22nd Annual Health SciencesTax ConferenceState and local tax and insurance tax updateDecember 5, 2012
Disclaimer►   Any US tax advice contained herein was not intended or    written to be used, and cannot be used, for the pu...
DisclaimerErnst & Young refers to the global organization of member firms of Ernst & YoungGlobal Limited, each of which is...
Presenters►   Kelvin Ault                                       ►     Brad Withrow    Sr. Vice President of Tax           ...
Post-election state and local tax implications
Election 2012 — federal races►   Why is federal outcome important for state taxes?    ►    Presidential, Senate and House ...
Election 2012 — state racesBallot initiatives — tax                  ►     Proposition 30 (Governor Brown)                ...
Election 2012 — state racesBallot initiatives — tax                  ►     Proposition 39 (co-chair Tom Steyer)           ...
Election 2012 — state racesGovernors races►   Governors races    ►    Only 12 state governors races in 2012         ►   Mo...
Pre-2012 election: who controls stategovernments?                                             Republicans                 ...
Post-2012 election: who controls stategovernments?                                             Republicans                ...
2010 composition of state legislatures                                             Republicans held both houses           ...
2012 post-election composition of statelegislatures                                        Republicans held both houses   ...
2012 post-election supermajorities                         Republicans supermajority both houses                          ...
States where one party has “supermajority”legislative control ►   2/3 Republican control of both                          ...
Business tax issues being addressed►   Sales tax on business inputs►   Taxation of tangible personal property►   Growing i...
States considering tax reform►   Connecticut    ► Business tax task force recommends phase-out of      corporate income ta...
States considering tax reform►   Iowa    ►     Governor Branstad (D) proposing income and property tax cuts for          b...
Blurring lines between tax-exempt andtaxable health care providers
Recent events►   Ascension Health forms joint venture with Oak Hill Capital    Partners to acquire hospitals in a taxable ...
Related articles►   “Illinois hospital tax break costs $10M, could help    MetroSouth,” Southland News, November 9, 2012► ...
2006 Congressional Budget Office studyPage 22    State and local tax and insurance tax update
Illinois charity care credit►   Income tax credit equal to the lesser of    ►     Property taxes on hospital parcel       ...
State tax implications: electronic healthrecords
Medicare and Medicaid electronic healthrecord incentive programs►   Medicare incentive payments    ►     The American Reco...
State tax issues: EHR incentives receipts►   State income tax implications of the incentives receipts    ►     Federal inc...
State tax issues: EHR expenditures►   Sales tax issues related to multistate hardware and    software costs►   Credit and ...
State tax nuances►   Texas margins tax    ►     Health care providers (100% exemption for government revenue)    ►     Hea...
Nonresident withholding
Introduction►   More and more states are focusing on nonresident withholding    ►     States are looking for money and man...
Nonresident withholding: Georgia►   Georgia audit example    ►     Notification of audit    ►     Assessments at the partn...
Working in the clouds: state taxconsiderations of cloud computing
Background►   Cloud computing is the delivery of shared resources, software and    information over a network or the inter...
Cloud computing definedThe three primary service models of cloud computing are:► Software as a Service (SaaS): application...
What’s happening now in the states?►   States try to expand existing law►   Legislative, judicial and regulatory developme...
Why have the issues become so prevalentfrom a sales-tax perspective?►   Hosted software, “cloud” computing and ASP    ►   ...
Sales tax on software►   Who is the “taxable person”?    ►     Is the vendor or the hosting company physically present in ...
Sales tax on software: classificationdetermines taxability►   First consideration    ►     Canned          ►   “Off-the-sh...
Sales tax on software: cloud computing(ASP model)►   Is the transaction taxable?    ►     Look to state treatment of ASP/S...
Sales tax on digital goods and services►   How are digital goods/services taxed?    ►     SST states          ►   Specifie...
Sales tax on digital goods and services►   What are digital goods/services?    ►     SST: “specified digital products” mea...
Sales tax on digital goods and services►   Federal    ►     The proposed law (The Digital Goods and Services Tax Fairness ...
Sales tax sourcing issues►   Should transaction be sourced (i.e., taxing location) based    on:    ►     Location of the s...
Multistate Tax Compact (the Compact)election
California►   S.B. 1015 (enacted June 27, 2012) — repeals all    provisions related to the Compact, effective immediately ...
Other states►   Michigan    ►     H.B. 4479 (enacted May 25, 2011) — beginning January 1, 2011,          taxpayers cannot ...
Texas margins, Compact developments andother updates►   In three recent rulings — Decision Nos. 106,503 (August 10, 2012),...
