PLR 1027038: Foreign insurers' segregated accounts qualify for variable-contract treatment

Plain-English summary

The IRS ruled that segregated accounts maintained by two foreign insurance companies would qualify as accounts segregated from general assets under section 817(d)(1). The companies had elected, or intended to elect, to be treated as domestic corporations under section 953(d), and the accounts were segregated under the law of their home country. The ruling treated the home-country jurisdiction as a qualifying state-law jurisdiction for this purpose. This allowed the contracts to satisfy the segregated-account element of the variable-contract definition, subject to the other requirements described in the ruling. The ruling did not address foreign insurance companies that had not made a section 953(d) election.

Ruling snapshot

• Question: May foreign insurers electing domestic treatment under section 953(d) use home-country law to satisfy section 817(d)(1)'s segregated-account requirement?
• Outcome: approved
• Key authorities: IRC §§ 72, 807, 817, 953, and 7701

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201027038 Third Party Communication: None
Release Date: 7/9/2010 Date of Communication: Not Applicable
Index Number: 817.00-00
Person To Contact:
------------------------- - ------------- ------------------------, ID No. -------------
---------------------------------- Telephone Number:
-------------------------------------------- ---------------------
---------------------- Refer Reply To:
------------------------------------------ CC:FIP:4
-------------------------- PLR-151475-09
------------------------ Date:
--------------------------------------------- March 31, 2010

Legend

Company X = --------------------------------------

Company Y = --------------------------------------------------------------

                                                  -------------------------------

Parent = --------------------------------------------

Intermediate Parent = ----------------------------------------

Ultimate Parent = --------------------------------------------------------------

Foreign Country A = ------------

State B = -----------

State C = --------

State D = ---------------------

Year 1 = -------
PLR-151475-09 2

Year 2 = -------

Dear ---- ---------------

This is in response to your authorized representatives’ submission dated November 18,
2009, requesting a ruling on the meaning of the term “State law or regulation” under
§ 817(d)(1) of the Internal Revenue Code of 1986.

                              FACTS

Company X was incorporated and licensed to conduct insurance business under
Foreign Country A law. Company X’s principal office is located in Foreign Country A.
Company X does not maintain permanent offices in the United States. All of the stock
of Company X is owned by Parent. Parent is a corporation organized under the laws of
State B. All of the stock of Parent is owned by Intermediate Parent, a State C
Corporation, which, in turn, is 100% owned by Ultimate Parent, a State D Corporation.
Company X joins with Ultimate Parent in filing a consolidated federal income tax return.

Company Y was incorporated and licensed to conduct insurance business under
Foreign Country A law. Company Y’s principal office is located in Foreign Country A.
Company Y does not maintain permanent offices in the United States. All of the stock
of Y is owned by Company X. Company Y anticipates filing its initial federal income tax
return by joining in Ultimate Parent’s consolidated return for calendar Year 2.

In accordance with § 953(d), Company X has already filed its election statement and
Company Y intends to file its election statement in Year 2, consistent with Rev. Proc.
2003-47, 2003-2 C.B. 55. Company X states that it qualifies as a life insurance
company as defined in § 816 and subject to tax under § 801. Company Y states that it
will qualify as a life insurance company as defined in § 816 and will be subject to tax
under § 801 when it begins operations.

Company X issues and Company Y proposes to issue annuity contracts and life
insurance contracts. Apart from the issue addressed in this request for rulings, each of
the contracts otherwise meets the definition of a variable contract in § 817(d). Thus, the
contracts that are annuity contracts provide for “the payment of annuities” and “the
amounts paid in, or the amount paid out, reflect the investment return and the market
value” of the separate accounts. Likewise, for contracts that are life insurance
contracts, “the amount of the death benefit (or the period of coverage) is adjusted on the
basis of the investment return and the market value” of the separate accounts.

