PLR 200213001: Mutual insurer acquisition meets continuity of interest rule

Plain-English summary

A mutual holding company planned to acquire a second mutual insurer after that insurer converted into a stock company. The IRS ruled that the conversion would be a § 368(a)(1)(E) recapitalization if state law treated the converted company as the same entity. The insurer's former members would recognize no gain or loss on the constructive exchange of membership interests for stock. Their new holding company membership interests would count as stock, and the reverse subsidiary merger would satisfy the continuity of interest requirement. The IRS expressly left open whether the merger as a whole qualified as a reorganization under § 368(a)(2)(E).

Ruling snapshot

• Question: What tax treatment applies to the second mutual insurer's conversion and merger into the holding company structure?
• Outcome: Approved on the specified issues, subject to the stated conditions and representations.
• Key authorities: IRC §§ 354, 368(a)(1)(E), 368(a)(2)(E); Treas. Reg. § 1.368-1(b).

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury

Number: 200213001
Washington, DC 20224
Release Date: 3/29/2002
Index Numbers: 368.05-00, 368.08-00 Person to Contact:

Telephone Number:

Refer Reply To:
CC:DOM:CORP:Br4 PLR-118041-
Date:
March 27, 2001

Company 1
=

Company 2
=

Company 3
=

Mutual Holding 1 =

Stock Holding 1
=

Stock Holding 2
=

Merger Sub
=

Merger Sub 2
=

Mutual Holding 2 =

State A
=

State B
=

New Name
=

This letter responds to your September 15, 2000 request for rulings on certain federal income tax consequences of a proposed series of transactions. Related transactions are addressed in PLR-118048-00 and PLR-118050-00, both issued this date.

The rulings given in this letter are based on facts and representations submitted by the taxpayer and accompanied by a penalties of perjury statement executed by an appropriate party. This office has not verified any of the -2-

materials submitted in support of the request for rulings. Verification of the information, representations, and other data may be required as part of the audit process.

Summary of Facts

Company 1 is a State A property and casualty mutual insurance company taxable under §§ 831 and 835 of the Internal Revenue Code (the "Code"). Company 1 is the common parent of a large affiliated group of corporations that files a consolidated federal tax return. Company 1 has one life insurance subsidiary.

Company 2 is a State A property and casualty mutual insurance company taxable under §§ 831 and 835. Company 2 has no subsidiaries.

Company 3 is a State B mutual insurance company taxable under §§ 831 and 835 and is the common parent of an affiliated group with no life insurance subsidiaries.

As mutual insurance companies, Company 1, Company 2, and Company 3 have membership interests rather than capital stock to reflect proprietary ownership. These membership interests, which are owned by policyholders, provide (i) the right to vote, (ii) the right to distributions of surplus upon liquidation, (iii) the right to dividends if and when declared by the board of directors, and (iv) such other rights as conferred by the company articles of incorporation or bylaws and by State A or State B law.

Proposed Transactions

For what are represented to be valid business reasons, it is proposed that, pursuant to an overall plan, (i) Company 1 convert into a stock insurance company controlled indirectly by newly formed Mutual Holding 1 and (ii) Mutual Holding 1 then acquire Company 2 and Company 3. More specifically:

Company 1 Conversion and Restructuring:

Upon satisfaction of various conditions precedent, Company 1 will convert into a stock insurance company controlled indirectly by newly formed Mutual Holding 1 as followings (the “Company 1 Conversion and Restructuring”):

(i) Under the laws of State A, Mutual Holding 1 will be formed on behalf of the Company 1 members, and Company 1 will organize Stock Holding 1 and -3-

Stock Holding 2. At no time before completion of the Company 1 Conversion (defined in step (ii) below) will Mutual Holding 1 be a member of the Company 1 affiliated group.

