PLR 1338004: Variable contract holders do not own underlying public fund shares

Plain-English summary

A regulated investment company offered its shares through insurance company separate accounts and related variable funds. It planned to invest across a broader range of asset classes, including public funds, some advised by the same adviser or an affiliate. The IRS concluded that variable contract holders would not be treated as the owners of the fund's shares because they could not direct the fund's investments or access particular public funds directly. The proposed investments therefore would not cause the contract holders to be taxed as owners of the underlying shares. The ruling addressed the investor-control and regulated-investment-company excise-tax issues described in the request, based on the submitted facts.

Ruling snapshot

• Question: Would investments in public funds cause variable contract holders to be treated as the owners of the regulated investment company's shares?
• Outcome: Approved, the proposed public-fund investments would not cause investor ownership.
• Key authorities: IRC §§ 61, 817(d), 817(h), 851, and 4982; Treas. Reg. §§ 1.817-5(b) and 1.817-5(f)(3).

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201338004 Third Party Communication: None
Release Date: 9/20/2013 Date of Communication: Not Applicable
Index Number: 817.00-00
Person To Contact:
------------------------- ------------------------, ID No. --------------
-------------- Telephone Number:
----------------------------------- ----------------------
------------------------------------------- Refer Reply To:
---------------------------------------------------- CC:FIP:B04
PLR-101429-13
Date:
June 04, 2013

Fund = -------------------------------------------------------------
Trust = ---------------------------------------------
State A = --------------
Date 1 = --------------------------
Date 2 = -------------------
State B = --------------
Adviser = ---------------------------------------------

Dear ------------------:

This is in response to the letter submitted by your authorized representative dated
December 21, 2012, requesting a ruling concerning the tax ownership of Fund, a series
of Trust, so that Fund can determine whether it qualifies for an exception from the
excise tax imposed by § 4982 of the Internal Revenue Code (the “Code”).

                                                   FACTS

Trust
Trust is a statutory trust formed under the laws of the State A on Date 1. Trust is
registered with the Securities and Exchange Commission (the “SEC”) as an open-end
management investment company under the Investment Company Act of 1940, as
amended (the “1940 Act”).

Fund
Fund is a series of Trust. Trust may issue an unlimited number of shares of beneficial
interest, no par value per share, in Fund. The shares of beneficial interest of Fund are
registered under the Securities Act of 1933, as amended.
PLR-101429-13 2

Fund is a “fund” as such term is used in § 851(g)(2), and accordingly, it is treated as a
separate corporation for federal income tax purposes pursuant to § 851(g)(1).

Fund has elected to be taxed as a regulated investment company under Part I of
Subchapter M of the Code. Fund has qualified and intends to continue to qualify for the
tax treatment afforded regulated investment companies under the Code for each of its
taxable years.

Fund’s annual accounting period is the year ended Date 2, and Fund uses the accrual
method of accounting for maintaining its accounting books and filing federal income tax
returns.

Ownership of Fund
Shares of Fund are offered to insurance company segregated asset accounts to serve
as an investment vehicle for variable annuity contracts and variable life insurance
policies (“Variable Contracts”) and to “Related Variable Funds.” Related Variable Funds
are also regulated investment companies that are offered to insurance company
segregated asset accounts to serve as an investment vehicle for Variable Contracts.
Both Fund and the Related Variable Funds are advised by Adviser.

Shares of Fund, except as otherwise permitted by § 1.817-5(f)(3) of the Income Tax
Regulations, are held by (a) segregated asset accounts underlying Variable Contracts
of one or more insurance companies, and (b) Related Variable Funds. Related Variable
Funds are also, except as otherwise permitted by § 1.817-5(f)(3) of the Income Tax
Regulations, held by (a) segregated asset accounts underlying Variable Contracts and
(b) other Related Variable Funds. The Variable Contracts are “variable contracts” within
the meaning of § 817(d).

Public access to Fund and the Related Variable Funds is available exclusively through
the purchase of a Variable Contract. Although the terms of each Variable Contract may
vary, the insurance company will generally hold the premiums paid by a Variable
Contract holder, net of any fees or commissions, and any income earned on the net
premiums in a segregated asset account. The Variable Contract holder generally will
be able to allocate amounts held in the segregated asset account among several
different investment options or subaccounts. At least one subaccount will correspond to
an investment in Fund.

Each segregated asset account that holds shares of Fund or shares of the Related
Variable Funds is a separate account registered with the SEC as a unit investment trust
under the 1940 Act. The life insurance companies whose segregated asset accounts
hold shares of Fund or shares of the Related Variable Funds are life insurance
companies within the meaning of § 816(a).

Fund’s Investment Objectives
Fund’s investment objective is long-term growth of capital primarily through diversified
holdings of marketable foreign equity investments. It currently invests primarily in equity
PLR-101429-13 3

securities that are listed on foreign exchanges and fixed income securities of foreign
governments and companies.

