On July 13, 2020, the Maryland Tax Court held that a captive insurance company subject to the state’s premium receipts tax as an unauthorized insurer was exempt from the corporate income tax on its non-premium related income.1
Taxation of insurance companies
Maryland generally imposes an income tax on the taxable income of each corporation doing business in the state.2 Consistent with constitutional limits, Maryland taxes all foreign corporations based on the portion of their income derived from or reasonably attributable to its in-state trade or business.3
Like most states, however, Maryland treats insurance companies differently than general businesses. Pursuant to Title 6 of the Insurance Article of the Maryland Tax Code, insurance companies pay a 2% tax on all new and renewed premiums that are allocable to Maryland and written during the preceding tax year.4 For such insurance companies, the premium receipts tax is the only tax they pay as insurance companies subject to taxation under this provision are exempt from the Maryland corporate income tax.5 For insurance companies that are unauthorized6 under Title 6 of the Insurance Article, a 3% tax is imposed on premiums under Title 4 of the Insurance Article, instead of the 2% tax on authorized insurance companies.
The taxpayer, a captive insurance company licensed and incorporated in Vermont, provides insurance for its parent company retailer, its subsidiaries and affiliates. During a 2010 audit of the corporate parent, the Maryland Comptroller discovered that the parent company had claimed roughly $2 billion in deductions for interest payments made to the taxpayer. The Comptroller assessed the taxpayer approximately $24 million in tax, penalties and interest for the 1996-2003 tax years based on this interest income.
The taxpayer appealed the Comptroller’s assessment to the Maryland Tax Court, which held that the taxpayer was subject to tax as an authorized insurance company under Title 6 of the Insurance Article and qualified for a corporate tax exemption. The Comptroller appealed, arguing that the taxpayer was not subject to taxation under Title 6, because it was an unauthorized insurer subject to taxation instead under Title 4 of the Insurance Article. Upon appeal, the Circuit Court for Anne Arundel County held that the taxpayer was exempt from the corporate income tax, either as an authorized insurer under Title 6 or as an unauthorized insurer under Title 4.
Following a further appeal by the Comptroller, the Maryland Court of Special Appeals held that the taxpayer did not qualify as an authorized insurer because it did not have, and was not required to have a certificate of authority from the Maryland Insurance Commissioner.7 However, the Court of Special Appeals declined to consider whether Title 4 provided a corporate tax exemption for unauthorized insurers, even though a provision in Title 4 states that the premium receipts tax on unauthorized insurers applies “instead of all other State taxes.”8 The Court of Special Appeals remanded the case for determination of whether the taxpayer was exempt from the corporate income tax because it was subject to a premium receipts tax as an unauthorized insurer under Title 4.
Tax Court decision
At the Court of Special Appeals’ direction, the Tax Court concentrated on the issue of whether Title 4 of the Insurance Article provides a corporate tax exemption to captive insurance companies like the taxpayer. The Comptroller argued that the taxpayer, as an unauthorized insurance company, is subject to Maryland corporate income tax because Title 4 levies a tax on insurance premiums rather than insurance companies. Further, the taxpayer did not earn any Maryland premiums from 1997-2003, but had substantial non-premium-related investment income. Thus, the Comptroller sought to tax the investment income by assessing corporate income tax in addition to the tax on premiums. Specifically, the Comptroller contended that the taxpayer should be treated like a financial institution, rather than an insurance company, and that the exemption provided by Title 4 applies only to insurance-related income.
As an unauthorized insurance company, the taxpayer only engaged in re-insurance transactions, and was not required by Maryland law to possess a certificate of authority. Further, it paid no premiums tax during the years at issue. The Court noted that all insurance companies, whether authorized or unauthorized, earn non-premium income to maintain adequate capital to cover their business risks. As a re-insurer, the taxpayer was responsible for maintaining enough capital to meet its obligations in the event of a covered loss.
