CAPTIVES: PROCUREMENT TAXES, REGULATORY ISSUES, AND NRRA

Transcription

1 CAPTIVES: PROCUREMENT TAXES, REGULATORY ISSUES, AND NRRA Jason Kimpel, Partner, Faegre Baker Daniels LLP Moderator Mike Lusk, Vice President--Insurance and Risk Management, ADM Fred Pomerantz, Partner, Wilson Elser Ken Levinson, Partner, Faegre Baker Daniels LLP March 12, :00 PM

2 Panelists Jason Kimpel, Partner, Faegre Baker Daniels LLP, (317) , Mike Lusk, Vice President--Insurance and Risk Management, Archer Daniels Midland, (217) , Fred Pomerantz, Partner, Wilson Elser, (212) , Ken Levinson, Partner, Faegre Baker Daniels LLP, (612) , 2

3 1. NRRA Update 2. Application of Direct State Procurement Taxes 3. Recent Federal and State Tax, Audit Issues 4. Comparison of U.S. State and International Insurance Issues 3

4 1. NRRA Update 4

5 Interaction with NRRA NRRA does not expressly mention captives Intention generally of NRRA was to simplify state taxation and regulation of surplus lines insurance; captives per se weren t addressed in the legislation, but the applicable definitions could threaten captive structures Independently procured insurance within NRRA definition of nonadmitted insurance is any property or casualty insurance permitted to be placed directly or through a surplus lines broker with a nonadmitted insurer eligible to accept such insurance P.L , 527 (9) Independently procured insurance also defined separately in NRRA: insurance procured directly by an insured from a nonadmitted insurer. 527 (7) Query: is a parent-owned captive covered? What about a group captive? 5

6 Interaction with NRRA (cont.) White Paper Discussing the NRRA and Its Potential Application to Captive Insurance, McIntyre & Lemon, PLLC (Oct, 6, 2011) ( White Paper ): Cites legislative history to provide intent for NRRA to reform surplus lines insurance regulation and allocation of premium taxes Reading the statute broadly to include independently procured insurance as nonadmitted insurance is contrary to the legislative intent of the NRRA, its statutory construction and the history of its language. Captive insurance not viewed as surplus lines insurance placed by an eligible nonadmitted insurer, nor do captive insurers seek to be surplus lines insurers. 6

7 Interaction with NRRA (cont.) On November 15, 2012, VCIA announces formation of a new coalition of the captive industry to push for clarity on NRRA's applicability on captives. Coalition for Captive Insurance Clarity seeking legislative language clarifying that captive insurance companies are not subject to NRRA. FaegreBD Consulting, one of the architects of NRRA, hired by VCIA and working in partnership with Mclntyre & Lemon PLLC. On January 8, 2013, it was announced that outgoing Chairman of the Subcommittee on Insurance of the Committee on Financial Services in the House of Representatives, Judy Biggert, reaffirmed in a letter to the new Chairman and Ranking Member of the Committee that NRRA was never intended to apply to captive insurance. "I can tell you unequivocally that the NRRA was never intended to include the captive insurance industry." 7

8 2. Application of Direct State Procurement Taxes 8

9 State Procurement Taxes The U.S. Supreme Court s protection of Direct Procurement dates back to 1897: Allgeyer v. Louisiana, 165 U.S. 578 (1897) St. Louis Compress Co. v. Arkansas, 260 U.S. 346 (1922) CT. Gen l Life v. Johnson, 303 U.S. 77 (1938) Direct Procurement recognized in statute by 38 states; in Delaware and N.Y.S. by case law Peo. v. Brit. & Amer. Casualty Co,133 M. 2d 352 (1986) Atlas Mut. Ins. Co. v. Fisheries Co., 22 Del. 256 (1907) 9

10 Todd Shipyards State Board of Ins. v. Todd Shipyards Corp., 370 U.S. 451 (1962): narrow parameters for Direct Procurement. The first judicial decision following enactment of the McCarran- Ferguson Act, which reserves to the states exclusive right to tax and regulate the business of insurance. Also implicitly recognized by NRRA Multi-state policy issued by unlicensed alien insurers that insured Texas property owned by N.Y. corporation Invalidated tax levied: no Texas state nexus except for the location of the insured property Applied Due Process Clause Test (Transactional nexus and taxpayer nexus) 10