Premiums paid for the contracts, less any applicable charges, are allocated to separate
accounts. Company X's separate accounts are established pursuant to a private act
PLR-151475-09 3

that it obtained in Year 1, which modifies Foreign Country A’s law as it applies to
Company X. As represented below, the legal effect of the private act is that assets
credited to a separate account are not available to pay the amounts due to creditors
whose claims do not relate to that separate account. Prior to issuing any contracts,
Company Y will obtain its own private act that will have the same legal effect with
respect to separate accounts it establishes.

The contracts are designed to comply with §§ 72, 817(h), 7702, and 7702A, as
applicable. Company X has issued contracts since Year 1, whereas Company Y will
begin issuing them in Year 2 or thereafter. The Company X and Company Y plan to
issue contracts only to non-United States persons, but they may issue contracts to U.S.
Persons in the future.

For purposes of this request for rulings, Company X and Company Y represent as
follows:

  (a) Company X has satisfied and Company Y will satisfy all requirements of

§ 953(d) and applicable procedures thereunder so that each company will be treated as
a domestic corporation for United States tax purposes.

   (b) Apart from the requirement that the separate accounts supporting the

contracts be segregated from each company’s general asset account “pursuant to State
law or regulation,” each of the contracts otherwise meets the definition of a “variable
contract” in § 817(d).

    (c) The legal effect of the private act pursuant to which the separate accounts are

(or will be) established is that assets credited to a separate account are not available to
pay the amounts due to creditors whose claims do not relate to that separate account.

  (d) Generally, for purposes of Part I of subchapter L, the amount of the life

insurance reserves for the contracts will be based on their net surrender values as
provided in § 807(d)(1)(A), reflecting the values of the underlying separate account
assets supporting the contracts.

                               RULING REQUESTED

For purposes of § 817(d)(1) of the Code, the separate accounts to which Company X
allocated and Company Y will allocate all or part of the amounts received under the life
and annuity contracts, which pursuant to Foreign Country A law, are segregated from
the general asset accounts of the companies, will be treated as accounts that are
segregated from the general asset accounts of the companies “pursuant to State law or
regulation.”

                               LAW AND ANALYSIS

PLR-151475-09 4

Section 817(a) of the Code provides that with respect to variable contracts, increases
and decreases in § 807(c) reserves attributable to the appreciation and deprecation in
the value of the assets in the segregated asset account are disregarded for purposes of
§ 807(a) and (b).

Under § 817(b), the basis of each asset in a segregated asset account is increased or
decreased by the amount of appreciation or deprecation, to the extent the reserves or
other items referred to in § 817(a) are adjusted.

Section 817(c) provides that, for purposes of Part I of subchapter L, a life insurance
company which issues variable contracts shall separately account for the various
income, exclusion, deduction, asset, reserve, and other liability items attributable to
such variable contracts.

Section 817(d) defines the term “variable contract,” for purposes of Part I of subchapter
L, as a contract that: (1) “… provides for the allocation of all or part of the amounts
received under the contract to an account which, pursuant to State law or regulation, is
segregated from the general assets of the company,” (2) provides for the payment of
annuities, is a life insurance contract, or provides for funding of insurance on retired
lives, as described in § 807(c)(6), and (3) in the case of an annuity contract, the
amounts paid in, or the amounts paid out, reflect the investment return and market
value of the segregated asset account, or in the case of a life insurance contract, the
amount of the death benefit (or the period of coverage) is adjusted on the basis of the
investment return and market value of the segregate asset account, or in the case of
funds held under a contract described in § 817(d)(2)(C), the amounts paid in, or the
amounts paid out, reflect the investment return and the market value of the segregated
asset account.

Section 817(h)(1) of the Code provides that, for purposes of subchapter L, § 72 (relating
to annuities), and § 7702(a) (relating to the definition of a life insurance contract), a
variable contract (other than a pension contract) which is otherwise described in § 817
and which is based on a segregated asset account shall not be treated as an annuity,
endowment, or life insurance contract for any period (and any subsequent period) for
which investments made by such account are not, in accordance with regulations
prescribed by the Secretary, adequately diversified.

