Was an insurance-company affiliate included in a California unitary combined report when it was operationally integral to the affiliated business?

Plain-English summary

California Legal Ruling 385 excluded an insurance-company affiliate from a unitary combined report even when the insurer was an integral part of the affiliated business.

The insurer's income and apportionment factors stayed outside the report because the California Constitution subjected insurers to a gross-premiums tax in lieu of the corporate franchise and income taxes. FTB therefore concluded that the insurer was not a "taxpayer" within the statutory definition required by section 25101.

Exclusion did not prevent FTB from examining intercompany transactions between the insurer and the included affiliates and adjusting the unitary income for excessive charges or inadequate reimbursement.

Facts addressed by the ruling

The affiliated group conducted a unitary financing or credit-sales business. Its insurance subsidiary sold life, accident, health, fire, or casualty coverage to the group's customers in connection with the regular financing transactions.

The ruling assumed the insurer's operations and management relationships with the group were substantial enough to make it an integral part of the unitary business.

The sole question was whether that operational unity required the insurer's inclusion in the combined report.

Why the insurer was not a section 25101 taxpayer

The historical California constitutional provision imposed an annual tax on most insurers' gross premiums and stated that the tax was in lieu of other state, county, and municipal taxes and licenses, except specified real-estate and motor-vehicle taxes.

The ruling said a constitutionally exempt insurer was outside the statutory definition of a corporation subject to the ordinary corporate franchise or income tax.

Section 25101 applied to a "taxpayer subject to the tax imposed under this part." Because the insurer was not subject to those corporate taxes, FTB treated it as outside the class of taxpayers eligible for formula apportionment through the combined report.

Income and factors were excluded

The ruling barred inclusion of both:

• the insurer's income; and
• the insurer's apportionment formula factors.

That result applied regardless of extensive intercompany business connections with the included unitary affiliates.

Out-of-state insurance affiliates

FTB extended the same exclusion to an insurance affiliate operating entirely outside California when documentation established that it regularly conducted an insurance business and was licensed and regulated under the laws of the states where it operated.

The ruling sought uniform treatment of insurers on basically similar facts, not inclusion merely because the insurer did not operate in California.

Intercompany transactions remained reviewable

Excluding the insurer did not make dealings with the unitary group invisible.

Under section 24725, FTB could examine whether:

• the insurer charged excessive amounts for services provided to affiliates; or
• the insurer inadequately reimbursed affiliates for services it received.

The agency could adjust the included unitary income if those transactions understated it.

What this means for you

Insurance groups

Under the historical ruling, operational integration did not override the insurer's separate constitutional tax status. Entity-level tax classification came before combined-report inclusion.

Financial-services companies

An excluded insurer's customer and service relationships with included affiliates still required arm's-length support and intercompany documentation.

Accountants and tax professionals

Determine whether an affiliate is legally an insurer subject to the relevant premium-tax regime, document its licensing and regulation, exclude only the entities and factors current law requires, and review intercompany pricing separately.

Common questions

Q: Did being part of one unitary business require the insurer's inclusion?

A: No. Its constitutional tax exemption meant it was not a section 25101 taxpayer under the ruling.

Q: Were only the insurer's profits excluded?

A: No. Both income and apportionment factors were excluded.

Q: Did the result apply to an insurer operating only outside California?

A: Yes, when documentation showed a regularly conducted, licensed, and regulated insurance business.

Q: Could FTB examine transactions with the excluded insurer?

A: Yes. Section 24725 allowed review of excessive charges and inadequate reimbursements affecting unitary income.

Q: Does this establish the current insurance-company combined-report rule?

A: No. It applies 1975 constitutional and statutory provisions that must be checked against current law.

Citations and references

• Former Cal. Const. art. XIII, § 14 4/5
• Former Cal. Rev. & Tax. Code §§ 23037, 23038, 23151, and 23501
• Cal. Rev. & Tax. Code §§ 24725 and 25101
• 15 Cal. App. 3d 343, 93 Cal. Rptr. 177 (1971)
• 30 Cal. 2d 472 (1947)

Source

• Landing page: California FTB Legal Rulings
• Official HTML: Legal Ruling 385

Original ruling text

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Legal ruling 385

STATE OF CALIFORNIA
Franchise Tax Board - Legal Division

March 28, 1975

Treatment of Insurance Company Affiliates for Combined reporting Purposes

A corporate insurer engaged in a unitary business must be excluded from the combined report for formula apportionment of unitary income under Section 25101. A corporate insurer operating in this state is not a "taxpayer" as defined in Section 23037 and as required for the purposes of Section 25101, since it is exempted from franchise, preference income, and corporate income taxes by the California Constitution.

