Opinion ID: 2187568
Heading Depth: 1
Heading Rank: 1

Heading: constitutionality of the gross premiums tax

Text: Prior to its amendment and reenactment by the 1983 Legislature, [2] § 26-01-11(1), N.D.C.C., provided: 26-01-11. Commissioner of insurance to collect premium taxInsurance companies generallyDomestic fire insurance companiesComputation.  Before issuing the annual certificate required by law, the commissioner of insurance shall collect the following annual taxes from insurance companies doing business within the state: 1. From every insurance company doing business in this state except stock and mutual companies organized under the laws of this state, a tax equal in amount to two and one-half percent of the gross amount of premiums, membership fees, and policy fees received in this state during the preceding year, such tax to be payable at the time when the annual statement of business required by law is filed; provided, however, that this tax shall not apply to considerations for annuities. [Emphasis added.] Under this statute, foreign insurance companies were subject to an annual assessment of 2½ percent on the gross amount of premiums, membership fees, and policy fees received from North Dakota policyholders. The tax was not imposed on insurance companies incorporated under the laws of the state, but domestic-incorporated insurance companies were subject to the state corporate income tax under § 57-38-30, N.D.C.C. This tax was assessed on taxable income at a graduated rate of between 2 percent and 7 percent. Foreign insurance companies that were assessed the gross premiums tax were not subject to the state corporate income tax because of an exemption provided for them under former § 57-38-09(15), N.D.C.C. [amended and reenacted by 1983 N.D.Sess. Laws Ch. 631, § 1]. Insurance companies organized under the laws of this state were also subject to a business and corporation privilege tax of 1 percent of net taxable income [§ 57-38-66, N.D.C.C., repealed by 1979 N.D.Sess.Laws Ch. 612, § 3], and the Vietnam bonus surtax which imposed a graduated tax of between $10 and $25 on domestic corporations for the tax years 1972 through 1974 [§ 57-38-30.2(2), N.D. C.C., repealed by 1975 N.D.Sess.Laws Ch. 476, § 2]. In Western & Southern Life Ins. Co. v. State Board of Equalization of California, 451 U.S. 648, 101 S.Ct. 2070, 68 L.Ed.2d 514 (1981), the United States Supreme Court, in upholding California's imposition of a retaliatory tax on foreign insurance companies, rejected a line of cases exemplified by Lincoln National Life Ins. Co. v. Read, 325 U.S. 673, 65 S.Ct. 1220, 89 L.Ed. 1861 (1945), which held that a state may impose a more onerous tax on foreign corporations for the privilege of doing business in the state without any requirement of a rational relationship between the tax and a legitimate state purpose. The Court stated: In view of the decisions of this Court both before and after Lincoln National, it is difficult to view that decision as other than an anachronism. We consider it now established that, whatever the extent of a State's authority to exclude foreign corporations from doing business within its boundaries, that authority does not justify imposition of more onerous taxes or other burdens on foreign corporations than those imposed on domestic corporations, unless the discrimination between foreign and domestic corporations bears a rational relation to a legitimate state purpose. Western & Southern, 451 U.S. at 667-668, 101 S.Ct. at 2083, 68 L.Ed.2d at 530. The State first asserts that the district court erred in determining that North Dakota placed a more onerous tax burden on foreign companies than was placed on domestic companies by virtue of the gross premiums tax. This contention is without merit. During the trial, the district court admitted into evidence documents indicating the amount of gross premiums taxes paid by the four plaintiffs for the years 1971 through 1980. The plaintiffs also introduced hypothetical North Dakota corporate income and business and privilege tax returns for the corresponding years. These hypothetical tax returns were introduced through the testimony of tax accountants from each company and indicated the amount of taxes each plaintiff would have paid if it had been taxed as a North Dakota-incorporated insurance company. The plaintiffs' federal income tax returns were used as a basis for computing the hypothetical North Dakota taxes, in addition to other business and accounting records of the plaintiffs. [3] The trial testimony based on these documents established that the gross premiums tax places a tax burden on foreign-incorporated companies that is far in excess of the amount the companies