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Washington state’s pursuit of out-of-state captives for unpaid premium taxes has caused an uproar in the captive community and raised a number of unanswered questions for stakeholders, including whether other states will follow Washington’s lead, experts say.
Washington Insurance Commissioner Mike Kreidler announced on Dec. 10 that captive insurers that have unlawfully insured any risk in the state in the past 15 years would be able to pay a substantially reduced fine and premium tax penalty for self-reporting the activity, following a settlement with Microsoft Corp. over unpaid premium taxes for its out-of-state captive. Failure to report during an 18-month grace period will result in the commissioner office’s pursuit of the maximum fines and tax penalties against captive insurers, including those who insured risk in Washington more than 15 years ago who fail to self-report, according to the statement.
“They are getting extremely aggressive, in my personal view, about going after companies and they’ve made this public,” Daniel Kusaila, Hartford, Connecticut-based tax partner for Crowe LLP, said during a webinar called A Taxing Way to Analyze Captive Structures, sponsored by the Vermont Captive Insurance Association, on Wednesday. “It’s really got industry in an uproar, rightfully so.”
But captive experts can only speculate about the impact of this evolving effort because many of the details are unclear, particularly in light of the Microsoft settlement, said Thomas Jones, Chicago-based counsel on tax, regulatory and legal matters involving captives, McDermott Will & Emery LLP.
“If there’s any upside to it … it appears that the Washington office of the commissioner is only going to apply all of this to a Washington-based multinational,” Mr. Jones said. “We don’t know, but that seems like where they’re going. And they seem to only be imposing the 2% tax on risk that is located in the state of Washington, although that’s not 100% clear. The downside if you don’t play their game, they’re going to go back more than 15 years, which is essentially unheard of in the state tax area. Six years usually is the defacto rule of (lookbacks), but they don’t seem to be constrained by what anybody else is doing. The $64,000 question, of course, is are other states going to look at this and say ‘wow, that’s a good source of revenue so I’m going to try to do the same thing.’ We don’t know that. I’m thinking probably not, but only time will tell.”
Captives who should self report include all those with a principal place of business in Washington, all those partially or wholly owned by a Washington state-based corporation or that have a principal place of business in the state, all captives that provide or have provided coverage for risks or property in the state, all those that have issued ocean marine and foreign trade insurance contracts in the state and all those that insure or have insured Washington consumers and/or entities, according to a frequently asked questions document issued alongside the announcement.
In May, Mr. Kreidler’s office issued a cease-and-desist order to Microsoft’s Arizona-based captive insurer and a notice that it intended to collect unpaid premium taxes. In August, the Redmond, Washington-based software giant agreed to pay $573,905 in unpaid premium taxes and $302,915 in interest and penalties and Mr. Kreidler rescinded the order to Microsoft’s captive Cypress Insurance Co. of Phoenix to stop transacting insurance without a license and pay tax on its written premiums.
Captive owners will have to examine whether this effort is an issue for them, Mr. Kusaila said.
“I think everybody’s got to take a look at their exposure out there because your captive auditors are going to want to take a look at their exposure,” he said. “It’s not an income tax exposure, but it is a contingency exposure that they definitely may want to take a look at and quantify.”
VCIA and the Captive Insurance Companies Association are tracking developments and exploring remedies, including potentially asking the state’s attorney general to weigh in on the legality of this issue, Mr. Jones said.
“They assume that what the captive is doing is unlawful, but they don’t explain why,” he said.
In other state news, the Illinois legislature voted to overturn Gov. Bruce Rauner’s amendatory veto of S.B. 1737, which would modernize the Illinois Insurance Code and make the state a more favorable environment for captive formations, in November.
Illinois law had required state-licensed captives to meet the minimum capital requirements for Illinois domestic insurers, which were much higher than the minimum levels set forth in the bill and in 2014 adopted a self-procurement tax of 3.5% of premiums imposed on Illinois-based businesses for payments made to unauthorized insurers, potentially including captives, in 2014, but the recently passed law lowers that tax rate to 0.5% of premiums.
“That’s a big break,” Mr. Jones said. “That’s a low rate when you talk about a self-procurement tax.”
Illinois had three captives in 2017, according to Business Insurance’s annual captive survey.
“There could be some activity in Illinois,” Mr. Jones said. “We don’t know. The Illinois Department of Insurance is not particularly interested in captives, regulating them, examining, but anything could happen. But it’s the self-procurement tax that drives this more than anything else.”
The department “championed this legislation to make Illinois a more attractive place for captives to operate,” the department said in a statement on Friday. “We are working on changing and establishing licensing and formation requirements, preparing for new hires and other department initiatives to support implementation.”
Washington state and Microsoft Corp. have settled allegations of taxes unpaid by the software giant’s captive insurer.