State taxation of premiums paid to captives
State taxation of premiums►   Premium tax    ►     Assessed against admitted insurance company    ►     Based on premiums ...
Independently procured insurance tax►   Imposed by a majority of states►   Statute varies state by state►   Historically, ...
Pre-Dodd–Frank contracts in effect prior toJuly 21, 2011►   The typical statute applies tax when insurance is procured    ...
Limitation on independently procuredinsurance tax — Todd Shipyards►   Todd Shipyards 370 U.S. 451 (1962)    ►     A New Yo...
Is Todd Shipyards still valid?►   Associated Electric & Gas Insurance Services, Ltd. 676    A.2d 1357 (RI 1996) AEGIS    ►...
Limitation on Todd Shipyards►   STP Nuclear Operating Company 239 S.W.3d 264 (Tex.    App. Austin 2007)    ►     Applicati...
Non-admitted and Reinsurance Reform Act(NRRA)►   NRRA part of Dodd–Frank legislation►   Enacted into law in July 2010, wit...
Key definitions►   Home state    ►     The state in which an insured maintains its principal place of          business   ...
Key definitions►   Independently procured insurance    ►     Insurance procured directly by an insured from a non-admitted...
States adoption of NRRA►   Adoption of NRRA varies by state►   Generally, states have adopted NRRA definitions and    modi...
States adoption of NRRA — reaction►   Vermont Captive Insurance Association    ►     White paper concludes that NRRA was n...
What to do    ►     Benchmark IPT          ►   Prepare analysis of location of risks being insured and premium            ...
State income tax issues►   Consolidated returns    ►     Entity included by virtue of inclusion in federal consolidated re...
State income tax issues►   Partnership investments in insurance subs — NY example    ►     Aggregate basis — corporate ent...
Partnership investments in insurance subs:aggregate basis►   Aggregate theory must be used if any of the following apply: ...
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State and local tax and insurance tax update

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This session will cover state budget and fiscal matters and related-tax policy implications as well as an update on captive insurance companies, self procurement taxes and recent legislation.

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State and local tax and insurance tax update

  1. 1. 22nd Annual Health SciencesTax ConferenceState and local tax and insurance tax updateDecember 5, 2012
  2. 2. Disclaimer► Any US tax advice contained herein was not intended or written to be used, and cannot be used, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions.Page 2 State and local tax and insurance tax update
  3. 3. DisclaimerErnst & Young refers to the global organization of member firms of Ernst & YoungGlobal Limited, each of which is a separate legal entity. Ernst & Young LLP is a client-serving member firm of Ernst & Young Global Limited operating in the US. For moreinformation about our organization, please visit www.ey.com.This presentation is © 2012 Ernst & Young LLP. All rights reserved. No part of thisdocument may be reproduced, transmitted or otherwise distributed in any form or byany means, electronic or mechanical, including by photocopying, facsimiletransmission, recording, rekeying, or using any information storage and retrievalsystem, without written permission from Ernst & Young LLP. Any reproduction,transmission or distribution of this form or any of the material herein is prohibited andis in violation of US and international law. Ernst & Young LLP expressly disclaims anyliability in connection with use of this presentation or its contents by any third party.Views expressed in this presentation are not necessarily those of Ernst & Young LLP.Page 3 State and local tax and insurance tax update
  4. 4. Presenters► Kelvin Ault ► Brad Withrow Sr. Vice President of Tax Ernst & Young LLP Vanguard Health Systems Nashville, TN Nashville, TN +1 615 252 2050 brad.withrow@ey.com► Troy Deason Sr. Manager, State Income Tax HCA Inc. ► Kevin Owens Nashville, TN Ernst & Young LLP Washington, DC +1 202 327 8828 kevin.owens@ey.comPage 4 State and local tax and insurance tax update
  5. 5. Post-election state and local tax implications
  6. 6. Election 2012 — federal races► Why is federal outcome important for state taxes? ► Presidential, Senate and House Races ► Head of the ticket — effect on state races ► Federal tax reform and tax law changes affect state taxes ► Federal legislation to limit state taxes ► Remote seller sales tax; nonresident withholding ► Supreme Court appointments ► Constitutional issues on state tax casesPage 6 State and local tax and insurance tax update
  7. 7. Election 2012 — state racesBallot initiatives — tax ► Proposition 30 (Governor Brown) ► ¼¢ increase in sales tax rate ► Up to 2.5% increase in personal income tax rates on those making US$250k or more ► California’s highest marginal rate is now 13.3% (NYC: 12.696%) California ► Retroactive to January 1, 2012 ► Business share of temporary CA sales tax increase may be as high as US$650m per year for four years ► CA personal income tax increase on business income  Yes 53.9%  No 46.1% Precincts reporting: 98.5%Page 7 State and local tax and insurance tax update
