Could an insurer include accepted reinsurance in Florida's premiums apportionment formula when reinsurance was less than half its business?

Subject

Separate Accounting

Plain-English summary

The insurer had to use Florida's direct-premiums-only apportionment formula and could not add accepted reinsurance. Reinsurance represented 23.17% of its total premiums, below the rule's greater-than-50% test for treating reinsurance as the principal source of premiums.

The alternative calculation reduced the factor from .55427 to .42587, but a different percentage alone did not show gross distortion. The company also did not establish whether ceding affiliates or nonaffiliates were Florida residents, and the situation was neither unique nor nonrecurring. The Department therefore denied alternative apportionment.

What this means for you

An insurer seeking a departure from the statutory formula needed clear evidence that the regular method attributed Florida income unreasonably and that the proposed method was fair. Falling below the reinsurance threshold and producing a lower alternative factor were not enough.

Common questions

When could accepted reinsurance enter the statutory formula? When it was the principal source of premiums, defined as more than 50% of premium dollars received.

Was the percentage difference enough for relief? No. The Department found no gross distortion.

Was separate accounting approved? No.

Citations and references

• Fla. Stat. §§ 220.151(1)(a)-(b) and 213.22
• Fla. Admin. Code rr. 12C-1.0151(3) and 12C-1.0152

Source

• Landing page: Florida Tax Law Library
• Advisement: TAA 94C1-010

Original ruling text

Nov 30, 1994

Re: Technical Assistance Advisement No. 94(C)1-010 Corporate Income Tax; Separate Accounting

Dear:

Your request for a technical assistance advisement on behalf of XXX (hereinafter referred to as "Company"), was referred to this office for a response.

ISSUE

Your letter of September 27, 1994, requested relief from the provisions of the direct premiums only apportionment method and requested permission to specifically include reinsurance accepted in the apportionment calculation.

STATEMENT OF FACTS

The facts that you have provided are as follows:

1) For the year ended December 31, 1993, Company's federal taxable income is approximately $11,035,000.

2) For the year ended December 31, 1993, Company's direct premiums written and reinsurance assumed are as followed:

Reinsurance Reinsurance

Written
Premium

Florida

Assumed

Assumed

From

From

Direct

Affiliates Nonaffiliates Total

$49,262,337 -0-

-0-

$49,262,337

Other States $39,614,941 $7,476,693 $19,320,065 $66,411,699 Total

$88,877,278 $7,476,693 $19,320,065$115,674,036

DISCUSSION OF LAW

The "Florida Income Tax Code" established under Chapter 220, Florida Statutes, provided for a unique apportionment procedure for insurance companies under s. 220.151, F.S. Section 220.151, F.S., states in part:

"Apportionment; methods for special industries.--

(1)(a) Except as provided in paragraph (b), the tax base of an insurance company... shall be apportioned to this state by multiplying such base by a fraction the numerator of which is the direct premiums written for insurance upon properties and risks in this state and the denominator of which is the direct premiums written for insurance upon properties and risks everywhere..." (emphasis added)

Therefore, any insurance company writing insurance policies upon "properties and risks in this state" would normally apportion their federal taxable income to Florida using the following fraction:

Direct Premiums Written in Florida
Direct Premiums Written Everywhere

However, if an insurer also writes reinsurance, their total reinsurance accepted business must be analyzed to determine its relationship to the insurer's total premiums written. Specifically, s. 220.151(1)(b), F.S., states:

"If the principal source of premiums written by an insurance company consists of premiums for reinsurance accepted by it, the tax base of such company shall be apportioned... by multiplying such base by a fraction the numerator of which is the sum of:

1. Direct premiums written for insurance upon properties
   and risks in this state, plus
2. Premiums written for reinsurance, accepted in respect to
   properties and risks in this state, and the denominator of which is the sum of direct premiums written for insurance upon properties and risks everywhere plus premiums written for reinsurance accepted in respect to properties and risks everywhere. For purposes of this paragraph, premiums

written for reinsurance accepted in respect to properties and risks in this state,..., may, at the election of the company, either be determined on the basis of the proportion which premiums written for reinsurance accepted from companies resident in... the state bears to premiums written for reinsurance accepted from all sources or, alternatively, on the basis of the proportion which the sum of the direct premiums written for insurance upon properties and risks in this state by each ceding company from which reinsurance is accepted bears to the sum of the total direct premiums written by each such ceding company for the taxable year." (emphasis added)

The statute, therefore, provides for two different apportionment methods for insurance companies writing premiums or accepting reinsurance on properties and risks in this state. One method is for insurers that only write direct premiums, or that write direct premiums and accept some reinsurance, where the reinsurance accepted does not represent "the principal source" of their premiums written. Secondly, for those insurers that accept reinsurance only, or that accept reinsurance and write direct premiums, and whose reinsurance accepted does represent "the principal source" of the insurer's premiums written, the statutes provide for an alternative apportionment method.