11 Todd Shipyards (cont.) Parameters as defined in Todd Shipyards: Policy negotiated/issued outside of Texas; Premium paid outside the state; Losses adjusted and paid outside of Texas; Insurers were not licensed in Texas; No offices or agents in Texas; Policies not solicited in Texas; and No adjustment of claims in Texas. Todd Shipyards analysis narrowed by state decisions: Howard v. Rosecliff Realty, 52 N.J. 313 (Sup. Ct. 1968) Haisten v. Grass Valley Med. Reimb. Fund, 784 F. 2d 1392 (9 th Cir. 1986) Assoc. Gas & Elec. Ins. v. Clark, 676 A. 2d 1357 (Sup. Ct. R.I. 1996) 11

12 Other Cases Dow Chemical v. Rylander, 38 S.W. 3d 741 (Tx. Ct. App. 1/01), cert. den. 10/01 Questioned right to tax state premium for independently procured policies Extended analysis in Todd Shipyards Location of risk insufficient nexus for taxation purposes Reporting/payment a safe harbor per TDI Texas State Comptroller s Office, January 2007: A policyholder owes independently procured insurance tax on policies: negotiated outside Texas, that cover property or risks located in Texas, obtained from an insurance company not licensed to do business in Texas if any contacts with Texas, including but not limited to: 12

13 Other Cases Dow Chemical (cont.) Texas State Comptroller s Office, January 2007 (cont.): A policyholder owes independently procured insurance tax on policies: if any contacts with Texas, including but not limited to: policies paid for in Texas; policies or related documents issued or delivered in Texas; Underwriting conducted in Texas prior to or subsequent to issuance; and loss and claims adjustments, other investigations or loss payments in Texas. TDI interpretation of Dow: Location of risk insufficient nexus for taxation Safe harbor : prevents determination of unauthorized insurance activities, but reporting and paying tax is part of the safe harbor 13

14 3. Recent Federal and State Tax, Audit Issues 14

15 I.R.S. Rulings and Structuring Considerations Key common principles established in 2002 (and subsequently reinforced) by the IRS for captives to qualify for Federal tax benefits: All premiums must be pooled by the captive; all assets (premiums, reserves, surplus) must be available to pay all risks being insured Captive cannot loan funds to its parent, owner(s) or insureds No parent or insured can guarantee the captive s performance Additional requirements for qualification as an insurance company: Adequate risk shifting and risk distribution requires that a loss by one policyholder is not borne in substantial part by such insured s premiums Captive must still meet business purpose, administrative/regulatory requirements, arms-length pricing, proper documentation, etc. 15

16 I.R.S. Rulings, Structuring Considerations (cont.) In Parent/Sub captive cases: More than half of captive s risks must be third party risks or captive does not qualify as an insurance company In Brother/Sister captive cases: Adequate risk shifting and risk distribution occurs with 12 insureds, each with 5% - 15% of the risks or arrangement does not qualify as insurance No ruling has yet combined parent/sub and brother/sister fact patterns No guidance as to whether a valid brother/sister insurance arrangement can absorb/shelter some parent risk, or if third party risk can cure brother/sister risk distribution or risk concentration issues In 2009, IRS looked through fronting structures to analyze risk shifting/risk distribution Apparent inconsistency between Rev. Rul look through of reinsurance and previously rigid view of single insured / 90% cases 16

17 Captive Tax Ruling Brother/Sister Rev. Rul (four Situations, all involving an unrelated insurer insuring risk of loss from the insured s operating courier business/fleet): Situation 1: single insured, no guarantees or loan-backs; HELD: no risk distribution Situation 2: two insureds (90%, 10% of insurer s risks); HELD: no risk distribution Situation 3: 12 SMLLCs (single member LLCs) as insureds (all between 5% - 15% of insurer s risks); HELD: treatment as disregarded entities means no risk distribution (like Situation 1) Situation 4: 12 SMLLCs all of which elected to be taxed as corporations (all between 5% - 15% of insurer s risks); HELD: good insurance per (Rev. Rul ) 17

18 Rev. Rul Captive Tax Ruling Cell Structures Two situations, each involving a segregated/protected cell structure insuring professional liability risks Each cell funded by capital contributions plus arms-length premiums Assets of each cell statutorily protected from creditors of other cells and from creditors of protected cell company itself. No guarantees of cell liability, no loan-backs by cell to cell owners Situation 1 cell insures risks of single insured; held no risk shifting or risk distribution Situation 2 cell insures risks of 12 corporate subsidiaries of owner, each having 5% - 15% or risks; Held good insurance 18