  8. 8. Election 2012 — state racesBallot initiatives — tax ► Proposition 39 (co-chair Tom Steyer) ► Mandatory single-sales factor ► Incremental monies raised dedicated to funding clean energy investments ► Estimated cost to business of mandatory single sales factor apportionment = +US$1b/yr. California ► Questions: ► Complications with respect to Gillette Co. and Multistate Tax Compact election. (Can taxpayers still elect three-factor?) ► Alternative sales sourcing? ► Can California reduce rates if revenues are greater than anticipated?  Yes 60.1%  No 39.9% Precincts Reporting: 98.5%Page 8 State and local tax and insurance tax update
  9. 9. Election 2012 — state racesGovernors races► Governors races ► Only 12 state governors races in 2012 ► Most states have governors races in “off-Presidential” year to avoid influence at top of the ticket (Wisconsin Governor Walker (R) survived recall) ► North Carolina ► Only state with a party change ► Governor, Senate and House now in Republican control ► Key retirements in the Department of Revenue (DOR) in the past month or so ► Strong possibility for tax reform, including potentially: ► Broadened base, lower tax rate, simplified franchise tax/business license fee, push to eliminate personal and corporate income taxes ► Looking ahead to 2013 elections ► New Jersey — Chris Christie (R) and Virginia — Bob McDonnell (R)Page 9 State and local tax and insurance tax update
  10. 10. Pre-2012 election: who controls stategovernments? Republicans Democrats Split WA MT VT ME ND MN OR ID NH SD WI NY WY MI IA PA CT MA NE NV OH IN NJ RI UT IL CA CO WV DE MD VA KS MO KY NC TN AZ OK NM AR SC AK AL GA MS TX LA HI FLSource: Multistate Associates.Page 10 State and local tax and insurance tax update
  11. 11. Post-2012 election: who controls stategovernments? Republicans Democrats Split Republicans gain Democrats gain WA MT VT ME ND MN OR ID NH SD WI NY WY MI IA PA CT MA NE NV OH IN NJ RI UT IL CA CO WV DE MD VA KS MO KY NC TN AZ OK NM AR SC AK AL GA MS TX LA HI FL Only 12 legislative houses changed from 2012Source: Multistate Associates.Page 11 State and local tax and insurance tax update
  12. 12. 2010 composition of state legislatures Republicans held both houses Democrats held both houses Control is split WA MT ME ND MN OR ID NY SD WI VT WY MI NH IA PA CT NV NE* OH MA IN NJ UT IL RI CA CO WV DE VA KS MO MD KY NC TN AZ OK NM AR SC AK AL GA MS TX LA HI FLSource: National Conference of State Legislatures (NCSL). * Nebraska has a non-partisan state legislature.Page 12 State and local tax and insurance tax update
  13. 13. 2012 post-election composition of statelegislatures Republicans held both houses Democrats held both houses Control is split WA MT ME ND MN OR ID SD WI NY VT WY MI NH IA PA CT NV NE* OH MA IN NJ UT IL RI CA CO WV DE VA KS MO MD KY NC TN AZ OK NM AR SC AK AL GA MS Dems. pick up four TX states; GOP picks LA HI up three states FLSource: NCSL. * Nebraska has a non-partisan state legislature.Page 13 State and local tax and insurance tax update
  14. 14. 2012 post-election supermajorities Republicans supermajority both houses Democrats supermajority both houses Republicans supermajority one house Democrats supermajority one houseSupermajority —more than 2/3rds WAvote of alegislative house MT ME ND OR MN ID NY SD WI VT WY MI NH IA PA CT NV NE* OH MA IN NJ UT IL RI CA CO WV DE VA KS MO MD KY NC TN AZ OK NM AR SC AK AL GA MS TX LA HI FL * Nebraska has a non-partisan state legislature. Page 14 State and local tax and insurance tax update
  15. 15. States where one party has “supermajority”legislative control ► 2/3 Republican control of both ► 2/3 Democratic control of both chambers: chambers ► Indiana ► California ► Idaho ► Hawaii ► Kansas ► Massachusetts ► Missouri ► Rhode Island ► North Dakota ► 2/3 Democratic control of one ► Oklahoma chamber ► South Dakota ► Illinois ► Tennessee ► New York ► Utah ► Vermont ► Wyoming ► West Virginia ► 2/3 Republican control of one chamber: ► Why is a supermajority significant? ► Alabama ► Satisfy constitutional requirements for ► Michigan 2/3rds vote of tax bills ► Ohio ► Amend state constitutions ► Virginia ► Pass legislation without debate ► Supermajorities don’t last foreverPage 15 State and local tax and insurance tax update
  16. 16. Business tax issues being addressed► Sales tax on business inputs► Taxation of tangible personal property► Growing importance of intangibles: property factor, sourcing, property tax base► Business tax competitiveness ► Effectiveness of incentives: transparency and targeting ► Effective tax rates for combined state-local business taxes, including corporate income taxesPage 16 State and local tax and insurance tax update