Section 7701 of the Code provides:

(a) When used in this title, where not otherwise distinctly expressed or manifestly
incompatible with the intent thereof - …

   (9) United States. The term “United States” when used in a geographic sense

includes only the States and the District of Columbia.
PLR-151475-09 5

 (10) State. The term “State” shall be construed to include the District of

Columbia, where such construction is needed to carry out the provisions of this title.

Section 953(d) provides:

1) In general. If –

    (A) a foreign corporation is a controlled foreign corporation (as defined in
    § 957(a) by substituting “25 percent or more” for “more than 50 percent” and by
    using the definition of United States shareholder under § 953(c)(1)(A)),

    (B) such foreign corporation would qualify under Part I or Part II of subchapter L
    for the taxable year as if it were a domestic corporation,

    (C) such foreign corporation meets such requirements as the Secretary shall
    prescribe to ensure that the taxes imposed imposed on it by Chapter 1 of the
    Code are paid, and

    (D) such foreign corporation makes an election to have this paragraph apply and
    waives all benefits to such corporation granted by the United States under any
    treaty,

for purposes of this title, such corporation shall be treated as a domestic corporation.1

Section 953(e)(5) provides that for purposes of § 953 and § 954, the determination of
whether a contract issued by a controlled foreign corporation or a qualified business unit
(within the meaning of § 989(a)) is a life insurance contract or an annuity contract shall
be made without regard to §§ 72(s), 101(f), 817(h) and 7702 if –

    (A) such contract is regulated as a life insurance or annuity contract by the
    corporation’s or unit’s home country, and

    (B) no policyholder, insured, annuitant, or beneficiary with respect to the contract
    is a United States person.

The issue presented in this case is whether the Company X’s and Company Y’s
(Companies’) separate account products are “variable contracts,” as defined in
§ 817(d)(1) of the Code. The difficulty in this case lies in § 817(d)(1) which requires a

1
Section 953(d)(3) provides an exception to the electing corporation’s treatment as a domestic
corporation. It provides that, if any corporation treated as a domestic corporation under § 953(d) is
treated as a member of an affiliated group for purposes of chapter 6 (relating to consolidated returns), any
loss of such corporation shall be treated as a dual consolidated loss for purposes of § 1503(d) without
regard to paragraph (2)(B) thereof.
PLR-151475-09 6

variable contract to provide “for the allocation of all or part of the amounts received
under the contract to an account which, pursuant to State law or regulation, is
segregated from the general assets of the companies. (Emphasis added.)” The term
“State” is defined in § 7701(a)(9)2 and (10) which are set forth above. The implication
from these paragraphs of § 7701(a) is that the term “State” means that one of the 50
states or the District of Columbia.

This implication is, however, subject to the flush language appearing at the beginning of
§ 7701(a): “When used in this title, where not otherwise directly expressed or manifestly
incompatible with the intent thereof.” Section 817(d)(1) does not contain a distinctly
expressed meaning for “State,“ other than one of the 50 states or the District of
Columbia. Neither does the legislative history underlying this Code provision. Thus, our
task is to determine whether the § 7701(a)(10) meaning of “State – one of the 50 states
or the District of Columbia - is “manifestly incompatible with the intent of [federal tax
law]” in the context of § 817(d)(1) and a foreign taxpayer that has elected to come within
the provisions of § 953(d).

In this case, the Companies have elected or will elect under § 953(d) to be treated for
purposes of the federal tax law as a domestic corporation. If the Companies’ separate
account contracts are not treated as variable contracts because “State” is given a
restrictive meaning, Companies and any of their U.S. policyholders will in the following
respects be treated differently from a situation involving a domestic life insurance
company.

Section 817(c) requires that a life insurance company that issues variable contracts
separately account from the “various income, exclusion, deduction, asset, reserve, and
other liability items properly attributable to such variable contracts.” If the Companies’
contracts are not variable contracts, even though they have separate accounts
protected from the Companies’ general creditors, the policyholders and the Companies
will not receive separate account treatment. This would be a major difference between
the treatment of a domestic life insurance company and § 953(d) electing company
issuing a similar product.

