ALJ Holds That Insurance Payments to Captive Insurance Company Are Not Deductible
In Matter of Stewart's Shops Corp., DTA No. 825745 (N.Y.S. Div. of Tax App., Mar. 10, 2016), a New York State Administrative Law Judge concluded that a corporation operating a convenience store chain could not deduct on its New York corporate franchise tax returns the insurance payments that it made to its wholly owned captive insurance company because such payments would not qualify as valid insurance premiums under federal income tax law.
Facts. Stewart's Shops Corp. ("Stewart's Shops") owns and operates over 300 convenience stores in New York and Vermont. In the face of increasing insurance costs for its operations, Stewart's Shops started self-insuring certain of its risks in 1992. Subsequently, in late 2003 to early 2004, Stewart's Shops decided to create a captive insurance company, Black Ridge Insurance Corp. ("BRIC"), to insure some of its self-insured risks. BRIC received authorization to operate as a captive insurance company licensed by the New York State Insurance Department ("Insurance Department") and provided Stewart's Shops coverage for: (1) losses incurred within the threshold deductible amounts and in excess of the maximum losses covered by its outstanding policies with third-party insurance companies; (2) its self-insured risks and claims from periods before the formation of BRIC ("loss portfolio transfer"); and (3) other risks, including pollution, identity theft, and crime, for which it did not have any insurance at the time of the formation of BRIC.
In the months prior to the formation of BRIC, William Dake, Stewart's Shops' President, engaged in discussions with the Insurance Department's captive insurance group. Mr. Dake testified that, as a result of these discussions, he understood that insurance payments paid to a New York captive insurance company would be deductible for New York corporate franchise tax purposes and believed that Stewart's Shops could not create a stable captive insurance company "without deducting the payments made to BRIC." However, an Insurance Department representative involved in the discussions with Mr. Dake testified that he could not recall representing that the payments were deductible.
BRIC filed annual statements with the Insurance Department and was never contacted by the Insurance Department with any concerns about the annual statements. BRIC also paid New York insurance company franchise tax on the insurance payments from Stewart's Shops. In response to a 2004 tax refund claim from BRIC related to payments received for the loss portfolio transfer coverage, in 2005 the Department issued a letter stating that such payments were properly classified as taxable "premiums" for New York insurance company franchise tax purposes.
In 2010 and 2011, the New York State Department of Taxation and Finance audited BRIC and Stewart's Shops. The Department concluded that BRIC was subject to the insurance company franchise tax and could not be included in Stewart's Shops' combined corporate franchise tax returns because BRIC was an insurance corporation. Nonetheless, the Department also disallowed Stewart's Shops' deductions for insurance payments to BRIC, concluding that such payments would not be allowable deductions for federal income tax purposes. During the audit, Stewart's Shops had conceded that, for federal income tax purposes, the insurance contracts between it and BRIC did not qualify as insurance contracts, and that payments made on such contracts did not constitute insurance premiums.
The Law. New York's corporate franchise tax is calculated based on a corporation's entire net income ("ENI"), and ENI is defined by New York tax law as being "presumably the same as" a corporation's federal taxable income. Tax Law § 208(9). While New York calculates taxable ENI by making numerous adjustments and modifications to the federal taxable income amount, no such adjustments were relevant to Stewart's Shops' insurance payments to BRIC.
The Decision. Based on the language of Tax Law § 208(9), the Department argued that Stewart's Shops' insurance payments were not deductible for New York corporate franchise tax because such payments were not deductible for federal income tax purposes. Stewart's Shops, on the other hand, argued that the term "presumably" in Tax Law § 208(9) allows a departure from federal taxable income when accounting for Stewart's Shops' insurance payments to BRIC, and that such a departure is justified, in part because of the legislative history of New York's captive insurance law, which was designed to increase the number of captive insurance companies operating in the State.