  17. 17. States considering tax reform► Connecticut ► Business tax task force recommends phase-out of corporate income tax (CIT) surcharge, minimum CIT and business-entity tax► North Carolina ► Lower the corporate tax rate and expand the sales/use tax base to include various services► New York ► Governor Cuomo (D) is set to announce members of NY State Tax Reform and Fairness Commission ► Governor wants “revenue-neutral” tax reform that increases economic growthPage 17 State and local tax and insurance tax update
  18. 18. States considering tax reform► Iowa ► Governor Branstad (D) proposing income and property tax cuts for businesses and individuals — 2012 revenues exceeded forecasts by US$260m ► Wants to use revenue to make Iowa “more competitive” and reduce “job killing” property taxes► Kentucky (Blue Ribbon Commission) ► Goal: shift taxes from business capital and labor income to consumption ► Broaden sales tax base, but “tax B-to-B less and tax consumption more”; option of local sales tax ► Major reform option: replace CIT with gross receipts tax ► Other: eliminate tangible personal property (TPP) tax, adopt single sales factor (SSF) with destination salesPage 18 State and local tax and insurance tax update
  19. 19. Blurring lines between tax-exempt andtaxable health care providers
  20. 20. Recent events► Ascension Health forms joint venture with Oak Hill Capital Partners to acquire hospitals in a taxable platform.► Ascension Health partners with India-based Narayana Hrudayalaya Hospitals to build US$2 billion health campus in Grand Cayman.► Mayo Clinic, NYU Hospitals and Dignity Health have issued US$1.1 billion in taxable bonds.► Caritas Christi converts to investor-owned status via acquisition by Cerberus Capital.► Detroit Medical Center is acquired by Vanguard.Page 20 State and local tax and insurance tax update
  21. 21. Related articles► “Illinois hospital tax break costs $10M, could help MetroSouth,” Southland News, November 9, 2012► “State may put non-profit hospitals on tax rolls, with incentives,” ChicagoBusiness.com, November 29, 2011► “Non-profits no better on charity care,” ChicagoBusiness.com, October 19, 2009► “Much is given by hospitals, more is asked,” Boston Sunday Globe, May 31, 2009► “Real Property Tax Exemptions at Risk,” Taxation of Exempts (WG&L Journals), 2008Page 21 State and local tax and insurance tax update
  22. 22. 2006 Congressional Budget Office studyPage 22 State and local tax and insurance tax update
  23. 23. Illinois charity care credit► Income tax credit equal to the lesser of ► Property taxes on hospital parcel Or ► Cost of charity care provided► Effective for tax years ending on or after December 31, 2012► Credit may be transferred or carried forward for five years► Initially discussed as an offset to 2007 gross receipts tax proposal, then ultimately enacted as part of grand compromise with hospitals on Medicaid and non-profit hospital tax exemption in 2012 spring legislative session ► Some legislators were initially proposing to tax all hospitals ► Possible constitutional challenges to legislation in light of Provena decision ► Charity care credit is also subject to a sunset clause as are all Illinois tax creditsPage 23 State and local tax and insurance tax update
  24. 24. State tax implications: electronic healthrecords
  25. 25. Medicare and Medicaid electronic healthrecord incentive programs► Medicare incentive payments ► The American Recovery and Reinvestment Act of 2009 (ARRA), Pub. L. No. 111, sec. 4102(a) (Feb 17, 2009), amended Section 1886 of the Social Security Act to establish incentive payments for certain eligible professionals and hospitals participating in the Medicare Fee For Service (FFS) program where they demonstrate “meaningful use” of certified electronic health records (EHR) technology, beginning in 2011 and ending in 2016.► Medicaid incentive payments ► Section 4201 of ARRA amended Section 1903 of the Social Security Act to establish incentive payments for certain eligible professionals and hospitals participating in the Medicaid program to “purchase, implement, operate (including support services and training for staff) and meaningfully use” certified EHR technology, beginning in 2011 and ending in 2021.► Eligible hospitals may receive both incentives as long as they meet requirements of each program.Page 25 State and local tax and insurance tax update
  26. 26. State tax issues: EHR incentives receipts► State income tax implications of the incentives receipts ► Federal income tax treatment conformity ► Separate entity-level treatment/allocation ► Tax base and apportionment impact ► Receipts factor inclusion ► Receipts factor sourcing ► Receipts from federal government► State and local receipts-based taxes and related implications of the incentives receipts ► Definition of taxable receipt ► Sourcing ► Offsets, exemptions, receipts from federal governmentPage 26 State and local tax and insurance tax update
  27. 27. State tax issues: EHR expenditures► Sales tax issues related to multistate hardware and software costs► Credit and incentive opportunities related to EHR expenditures ► Headquarter state opportunities ► Multistate opportunities related to expenditures at the facilities ► Consider any potential negative implications to credit and incentive programs limited by government funding► Property tax valuation issues► Franchise tax implicationsPage 27 State and local tax and insurance tax update
