A New York State Tax Appeals Tribunal has denied deductions made by Stewart’s Shops (SS) for premium amounts paid to its wholly-owned captive insurance company, Black Ridge Insurance Company (BRIC).
For the tax years from 2006 to 2009, SS, a New York corporation that owns convenience stores and gas stations in upstate New York and Vermont deducted insurance payments that it made to its captive.
Following an audit into SS’ franchise tax returns between 2006 and 2009, the New York Department of Taxation disallowed the claimed deductions and found that the company owed $2 million, plus interest and penalties.
SS then appealed the decision through the Division of Tax Appeals.
In response to that appeal, the administrative law judge determined that the payments to the captive did not constitute insurance premiums under federal tax law and were therefore not deductible from SS’ net income for franchise tax purposes.
The judge did, however, dismiss the penalties as it found that SS had acted in good faith when making the deductions.
SS then sought a review of the judge’s decision through a New York State Tax Appeals Tribunal, however, the tribunal’s final decision was to confirm the previous determinations to deny SS’ deductions for premium amounts paid to BRIC, without assessing any additional costs or penalties.
The Tribunal
The tribunal determined that federal law applied in concluding that SS was not entitled to a deduction from its entire net income for insurance premiums paid to BRIC.
SS then highlighted an amendment to New York Tax Law in 1997 that it argued authorised the creation of captives and intended to establish a favourable tax regime, including allowing a parent company to deduct the insurance premiums paid to its captive as a business expense on the parent’s franchise tax return.
The tribunal disagreed, suggesting that though the 1997 amendment did set a competitive tax rate for captives and establish certain assessments to be paid by a captive, it did not amend the tax law to “provide a statutorily enumerated deduction for premiums paid by a parent corporation to a captive”.
Additionally, the tribunal suggested that other than SS’ assertion that the deductibility of premiums was a critical part of the new captive structure it was unable to highlight any clear part of the 1997 legislation which “actually provides for the deduction it now seeks”.
An important footnote
In Footnote 1 of the memorandum and judgement, the tribunal suggested that SS could have structured the captive arrangement so that requisite risk shifting and risk distribution were included so that the payments to the captive would have “met the criteria for bona fide insurance payments and been tax deductible under federal law”.
The tribunal suggested: “BRIC could have, among other things, insured affiliated companies, formed a group captive insurance company or reinsured its risk with a third-party insurer.”
Adkisson’s analysis
Writing for Forbes, Jay Adkisson, partner at Riser Adkisson, noted that the case illustrates another issue with state taxation of captives–the assumption that because a state has special premium taxes for captives that premiums paid to the captive will be deductible for the parent.
He suggested that there are likely more captives making the same assumption and waiting to find out they’re also mistaken.
More than 600 cases involving risk-pooled 831(b) captives are currently docketed before the US Tax Court, and Adkisson predicted that as well as other tax law challenges, “it could come as a nasty shock for captive owners to have their deductions against state court corporate income taxes denied as well”.
He added: “It is probably worth having competent captive tax counsel review the arrangement, particularly if one is doing business in New York.”