(ii) Company 1 will convert under the laws of State A into a stock insurance company (the “Company 1 Conversion” and "Reorganized Company 1"). In the Company 1 Conversion, (a) the Company 1 membership interests will be extinguished, (b) the former Company 1 members will automatically become Mutual Holding 1 members, and (c) Reorganized Company 1 will initially issue all of its stock to Mutual Holding 1. Company 1 members will receive no consideration in the Company 1 Conversion other than Mutual Holding 1 membership interests, and the existing Company 1 insurance policies will not change (i.e., premiums, policy benefits, or other obligations to policyholders will remain the same).

(iii) Mutual Holding 1 will contribute the stock of Reorganized Company 1 to Stock Holding 1 in exchange for all the stock of Stock Holding 1.

(iv) Stock Holding 1 will contribute the stock of Reorganized Company 1 to Stock Holding 2 in exchange for all the stock of Stock Holding 2.

Mutual Holding Company 1 Acquisition of Company 2:

As expeditiously as possible following the Company 1 Conversion and Restructuring, Company 2 will convert into a stock insurance company and be acquired by Mutual Holding 1 as follows (the “Mutual Holding Company 1 Acquisition of Company 2”):

(v) Mutual Holding 1 will form Merger Sub as a State A property and casualty stock insurance company.

(vi) Company 2 will convert into a State A property and casualty stock insurance company (the "Company 2 Conversion" and "Reorganized Company 2").

(vii) Merger Sub will merge into Reorganized Company 2, with Reorganized Company 2 surviving (the "Company 2 Reverse Subsidiary Merger"). In the Company 2 Reverse Subsidiary Merger, (a) the Company 2 membership interests will be extinguished, (b) the former Company 2 members will automatically become Mutual Holding 1 members, and (c) Reorganized Company 2 will issue all of its stock to Mutual Holding 1. Company 2 members will receive no consideration in the Company 2 Reverse Subsidiary Merger other -4-

than Mutual Holding 1 membership interests, and existing insurance policies of Reorganized Company 2 will not change (i.e., premiums, policy benefits, or other obligations to policyholders will remain the same). Mutual Holding 1 membership interests existing before the Company 2 Reverse Subsidiary Merger will remain outstanding.

(viii) After the Company 2 Reverse Subsidiary Merger, Mutual Holding 1 will contribute the Reorganized Company 2 stock to Stock Holding 1, and Stock Holding 1 will contribute the stock to Stock Holding 2.

Mutual Holding Company 1 Acquisition of Company 3:

As expeditiously as possible following the Company 1 restructuring described above, Mutual Holding 1 will acquire Company 3 as follows:

(ix) Mutual Holding 1 will form Merger Sub 2 as a State B corporation.

(x) Company 3 will form Mutual Holding 2 under State B law and will convert into a State B property and casualty stock insurance company (the "Company 3 Conversion" and "Reorganized Company 3"). Mutual Holding 2 is being formed to facilitate the acquisition of Company 3 by Mutual Holding 1. In the Company 3 Conversion, (a) the Company 3 membership interests will be extinguished, (b) the former Company 3 members will automatically become Mutual Holding 2 members, and (c) Reorganized Company 3 will initially issue all of its stock to Mutual Holding 2. Company 3 members will receive no consideration in the Company 3 Conversion other than Mutual Holding 2 membership interests, and the existing Company 3 insurance policies will not change (i.e., premiums, policy benefits, and other obligations to policyholders will remain the same). With the consent of the Commissioner of Insurance of State B, Reorganized Company 3 will change its name to New Name.

(xi) Merger Sub 2 will merge into Reorganized Company 3, with Reorganized Company 3 surviving (the "Company 3 Reverse Subsidiary Merger"). Simultaneously, Mutual Holding 2 will merge into Mutual Holding 1, with Mutual Holding 1 surviving (the "Mutual Holding 2 Merger" and, together with the Company 3 Reverse Subsidiary Merger, the "Merger"). Pursuant to the Merger, the Mutual Holding 2 membership interests will be extinguished, and the former Mutual Holding 2 members will automatically receive membership interests in Mutual Holding 1. Mutual Holding 2 members will receive no consideration in the Merger other than Mutual Holding 1 membership interests, and the existing insurance policies of Reorganized Company 3 will not change (i.e., premiums, policy benefits, and other obligations to policyholders will remain -5-

the same). Following the Merger, Mutual Holding 1 will own all the stock of Reorganized Company 3. Mutual Holding 1 membership interests existing before the Merger will remain outstanding.