  28. 28. State tax nuances► Texas margins tax ► Health care providers (100% exemption for government revenue) ► Health care institutions (50% exemption for government revenue) ► Administrative guidance ► Comptroller’s Ruling 200810212L (10/27/2008) ► Comptroller’s Ruling 201001990L (01/27/2010) ► Consider how your compliance group accumulates the data► Others?Page 28 State and local tax and insurance tax update
  29. 29. Nonresident withholding
  30. 30. Introduction► More and more states are focusing on nonresident withholding ► States are looking for money and many already have laws on their books ► Nonresident withholding is becoming more highly scrutinized► Exemptions/waivers ► Corporation signs waiver, indicating they will file/pay at corporate level ► Corporate owners often meet the exceptions to the requirements, but if they fail to certify in writing, the states may go after the partnership for failure to withhold► ASC 740 ► The pass-through entity is not subject to income tax but the entity is liable for the nonresident withholding ► Consider characterization of income as an income tax at the partnership levelPage 30 State and local tax and insurance tax update
  31. 31. Nonresident withholding: Georgia► Georgia audit example ► Notification of audit ► Assessments at the partnership level► Potential policy change (regarding penalty abatement)► In this example, Georgia Department of Revenue appears to be focusing more on this issue from a policy perspective and may be less willing to waive penaltiesPage 31 State and local tax and insurance tax update
  32. 32. Working in the clouds: state taxconsiderations of cloud computing
  33. 33. Background► Cloud computing is the delivery of shared resources, software and information over a network or the internet which can be accessed by computer or other devices.► Users are typically not aware of the underlying technologies used to provide the services (e.g., servers), only that the resources they wish to purchase are available over the internet (the backbone of the cloud).► Cloud revenue growth is forecast to experience a 26% compound annual growth rate between 2011 and 2014 — five times faster than the IT industry as a whole.► Cloud computing is borderless by nature but tax regulations and compliance are not.► Cloud computing gives rise to complex and potentially material tax issues.Page 33 State and local tax and insurance tax update
  34. 34. Cloud computing definedThe three primary service models of cloud computing are:► Software as a Service (SaaS): applications both general, such as word processing, email and spreadsheet, and specialized, such as customer relationship management (CRM) and enterprise resource planning (ERP). SaaS is sometimes referred to as hosted or managed software, and the original offerings were from application service providers (ASPs)► Platform as a Service (PaaS): databases, development tools and other components required to support the delivery of custom applications► Infrastructure as a Service (IaaS): raw computing power, storage and network bandwidthPage 34 State and local tax and insurance tax update
  35. 35. What’s happening now in the states?► States try to expand existing law► Legislative, judicial and regulatory developments occurred at an increasing rate ► Most notably with respect to nexus and tax base ► Primary focus has been on sales and use taxes ► Convenient source of revenue ► Perception that it is less complicated and politically charged than going after income-based taxesPage 35 State and local tax and insurance tax update
  36. 36. Why have the issues become so prevalentfrom a sales-tax perspective?► Hosted software, “cloud” computing and ASP ► SaaS vs PaaS vs IaaS► States still coming to grips with IaaS and PaaS ► IaaS as a rental of tangible personal property► Historical treatment of SaaS ► Electronic delivery? ► Information service or database access? ► Another enumerated taxable/non-taxable service?Page 36 State and local tax and insurance tax update
  37. 37. Sales tax on software► Who is the “taxable person”? ► Is the vendor or the hosting company physically present in the taxing state? ► Where are the data centers located? ► Where is the software housed?► How are transactions sourced? ► Generally based on destination — where the customer uses/accesses the software/service ► Customer multistate use exemption ► Difficult for vendor or hosting company to determine where use occurs ► Streamlined sales tax (SST) sourcing rulesPage 37 State and local tax and insurance tax update
  38. 38. Sales tax on software: classificationdetermines taxability► First consideration ► Canned ► “Off-the-shelf” ► Designed for multiple users ► Custom ► Designed for specific single user ► Modifications to canned software can be a gray area► Second consideration: method of delivery ► Tangible format ► Electronic delivery ► ASP — also called SaaS or “in-demand software” or “cloud computing” ► Load and leave/load and returnPage 38 State and local tax and insurance tax update
