New Jersey Court Reinforces Taxation on Captive Insurance

A decision recently passed by the New Jersey Tax Court determined that a company incorporated in New Jersey was liable for self-procurement tax based on all of the U.S. premiums paid to its captive insurer. This decision, based on a broad interpretation of statutes related to nonadmitted and captive insurance, may have a significant impact on companies in New Jersey and throughout the country.

The Court Case

In Johnson & Johnson v. Director, Division of Taxation, N. 013502-2016, Johnson & Johnson as the plaintiff argued that a refund of taxes was due because of an incorrect interpretation of statute. Johnson & Johnson is incorporated in New Jersey and has a wholly-owned captive insurance company domiciled in Vermont. In New Jersey, premium tax is imposed on self-procured policies from a nonadmitted, or out-of-state, insurance company. Johnson & Johnson originally began paying self-procurement tax to New Jersey based only on the portion of premiums allocable to the state of New Jersey. In 2010, it adjusted its calculation to include all premiums earned in the United States per New Jersey’s application of the federal Nonadmitted and Reinsurance Reform Act of 2010 (“NRRA”). The plaintiff then determined that this application was incorrect, and requested a refund of almost $60 million from the state.

The New Jersey Division of Taxation disagreed with this request for refund, and instead stated that the tax was correctly based on all U.S. premiums. As the defendant, the State argued that nonadmitted insurance includes self-procured insurance, and that, as self-procured insurance, captive agreements fall within its scope. After a review of the relevant facts and legislative history, the New Jersey Tax Court ruled in favor of the defendant and denied the refund request made by the taxpayer.

The Nonadmitted and Reinsurance Reform Act of 2010

The most important aspect of this case was the state’s interpretation of the NRRA on the taxation of captive insurance. The NRRA was passed by Congress as a part of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”). The Act established the “Home State Rule” which prohibits any state other than the home state of the insured to impose a premium tax on nonadmitted insurance (15 U.S. Code § 8201(a)). Shortly after this Act was passed, the New Jersey legislature passed its own statutes to adopt the Home State Rule, and expand taxation of these nonadmitted lines.

Ambiguity existed on the application of the State’s legislation, and searching for clarity led the plaintiff to seek a judgement from the court. Johnson & Johnson argued that only surplus lines were actually included in the NRRA, and pointed to statements made to that effect by leaders in Congress. The Division of Taxation argued that the intent of the state legislation was to include both self-procured and surplus markets. Although the exact wording of the statute was unclear, the Court determined that the defendant was correct and that, in line with past legislation, the intent of New Jersey’s statutes did indeed cover both.

The Impact

The immediate impact of this decision was that all of the U.S. premiums paid by the plaintiff to its captive were subject to self-procurement tax, and that no refund was owed. The captive insurer already pays tax to the state of Vermont based on premiums collected, and these premiums are now double-taxed by New Jersey. The case however has a much larger impact; New Jersey companies with captives must now ensure that they are in compliance with this judgement. It is expected that other states will also begin analyzing their own regulations in light of New Jersey’s application. Although the official opinion of the New Jersey Tax Court left interpretation of the actual intent of the NRRA to federal courts, it did judge the state’s amendments put in place after the Act was released. The Court’s broad interpretation is sure to trigger actions in many states, and may even reach the federal level of government.

Read the full court opinion here.