Facts

Advice has been requested whether a combined report for a group of affiliated corporations conducting a unitary business should include an insurance company subsidiary engaged in substantial intercompany activities with the unitary affiliates.

Unitary businesses such as small loan financing, or commercial financing, or wholesale or retail sales on credit sometimes have one or more insurance company subsidiaries which sell life, accident, health, or fire and other casualty insurance to the unitary business customers in connection with the regular financing transactions. In some instances premiums from this activity represent either a majority or substantially all of the premiums paid to the insurance company. It is assumed herein that the various operations and management relationships between an insurance company and its affiliated unitary group are of substantial magnitude so that the insurance company would be considered an integral part of that unitary business.

Question

Should an insurance company affiliate be included in the combined report for the unitary business?

Decision

No.

Discussion

All insurance companies operating in California are licensed by and subject to the stringent regulation and control of the California Department of Insurance even where they operate in other states as well. Each company is also separately licensed and regulated under the particular laws of each other state and country in which it conducts its insurance business.

The Constitution of California, Article XIII, Section 14 4/5, as amended November 8, 1966, expressly covers the taxation of insurers. Certain provisions relate only to title and ocean marine insurance companies. All other insurers are subject to an annual tax on their gross premiums. Subsection (f) states that the tax imposed by this section on insurers "is in lieu of all other taxes and licenses, state, county, and municipal . . ." except for taxes upon their real estate and taxes and licenses upon their motor vehicles.

In First American Title Ins. & Trust Co. v Franchise Tax Board, 15 Cal.App.3d 343, 93 Cal.Rptr. 177 (1971), the court held this insurance company was not subject to the Section 23151 franchise tax on corporations measured by the income from the businesses, previously conducted by its noninsurance subsidiaries, which it had acquired via reorganization. Referring to Article XIII, Section 14 4/5, the court said:

The constitutional exemption is clear and unequivocal and, as such, needs no outside aid to test its meaning, which is that the tax there prescribed is: "in lieu of all other taxes." We are mindful of the consequential loss of revenue from franchise tax sources, but this loss, even though serious, is but a result of the system put in operation by the Constitution, which we and the Legislature are powerless to change.

Revenue and Taxation Code Section 23038 excludes from its definition of "corporation" a corporation expressly exempt by the California Constitution. Thus, a corporate insurer, being so exempted, likewise is not subject to the Section 23501 corporation income tax since either it or the Section 23151 franchise tax is imposed only on a "corporation" within that definition.

The use of an apportionment formula to determine the California portion of the net income from a unitary business conducted within and without this state is authorized by Section 25101. Formula apportionment by the combined report method thereunder, where the unitary business is conducted by a group of affiliated corporations, has been sustained in a long line of cases since its approval in the landmark decision of the California Supreme Court in Edison California Stores, Inc. v. McColgan, 30 Cal.2d 472 (1947). Under that method, after the California portion of the unitary business net income has been determined by formula the franchise tax is then separately imposed on each affiliated corporation engaged in the unitary business activities in California measured by its share of that California portion as further determined via an intrastate apportionment computation.

Section 25101 limits its application to "a taxpayer subject to the tax imposed under this part." As defined in Section 23037 a "taxpayer" is a corporation or bank subject to the franchise tax, the tax on preference income, or the corporation income tax. Thus, any general or financial corporation or bank which does business in this state or derives income from sources within this state as an integral part of a unitary business is a taxpayer for Section 25101 apportionment formula purposes. Any such unitary affiliate is includible in a combined report unless it can affirmatively establish it is not a taxpayer on the basis that it is wholly exempt from these taxes either as (1) one of the specified exempt organizations in Sections 23701 through 23709 (certain charitable, religious, educational, fraternal, and other organizations) or as (2) within a business category covered by a particular article of the California Constitution.

A corporate insurer expressly exempted from these taxes by the California Constitution is not a "taxpayer" as defined in Section 23037. Accordingly, the Section 25101 limitation to a "taxpayer" bars the inclusion in a combined report of the income and formula factors of any corporate insurer operating in California, irrespective of the fact that it may have extensive intercorporate business connections with its affiliates conducting the unitary business.

In accord with the established departmental practice of uniform treatment on basically similar facts, this required exclusion from a combined report of a corporate insurer operating in this state similarly applies in any unitary business situations where the insurance company affiliate operated entirely outside California. It will be excluded from the combined report where the documentation establishes that it regularly engaged in an insurance business and was so licensed by and subject to regulation under the laws of the state or states where it operated.

The business activities between an excluded insurance company and the unitary business affiliates are an appropriate area of inquiry in determining the correct combined unitary income. Section 24725 authorizes examination of those activities by this department to ascertain whether there may have been an understatement of unitary income through excessive intercompany charges for insurance company services or inadequate reimbursement by it for intercompany services received.

Last updated: 09/24/2025