(xii) Mutual Holding 1 will contribute the Reorganized Company 3 stock to Stock Holding 1, and Stock Holding 1 will contribute the stock to Stock Holding 2.

You have requested rulings (a) that the Company 2 Conversion and step (vii)(a) above together be treated as if the Company 2 members had exchanged their Company 2 membership interests for all the stock of Reorganized Company 2 in a reorganization qualifying under § 368(a)(1) (E), (b) that this Reorganized Company 2 stock deemed held by former Company 2 members be treated as exchanged for membership interests in Mutual Holding Company 1 in the Company 2 Reverse Subsidiary Merger, and (c) that the Company 2 Reverse Subsidiary Merger as recast be treated as a reorganization under § 368(a) (1)(A) and (a)(2)(E). As an alternative to request (c), you have asked us to rule that the deemed exchange of Reorganized Company 2 stock for membership interests in Mutual Holding 1 in the Company 2 Reverse Subsidiary Merger will not violate the continuity of interest requirement of § 1.368-1(b) of the Income Tax Regulations.

Under section 3.01(23) of Rev. Proc. 2000-3, 2000-1 I.R.B. 103, 105-106 (the revenue procedure in effect at the time this request was filed), the Service will not rule on whether a transaction qualifies as a reorganization under § 368(a)(1)(A) and (a)(2)(E). The Service has the discretion, however, to rule on significant subissues that must be resolved to determine whether the transaction qualifies under § 368(a)(1)(A) and (a)(2)(E). The Service will rule on such subissues only if they are significant and not clearly addressed by a statute, regulation, decision of the Supreme Court, tax treaty, revenue ruling, revenue procedure, notice, or other authority published in the Internal Revenue Bulletin.

Should we rule favorably on your request that the transaction be recast as requested in (a) and (b) above and that the deemed exchange of Reorganized Company 2 stock for membership interests in Mutual Holding 1 in the Company 2 Reverse Subsidiary Merger will not violate the continuity of interest requirement of § 1.368-1(b), Company 2 represents that, to the best of its knowledge and belief, the Company 2 Reverse Subsidiary Merger is a reorganization qualifying under § 368(a) (1)(A) and (a)(2)(E).

Other Representations
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Company 2 has made the following additional representations concerning the Mutual Holding Company 1 Acquisition of Company 2:

(a) The fair market value of the Reorganized Company 2 stock treated as received by the Company 2 members will approximately equal the fair market value of the Company 2 membership interests surrendered in exchange therefor.

(b) The Company 2 Conversion is not part of a plan to periodically increase the proportionate interest of any Company 2 member in the assets or earnings and profits of Company 2.

(c) Following the Company 2 Conversion, Reorganized Company 2 will continue, as a stock insurance company, in the same business that Company 2 conducted before the Company 2 Conversion.

(d) Each party to the Company 2 Conversion will pay its, his, or her own expenses, if any, incurred in the Company 2 Conversion.

(e) The Company 2 Conversion will occur under a plan agreed upon before the Company 2 Conversion.

(f) Company 2 is not under the jurisdiction of a court in a Title 11 or similar case within the meaning of § 368(a)(3)(A).

(g) Following the Company 2 Conversion, Reorganized Company 2 will be treated under the laws of State A as the same corporation as Company 2 before the Company 2 Conversion.

(h) Immediately after the Company 2 Conversion, Mutual Holding 1 and its direct and indirect subsidiaries will continue to own substantially all the assets that were held by Company 2 and its direct and indirect subsidiaries before the Company 2 Conversion.

(i) Neither Company 1, Company 2, nor Company 3 is a life insurance company within the meaning of § 801.