  39. 39. Sales tax on software: cloud computing(ASP model)► Is the transaction taxable? ► Look to state treatment of ASP/SaaS/cloud computing ► What does the customer receive? ► Access to software or access to infrastructure?► State positions taken (note this is based on various levels of authority and specific facts) ► Not taxable: AL, AR, CO, IL, KS, LA, ME, MS, NE, NV, NJ, OK, PA, RI, TN, VA, WI ► Taxable: AZ, CT, HI, ID, IN, KY, MA, MI, NM, NY, SC, SD, TX, UT, VT, WA, WV► Other states that lack specific guidance may determine taxability by treating transaction as: ► Sale/license of electronically delivered software ► Provision of “computer” services (e.g., data processing, information services)Page 39 State and local tax and insurance tax update
  40. 40. Sales tax on digital goods and services► How are digital goods/services taxed? ► SST states ► Specified digital products ► Other products “transferred electronically” ► Non-SST states will tax based on classification ► Look to definition of “tangible personal property” ► Consider state sales and use tax treatment of service transactions ► Growing trend toward providing specific guidance and toward taxing “digital equivalents” ► Is the digital good a software or a service? For example: ► New York — online games are taxable as “pre-written software” ► Texas — online games are taxable: “data processing,” “pre-written software” or “amusement services”Page 40 State and local tax and insurance tax update
  41. 41. Sales tax on digital goods and services► What are digital goods/services? ► SST: “specified digital products” means electronically transferred: ► “Digital audio-visual works” ► “Digital audio works” ► “Digital books” ► Non-SST states will often look to agreement to determine characterization of sales as: ► Tangible personal property ► Services ► Mixed transaction ► Something elsePage 41 State and local tax and insurance tax update
  42. 42. Sales tax on digital goods and services► Federal ► The proposed law (The Digital Goods and Services Tax Fairness Act of 2011, H.R. 1860/S. 971) would establish a national framework for taxation of digital goods and services and prevent retail sales of such products from being taxed by multiple states. ► The bill stops short of prescribing a specific system for how states can tax sales of digital goods. ► It prohibits state and local governments from applying taxes to those products that do not apply to similar tangible goods.Page 42 State and local tax and insurance tax update
  43. 43. Sales tax sourcing issues► Should transaction be sourced (i.e., taxing location) based on: ► Location of the seller? ► Where SaaS is used? ► Some other location?► Once the situs has been determined, a sales tax determination can be made.Page 43 State and local tax and insurance tax update
  44. 44. Multistate Tax Compact (the Compact)election
  45. 45. California► S.B. 1015 (enacted June 27, 2012) — repeals all provisions related to the Compact, effective immediately ► California no longer “sovereignty member” of Compact ► Not approved by 2/3rds vote of either house — Prop 26 problem? ► Doctrine of election — Legislative Counsel’s Digest — Legislature “intended” that any election must be made on an originally filed return► Gillette (Cal. App. Ct.) — The 1993 law change mandating that the double-weighted sales factor be used did not repeal the Compact election and, therefore, taxpayers were entitled to make the Compact election. ► The Compact is a valid compact that California as a signatory state is bound by until the state withdraws from the Compact.Page 45 State and local tax and insurance tax update
  46. 46. Other states► Michigan ► H.B. 4479 (enacted May 25, 2011) — beginning January 1, 2011, taxpayers cannot apportion/allocate income in accordance with the Compact, but rather must use the method provided by the Michigan Business Tax (MBT) and CIT. ► Litigation (IBM) is currently before the Court of Appeals on whether the election is allowed under the MBT.► Oregon ► ORS 314.606 specifically provides that when the Compact provisions are inconsistent with the Uniform Division of Income for Tax Purposes Act, the Oregon statutory provisions “shall control.” ► Litigation (HealthNet) is currently before the Tax Court.Page 46 State and local tax and insurance tax update
  47. 47. Texas margins, Compact developments andother updates► In three recent rulings — Decision Nos. 106,503 (August 10, 2012), 106,298 (September 6, 2012) and 106,149 (September 11, 2012), the Comptroller of Public Accounts continues to reject taxpayers’ use of the three-factor apportionment formula under Article IV of the Compact. ► The Comptroller has determined that when apportioning taxable margin to Texas, the taxpayer is required to use the single gross receipts factor provided under Tex. Tax Code Ann. § 171.106(a). ► A taxpayer whose attempted use of the Compact’s three-factor formula was rejected by the Comptroller is challenging the rejection and has filed a lawsuit in a Texas district court (Graphic Packaging Corp. v. Combs, Doc. 2012-22096 (Tex. Dist. Ct., Travis County, filed Oct 2012)).► The Texas Supreme Court has held that the state franchise tax does not violate the Texas Constitution’s Equal and Uniform Clause and the federal Equal Protection, Due Process and Commerce Clauses. As an initial matter, the court determined that it has original jurisdiction over challenges to the constitutionality of the tax. (In re: Nestle USA, Inc., Tex. S. Ct., Dkt. No. 12-0518, 10/19/2012.)Page 47 State and local tax and insurance tax update
