Self Procurement taxes - Delaware Captive Fall Forum/Self... · 2016-09-22 · and many states have used this to justify imposing self-procurement taxes on the insured entities in

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Self Procurement taxes

Daniel J. Kusaila, Tax Partner

Crowe Horwath LLP


Audit | Tax | Advisory | Risk | Performance © 2015 Crowe Horwath LLP 2

Agenda

What is a procurement tax

Nexus standards and Todd Shipyards

Non admitted Reinsurance Reform Act

Todd Shipyards vs. NRRA

States Reaction

Industries Reaction

What we are seeing

Impact on captive domicile selection

Delaware statute

Questions



What is a Procurement tax

A procurement tax is a tax to the insured entities on gross premium paid to

nonadmitted (unauthorized out of state) insurance companies that was

obtained without a broker.

Approximately 80% of the states have a form of procurement tax.

By using a nonadmitted carrier, the insured has no access to the state’s

insurance department resources or associations in case of a default or

insolvency

States discourage using nonadmitted carriers through the self-procurement tax



Procurement taxes by state

The general procurement tax rates disclosed above are for discussion purposes. Please

note that other fees, taxes and exceptions may apply. Consult your tax adviser or the state

statute prior to remitting tax.

State

Procurement

Tax Rate State

Procurement

Tax Rate State

Procurement

Tax Rate

Alabama 4% Kentucky 2% North Dakota 1.75%

Alaska 3.7% Louisiana 4.85% Ohio 5%

Arizona 3% Maine 3% Oklahoma 6%

Arkansas 2% Maryland 3% Oregon 2%

California 3% Massachusetts Pennsylvania 3%

Colorado 3% Michigan 2% Rhode Island 4%

Connecticut 4% Minnesota 2% South Carolina

Delaware 3% Mississippi 3% South Dakota 2.5%

District of Columbia Missouri 5% Tennessee 5%

Florida 5% Montana 2.75% Texas 4.85%

Georgia 4% Nebraska 3% Utah 4.25%

Hawaii 4.68% Nevada 3.5% Vermont 3%

Idaho 1.5% New Hampshire 4% Virginia

Illinois 3.5% New Jersey 5% Washington

Indiana New Mexico 3.003% West Virginia

Iowa 1% New York 3.6% Wisconsin 3%

Kansas North Carolina 5% Wyoming 3%



Nexus Standards

In general, in order for a state to have authority to tax an entity such as an

insurance company, the entity needs to have sufficient nexus, or connections,

with the state.

The nexus standards applicable to procurement taxes differ from the income

tax nexus standards.

In 1868, the Supreme Court ruled in Paul v. Virginia that the interstate

commerce clause did not apply to the insurance industry. 75 U.S. 357 (1868).

Unlike other industries the business of insurance is regulated by the states and

is not subject to federal interstate commerce regulation – insurance is not

commerce.

New York Life Insurance Co. v. Deer Lodge County reaffiimed that the

insurance industry is only subject to state regulation. 231 U.S. 495 (1913).

Then in 1944 the Supreme Court ruling United States v. South-Eastern

Underwriters Ass’n., held that insurance was in fact interstate commerce which

Congress could regulate under the Commerce Clause. 322 U.S. 533 (1944).



Nexus Standards Continued

With the contradictory Supreme Court ruling, clarification was needed regarding

whether and to what extent the states could continue to regulate and tax

insurance companies.

As a result, in 1945 the McCarran Ferguson Act, 59 Stat. 33 (1945), was

passed leaving the authority of regulation and taxation of insurance up to states

without the restrictions of the Commerce Clause.

Therefore an analysis of nexus is left up to the Due Process and Equal

Protection Clauses of the Fourteenth amendment.



Nexus Standards – Todd Shipyards

In State Board of Insurance v. Todd Shipyards Corp., 370 U.S. 451 (1962), the

Texas Board of Insurance levied and collected self-procurement taxes on a

New York domiciled company that insured property in Texas.

Facts:

Policies issued outside of Texas

Adjusted and paid outside of Texas

Insurers did not solicit business in Texas

Insurers had no agents in Texas

Insurers did not investigate risks or claims in Texas

Although the Due Process Clause nexus standard is much lower than the

Commerce Clause, The United States Supreme Court held that merely insuring

a risk in a state was not sufficient activity under the Due Process Clause to

subject a company to a procurement tax.