The ALJ decided the first issue in the Department's favor, citing case law stating that "[f]ederal law controls for the purpose of defining 'entire net income'" unless there is a specific state departure. Matter of Dreyfus Special Income Fund, Inc. v. N.Y.S. Tax Comm'n, 126 A.D.2d 368, 372 (3d Dep't 1987), aff'd 72 N.Y.2d 874 (1988). The ALJ rejected Stewart's Shops' claim that New York Tax Law amendments requiring certain captive insurance companies to be included in a New York corporate franchise tax combined return affected such analysis and further concluded that Tax Law § 208(9) did not contain any ambiguity necessitating an examination of the legislative history of New York's captive insurance law.
Although Stewart's Shops had conceded during audit that its insurance payments to BRIC did not constitute insurance premiums for federal income tax purposes, the ALJ nonetheless conducted an independent analysis of federal law and reached the same conclusion. Specifically, the ALJ identified four criteria in determining the existence of insurance for federal income tax purposes: (1) the arrangement must involve insurable risk; (2) the arrangement must meet commonly accepted notions of insurance; (3) the arrangement must shift the risk of loss to the insurer; and (4) the insurer must distribute the risks among its policyholders. While the ALJ concluded that Stewart's Shops satisfied the first two criteria, she also determined that the insurance arrangements with BRIC did not shift the risk of loss or distribute risks among policyholders. The ALJ stated that numerous federal tax cases on the issue had a "common thread," in that "payments from a parent to a wholly-owned captive do not qualify as deductible insurance premiums because the arrangement lacks risk shifting and risk distribution."
The ALJ also rejected Stewart's Shops' claim that the Department was estopped from denying the deductibility of the insurance payments. The ALJ explained that the record did not support a conclusion that the Insurance Department made any representation related to the deductibility of insurance payments by Stewart's Shops to BRIC, and that the Department's letter to BRIC classifying insurance payments as premiums for New York insurance company franchise tax purposes had no bearing on the classification of such payments for federal income tax or New York corporate franchise tax purposes. However, the ALJ waived penalties in part because she found Stewart's Shops' reliance on such letter from the Department on the payments classification under the Insurance Law to be reasonable.
Additional Insights
The Stewart's Shops decision is notable because there is no prior New York precedent examining the deductibility of insurance payments to a captive insurance company. The decision suggests that the deductibility of insurance payments to captive insurance companies for New York corporate franchise tax purposes will generally depend on whether such insurance payments are properly classified as insurance premiums under federal income tax law. However, as decisions from New York ALJs are not precedential, additional guidance from the New York State Tax Tribunal may be necessary to bring further clarity to taxpayers.
Tribunal Holds That Furnishing of Retail Store Pricing Information is Subject to Sales Tax
In two related decisions, the Tax Appeals Tribunal has upheld the imposition of sales tax on the furnishing of retail grocery store pricing information, rejecting arguments made by the vendor and one of the vendor's clients that the information services qualified for the sales tax exclusion for information that is "personal and individual in nature." Matter of RetailData, LLC, DTA No. 825334 (N.Y.S. Tax App. Trib., Mar. 3, 2016); Matter of Wegmans Food Markets, Inc., DTA No. 825347 (N.Y.S. Tax App. Trib., Mar. 10, 2016). The Tribunal decisions make clear that where the source of the information being furnished is readily accessible to the general public – even if the information is not obtained from a common data base nor substantially incorporated into reports furnished to others – the "personal and individual" exclusion does not apply. The decisions relate to the same underlying services, the taxability of which was challenged by RetailData, LLC (the service provider) and by Wegmans Food Markets, Inc. ("Wegmans"), a supermarket chain and RetailData's largest New York client. RetailData provides price checking services for grocery and retail establishments throughout the United States, including New York State. RetailData principally conducts what are known as "competitive price audits" for its clients. This involves collecting pricing information on specified retail products – usually, comparable private label products – sold in a competitor's stores at specified locations. The pricing data is then validated and transmitted to clients electronically or in printed form. The information is obtained from publicly available sources, i.e., the prices of goods on display on sales floors and shelves in competitors' stores. This data is used by RetailData's clients, such as Wegmans, for their own pricing and marketing strategies. The pricing reports furnished by RetailData to one client were never sold to another client.