The statute explicitly states that to use the combined apportionment calculation, i.e., reinsurance accepted plus direct premiums written, reinsurance must be "the principal source" of premiums written, not just "a" principal source of premiums written. The principal source of premiums written is defined in Rule 12C-1.0151(3)(a)3., Florida Administrative Code, as:

"... the majority (greater than 50 percent) of premium dollars received."

Rule 12C-1.0151(3)(b), F.A.C., further states that if "the principal source of premiums written by an insurance company is not for premiums for reinsurance accepted by it, the adjusted federal taxable income is apportioned to Florida" using the

apportionment calculation that considers direct premiums only. Upon analysis of Company's premium business, clearly reinsurance accepted does not meet the 50% test provided for in the rule.

The following is a breakdown of Company's 1993 insurance premium business showing that reinsurance accepted represents 23.17% of their total business: Percentage of Total Direct Premiums Total

$88,877,278

76.83%

Reinsurance Premiums Total $26,796,758 Total Premiums

23.17%

$155,674,036

You are requesting that Florida allow Company to include reinsurance accepted with direct premiums as the basis for determining the income apportioned to the State, rather than use the general direct premium only apportionment method. Rule 12C-1.0152, F.A.C., addresses the issue of other methods of apportionment and states:

"(1) If the general method of apportionment provided in s. 220.15, F.S., or the special method of apportionment provided in s. 220.151, F.S., does not fairly represent the taxpayer's business activity in this state, the taxpayer may petition for, or the Executive Director or his designee is authorized to require, in respect to all or any part of the taxpayer's business activity, if reasonable: "(a) Separate accounting; "(b) The exclusion of any one or more of the factors; "(c) The inclusion of one or more additional factors which will fairly represent the taxpayer's business activity in this state; or "(d) The employment of any other method to effectuate an equitable apportionment of the taxpayer's income. "(2)(a) A departure from the applicable method of apportionment required under the provisions of ss. 220.15 or 220.151, F.S., shall be permitted only where the method does not accurately and fairly reflect business activity in Florida. An alternative method may not be invoked, either by the Department of Revenue or the taxpayer, merely because it reaches a different apportionment percentage

than the regularly applicable formula. However, if the applicable formula will lead to a grossly distorted result in a particular case, a fair and accurate alternative method is appropriate (see Norfolk and Western Railway Co. v. Missouri State Tax Commission, 390 U.S. 217, 88 S. Ct. 995, 19 L. Ed. 2d 1201 (1968), which is incorporated by reference in Rule 12C-1.0511, F.A.C.). "(b) The party (Department of Revenue or the taxpayer) seeking to utilize an alternative apportionment method must show by clear and cogent evidence that the regularly applicable formula would result in taxation of extraterritorial values (see Butler Bros. v. McColgan, 315 U.S. 501, 62 S. Ct. 701, 86 L. Ed. 991 (1942), which is incorporated by reference in Rule 12C-1.0511, F.A.C.). This can be shown only if the regularly applicable formula is demonstrated to operate unreasonably and arbitrarily in apportioning to Florida a percentage of income which is out of all proportion to the business transacted in Florida (see Hans Rees' Sons, Inc. v. North Carolina ex rel Maxwell, 283 U.S. 123, 51 S. Ct. 385, 75 L. Ed. 879 (1931), which is incorporated by reference in Rule 12C-1.0511, F.A.C.). "(3) The party seeking to use an alternative formula must prove that the alternative formula fairly and accurately apportions income to Florida based upon business activity in this state. "(4) A departure from the regularly applicable apportionment method will be authorized only in limited and specific cases where unusual fact situations (which ordinarily will be unique and nonrecurring) produce a result that is incongruous with the results of previous tax years under the regularly applicable apportionment method. "(5) A taxpayer shall petition the Department for a departure from the required apportionment method by filing, on or before the due date for filing of the return for the taxable year, with extension, either: a written request for a technical assistance advisement under s. 213.22, F.S., and Department of Revenue Rule Chapter 12-11, F.A.C.; or, a petition for a declaratory statement under s. 120.565, F.S., and Department of Revenue Rules 12-2.010, 12-2.011, 12-2.012, and 12-2.013, F.A.C.