This disparity of treatment is readily seen if we focus on the treatment of the reserves
for the Companies and a domestic company’s separate account products. First,
assume that the Companies’ reserves for its separate accounts do not receive the
treatment mandated by § 817(a)-(c) for variable contracts. The reserves estabished by
the Companies for their life insurance contracts should qualify as life insurance reserves
under § 807. The Companies will be allowed a deduction for increases in the reserve
under §§ 805(a)(2) and 807(b) and will be required to include deceases in reserves in
gross income under §§ 803(a)(3) and 807(a). The amount of the reserves will be

2
Section 7701(a)(9) is actually a definition of the term “United States.” Section 7701(a)(9)’s definition of
“United States” helps place § 7701(a)(10)’s definition of “State” in context.
PLR-151475-09 7

established under § 807(d)(1) as the greater of the net surrender value of the contract
or the reserve established under § 807(d)(2).

If the value of the underlying assets held in the separate account increases, the cash
surrender value of the contract will increase. The Companies will be entitled to a
deduction for the increase in the reserve. No adjustment will be made to the basis of
the assets to reflect the increase in market value. When the assets are sold, the
Companies will recognize a capital gain. Accordingly, the Companies will recognize a
current deduction when the value of the assets increases and a future capital gain when
the assets are disposed. In contrast, life insurance companies that are subject to
§ 817(a) would not recognize a current deduction for the increase in reserve attributable
to the increase in the value of the assets and, due to the basis adjustment provisions of
§ 817(d), would not recognize any gain on the disposition of the assets.

Conversely, if the value of the assets held in the separate account decreases, the cash
surrender value of the contract will decrease. If § 817(a) does not apply to the
Companies, the Companies unlike domestic life insurance companies subject to the
provisions of § 817(a), will be required to include the decrease in reserves in gross
income. No adjustment will be made to the basis of the assets to reflect the decrease in
market value. When the assets are sold, the companies will recognize capital losses.
Accordingly, the Companies will recognize current ordinary income when the value of
the assets decreases and a future capital loss when the assets are disposed.

If the Companies’ separate account products are not treated as variable contracts, its
contracts will receive different treatment from domestic contracts under § 817(h) and the
regulations thereunder prescribing diversification rules. The diversification rules under
§ 817(h) only apply to variable contracts (other than pension plan contracts). Thus, if
the Companies’ separate account products are not variable contracts, the diversification
rules would be inapplicable to them.

The Code’s sanction for not meeting the diversification requirements is severe. Section
817(h) provides that, for purposes of subchapter L, § 72, and § 7702(a), a variable
contract that does not meet the diversification requirements shall not be treated as an
annuity, endowment, or life insurance contract for any period (and any subsequent
period) for which the investments made by the segregate asset account are not
adequately diversified under regulations prescribed by the Secretary.

The diversification rule of § 817(h) was added to the Code in the Tax Reform Act of
1984. The Senate Finance Committee in 1 S. Prt. 98-169, 98th Cong., 2d Sess. 546
(1984), explained the purposes of new § 817(h) as follows:

         The bill adopts a provision that grants the Secretary of the Treasury
  regulatory authority to prescribe diversification standards for investments of
  segregated assets accounts underlying variable contracts. The diversification

PLR-151475-09 8

   requirement is provided in order to discourage the use of tax-preferred variable
   annuities and variable life insurance primarily as investment vehicles. The
   committee believes that, by limiting a customer’s ability to select specific
   investments underlying a variable contract, the bill will help ensure that a
   customer’s primary motivation in purchasing the contract is more likely to be the
   traditional economic protections provided by annuities and life insurance.

