If a surplus lines insurer charges a separate engineering inspection fee to an applicant, is that fee subject to Texas sales tax even though the surplus lines premium (which may end up including that fee) is already subject to the 4.85% surplus lines premium tax?

Subject

Engineering Inspection Fee For Surplus Lines Insurance — Taxable Insurance Service Vs. Premium

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9312L1276A01

Plain-English Summary

The taxpayer asked the Comptroller about the taxability of an engineering inspection fee charged to an applicant who was trying to obtain a surplus lines insurance policy. The inspection fee (plus the applicable 6.25% Texas state and local sales and use tax on that fee) was charged directly to the applicant/insured. Separately, the fee — along with the sales tax on it — was reported to the Stamping Office and became subject to the surplus lines (gross premium) tax of 4.85%, because the Stamping Office said it could not separate the inspection fee out of the premium; it rejected submissions where the fee had been broken out before filing. The taxpayer's concern was that the insured ended up being taxed twice on the same dollar amount — once as sales tax on the inspection fee, and again as surplus lines premium tax when that fee was folded into the reported premium.

The Comptroller worked through the statutory framework to explain why both taxes apply:

• Tax Code 151.051 imposes sales tax on every sale of a taxable item in Texas.
• A "taxable item" (151.010) includes taxable services, and 151.0101(a)(9) lists insurance services as a taxable service.
• 151.0039 defines "insurance services" to include "insurance investigation," but expressly excludes "insurance coverage for which a premium is paid." Rule 3.355(c)(1) repeats that same exclusion.
• Rule 3.355(b) imposes sales tax on insurance services performed for an insurance carrier, insured, policyholder, or others, in connection with a policy of insurance, "for monetary fees, dues, or other consideration."
• Insurance Code Article 1.14-2, Section 12(a) defines "premium" broadly to include "all premiums, membership fees, assessments, dues or any other consideration for insurance," and Article 1.14-2 states the surplus lines tax "shall be in lieu of all other insurance taxes." Surplus lines agents collect a 4.85% premium tax on gross premiums.

The Comptroller then relied on Hammerman & Gainer, Inc. v. Bullock (App. 3 Dist. 1990), where the court upheld the constitutionality of the Comptroller's narrow reading of the "insurance coverage for which a premium is paid" exclusion in 151.0039(b). In that case, the court rejected the argument that claims adjustment services paid for by an insurance carrier were part of the "insurance coverage" exempt from sales tax, reasoning that "coverage" can reasonably be read narrowly to mean only the risk of liability, not every cost an insurer bears.

Applying that reasoning, the Comptroller's position here is that the purchase of an insurance service (the engineering inspection) is a separate and distinct transaction from the purchase of insurance coverage. Sales tax is owed once on the insurance service itself. The fact that the inspection fee (and its sales tax) later gets folded into the "premium" reported to the Stamping Office — and taxed again there under the surplus lines premium tax — does not exempt the inspection fee from sales tax in the first place.

What This Means For You

If you sell or arrange surplus lines insurance and charge a separate engineering/inspection fee: This letter confirms the fee for the inspection itself is a taxable "insurance service" under 151.0101(a)(9) and Rule 3.355(b), so 6.25% Texas state and local sales tax applies to it, billed to the applicant/insured.

Be aware of the double-taxation friction this letter itself flags: The letter acknowledges that when the Stamping Office cannot or will not separate the inspection fee out of the gross premium, the insured effectively pays sales tax on the fee and the 4.85% surplus lines premium tax on that same fee once it's absorbed into "premium." The Comptroller did not resolve or eliminate that overlap — it explained why, under the statutes and Hammerman & Gainer, the sales tax on the service is still owed regardless of what happens with the premium tax downstream.

Practical takeaway: If you want to avoid the double tax exposure this letter describes, the friction point is with the Stamping Office's processing of separately-stated fees, not with the sales tax rule itself — the letter states the Stamping Office "rejects the payment when the fee is separated out prior to submission."

Q&A

Q: Is an engineering inspection fee charged to an applicant for surplus lines insurance subject to Texas sales tax?
A: Yes. The Comptroller treated it as a taxable "insurance service" under Tax Code 151.0101(a)(9) and Rule 3.355(b), subject to the 6.25% Texas state and local sales and use tax, charged to the applicant/insured.

Q: Doesn't the exclusion for "insurance coverage for which a premium is paid" in 151.0039 cover this fee, since it ends up part of the premium?
A: No. The letter explains that the purchase of the insurance service (the inspection) is a separate transaction from the purchase of insurance coverage. Citing Hammerman & Gainer, Inc. v. Bullock, the Comptroller applies a narrow reading of "insurance coverage," so the exclusion does not reach the inspection fee even though the fee later becomes part of the reported premium.

