On June 21, the Indiana Supreme Court ruled that the income received by a package delivery corporation's affiliated foreign reinsurance companies that insured risks located in Indiana was not subject to the state's gross premium privilege tax, and as a result, not exempt from the state's adjusted gross income tax.1 The Court reasoned that the affiliated foreign reinsurance companies failed to meet the necessary prerequisite of "doing business within" Indiana in order to be subject to the premiums tax.
Background
United Parcel Services (UPS) and its affiliates, including a number of reinsurance companies, obtained both worker's compensation insurance to cover its employees and liability insurance to cover damage to packages it delivered to its customers. UPS originally contracted with primary insurers to provide this insurance and subsequently had its affiliates reinsure or indemnify the primary insurers for the risks for worker's compensation and package damage losses. Therefore, in essence, UPS's subsidiaries ultimately insured UPS's risks.
Historically, UPS filed one consolidated Indiana corporate income tax return on behalf of itself and its affiliates. The Indiana Department of Revenue audited UPS's 2000 and 2001 Indiana corporate tax returns. UPS amended its 2000 return to exclude the income of its affiliates from federal taxable income and Indiana adjusted gross income. Similarly, UPS's 2001 return also excluded the income of the affiliates, which resulted in a lower tax liability. The Department denied UPS's request for a refund for tax year 2000 and issued a proposed assessment for underpaid taxes in 2001.
The Department denied UPS's protest of the assessment. The Tax Court granted UPS's subsequent motion for summary judgment, reasoning that because UPS was subject to the premiums tax, it was exempt from the adjusted gross income tax. The matter was appealed to the Indiana Supreme Court, which granted review.
Taxation of Foreign Insurance Companies
In Indiana, foreign insurance companies are required to pay a gross premium privilege tax on earned premiums on policies of insurance covering risks within Indiana.2 This premiums tax essentially serves as an excise tax that permits foreign insurers to do business in the state. An insurance company that is subject to the premiums tax is exempt from the state's adjusted gross income tax.3
Foreign Reinsurance Companies Not Exempt from Income Ta
The issue for the Indiana Supreme Court to decide was whether UPS's affiliates that reinsured UPS's risks were "subject to" the premiums tax and as a result, exempt from the adjusted gross income tax.
While the Indiana Tax Court had previously interpreted the phrase "subject to" to mean that one is only "placed under the authority, dominion, control or influence" of the premiums tax and not necessarily required to pay the tax, the Indiana Supreme Court was of the opinion that being "placed under" such authority or control was not determinative of whether UPS was entitled to the exemption from adjusted gross income tax.
Rather, based on the plain language of the statute, the Indiana Supreme Court determined that in order to qualify for the exemption, the foreign insurance company must be "doing business in this state." The fact that UPS's affiliates collected premiums for reinsurance of risks in Indiana did not by itself establish that the affiliates were doing business in Indiana. In a 1917 Indiana Court of Appeals decision, a state auditor sought to impose premiums tax on reinsurance premiums received by an insurance company that was organized under the laws of New York.4 The Court of Appeals held that the premiums tax only applied to "business done within the territorial boundaries of the state of Indiana." The mere fact that the risks were located in Indiana did not mean that the premiums tax applied. Because the Court of Appeals found that the reinsurance transaction at issue occurred entirely outside Indiana, it held that the reinsurance company was not required to pay the premiums tax.
In the present case, the Indiana Supreme Court determined that the rule of law espoused in the 1917 Court of Appeals decision applied with equal force. Therefore, the decision turned upon whether UPS's affiliates were "doing business within this state." Both the primary insurers and the reinsurers were organized under state laws other than the laws of Indiana. Despite the fact that the risks may have been located in Indiana, the contractual language controlling the reinsurance transactions did not show that the transactions took place in Indiana. The contracts made reference to payments made to a location outside the state, orders and requests made to a location outside the state, and arbitration and choice of venue for locations outside the state. As such, the reinsurers were not doing business within Indiana and did not meet a necessary condition of being subject to the premiums tax. Because UPS failed to meet its burden of establishing that it was entitled to summary judgment as a matter of law, the Indiana Supreme Court reversed the Tax Court's granting of summary judgment in favor of UPS and remanded the case for further proceedings.
Commentary
Often companies are trying to argue that their activities do not rise to the level of doing business in order to prevent the imposition of a tax. This case presents the less common fact pattern where a company tried to argue that its tangential activities did constitute doing business, in order to subject itself to a tax. Of course, the company did so after considering the effect that such conclusion would have on its overall tax footprint - a substantial decrease in its income tax, and no real premiums tax liability as a full exemption from the tax would have applied.
The case also illustrates the relatively common business practice of reinsurance, under which reinsurance companies help to spread the risk of loss and help businesses to insure their own risks without being subject to the federal tax disadvantages of self5insurance. Often, these reinsurance companies carry state tax advantages as well. According to the Indiana Supreme Court, however, out of state reinsurance companies that insure risks located in Indiana do not necessarily qualify for the exemption from income tax normally afforded to foreign primary insurance companies, because the foreign reinsurance company may be agreeing to insure the risks of another foreign insurer. In order to qualify for the exemption, the reinsurance company must be "subject to" the premiums tax by virtue of actually doing business in the state, and the Court determined that UPS's affiliated reinsurance companies were not engaged in that activity.5
Note that the Indiana Supreme Court reversed summary judgment in favor of UPS, but it did not specifically grant the Department's motion for summary judgment. While the Court did not conclude that the Department established it was entitled to summary judgment as a matter of law, it would be difficult for the Tax Court not to come to that conclusion based upon the Indiana Supreme Court's opinion.
This decision clarifies the "doing business" standard somewhat, but does not necessarily benefit taxpayers that argue that certain activities do not result in a finding of nexus for purposes of certain taxes. The Department potentially may be able to use this decision to argue that taxpayers have nexus if they have business activities in Indiana that are more expansive than the activities in the instant case.
Footnotes
1 Indiana Department of Revenue v. United Parcel Service, Inc., Indiana Supreme Court, No. 49S10511075TA5417, June 21, 2012.
2 IND. CODE § 275151852.
3 IND. CODE § 6535252.8(4).
4 State ex rel. Crittenberger v. Continental Insurance Co., 116 N.E. 929 (In. Ct. App. 1917).
5 Note that other states provide an exemption from the general corporate income tax or franchise tax if an insurer is subject to the state's premiums tax. For example, California imposes a gross premiums tax on each insurer doing business in the state, but exempts these insurers from the corporation income tax. CAL. CONST. art. XIII, § 28. The California Franchise Tax Board has held that an insurance company affiliate should not be included in a combined report for a unitary business because it was not a taxpayer subject to the corporation income tax. Legal Ruling 385, California Franchise Tax Board, March 28, 1975. In New York, insurers that are subject to the franchise tax on insurance corporations are exempt from the general business corporation franchise tax. N.Y. COMP. CODES R. & REGS. tit. 20, § 153.4. In Texas, insurance companies that are subject to the annual gross premiums tax are exempt from paying the revised Texas franchise tax. TEX. TAX CODE ANN. § 171.052; 34 TEX. ADMIN. CODE § 583(d)(1). The Texas Comptroller of Public Accounts has held that an insurance company that paid gross premiums tax in another state must be included in the combined Texas franchise tax report because it did not qualify for the franchise tax exemption for insurance companies that pay Texas gross premiums tax. Letter No. 201109204L, Texas Comptroller of Public Accounts, Sep. 30, 2011.
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