Rulings

Based solely on the information submitted and the representations set forth above, we rule as follows on the Mutual Holding Company 1 Acquisition of -7-

Company 2:

(1) For federal income tax purposes, the transactions described in steps (v) through (viii) above will be treated as if (i) Company 2 had converted from a mutual insurance company to a stock insurance company, with the Company 2 members exchanging their Company 2 membership interests for Reorganized Company 2 stock; (ii) Merger Sub then had merged into Reorganized Company 2, with the holders of Reorganized Company 2 stock exchanging the stock for membership interests in Mutual Holding 1; (iii) Mutual Holding 1 then contributed the Reorganized Company 2 stock to Stock Holding 1 in exchange for stock of Stock Holding 1; and (iv) Stock Holding 1 then contributed the Reorganized Company 2 stock to Stock Holding 2 in exchange for stock of Stock Holding 2.

(2) Provided Reorganized Company 2 is considered under State A law to be the same entity as Company 2 before the conversion, the conversion of Company 2 from a mutual insurance company to a stock insurance company and the constructive exchange of Company 2 membership interests for Reorganized Company 2 stock will be a recapitalization under § 368(a)(1)(E). Company 2 will be “a party to a reorganiza-tion” under § 368(b).

(3) No gain or loss will be recognized by the Company 2 members on their constructive exchange of Company 2 membership interests for Reorganized Company 2 stock (§ 354(a)(1)).

(4) The basis of each Company 2 membership interest is zero (Rev. Rul.
71-233, 1971-1 C.B. 113; Rev. Rul. 74-277, 1974-1 C.B. 88). The basis of the Reorganized Company 2 stock constructively received in exchange for a Company 2 membership interest will equal the basis of the Company 2 membership interest surrendered therefor (§ 358(a)(1)).

(5) The holding period of the Reorganized Company 2 stock constructively received in exchange for a Company 2 membership interest will include the period the Company 2 member held the Company 2 membership interest (§ 1223(1)).

(6) No gain or loss will be recognized by Reorganized Company 2 on its constructive issuance of Reorganized Company 2 stock for Company 2 membership interests (§ 1032(a)).

(7) Provided the requirements of § 368(a)(2)(E) are satisfied, the tax consequences of the Company 2 Reverse Subsidiary Merger will flow from § 368(a)(2) (E) rather than § 351.
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(8) The Mutual Holding 1 membership interests received by Company 2 members in exchange for their ownership in Reorganized Company 2 will be treated as stock within the meaning of § 368 (Rev. Rul. 69-3, 1969-1 C.B. 103).

(9) The constructive exchange of Reorganized Company 2 stock for membership interests in Mutual Holding 1 in the Company 2 Reverse Subsidiary Merger will satisfy the continuity of interest requirement of § 1.368-1(b).

Caveats

No opinion is expressed about the tax treatment of the above transactions under other provisions of the Code or regulations, or the tax treatment of any conditions existing at the time of, or effects resulting from, the above transactions that are not specifically covered by rulings (1) through (9). In particular, no opinion is expressed concerning:

(i) Whether the Company 2 Reverse Subsidiary Merger will qualify as a reorganization under § 368(a)(1)(A) and (a)(2)(E);

(ii) Whether the stock contributions described in step (viii) will qualify under
§ 351(a); and

(iii) The federal income tax consequences of the transactions described in steps (i) through (iv), and steps (ix) through (xii). Full rulings on these transactions appear in letter rulings PLR-118048-00 and PLR-118050-00, both issued this date.

Our ruling that the Company 2 Conversion qualifies as a reorganization under
§ 368(a)(1)(E) is conditioned on Reorganized Company 2 being considered, under State A law, the same entity as Company 2 before the Company 2 Conversion. No opinion is expressed on whether this requirement will be met.

Procedural Statements

This ruling letter is directed only to the taxpayer who requested it. Section 6110(k)(3) provides that it may not be used or cited as precedent.

Each taxpayer affected by the above transactions should attach a copy of this ruling letter to its, his, or her federal income tax return for the taxable year in which the transactions are completed.
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Under a power of attorney on file in this office, a copy of this letter is being sent to each of your authorized representatives.

Sincerely,
Associate Chief Counsel (Corporate)
By: Wayne T. Murray
Senior Technician/Reviewer
Branch 4