The Court explicitly rejected the Comptroller’s argument that the exemption language included in Title 4 of the Insurance Article is meant only to exempt unauthorized insurers from sales and use tax, citing a previous decision in support of its conclusion that the Maryland legislature intended that unauthorized insurance companies are exempt from all other Maryland taxes.9 Further, the Court found no basis in the Comptroller’s position that the income of any unauthorized insurer is subject to Maryland corporate income tax. Finally, the Court disposed of the Comptroller’s argument that “it defies logic or common sense” to conclude that the General Assembly intended the exemption to shelter the taxpayer from all tax on approximately $2 billion of income from non-premium receipts. Instead, it reasoned, the legislature was fully aware that corporate income tax was included in the meaning of “all other State taxes” set out in the exemption. Accordingly, the Tax Court reversed the Comptroller’s assessment of corporate income tax.
It is interesting that the Comptroller sought to tax the interest income at issue by focusing solely on rejecting the taxpayer’s claimed exemption from corporate income tax. Query whether the Comptroller could have challenged the validity of the captive insurance company itself through an economic substance argument. Alternatively, the Comptroller might have wanted to challenge the interest deduction taken by the taxpayer’s parent company during the original audit. As a means to prevent companies from engaging in related-party transactions that would result in permanent state tax benefits in separate reporting jurisdictions. for corporate income tax purposes for taxable years beginning after 2003, Maryland law generally requires taxpayers to add back interest paid to related parties to federal taxable income in computing state taxable income.10
Certainly, these methods would have more closely aligned with other litigation dealing with related-party transactions.11 However, the Comptroller might have been unable to make a direct challenge in this manner, on the basis that the statutory provisions disallowing deductions for certain amounts paid to related parties do not appear applicable to transactions between general corporations and insurance companies taxed in a completely different manner, and governed by completely different sections of Maryland law.
Notably, the Court focused solely on the statutory construction of Maryland law in its decision, and not an analysis of the federal limitation on the ability of a state to assert tax under the McCarran-Ferguson Act. It would be interesting to know how and if the pertinent issues and analysis would have been impacted if the taxpayer had been an authorized insurer.
The case does provide some comfort for business enterprises with captive insurance companies operating similarly to the taxpayer at issue. It should be noted that the case also highlights the Comptroller’s continuing persistence in challenging intercompany transactions that minimize tax revenue in a separate reporting environment.
1 Leadville Insurance Co. v. Comptroller of Maryland, No. 13-IN-OO-0035, Maryland Tax Court, July 13, 2020.
2 MD. CODE ANN., TAX-GEN. § 10-102.
3 MD. CODE ANN., TAX-GEN. § 10-402(a).
4 See MD. CODE ANN., INS. § 6-102.
5 MD. CODE ANN., TAX-GEN. § 10-104(4).
6 An unauthorized insurer is defined as an insurer which does not hold a certificate of authority in Maryland. MD. CODE ANN., INS. § 1-101(rr).
7 Comptroller of Maryland v. Leadville Insurance Co., No. C-02-CV-17-001285, Circuit Court for Anne Arundel County (Unpublished), Mar. 26, 2019.
8 MD. CODE ANN., INS. § 4-209(c).
9 See MEDCO v. Montgomery County, 431 Md. 189, Md. Court of Appeals (2013). In that case, Montgomery County attempted to restrict similar exemption language by interpreting a statute to exempt only direct taxes and not excise taxes. The Court interpreted “all or any” taxation to mean that the Maryland legislature intended a broad and expansive meaning of the exemption.
10 MD. CODE ANN., TAX-GEN. § 10-306.1(b)(2).
11 See, for example, In re ConAgra Brands, Inc., Maryland Circuit Court for Anne Arundel County, No. C-02-CV-15-993, Oct. 19, 2015 and Michigan Host, Inc. v. Comptroller of the Treasury, Maryland Tax Court, No. 12-IN-00-1187, Feb. 1, 2017. GT SALT Alert: Maryland Tax Court Finds Out-of-State Subsidiary Lacked Economic Substance Separate From Maryland-Based Parent
Jamie C. Yesnowitz
Jamie Yesnowitz, principal serving as the State and Local Tax (SALT) leader within Grant Thornton's Washington National Tax Office, is a national technical resource for Grant Thornton's SALT practice. He has 22 years of broad-based SALT consulting experience at the national and practice office levels in large public accounting firms.
Washington DC, Washington DC
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