"(a) The taxpayer shall file the request or petition with the Division of Taxpayer Assistance, P.O. Box 7443, Tallahassee, Florida 32314-7443. "(b) The taxpayer's request or petition must include a summary of the evidence to support the taxpayer's contention that the applicable apportionment formula results in taxation of extraterritorial values and to demonstrate that the regular formula operates to unreasonably and arbitrarily attribute income to Florida far out of proportion to the business transacted in Florida. The taxpayer must also furnish evidence that the use of an alternative method fairly and accurately apportions income to Florida." (emphasis added)

The taxpayer should also be aware of the decision reached in the case Roger Dean Enterprises, Inc., v. State of Florida, Department of Revenue, 371 So.2d 101 (1978), in which the Supreme Court said, "There is a very strong presumption in favor of normal three-factor apportionment and against the applicability of the relief provisions. See Donald M. Drake Co. v. Department of Revenue, 263 Or. 26, 500 P.2d 1041 (1972)." The court then stressed that the "relief provisions of section 214.73, F.S., are to be used in only very rare instances where normal three-factor apportionment could lead to an unconstitutional result. Finally, the court concluded that "Departures from the basic formula should be avoided except where reasonableness requires." The relief provision, therefore, should be used where the statute reaches arbitrary or unreasonable results so that its application could be attacked successfully on constitutional grounds.

CONCLUSION

After carefully considering your request, we have determined, from the facts that you have presented, that Company did not meet the 50% test established under Rule 12C1.0151(3)(a)3., F.A.C. Further, it is clear from the statute that the 50 percent test is reasonable given the explicit statutory language which provided for the inclusion of reinsurance accepted only when the reinsurance accepted represents "the principal source of premiums written by an

insurance company" not just "a" principal source of premiums written.

The Company's 1993 apportionment factor calculated using direct premiums only was .55427 and the apportionment factor using direct premiums plus reinsurance accepted was .42587, a difference of .1284. Rule 12C-1.0152(2)(a), F.A.C., provides:

"An alternative method may not be invoked, either by the Department of Revenue or the taxpayer, merely because it reaches a different apportionment percentage than the regularly applicable formula."

This difference is not a "grossly distorted result," but rather a normal, acceptable difference. Rule 12C-1.0152(3), F.A.C., goes on to stress that:

"The party seeking to use an alternative formula must prove that the alternative formula fairly and accurately apportions income to Florida based upon business activity in this state."

The Company did not state in its letter, nor could you confirm during our telephone conversation of October 28, 1994, whether any of the "affiliates" or "nonaffiliates" were resident in this state. The apportionment factor of .42587 was calculated on the assumption that none of the reinsurance accepted was from insurers resident in this state. If, however, some of these insurers were resident in Florida, this apportionment factor would increase, and the difference between it and the direct premium only apportionment factor would decrease.

Finally, Rule 12C-1.0152(4), F.A.C., states:

"A departure from the regularly applicable apportionment method will be authorized only in limited and specific cases where unusual fact situations (which ordinarily will be unique and nonrecurring) produce a result that is incongruous with the results of previous tax years under the regularly applicable apportionment method."

This situation is not unique to this insurer; indeed, it is not uncommon for insurers that write direct premiums in Florida to also have reinsurance business. Such insurers may have a greater amount of reinsurance accepted than Company, or a lesser amount; however, the Department's position is that if the reinsurance accepted is less than 50% of total premiums written business, they must use the direct premiums only apportionment method. Additionally, this is not a unique situation for this taxpayer. Indeed, this exact issue was discovered during an audit of this company for the tax years ending 12/31/86 through 12/31/89. This situation is, therefore, common to this company and to other insurers writing direct premiums in Florida.

Therefore, based on the facts presented, the Department's position is that the direct premium formula consisting of:

Direct Premiums Written in Florida
Direct Premiums Written Everywhere

provides a representative share of the Company's activities within this state. Your request for inclusion of the Company's reinsurance accepted business in the apportionment factor is therefore denied.

This response constitutes a technical assistance advisement under s. 213.22, F.S., which is binding on the Department only under the facts and circumstances described in the request for this advice as specified in s. 213.22, F.S. Our response is predicted on those facts and the specific situation summarized above. You are advised that subsequent statutory or administrative rule changes or judicial interpretations of the statutes or rules upon which this advice is based may subject similar future transactions to the different treatment than expressed in this response.

You are further advised that this response and your request are public records under Chapter 119, F.S., which are subject to disclosure to the public under the conditions of section 213.22, F.S. Your name, address, and any other details which might lead to identification of the taxpayer must be deleted by the Department before disclosure. In an effort to protect

confidential information, we request you notify the undersigned in writing within 15 days of any deletions you wish made to the request or this response.

Sincerely,

Paul J. Munyon
Taxpayer Assistant
Statutory Compliance Section

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