The New York Tax Appeals Tribunal (Tribunal), reversing an earlier determination by an Administrative Law Judge (ALJ), cancelled deficiencies issued to two German insurance companies by the New York Division of Taxation (Division) under an alternative allocation method because the companies were being discriminated against in violation of the US-German tax treaty (the Treaty).¹ The Tribunal found that the companies' tax treatment (in which they had a zero premiums factor, leading the Division to use an alternative allocation method under its discretionary authority) subjected the companies to taxation or other connected requirements that are "other or more burdensome" than that of US insurance corporations.

Background

The following is a brief summary of the key facts underlying this case:

— Bayerische Beamtenkrankenkasse AG ("Bayerische" or "Taxpayer") is a German unauthorized non-life insurance company.

— Bayerische did not conduct any insurance business in the US. Its nexus with New York was through (and its only New York-source income was derived from) its investment as a limited partner in certain real estate investment partnerships that owned real property located in New York.

— Bayerische had no effectively connected income or US-source insurance premiums and, thus, had no premiums factor for apportionment purposes.

— Bayerische's only New York apportionment factors were derived from the flow-through factors of its partnership investments. This resulted in a New York receipts factor of about 70% and a New York payroll factor of 100%.

— The ALJ had held that Bayerische was subject to the life insurance company franchise tax under Article 33 (N.Y. Tax Law Section 1501), which includes an income-based tax.²

See Tax Alert 2016-0749 for a more in-depth discussion of the ALJ's ruling and a discussion of the history and relevant background of New York's taxation of unauthorized life and non-life insurance companies.

Application of Article 33 Franchise Tax and alternative apportionment to Bayerische

While the Tribunal ultimately reversed the ALJ on other grounds, the Tribunal noted its agreement with the ALJ's conclusion that, according to the plain language of the statutes, an unauthorized non-life insurance company is subject to the life insurance company franchise tax under N.Y. Tax Law Section 1501. The life insurance company tax is a tax imposed on the highest of several alternative tax bases, including entire net income (ENI). A 90% premium / 10% payroll factor is the default rule used to apportion the life insurance company tax. The ALJ agreed with the Division, however, that Bayerische would be subject to alternative apportionment based on N.Y. Tax Law Section 1504(d), which provides that the Division can employ an alternate apportionment method if the standard method "does not properly reflect the activity, business or income of the taxpayer within the state."³ Given the nature of Bayerische's income and investment-related contact with New York, the Division applied Article 9-A single receipts factor apportionment to Bayerische's investment partnership income, a position with which the ALJ agreed.

The Tribunal agreed with the ALJ and noted it would have been "out of all appropriate proportion" to the petitioner's business in New York to use the default statutory formula, which would have resulted in apportionment by only the (100%) payroll factor, given Bayerische did not have a premium factor for New York purposes. Bayerische argued that it was distortive to only use its US-source premiums and that it should be allowed to apportion its income by using its worldwide premiums and/or worldwide receipts under Article 9-A. The Tribunal reasoned that only effectively connected factors should be employed given that the Article 33 tax base is limited to effectively connected activity rather than worldwide activity for non-US taxpayers.⁴ Though the Tribunal noted its approval of the ALJ's and the Division's application of the Article 33 franchise tax and alternative apportionment to Bayerische, the Tribunal ultimately held that Article 33 franchise tax as applied in the ALJ determination violated the nondiscrimination provision of the Treaty and the ALJ's determination must therefore be reversed.⁵

Nondiscrimination under the United States-German tax treaty

It is relatively rare for a state tax decision to be decided on the grounds that the state's tax action violated a US bilateral income tax treaty as US tax treaties are generally silent on specific state taxes.⁶ For state tax purposes, generally the only question is whether states will follow the federal income tax treatment⁷ under a US bilateral tax treaty. Because states are not party to US international tax treaties, they generally are not bound to follow a treaty's federal income tax treatment, depending on the state's particular conformity to the federal tax code and/or federal "starting point." Thus, the Tribunal's application of the nondiscrimination provision of the Treaty⁸ to a state corporate franchise tax is noteworthy.

The nondiscrimination analysis applied by the Tribunal is similar to the internal consistency hypothetical test set forth in the US Supreme Court's recent decision in Wynne.⁹ The Tribunal compared the tax treatment of a hypothetical US insurance company, unauthorized in New York and having only non-US premiums, to Bayerische, a German insurance company, unauthorized in New York and having only non-US premiums. Since US corporations are subject to tax on their worldwide income for New York state purposes, the US company would have a zero New York premium numerator and a denominator equal to its worldwide premiums. In this case, the US company clearly receives advantageous treatment under the New York tax scheme as formulated by the ALJ. The Tribunal held that the nondiscrimination section of the Treaty extends to all taxes of the "Contracting State." This, the Tribunal concludes, encompasses all state and local taxes.¹⁰ The Tribunal also held that, because the New York Tax Law and the Tax Treaty conflicted, the Treaty must prevail and the notice of deficiency issued to Bayerische by the Division must be deemed invalid.

Implications

The Tribunal's decision here is potentially important for both non-US inbound taxpayers (insurance or otherwise) and any insurance companies unauthorized in New York, but that receive New York source income from investments or other business activities. First, this decision provides welcome support for the application of nondiscrimination provision of US tax treaties for situations where a non-US taxpayer may be treated less favorably than domestic counterparts in the application of various state income and franchise taxes. Additionally, this case confirms that unauthorized insurance companies, regardless of where domiciled, are subject to the life insurance company tax under N.Y. Tax Law Section 1501. Moreover, if a taxpayer lacks an otherwise representative apportionment factor, the Division has the authority to affix its own factor.

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ENDNOTES

¹ In the Matter of the Petition of Bayerische Beamtenkrankenkasse AG, DTA No. 824762 (N.Y. Tax App Trib. Sept. 11, 2017). The tax years at issue are 2006 and 2007.

² In the Matter of the Petition of Bayerische Beamtenkrankenkasse AG, DTA No. 824762 (N.Y. Div. Tax App. March 3, 2016).

³ N.Y. Tax Law §1504(d).

⁴ For tax years at issue, the Article 9-A franchise tax was based on worldwide income and worldwide apportionment factors. However, since the Article 33 tax base includes effectively connected income only, the Tribunal concluded that only effectively connected Article 9-A factors should be used in the case of Bayerische.

⁵ Because the Tribunal ultimately reversed the ALJ's ruling on other grounds, its discussion of the New York taxation of unauthorized non-life insurance companies as formulated by the ALJ is arguably dicta and therefore is persuasive authority only and not precedential.

⁶ The Division contended that the Tribunal did not have jurisdiction to review a claim under the Treaty. The Tribunal, however, asserted that it does have such jurisdiction and noted that it has exercised its jurisdiction to consider a similar nondiscrimination claim under the United States-United Kingdom tax treaty See Matters of Reuters, Ltd, (Tax Appeals Tribunal, Mar. 21, 1991).

⁷ This is generally for purposes of computing the state "starting point" for the tax base.

⁸ Treaty Article 24.

⁹ See Comptroller of the Treasury v. Wynne, 135 S. Ct. 1787, 1803 (2015).

¹⁰ Id. at 6. ("The provisions of this Article shall … apply to every kind and description imposed by a Contracting State or a political subdivision or local authority thereof").