Nexus standards continued

Although Todd Shipyards is still good law, the Supreme Court of Rhode Island

argued that use of correspondence directed to insured entities in Rhode Island

was sufficient to provide Due Process nexus for a procurement tax. Associated

Elec. & Gas Ins. Services, Ltd. v. Clark, 676 A. 2d 1357 (1996).

Generally, there is a risk that sufficient activities will be conducted in the home

state of the insured entities when officers of such entities are also officers of the

captive.

Then in 2001, a case with similar fact patterns to Todd Shipyards reaffirmed

that the ruling in Todd Shipyards is the current law and precedent.



Dodd-Frank Implications

The federal Nonadmitted and Reinsurance Reform Act (NRRA) which was part

of the Dodd-Frank Wall Street Reform and Consumer Protection Act, P.L. 111-

203 (July 21, 2010), did not specifically exclude captive insurance companies

and many states have used this to justify imposing self-procurement taxes on

the insured entities in their states.

A number of states, generally captive domicile states, have argued that Dodd-

Frank does not apply to captive insurance companies, however, these public

statements are not binding on the states.



Home state defined under NRRA

(6) HOME STATE. -

(A) IN GENERAL. - Except as provided in subparagraph (B), the term "home

State" means, with respect to an insured-

(i) the State in which an insured maintains its principal place of business or, in

the case of an individual, the individual's principal residence; or

(ii) if 100 percent of the insured risk is located out of the State referred to in

clause (i), the State to which the greatest percentage of the insured's taxable

premium for that insurance contract is allocated.

(B) Affiliated groups. - If more than 1 insured from an affiliated group are named

insureds on a single nonadmitted insurance contract, the term "home State"

means the home State, as determined pursuant to subparagraph (A), of the

member of the affiliated group that has the largest percentage of premium

attributed to it under such insurance contract.

§527(6) of the Nonadmitted and Reinsurance Reform Act of 2010.



Home state defined under NRRA

The home state analysis is performed on a separate policy by policy basis.

ABC Insurance Company

Policy 1

Premium allocation of

Named Insured 1

Premium allocation of

Named Insured 2

Policy 2

Named Insured



Impact of home state

Under the NRRA, the home state of the insured entity is the only state with

authority to collect premium taxes with respect to an insurance policy.

Under this new law states can now be liable for self-procurement tax in states

where they may never have been required to pay this before.

Although there are several agreements for splitting the premium once collected,

if the NRRA applies to captives, then the home state of the insured determines

which state collects either the premium or the procurement tax.

“NIMA” Non-Admitted Insurance Multi-State Agreement:

14 states

22% of surplus lines market

Currently 5 states remaining – board voted to dissolve in April 2016

“SLIMPACT” Surplus Lines Insurance Multi-State Compact

Currently inactive - 9 states

Need 10 to become effective



Todd Shipyards vs. NRRA

Assume Delaware is the location of the headquarters of the holding company

and each of its subsidiaries. The captive is domiciled in Nevada and collects

property insurance premium from the subsidiaries of $1 million. The holding

company only has activity in Delaware. Each subsidiary has 60% of insured

risk related to Delaware operations and 40% insured risk related to Kentucky

operations. Assume the Delaware self procurement rate is 3%.

Insureds

InsurerABC Captive

Insurance Company

(NV)

Holding Co.

(DE)

$100,000

X Sub. Co.

(DE)

$100,000

Y Sub. Co.

(DE)

$300,000

Z Sub. Co.

(DE)

$500,000



Todd Shipyards vs. NRRA (continued)

Home state of holding company and the insured subs would be Delaware.

Under NRRA, procurement tax paid to Delaware because it is home state and there is

insured risk in the state.

Under NRRA self procurement tax due from subs would be $1,000,000 x 3%=

$30,000.

Due to numerous open questions regarding the laws, this is not always as

straight forward as it would appear.



Todd Shipyards vs. NRRA (continued)

Based on the old precedent of Todd Shipyards the analysis will be as follows:

Based upon Delaware risks, the tax would be $1,000,000 x 60% x 3% = $18,000 and

the insured entities would also have to determine if they owed Kentucky any

procurement tax.

Insureds

InsurerABC Captive

Insurance Company

(NV)

Holding Co.

(DE)

$100,000

X Sub. Co.

(DE)

$100,000

Y Sub. Co.

(DE)

$300,000

Z Sub. Co.

(DE)

$500,000



States Reaction

Section 521(b)(1) of the Act suggests that the States may enter into a compact

or establish procedures to allocate the premium taxes paid to the insured’s

home State among the states in which the risk reside.