would have paid under the North Dakota corporate income, corporate business and privilege, and Vietnam bonus surtaxes applicable to North Dakota-incorporated companies. The record establishes that between 1971 and 1980, Massachusetts Mutual Life Insurance Company paid $223,247 more in gross premiums taxes than if it had been taxed as a North Dakota company. Between 1975 and 1980, Prudential Property and Casualty Insurance Company paid $75,063 more than if it had been taxed as a domestic company during the same period of time. Prudential Insurance Company of America paid $1,696,560 more than it would have if taxed as a domestic company between 1971 and 1980. Between 1970 and 1980, Metropolitan Life Insurance Company paid $605,033 more than it would have if it had been taxed as a domestic company. [4] The State's expert economist admitted on cross-examination that the effective North Dakota income tax rate on gross corporate receipts is .02 percent. Comparing the two tax rates, he estimated that foreign insurance companies paid at a rate as much as 125 times higher than domestic insurance companies. To argue, as does the State, that when looking at the tax system as a whole in computing the relative tax burdens, the burden on the foreign companies was not unduly significant or discriminatory, ignores the realities of the situation. There is no question that the North Dakota statutory scheme for taxing insurance companies placed a more onerous burden on foreign-incorporated companies than was placed on domestic-incorporated companies, and that it did so based solely on the place of incorporation of the taxpayer. We next determine whether or not the discrimination between foreign and domestic corporations bears a rational relation to a legitimate state purpose. Western & Southern, supra, 451 U.S. at 668, 101 S.Ct. at 2083, 68 L.Ed.2d at 530. This necessitates a twofold inquiry: (1) Does the challenged legislation have a legitimate purpose? and (2) Was it reasonable for the lawmakers to believe that use of the challenged classification would promote that purpose? Western & Southern, supra . In Metropolitan Life Ins. Co. v. Ward, ___ U.S. ___, 105 S.Ct. 1676, 84 L.Ed.2d 751 (1985), the United States Supreme Court was presented the question whether or not Alabama's domestic preference tax statute, which taxed foreign insurance companies at a higher rate than domestic insurance companies, violated the Equal Protection Clause. In Ward, several foreign insurance companies sought a judgment declaring the Alabama tax unconstitutional and requiring the Commissioner of Insurance to make appropriate refunds. On cross-motions for summary judgment, a state circuit court ruled that the statute was constitutional because it served `at least two purposes, in addition to raising revenue: (1) encouraging the formation of new insurance companies in Alabama, and (2) encouraging capital investment by foreign insurance companies in the Alabama assets and governmental securities set forth in the statute.' Ward, supra, ___ U.S. at ___, 105 S.Ct. at 1679, 84 L.Ed.2d at 756. The state court of civil appeals affirmed the circuit court's rulings as to the existence of the two legitimate state purposes, but remanded for an evidentiary hearing on the issue of rational relationship. The foreign companies waived their right to a hearing on the rational relationship issue, and requested a final determination from the Alabama Supreme Court on the legitimate purpose issue. The Alabama Supreme Court ultimately entered a final judgment in favor of the State, and the companies appealed to the United States Supreme Court. The Supreme Court reversed, holding by a 5-4 majority that promotion of domestic business by imposing a discriminatory tax against nonresident competitors, and that encouraging investment in state assets and securities through imposition of a discriminatory tax, are not legitimate state purposes under the Equal Protection Clause. The Supreme Court did not invalidate Alabama's domestic preference tax statute, but because of the procedural posture of the case, remanded for further proceedings in which the State will be free to advance again its arguments relating to the legitimacy of 15 additional purposes advanced in support of the Alabama statute. Ward, supra, ___ U.S. at ___ n. 5, 105 S.Ct. at 1680 n. 5, 84 L.Ed.2d at 758 n. 5. In the present case, the State has advanced 23 purposes in support of § 26-01-11(1), N.D.C.C. A list of six proposed legislative motives or purposes was presented by the State's expert economist. The State's brief lists 17 other possible legislative purposes. The district court ruled that [t]o the extent that any of the ... purposes advanced