The Department assessed sales tax against RetailData for failing to collect and remit sales tax for the period June 1, 2005 through May 31, 2011, on the grounds that the company was providing a taxable information service. In a separate case involving the same services, Wegmans was assessed sales tax on the amounts it paid to RetailData for those services for the overlapping period June 1, 2007 through February 28, 2010. RetailData and Wegmans brought separate challenges to the assessments. ALJ Decision. An information service is not taxable if it (i) is personal and individual in nature to each client and (ii) is not or may not be substantially incorporated into reports furnished to other clients. Tax Law § 1105(c)(1). In two separate decisions issued by two different Administrative Law Judges (discussed in the March 2015 issue of New York Tax Insights), the ALJs held that the information services purchased by Wegmans from RetailData were not "personal and individual" in nature and therefore were subject to sales tax pursuant to Tax Law § 1105(c)(1). Neither taxpayer disputed that what was being furnished was an "information" service, so the only issue was whether the purchased information was "personal and individual in nature." The ALJs concluded that it is the source of the information that determines whether the information qualifies for the "personal and individual" exclusion, and it did not matter that the information did not come from a common database, government database, or a published database. These appeals followed.
Tribunal Decision. RetailData and Wegmans made essentially the same arguments before the Tribunal as they did before the ALJs, the thrust of which was that each report being furnished was tailored to a client's specific needs and was therefore never substantially incorporated into reports furnished to others, and that the information being provided in those reports was not derived from a common database, a governmental database, or a published database and was therefore "personal and individual" to each client.
The Tribunal affirmed both decisions, holding that the information being provided was not "personal and individual in nature" under Tax Law § 1105(c)(1). While noting that tax exclusions are to be strictly interpreted in the taxpayer's favor, the Tribunal also pointed out that the burden of proof still rested with the taxpayer to establish entitlement to the exclusion, concluding that the taxpayers' burden of proof was not met. The Tribunal held that in order to qualify for the "personal and individual" exclusion, the information must be "uniquely personal," citing Matter of Allstate Ins. Co. v. State Tax Comm'n, 115 A.D.2d 831, 834 (3d Dep't 1985), aff'd, 67 N.Y.2d 999 (1986). Since the information being furnished – the price of products on the shelves of supermarkets open to the public – was not "uniquely personal," it did not qualify for the exclusion. The fact that no two reports are likely to be the same because they were customized for each client did not change this conclusion.
The Tribunal also rejected the argument that whether information qualifies for the "personal and individual" exclusion depends on whether it is obtained from a common database, a government database, or a published database, factors which had been cited in other decisions involving information services. According to the Tribunal, the information did come from a "common source" that was not confidential and was widely accessible – non-confidential pricing information obtained from the shelves of competitor supermarkets that were open to the public, citing Matter of ADP Automotive Claims v. Tax App. Trib., 188 A.D.2d 245 (3d Dep't 1993) (upholding the imposition of sales tax on the furnishing of cost estimates for automobile repairs using information obtained from widely circulated publications). The Tribunal rejected the taxpayers' claim that only information taken from publicly accessible electronic databases or published bulletins ran afoul of the "personal or individual" exclusion.
Additional Insights
Unless reversed on appeal, these two Tribunal decisions establish a narrow interpretation of the "personal and individual" exclusion from taxable information services. Under the holdings in these two decisions, so long as the source of the information being furnished is publicly available, it does not matter that it was not obtained from a common database, or that it was not substantially incorporated into reports furnished to other clients. Although there is considerable case law holding that the provision of information obtained from a publicly accessible common database does not qualify as personal and individual, these two decisions extend the disqualifying publicly accessible database criteria to include any source of publicly available information. In that regard, Matter of RetailData and Matter of Wegmans are potentially important cases that may have a significant impact on the taxation of information services in New York State.
Although not discussed in the decisions, the Department should only be entitled to collect the sales tax once with respect to the information services furnished by RetailData to Wegmans.
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Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.
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