“NIMA” Non-Admitted Insurance Multi-State Agreement

Gained membership of 14 states

With only currently 5 states remaining on April 28, 2016 board voted to dissolve

“SLIMPACT” Surplus Lines Insurance Multi-State Compact

Gained membership of 9 states

Needs 10 to become effective

National Association of Professional Surplus Lines Offices sees costs of

supporting tax sharing systems exceeds their benefit

Some states have amended their statutes to tax 100% of the premium for home

states with no compact authorized, such as NY.

Some states have used this to try to incentivize captives to redomicile.



Industries Reaction

In November of 2012, a Coalition was developed for Captive Insurance Clarity

(“CCIC”).

Organized by the Vermont Captive Insurance Association.

Actively working with Congress to craft new language to clarify ambiguities in

the present law.

In a letter written by Chairman Judy Biggert of the Subcommittee on Insurance,

Housing and Community Opportunity, she states:

“As a supporter of NRRA and an advocate for its inclusion and passage as part of

Dodd-Frank, I can tell you unequivocally that the NRRA was never intended to include

the captive insurance industry. Unfortunately, the varying interpretations from different

states are having a detrimental impact on the industry.”



What we are seeing

Mature captives are using their historical positions and taking a wait and see

approach before making a change.

Some re-domesticated the captive to the home state.

Some established a new captive to direct write and cede to its original captive.

New formations are being setup with more thought in this area.



Impact on domicile selection

A procurement tax in the home state of the insured entities may influence the

selection of a domicile because it can result in double taxation but it is one of

many factors to consider in domicile selection.

Captive statute differences

Threshold number of risk bearing captive entities under regulation

Reputation and knowledge of the regulators

Familiarity of the regulators with the types of risks to be insured by the captive

Pool of qualified service providers

Ease and desirability of location if annual meetings required



Delaware Procurement statute

Title 18 Insurance Code, Chapter 19. Delaware Nonadmitted Insurance Act,

Subchapter II. Surplus Lines Insurance, § 1925 Tax on surplus lines:

(b) Every surplus lines broker shall collect and pay to the State Treasurer through the

Commissioner a 3 percent tax on the gross premiums charged, less any returned

premiums and exclusive of sums collected to cover federal and state taxes and

examination fees, for insurance placed or procured under his or her surplus lines

license in which this State is the home state of the insured.

(e) Annually, on or before March 1, unless more frequent reporting and payment is

ordered by the Commissioner, each surplus lines broker shall pay the premium tax due

according to subsection (b) of this section for the policies written during the preceding

calendar year as shown by his or her annual statement filed with the Commissioner

pursuant to § 1924 of this title. Payment shall accompany such forms and shall be

made in such manner as is prescribed by the Commissioner.

§ 1926 Independently procured insurance:

(d) At the time of filing the report required in subsection (b) of this section, the insured

shall pay to the State Treasurer through the Commissioner a tax at the same rate and

in the same manner as surplus lines brokers, as required in § 1925(e) of this title.



2016 Delaware law

The rate of the procurement tax is basically the surplus lines rate of 3% (tax is

imposed on the insured).

Dodd-Frank Adopted:

§ 1926 (b) Each insured whose home state is this State that independently procures or

continues or renews insurance with a nonadmitted insurer on properties, risks, or

exposures located or to be performed in whole or in part in this State, other than

insurance procured through a surplus lines broker, is subject to the same tax reporting

requirements under this chapter as apply to a surplus lines broker.

Additional Requirements:

§ 1926 (c) On or before March 1 each year, the insured that independently procures

insurance must file a written report with the Commissioner, upon forms prescribed by

the Commissioner, showing the name and address of the insured or insureds, name

and address of the insurer, the subject of the insurance, a general description of the

coverage, the amount of premium currently charged, and additional pertinent

information reasonably requested by the Commissioner.



Other issues

Note: most statutes that exempt an insurance company from a state corporate

income tax are tied into the insurance company paying that states premium tax

and do not reference the procurement tax. Although, the captive may not have

nexus in the state, whether it is included in the unitary or consolidated return is

often a very difficult determination.

Texas Rule 3.835

States increasing aggressiveness in looking to find income tax or other revenue

from insurance companies.



Disclaimer

The information provided herein is educational in nature and is based on

authorities that are subject to change. You should contact your tax adviser

regarding application of the information provided to your specific facts and

circumstances.

Documents

Self Procurement taxes - Delaware Captive Fall Forum/Self... · 2016-09-22 · and many states have used this to justify imposing self-procurement taxes on the insured entities in