  48. 48. State taxation of premiums paid to captives
  49. 49. State taxation of premiums► Premium tax ► Assessed against admitted insurance company ► Based on premiums allocable to state► Surplus lines ► Insurance company not licensed to sell insurance in state ► Insurance placed by lines broker with non-admitted company ► Surplus lines tax assessed against surplus lines broker► Independently procured insurance ► Insured acquires insurance directly from non-admitted company ► Most states assess tax against insuredPage 49 State and local tax and insurance tax update
  50. 50. Independently procured insurance tax► Imposed by a majority of states► Statute varies state by state► Historically, has not been rigorously enforced by most states ► California, New York, Texas and Florida have been more active► Generally applies when insurance is purchased from non-admitted insurance company ► May apply to insurance from captive insurance companies as they are only licensed in state of domicilePage 50 State and local tax and insurance tax update
  51. 51. Pre-Dodd–Frank contracts in effect prior toJuly 21, 2011► The typical statute applies tax when insurance is procured from an insurance company not admitted to do business in the state. ► NYS: “There is hereby imposed on any person who purchases or renews a taxable insurance contract from an insurer not authorized to transact business in this state under a certificate of authority from the superintendent of insurance …” ► CA: “Every person who effects insurance with a non-admitted insurance carrier is required to pay a tax of 3% of net premiums.”► The tax only applies to risks located in that statePage 51 State and local tax and insurance tax update
  52. 52. Limitation on independently procuredinsurance tax — Todd Shipyards► Todd Shipyards 370 U.S. 451 (1962) ► A New York corporation did business and owned property in Texas. ► All transactions regarding the insurance occurred outside of Texas; the insurance was purchased, the premiums were paid, and any claims were to be adjusted and paid in New York. ► The insurers were located in London, were not licensed in Texas, had no agents in Texas and did no business in Texas. ► The broad Texas self-procurement statute contained no limitations requiring actions in the state to give rise to the tax. ► The Supreme Court invalidated the tax levied. ► Texas tax may not be constitutionally imposed when the only connection between the insurance transaction and the state is that the insured risk is located in Texas.Page 52 State and local tax and insurance tax update
  53. 53. Is Todd Shipyards still valid?► Associated Electric & Gas Insurance Services, Ltd. 676 A.2d 1357 (RI 1996) AEGIS ► Premium taxes assessed by Rhode Island against Bermuda insurance company ► Todd Shipyards had been superseded► Dow Chemical Co. 38 S.W.3d 741 (Tex. Ct. App. 2001) ► Attempt by Texas to impose essentially the same self-procurement tax statute at issue in Todd Shipyards ► Texas court rejected argument used in AEGIS ► Todd Shipyards still validPage 53 State and local tax and insurance tax update
  54. 54. Limitation on Todd Shipyards► STP Nuclear Operating Company 239 S.W.3d 264 (Tex. App. Austin 2007) ► Application of Texas Independently Procured Tax upheld ► Factual difference with Todd Shipyards ► Insured headquartered in Texas ► Supervisor of corporate insurance was located in Texas ► Direct communications via email and letters between the corporation and the nonadmitted insurer ► Insurance contracts negotiated and approved by the corporation’s employees in Texas ► Premium payments originated in Texas ► Losses were payable to insureds in TexasPage 54 State and local tax and insurance tax update
  55. 55. Non-admitted and Reinsurance Reform Act(NRRA)► NRRA part of Dodd–Frank legislation► Enacted into law in July 2010, with most provisions effective July 21, 2011► Reforms the taxation and regulation of insurance between an insured and an insurance company ► Focuses on surplus lines but includes directly procured insurance ► Only the “home state” can tax or regulate insurance with a non- admitted insurance company► NRRA provides several key definitionsPage 55 State and local tax and insurance tax update
