Insurance Tax Law Challenge : Supreme Court: Los Angeles and other cities ask the state justices to allow taxation of insurance company income not derived from premiums.

In a bid for a new and lucrative source of revenue, attorneys for Los Angeles and other cities asked the state Supreme Court on Wednesday to remove a legal barrier that has long protected insurance company investment income from municipal taxes.

At issue is a state constitutional provision, enacted in 1910, that, with some exceptions, frees insurers from “all other taxes” in return for paying a tax on gross income from premiums. That provision has been thus far interpreted to ban local business taxes on insurers.

The city of Los Angeles, backed by several other California municipalities, now contends that such protection should not apply when firms are engaged in non-insurance-related business, such as operating a parking facility or a hotel.

“Insurers have spread out into other activities, with no connection to the insurance business,” Los Angeles Assistant City Atty. Ronald A. Tuller said during arguments before the high court in Los Angeles.

But the justices were told by an insurance company lawyer that the state Constitution’s plain language prohibits such taxation. “The city is saying the Constitution doesn’t mean what it says,” said Douglas P. Smith of Irvine, an attorney for Mutual Life Insurance Co. of New York.

Smith also said that contrary to the city’s claim, the revenue at issue helps support the industry and thus is directly related to insurance and is protected against taxation. “The business of insurance is investment,” he said.

The case has emerged as cities seek to replenish treasuries still suffering the effects of Proposition 13, the 1978 property tax-limit initiative--and as insurers confront the rate-cutting demands of Proposition 103, the insurance reform measure passed by voters in 1988.

The impact of the high court’s ruling, due within 90 days, could have wide impact. While no precise data is available, officials believe that a ruling in favor of Los Angeles would open the way for cities and counties to collect millions of dollars in new revenue annually. Los Angeles alone has already collected more than $1 million from insurers in contested revenue, pending the outcome of the case.

According to Brad Wenger, president of the Assn. of California Life Insurers, firms will pay the state well over $1 billion in gross premium taxes this year. “Our conclusion is we pay well in excess of our fair share of taxes already,” he said in an interview.

The stage was set for the tax dispute when a state Court of Appeal, acting in a separate case, ruled in 1982 that San Francisco could collect a personal property tax on a hotel owned by an insurance company.

The city of Los Angeles responded by charging insurers with municipal taxes on parking facilities, commercial-property rental and utility use it believed to be unrelated to insurance. The insurers filed suit, and in December, 1988, won a ruling from a state Court of Appeal in Los Angeles that the Constitution barred such taxation.