Surplus Lines and Independently Procured Insurance – Taxability of Policies Sold to State or Federal Agencies and Exemptions/Preemptions

The following appeared in the March 2011 issue of the Texas Comptroller’s “Tax Policy News”:

Surplus Lines and Independently Procured Insurance — Taxability of Policies Sold to State or Federal Agencies and Exemptions/Preemptions

State and federal agencies are not exempt from payment of surplus lines or independently procured taxes on policies purchased. Unless there is a specific exemption or preemption from taxation, policies sold to these agencies are subject to tax. As we will discuss, there are few exemptions or preemptions from taxation for surplus lines and independently procured business.

The Texas Insurance Code, in Sections 225.004 and 226.003, exempts from surplus lines and independently procured taxation respectively, premiums on risks or exposures that are properly allocated to federal waters or international waters or are under the jurisdiction of a foreign government.

“International waters” is defined as being outside the Three Marine League Line, which is approximately 10.4 miles from shore. Texas has full sovereignty over the water; beds and shores; and arms of the Gulf of Mexico within its boundaries, including all land that is covered by the Gulf of Mexico and the arms of the Gulf of Mexico, either at low tide or high tide.

Policies covering risks within 10.4 miles of the Texas coast and Texas inland waters are taxable. Any U.S. possessions or territories as listed with the Office of Territorial and International Affairs of the U.S. Department of the Interior do not qualify as functioning under the jurisdiction of a foreign government; therefore, policies covering risks in these locations remain subject to taxation.

Federal preemptions to state taxation for surplus lines or independently procured insurance exist for premiums on policies that are issued for the following entities: the Federal Deposit Insurance Corporation (FDIC) under 12 U.S.C. §1825 (b), when it acts as the receiver of a failed financial institution that holds the property being insured; the National Credit Union Administration under 12 U.S.C. §1787 (b), when acting as conservator for a liquidating agent for Federal Credit Unions; and a federally chartered credit union under 12 U.S.C. §1768.

The Federal Indian Reorganization Act of 1934 (Act) provides special protection from taxation on activities that occur on tribal lands. Section 1151, Title 18, U.S.C., states that “Indian country” is limited to territory within the United States. Generally, the terms “Indian tribes,” “Indian country,” “tribal nations” and “Indian reservations” refer to the American Indian tribal lands within the borders of the United States. The limitation on taxation provided by the Act is specific to activities that occur on the tribal lands.

The state, therefore, recognizes a federal preemption from surplus lines and independently procured taxation for insurance that covers exposures within the borders of tribal lands, but not on insured exposures of the tribal nation located outside its borders.

For example, no tax is due for insurance on buildings, equipment or automobiles if they are located within or garaged within the tribal lands. If the buildings, equipment or automobiles are owned by the tribal nation but not located within or garaged within the tribal lands, and are insured under a surplus lines or independently procured policy, tax is due.

Surplus lines or independently procured tax is due on property/building exposures that are leased by a tribal nation. No tax is due for liability insurance exposures on activities that occur within the tribal lands. Liability coverage on activities by a tribal nation that occur outside of the tribal lands is subject to surplus lines or independently procured tax.

The surplus lines tax is due March 1 of each year for business from the previous calendar year and the rate is 4.85 percent of the taxable premium. The independently procured tax is due May 15 following the calendar year in which the insurance was procured, continued or renewed and the rate is 4.85 percent of the taxable premium.