New York State Seal
STATE OF NEW YORK
INSURANCE DEPARTMENT
25 BEAVER STREET
NEW YORK, NEW YORK 10004

Eliot Spitzer
Governor

Eric Dinallo
Superintendent

The Office of General Counsel issued the following opinion on August 28, 2007 representing the position of the New York State Insurance Department.

Re: Tax Allocation Agreements

Question Presented:

In preparing a pro forma tax return for a domestic controlled insurer, does Circular Letter 33 (1979) (the “Circular Letter”) state that the tax return must be prepared without regard to the fact that the domestic controlled insurer is a member of its affiliated group?

Conclusion:

The Circular Letter states only that the domestic insurer’s tax liability is to be calculated as if the insurer were to file on a separate return basis. It does not distinguish between filing on a separate return basis as a member of an affiliated group or filing on a separate return basis without being a member of an affiliated group. If the domestic controlled insurer is in fact a member of an affiliated group, then any pro forma tax return should be calculated as such on a separate return basis.

Facts:

A domestic insurer (the “Company”) has a tax allocation agreement1 with its parent. The Company intends shortly to file this agreement with the Department. In that connection, and as provided by the Circular Letter, the Company is preparing a pro forma tax return as though it would file a separate return. The accountants preparing the return contend that even if the Company is not included in a consolidated return,2 its status as a member of an affiliated group will cause its tax liability to be different than if it were not a member of an affiliated group when the calculation is done on a separate return basis.

Analysis:

The Circular Letter was issued by the Department to ensure that a domestic insurer that is a member of a holding company system that includes foreign insurers will not be adversely affected by the domestic insurer’s inclusion in a consolidated tax return. To that end, the Circular Letter states that any domestic insurer that is a party to a consolidated federal tax filing must have a written agreement governing its participation therein. The Circular Letter further lists three alternative acceptable methods for the domestic insurer to calculate its tax liability.3 This calculation is required in order to ensure that the domestic insurer’s inclusion in the consolidated return does not cause it to lose the benefit of any tax credits to which it would otherwise be entitled.

The inquiry states that, under I.R.C. §§ 1503 and 1504 (2007),4 certain requirements are imposed upon members of an affiliated group5 regardless of whether a consolidated return is filed by the group. It is beyond the purview of this Department to comment upon the tax effects of I.R.C. §§ 1503 and 1504, but assuming that this assertion is correct, the Company’s accountants have raised the question of whether or not, for purposes of complying with the Circular Letter, the pro forma separate return for the Company should be completed as if it were a member of an affiliated group.

The Circular Letter does not expressly state whether the pro forma should be prepared on a separate return basis as a member of an affiliated group or on a separate return basis as not a member of an affiliated group. But such an explicit direction is not necessary. Rather, the language of the Circular Letter should be applied as written. Thus, if an insurer is in fact a member of an affiliated group, then the insurer’s pro forma separate return should be prepared on that basis. Doing so is logical because the preparation of the pro forma is meant to show the actual tax situation of the insurer, were the insurer to file a separate return. If the insurer is in fact a member of an affiliated group, then only a pro forma return that reflects this fact would be accurate. In addition, this approach is consistent with the stated intent of the Circular Letter, i.e., to ensure that tax allocation agreements fairly and equitably apportion tax liabilities, and recognize the separate operating identity of the domestic insurer.

For further information you may contact Supervising Attorney Michael Campanelli at the New York City office.

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1 Tax allocation agreements are used to apportion tax liabilities among members of a holding company system.

2 A consolidated return is one in which the returns of all the companies in an affiliated group are combined.  Essentially, all income items, losses, deductions and credits of each member of the group are considered together to arrive at the final tax liability for the entire group as a whole.  See Internal Revenue Code (I.R.C.) § 1501 et seq. and the U.S. Department of Treasury regulations promulgated thereunder.

3 The Circular Letter provides, in pertinent part, as follows:

The domestic insurer must calculate its tax liability under method (A), (B), or (C) below.

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(A)  The tax charge or tax refund to the domestic insurer under the agreement shall be the amount that the domestic insurer would have paid or received if it had filed on a separate return basis with the Internal Revenue Service.

To help assure the domestic insurer’s enforceable right to recoup federal income taxes in the event of future net losses an escrow account ... shall be established  ... by the parent in an amount equal to the excess of the amount paid by the domestic insurer to the parent for federal income taxes over the actual payment made by the parent to the Internal Revenue Service.

                                *                               *                               *                               *

(B) The tax charge to the domestic insurer under the agreement shall not be more that it would have paid if it had filed on a separate return basis.  The domestic insurer shall be “paid” for any foreign tax credits, investment credits, losses, or any loss carry over (collectively herein referred to as credits) generated by it, to the extent actually used in the consolidated return.  Payment shall be equal to the “savings” generated by its credits.  All payments shall be recorded on the domestic insurer’s books as contributed surplus.

If the amount paid by the domestic insurer to the parent for federal income taxes is greater than the actual payment made by the parent... then the difference shall be placed in escrow in the same manner ... as in (A) above.

                                *                               *                               *                               *

(C)  Any other method of calculating the domestic insurer’s tax liability which provides:

(i)  That the tax charge to the domestic insurer shall not be more than it would be would have paid if it had filed on a separate return basis,

(ii) That payments to the domestic insurer give appropriate recognition to the separate operating identity of the insurer, and

(iii) for a method, such as the use of an escrow account as described in (A) above, to help assure the domestic insurer’s enforceable right to recoup federal income taxes in the event of future net losses.

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4 These sections set forth, respectively, the rules for computation and payment of tax in connection with consolidated returns and the definitions applicable thereto.  

5 I.R.C. § 1504(a) defines “affiliated group” in pertinent part as follows:

The term “affiliated group” means—

(A)   1 or more chains of includible corporations connected through stock ownership with a common parent corporation which is an includible corporation, but only if—

 (B)     (i) the common parent owns directly stock meeting the requirements of paragraph (2) in at least 1 of the other includible corporations, and

(ii) stock meeting the requirements of paragraph (2) in each of the includible corporations (except the common parent) is owned directly by 1 or more of the other includible corporations.

(2)   80-percent voting and value test

The ownership of stock of any corporation meets the requirements of this paragraph if it—

(A) possesses at least 80 percent of the total voting power of the stock of such corporation, and

(B) has a value equal to at least 80 percent of the total value of the stock of such corporation.

This definition clearly includes an insurer that is a wholly owned subsidiary and its holding company parent.