of captive insurance premiums. Further, although the captive insurance subsidiary had paid insurance tax on the premiums, the Division now believed that the payments were not premiums under Article 33 and had agreed to refund the tax paid under Article 33. The Tribunal also rejected the taxpayer’s assertions that various amendments to New York’s captive insurance laws and provisions for combining captive insurance companies supported its position that the payments at issue were deductible. In the Tribunal’s view, the legislature was aware of the issue regarding the deductibility of captive premium payments but did not act to make changes to the tax laws to allow for such a deduction. Finally, the Tribunal rejected the taxpayer’s position that the Division was estopped from denying the deduction because it previously treated the captive insurance subsidiary as an insurance companies for purposes of the Article 33 premiums tax. Estoppel applies only in exceptional circumstances that the Tribunal concluded did not exist here. Please contact Russ Levitt at 202-872-6717 with questions on Matter of Stewart’s Shops Corp.

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The following information is not intended to be "written advice concerning one or more federal tax matters" subject to the requirements of section 10.37(a)(2) of Treasury Department Circular 230.

The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.