by defendants were considered by the legislature they are either not legitimate or are not rationally related to the achievement of a legitimate state purpose. [5] The vast majority of the purposes presented by the State, and upon which the State relied most heavily in the district court, relate to promotion of the domestic insurance industry within the state and encouragement of capital investment in the state. Both of these purposes were determined by the Supreme Court in Ward not to be legitimate under the Equal Protection Clause when furthered by discrimination. The State has not specifically directed our attention to any particular one of the remaining purposes which it believes might survive equal protection analysis after the Supreme Court's decision in Ward. In any event, the five purposes we discern not to be directly related on their face to the purposes invalidated in Ward are that the gross premiums tax: (1) Serves in lieu of a tax on revenues received by foreign insurance companies as a result of reinsurance arrangements with domestic companies; (2) Compensates North Dakota for benefits received by foreign insurance companies as a result of government services provided by North Dakota and its political subdivisions; (3) Equalizes the burden which the tax system as a whole imposes upon domestic and foreign insurance companies in North Dakota; (4) Simplifies and eases the administration of tax and insurance laws; and (5) Encourages foreign insurers to transact business in the state. If, under Ward, promoting domestic business and encouraging capital investment are not legitimate state purposes when furthered by discrimination, we are unable to perceive how the above-mentioned purposes can be construed as sustaining the gross premiums tax when viewed in light of its excessively discriminatory nature. The first purpose advanced by the State rests upon the premise that reinsurance premiums received by foreign insurance companies should be subject to taxation while those received by domestic insurance companies should not be subject to taxation. We agree with the plaintiffs that advancing this purpose as a justification for the discriminatory gross premiums tax is tantamount to advancing discrimination as a purpose to be accomplished by discrimination. Purposes 2 and 3 are somewhat interrelated. Purpose 2 implies that foreign insurance companies should be required to pay a gross premiums tax, just as domestic insurance companies are required to pay income taxes, as compensation for services rendered by the state and its political subdivisions. We first note that in order to qualify for the exemption from the gross premiums tax, a company need not be domiciled within the state, but need only be incorporated under state law. Although the State has not specified what these services might be, it can logically be assumed that foreign insurance companies receive no more in the way of such services than do domestic insurance companies. Purpose 3 similarly implies that the gross premiums tax is imposed on foreign companies to equalize the tax burden on all companies because domestic companies must pay corporate income taxes while foreign companies do not. The flaw in these arguments is that the tax burdens are far from equal, and foreign companies are taxed at a rate significantly higher than domestic companies. To call this equalizing the tax burden under these circumstances is a misnomer. The excess burden imposed upon the foreign companies through this discriminatory taxing scheme cannot conceivably be construed as contributing to the accomplishment of these purposes. With regard to purpose 4, we fail to see any legitimacy in the contention that the discriminatory gross premiums tax simplifies and eases the administration of tax and insurance laws. Uniform tax treatment of both classes of companies would seem to be the rational means to achieve this purpose. Assuming for purposes of argument that encouraging foreign companies to transact business in the state is a legitimate purpose, it is difficult to comprehend how a tax scheme which significantly discriminates against foreign companies conceivably could have been believed to achieve that purpose. We conclude that none of the purposes advanced by the State are legitimate when furthered by discrimination, or if legitimate, that the tax is not rationally related to the achievement of those purposes. Especially in light of the United States Supreme Court decision in Ward, we hold that North Dakota's pre-1983 gross insurance premiums tax bears no rational relationship to a legitimate state purpose and therefore violates the Equal Protection Clauses of the Federal and State Constitutions. [6]