  56. 56. Key definitions► Home state ► The state in which an insured maintains its principal place of business ► If 100% of the insured risk is located out of that state, the state to which the greatest percentage of the insured’s taxable premium for that insurance contract is allocated (this method of allocation is commonly referred to as the “cost of performance”) ► If there are more than one insureds from an affiliated group identified as named insureds on a single non-admitted insurance contract, the “home state” means the home state of the member of the affiliated group that has the largest percentage of premium attributed to it under such insurance contract. “Affiliated group” means any group of entities that share common control. An affiliated group may include entities that share parent-subsidiary and/or brother-sister corporate relationshipsPage 56 State and local tax and insurance tax update
  57. 57. Key definitions► Independently procured insurance ► Insurance procured directly by an insured from a non-admitted insurer► Non-admitted insurance ► Any property and casualty insurance permitted to be placed directly or through a surplus lines broker with a non-admitted insurer eligible to accept such insurance► Non-admitted insurer ► An insurer not licensed to engage in the business of insurance in a particular state. A non-admitted insurer does not include a risk retention group, as defined in the Liability Risk Retention Act of 1986, 15 U.S.C. 3901(a)(4)Page 57 State and local tax and insurance tax update
  58. 58. States adoption of NRRA► Adoption of NRRA varies by state► Generally, states have adopted NRRA definitions and modified law to use those definitions► States adopting NRRA definitions also tax 100% of premiums, e.g., New York and Texas ► Prior to NRRA, generally only premiums allocable to state were subject to tax► Current status of tax is very confusing ► For example, Virginia has legislative procedure to collect tax but has not placed tax on its books ► Not all states have adopted NRRA definitions, e.g., AlabamaPage 58 State and local tax and insurance tax update
  59. 59. States adoption of NRRA — reaction► Vermont Captive Insurance Association ► White paper concludes that NRRA was not intended to apply to captive insurance companies ► Does not address changes in state lawPage 59 State and local tax and insurance tax update
  60. 60. What to do ► Benchmark IPT ► Prepare analysis of location of risks being insured and premium allocable to those locations ► Determine home state under NRRA ► Determine law of home state — does home state impose IPT? ► Determine if any risks are in states that have not adopted NRRA ► Planning considerations ► Re-domesticate captive to home state ► Control determination of home state, e.g., multiple contracts or contracts with varying coverages ► Move insurance functions in order to invoke Todd Shipyards ► Possible legal arguments ► Contest tax on 100% of premiums on constitutional grounds ► Determine whether arrangement insurance is for IPT purposesPage 60 State and local tax and insurance tax update
  61. 61. State income tax issues► Consolidated returns ► Entity included by virtue of inclusion in federal consolidated return ► Consider income classification and possible non-business treatment (e.g., investment income)► Unitary returns ► Alaska and Idaho — sales factor based on premiums plus property factor for investments ► New Hampshire — separate apportionment method and then combine post-apportioned income with the group ► California — statutory exclusionPage 61 State and local tax and insurance tax update
  62. 62. State income tax issues► Partnership investments in insurance subs — NY example ► Aggregate basis — corporate entity combines its income, capital and factors with its distributive share of the partnership’s income, capital and factors ► Entity basis — corporation reports distributive share of partnership income and capital but apportions based on the corporation’s factors (favorable if the corporate partner’s NY apportionment would be zero) ► Foreign corporate partner election — the corporate partner reports its share of partnership income and capital as apportioned at the partnership level ► Regulations governing this election may or may not apply to insurance companies that are subject to Article 33. The regulations are ambiguous on this point and the Department has informally granted leeway with similar fact patternsPage 62 State and local tax and insurance tax update
  63. 63. Partnership investments in insurance subs:aggregate basis► Aggregate theory must be used if any of the following apply: ► The corporate partner is conducting a unitary business with the partnership ► The corporate partner is a general partner of the partnership or a managing member of an LLC treated as a partnership ► The corporate partner has a 5% or greater interest in the partnership ► The partnership interest constitutes more than 50% of its total assets Or ► Any member of the corporate partner’s affiliated group has the information necessary to perform an aggregate computation ► For this test, a corporate partner that receives a complete Form IT-2-04-CP must file using the aggregate methodPage 63 State and local tax and insurance tax update
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