19 Rev. Rul Captive Tax Rulings: Reinsurance Two Situations involving reinsurance structures with unrelated reinsurers Situation 1: Insurer Y has 10,000 unrelated insureds for multiple commercial perils; Y quota-shares with Reinsurer Z for 90% of the risks for 90% of the premiums; this was Z s only risks; HELD: good insurance, good risk distribution Situation 2: Insurer Y has risks from unrelated insureds for multiple commercial perils; Y reinsures only one insured s entire risks (X s) with Reinsurer Z, which also reinsures similar risks of other insurers; HELD: good risk distribution as to X s risks reinsured by Z 19

20 State Tax Issues Captive may be excluded from unitary group, and is separate entity in separate return states Inter-group premium payments generally not added back into state taxable income (unlike inter-group interest, royalty payments) Note: if state tax law wholly conforms to federal law (Internal Revenue Code), the IRS interpretation of insurance would also control state tax consequences of captive arrangement In states with partial conformity, the federal tax guidelines in the captive insurance area may be followed -- it depends on the various state laws May have obligation to register or pay state premium/self procurement tax States are not parties to US tax treaties, so business or relationships within a state of foreign-domiciled captives may still subject those captives to local income tax and/or state premium tax (even if exempt from FET on premiums) State-licensed captive generally exempt from that state s income tax (investment earnings and underwriting profits are not subject to state income tax) Premium payments generally deductible by payor/insureds 20

21 Loan-backs IRS Audit Activity Direct or indirect; recharacterization concerns Non-insured affiliates as borrowers Use of proceeds themselves Arms length terms Creditworthiness to repay (without parent/affiliated insured guarantee) Regulatory approval (irrespective of Federal tax consequences) Contingent Equity arrangements Risk Distribution / Risk Concentration issues Too much risk/premium from one (or few) legal entities Rollup effects of SMLLCs (Rev. Rul , Sit. 3); disparate treatment by Agents of multimember LLCs/partnerships (TAM , PLR ) Taxpayer responses, opportunities 21

22 IRS Audit Activity (cont.) Effects of Adverse Federal Tax Audit Outcome The arrangement doesn t qualify as insurance The captive doesn t qualify as an insurance company State conformity implications if Federal tax deduction for premium expense is reduced/eliminated or if permissible reserve deduction for tax purposes is reduced upon audit at consolidated parent level or if captive not respected as insurance company (see Illinois DOR v. Gatsby Industries, Inc.) FIN 48/UTP positions, reserves Effect of Federal audit adjustment on multiple years; accounting reconciliation, adjustments and footnotes Treatment for Domicile state s annual report/certified financials and state premium tax purposes NRRA nuances: What is effect, if any, if the captive is not characterized as an insurance company under Federal tax law? 22

23 Surplus Lines Taxes State Audit Activity Surplus lines taxes asserted against broker/consulting services payments Targets: brokers/big clients with range of services/advisory consulting for a set fee, irrespective of where, whether, from whom or how much insurance is purchased Failure of invoice or accounting to identify a commission amount State law definition of taxable premium (MINN: Taxable Gross Premiums include fees and commissions ) 23

24 State Audit Activity (cont.) Unitary Inclusion of Captives: Illinois Dept. of Rev. v. Gatsby Industries Inc. (IL Admin Hearing IT 00-10, No. 98-IT-0000, May 26, 2000.) Illinois income tax audit of exclusion of Vermont captive (Pennypacker Insurance Company) from Illinois unitary group (parent: Gatsby, a PA corp.) VT licensed Pennypacker as an insurance company and collected premium tax on payments of premiums to that company Pennypacker loaned virtually all its assets to its indirect parent, Gatsby (~98%), amounting to $474 MM during the audit years IRS did not recognize Pennypacker as an insurance company for federal tax purposes, and captive did not file 1120PC ( premiums treated as contributions to capital; claim payments as dividends to its parent) IL law starts with federal taxable income : if the insurer is not regarded as a valid insurance company in the determination of [its] federal taxable income it cannot be valid under Illinois tax law, according to the decision Accordingly, Pennypacker was not excludable from the IL unitary group 24

