24 February 2023Analysis

Grant Thornton issues analysis of Maryland captive case

The Maryland Court of Special Appeals (CSA) has affirmed the Circuit Court for Anne Arundel County’s determination that a captive insurance company subject to the state’s premium tax as an unauthorised insurer was exempt from the corporate income tax on its non-premium-related income.

An analysis of the case by Grant Thornton said that the taxpayer, a captive insurance company licensed and incorporated in Vermont, provides insurance for its parent company retailer, its subsidiaries and affiliates in situations where they cannot obtain market coverage for excess earthquake risks. The taxpayer wrote all of its insurance policies in Vermont, but insured some risks in Maryland arising from its parent’s retail department stores based in Maryland.

During a 2010 audit of the corporate parent, the Maryland Comptroller discovered that an affiliate had claimed roughly $2 billion in deductions for interest payments made to the taxpayer. Historically, the taxpayer paid premium tax in Vermont but did not pay premium or corporate income taxes in Maryland. The taxpayer did not earn Maryland premiums during its 1997-2003 tax years, but had substantial interest income related to non-premium-related investment income. Following the audit, the amount claimed as deductions by the affiliate was added back to the affiliate’s taxable income and assessed against the taxpayer. The Comptroller ultimately assessed the taxpayer approximately $24 million in tax, penalties and interest for the 1996-2003 tax years based on this interest income.

The taxpayer appealed the Comptroller’s assessment to the Maryland Tax Court, which held that the taxpayer was subject to tax as an authorised insurance company under Title 6 of the Insurance Article and qualified for a corporate income tax exemption. The Comptroller appealed, arguing that the taxpayer was not subject to taxation under Title 6 because it was an unauthorised insurer subject to taxation instead under Title 4 of the Insurance Article. On appeal, the Circuit Court for Anne Arundel County held that the taxpayer was exempt from the corporate income tax, either as an authorized insurer under Title 6 or as an unauthorised insurer under Title 4.

A series of decisions and appeals then followed, involving a number of courts, until eventually the CSA held that “according to the statute, as written, the premium tax is instead of all other Maryland state taxes.” Finally, the CSA held that the Tax Court reached a sound conclusion that was consistent with applying the correct legal standard of giving the statute its plain meaning.

According to Grant Thornton: “The CSA’s latest decision appears to be the final word on this matter, as the Maryland Supreme Court recently declined to review this case. This is a positive decision for business enterprises with captive insurance companies similarly situated to the taxpayer because the court interpreted the statutory language to exempt the taxpayer’s substantial interest income from corporate income tax. The exemption in the insurance statute prevented the taxation of this income even though it was considered to be non-insurance-related income. Furthermore, the exemption applies if the captive insurance company is subject to the premium tax even if it does not actually pay the tax.
“The Maryland Comptroller tried to argue that the relatively clear statutory language providing that the premium tax on unauthorized insurers applies “instead of all other State taxes” was ambiguous. In rejecting this argument, the Maryland courts consistently considered the plain meaning of the statutory language, disagreeing with the Comptroller’s efforts to interpret this statute in a manner that would require taxation of the interest income. This decision has significance beyond the tax context because it reinforces the judicial doctrine that the plain meaning of statutory language should be applied by courts unless the language truly is ambiguous. It should be noted that the case also highlights the Comptroller’s continuing persistence in challenging intercompany transactions that have the effect of minimising tax revenue in a separate reporting environment.”