If the Companies’ separate account products are denied variable account status, then,
as stated above, the diversification rules of § 817(h) and the regulations thereunder will
not apply to the Companies’ separate account products. The result will be that the
Companies’ separate account products will be recognized as life insurance contracts
without meeting the diversification rules of the Code and regulations. Further,
Congress’ stated purpose in enacting the diversification requirements, to discourage the
use of tax-preferred variable annuity and variable life insurance primarily as investment
vehicles, would be subverted.3

Thus, another anomaly will exist if the Companies’ separate account products are
denied variable account status. A foreign insurance company that elected to be treated
as a domestic insurance company under § 953(d) would be able to issue separate
account products that do not meet the diversification rules, but nevertheless qualify as
life, endowment, or annuity contracts. The inside buildup on the electing foreign
company’s nondiversified contracts would not be subject to current taxation, while the
inside buildup on nondiversified contracts issued by domestic companies would be
subject to current taxation. This is a dubious result, which does not treat the electing
§ 953(d) company the same as a domestic company. The electing foreign company is
given better treatment and their policyholders given less protection against what
Congress saw as an abusive use of separate account products.

The anomalies that we have discussed above with respect to reserves for separate
account products and with respect to the diversification standards exist because
§ 953(d) was added to the Code later than § 817, which was added to the Code in
1984.4 We conclude, in light of the anomalies whose existence we have demonstrated,
the statutory scheme of § 953(d), permitting an electing foreign insurance company to
be treated as a domestic insurance company for all purposes (except with respect to
dual consolidated losses) is manifestly incompatible with giving “State” a restrictive
meaning in § 817(d)(1), and denying variable contract status to Companies’ separate
account products. We conclude that, in the context of electing § 953(d) companies,
“State,” in § 817(d)(1) should be interpreted broadly enough to include the jurisdiction

3
Cf. United States v. Bardina, 365 F. Supp. 459 (S.D. N.Y. 1973), dealing with the six year statute of
limitations, in which the court found reasons, including legislative history, not to use § 7701(a)(9)’s
definition of “United States,” and instead used a broader definition.
4
Section 953(d) was added to the Code by section 6135(a) of the Technical and Miscellaneous Revenue
Act of 1988, effective for tax years beginning after December 31, 1987.
PLR-151475-09 9

exercising statutory or regulatory authority over the companies’ separate accounts. In
this case, that is Foreign Country A.

Another provision that further supports our conclusion is § 953(e)(5), set forth above.
Section 953(e) was added to the Code in 1998 by section 1005(b)(1)(B) of the Tax and
Trade Relief Extension Act of 1998, Pub. L. No. 105-277. If the foreign controlled
corporation’s separate account products are regulated as life insurance or annuity
contracts by the home country and no policyholder, insured annuitant, or beneficiary
with respect to the contract is a United States person, the reference to § 817(h) is given
a restrictive meaning.

                               CONCLUSION

For purposes of § 817(d)(1) of the Code, the separate accounts to which Company X
allocated and Company Y will allocate all or part of the amounts received under life
insurance and annuity contracts issued by the Companies, which pursuant to Foreign
Country A law, are segregated from the general asset accounts of the Companies, will
be treated as accounts that are segregated from the general asset accounts of the
Companies, “pursuant to State law or regulation.”

                                CAVEATS

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax consequences of any aspect of any transaction or item discussed or reference in
this ruling letter.

No opinion is expressed or implied concerning any foreign insurance company that has
not made an election to be treated as a domestic company under § 953(d)

This ruling is directed only to the taxpayers requesting it. Section 6110(k)(3) of the
Code provides that it may not be used or cited as precedent.

In accordance with the authorization on file with this office, copies of this letter are being
sent to your authorized representatives.

The rulings contained in this letter are based upon information and representations
submitted by the taxpayer and accompanied by a penalty of perjury statement executed
by an appropriate party. While this office has not verified any of the material submitted
in support of the request for rulings, it is subject to verification on examination.
PLR-151475-09 10

                 Sincerely,


                        /S/

                 DONALD J. DREES, JR.
                 Senior Technician Reviewer
                 (Financial Institutions & Products)