Q: Why does the insured end up taxed twice on the same fee?
A: Because the inspection fee, plus its sales tax, is reported to the Stamping Office as part of the gross premium, and the 4.85% surplus lines premium tax then applies to that gross premium amount. The Stamping Office told the taxpayer it cannot separate the inspection fee out of the premium and rejects filings where the fee is separated out beforehand — so the sales tax and the premium tax both end up applying to the same dollars.

Q: Does this letter resolve the double-taxation problem?
A: No. The letter explains the legal basis for why the sales tax on the inspection fee is owed, but it does not describe any mechanism to prevent that fee from also being swept into the premium tax base — the letter simply lays out why both taxes independently apply under current law and the Stamping Office's practice.

Original ruling text

December 22, 1993

Dear **

Thank you for your letter of October 19, 1993, to Mr. Gary Johnson of
this office concerning the taxability of engineering inspections
performed for an applicant seeking to obtain an insurance policy on a
surplus lines basis.

The engineering inspection fee is charged to the applicant (insured),
including the applicable 6.25% Texas state sales and local sales and
use taxes.

The fee for the inspection and the applicable Texas state and local sales
and use tax is reported to the * is also subject to surplus lines (gross
premium) tax. Because the insured is also charged for the surplus lines tax,
the insured is being taxed twice on the amount that represents the inspection
fee. The Stamping Office indicates that it is unable to separate out the
inspection fee so as to avoid the premium tax on that amount and rejects the
payment when the fee is separated out prior to submission.

Texas Tax Code 151.051 imposes a sales tax on each sales of a taxable
item in this state. A taxable item is defined in 151.010 as tangible personal
property and taxable services. Taxable services are defined in 151.0101(a)(9)
to include insurance services.

Insurance services are defined in 151.0039 to mean ". . . insurance
investigation . . . but does not include insurance coverage for which a premium
is paid . . ." Rule 3.355(c)(1) incorporates that same exclusion.

Rule 3.355(b) concerning insurance services imposes a sales tax on
insurance services as defined in subsection (a) of the rule when "performed, on
behalf of an insurance carrier, its insured, its policyholder, or others
pertaining to a policy or policies of insurance for monetary fees, dues, or
other consideration."

Article 1.14-2, Section 12(a) of the Texas Insurance Code defines the
term "premium" to include "all premiums, membership fees, assessments, dues or
any other consideration for insurance." (Emphasis added.)

Article 1.14-2 of the Texas Insurance Code states: "Such tax shall be in
lieu of all other insurance taxes." (Emphasis added.) Surplus lines agents
collect a premium tax of 4.85% of gross premiums charged for surplus lines
insurance.

In Hammerman & Gainer, Inc. v. Bullock (App.3 Dist. 1990) S.W.2d 330),
the court upheld the constitutionality of the Comptroller's interpretation of
151.0039. The appellants argued that the imposition of sales tax on claims
adjustment services when rendered to insurance carriers whose rates and
policies were regulated by the State Insurance Board (now the Insurance
Commission) were exempt from sales tax. The appellants argued that the cost of
the claims adjustment services were borne by the insurance carrier and were
part of the insurance coverage for which a premium is paid.

The court pointed to the difficulty in interpreting the scope of
151.0039(b): "insurance coverage for which a premium is paid." In upholding the
Comptroller's narrow interpretation of the phrase and the constitutionality of
Rule 3.355, the court reasoned:

Insurance "coverage" is susceptible to a range of interpretations.
Generally, it can be defined as the "amount and extent of risk covered by
insurer." Blacks Law Dictionary 330 (5th ed. 1979). Construed most broadly,
the phrase "extent of risk" might include a multitude of costs borne by an
insurer, including defense costs and possibly even the costs and possibly even
the cost of adjustment services. However, "extent of risk" can also be
reasonably construed more narrowly to include only the risk of liability.

The Comptroller takes the position that the purchase of an insurance
service by the insured, the insurance carrier, or the managing general agency
is a separate and distinct transaction from the purchase or sale of insurance
coverage. The sales tax is paid once on the insurance service. The fact that
the insurance service and the applicable sales tax on the service are included
in the "premium" does not exempt the purchase of the insurance services from
sales tax.

This opinion is based on the facts presented. If there are additional or
different facts, the opinion may change.

You may call toll free 1-800-531-5441, extension 3 4683 if you have any
questions or need more information. You may write to Tax Administration
Division, Comptroller of Public Accounts.

Sincerely,

Eddie C. Washington
Tax Administration Division

NOTE: Previous Accession Number 9311147L.3 and/or 9311147L