25 State Audit Activity (cont.) Doing Business/Licensing of IP by Captives: the Wendy s cases Wendy s International Inc. v. Virginia Dep t of Tax n, VA Cir. Ct. No. CL , Mar. 29, 2012; Scioto Insurance Co. v. Oklahoma Tax Comm n, Okla. No , May 1, Wendy s International Inc. ( WII ) formed Scioto (a VT Captive), which formed Oldmark (a disregarded SMLLC); Scioto insured risks of WII and affiliates, but did not insure franchisees or any Wendy s risks in Oklahoma Oldmark acquired Wendy s trademarks/trade names/copyrights, and licensed them back to WII (for 3% of gross restaurant sales);wii sublicensed them (for 4% of gross restaurant sales) to third party Wendy s restaurants in Oklahoma (and elsewhere) Virginia concluded that Wendy s qualified for the exception it its add-back rules (since at least 1/3 of Oldmark s income, per VA law, was attributed to unrelated restaurants from the royalty income derived from its license to WII, even though it was not paid directly by the unrelated restaurants); royalty payable to Oldmark not added back to WII income Oklahoma concluded that it had no connection or power to tax income to Oldmark from the WII license, since Oldmark didn t contract directly with the unrelated restaurants and had to be paid by WII regardless of whether WII received payments from the sublicensee restaurants. 25

26 State Audit Activity (cont.) Reinsurance Captives and Doing Business in State: Indiana Department of Revenue vs. UPS, Inc. (Ind. Sup. Ct., No. 49S TA-417, June 21, 2012) UPS established two offshore reinsurance companies, UPINSOC (U.S. Virgin Islands) and UPS Re (Bermuda), to reinsure employee workers comp risks and liability for damage to its customers packages, both of which policies were fronted by commercial U.S. carriers Indiana risks were included in those reinsured by the two captives, but neither was licensed to do business in Indiana or paid premium tax on the Indiana risks UPS excluded the premium income attributable the Indiana risks of the reinsurers from its Indiana corporate tax return, and claimed the exclusion was based on preemption by being subject to the Indiana premium tax law instead (even though UPS claimed no premium tax was due under that law because the reinsurance transaction did not take place in Indiana) The Indiana Supreme Court held that merely collecting premiums attributed to Indiana risks does not mean the reinsurers were doing business there, and the reinsurance transaction did not occur in Indiana Since doing business was a prerequisite to being entitled to the income tax exemption under Indiana law, the Court remanded the case for further proceedings 26

27 State Insurance Regulator Challenges After NRRA State of Washington View Washington s surplus lines law adopts the home state definition of the NRRA and Washington law follows the NRRA approach in most respects. Washington further defines principal place of business as the state where the insured maintains its headquarters and where the insured's high-level officers direct, control, and coordinate the business activities of the insured. Hertz v. Friend,130 S. Ct. 1181; 175 L. Ed. 2d 1029 (2/8/2010) Washington has never recognized/taxed policy premiums in transactions by insurers and captives using direct procurement Cease and Desist Orders issued by State of Washington OIC against two insurers, one a direct procurement insurer in the student loan market (2011), the other an offshore medical malpractice captive insurer (2010) Licensed insurer (in its state of domicile) that guarantees to banks and credit unions repayment on 100% of private student loans, and issues surety bonds by direct procurement. Federal lawsuit pending against the Washington OIC in the U.S.D.C., W.D. Tacoma, Washington 27

28 Enforcement Implications of NRRA Against Captives: Risk Retention Reporter, Nov. 2012: A Coming Storm by Faegre Baker Daniels LLC IRMI.com McIntyre & Lemon, PLLC White Paper Oct Coalition for Captive Insurance Clarity activity Other than Ms. Biggert's reaffirmation that NRRA was not intended to apply to captive insurance, little to no authority on point, thus far 28

29 4. Comparison of U.S. State and International Insurance Issues 29

30 Tax Implications for Multinational Programs Sources of information Admitted vs. Non-admitted Legal Requirements Business Reasons 30

31 Reinsurance Issues Brazil India Argentina Front Company 31

32 Claims Issues Capital Tax Financial Interest India Lessons Currency Exchange 32

33 Compliance Payment of Tax Contractual Obligations D & O 33

34 Questions? Thank you all for your participation and attendance 34