Adviser and Subadvisers of Fund
Fund has entered into an investment advisory agreement with Adviser. Adviser is a
corporation organized under the laws of State B and is a registered investment adviser
under the Investment Advisers Act of 1940, as amended. Pursuant to the investment
advisory agreement, Adviser is responsible for managing the investment and
reinvestment of Fund’s assets, and continuously reviewing, supervising and
administering Fund’s investment programs.

Adviser has entered into investment subadvisory agreements with subadvisers
regarding the management of Fund. Pursuant to the investment subadvisory
agreements, each subadviser is responsible for making investment decisions, buying
and selling securities, and conducting research that leads to purchase and sale
decisions for the portion of Fund’s portfolio allocated to each subadviser.

Adviser assists and consults with each subadviser in connection with Fund’s investment
program. Adviser also reviews, monitors and reports to the Board of Trustees of the
Trust regarding the investment performance and investment procedures of each
subadviser.

Adviser has discretion over the percentage of Fund’s assets allocated to each
subadviser and, to the extent Adviser deems it appropriate to achieve Fund’s
investment objective, may reallocate the percentage of Fund’s assets overseen by each
subadviser. Pursuant to an exemptive order from the SEC, Adviser, without
shareholder approval (as normally would be required under the 1940 Act), may replace
or remove the subadvisers, or may add subadvisers and enter into subadvisory
agreements with such subadvisers with respect to all or a portion of Fund’s portfolio
upon the approval of the Board of Trustees of the Trust.

Change in Fund’s Investment Strategy
Fund would like to achieve its investment objective by investing across a wider range of
asset classes and utilizing a wider variety of securities and investment styles. In order
to gain exposure to these asset classes and investment styles, Fund intends to invest a
certain percentage of its assets in other regulated investment companies and other
pooled investment vehicles (whether or not such pooled investment vehicles qualify as
regulated investment companies), including exchange traded funds that invest in a
variety of U.S. and foreign equity, debt, money market securities, futures and other
instruments (“Underlying Funds”).

Some of the Underlying Funds in which Fund will invest may be Related Variable
Funds. There are currently, however, only a limited number of Related Variable Funds
that provide exposure to the asset classes and investment styles that meet Fund’s
investment needs. To obtain exposure to specific asset classes and investment styles
for which Related Variable Funds are not available and to more effectively execute
Fund’s investment strategy, Fund may invest in Underlying Funds that are available to
PLR-101429-13 4

investors other than through the purchase of a Variable Contract (“Public Funds”).
Some of the Public Funds in which Fund may invest are advised by Adviser or an
affiliate of Adviser. It is possible that at times up to one hundred percent (100%) of
Fund’s total assets may be invested in Public Funds.

Adviser will regularly review Fund’s investments, including investments in Underlying
Funds, and adjust Fund’s investments in seeking to take advantage of current or
expected market conditions, or to manage risk. The portion of Fund’s assets allocated
to an Underlying Fund will change over time and there can be no expectation that
current or past positions in an Underlying Fund will be maintained in the future.

Variable Contract Holders
All investment decisions concerning Fund will be made by Adviser or a subadviser in
their sole and absolute discretion. A Variable Contract holder will only be able to
allocate premiums and transfer amounts in the insurance company segregated asset
account to and from the insurance company subaccount corresponding to a fund. A
Variable Contract holder will not be able to direct Fund’s investment in any particular
asset or recommend a particular investment or investment strategy, and there will be no
agreement or plan between Adviser and a Variable Contract holder or between a
subadviser and a Variable Contract holder regarding a particular investment. A Variable
Contract holder will have no current knowledge of Fund’s specific assets. Fund’s
portfolio holdings, however, will be available in quarterly filings with the SEC, including
annual and semi-annual reports to shareholders.

A Variable Contract holder will have no legal, equitable, direct, or indirect interest in any
of the assets of Fund. Rather, a Variable Contract holder will have only a contractual
claim against the insurance company offering the Variable Contract to receive cash
from the insurance company pursuant to the terms of the specific Variable Contract.

Fund’s Diversification
Fund will comply with the diversification requirements of § 817(h) and § 1.817-5(b) of
the Income Tax Regulations.

                                        LAW

Investor Control Rules
If the separate account assets underlying the variable contract are considered the
assets of the life insurance company that issues the contract and not the property of the
contract holder, § 817 governs the tax treatment of the contract. If the separate account
assets underlying the contract are considered the assets of the contract holder, the
contract holder is taxed on the income derived from the investment assets under § 61.

In general, the holder of legal title is the owner of the property and is taxed on the
income derived from the property. However, if a person other than the holder of legal
title possesses the “benefits and burdens” of ownership, that person is attributed
ownership of property for tax purposes. See, e.g., Frank Lyon Company v. United
States, 435 U.S. 561 (1978); Helvering v. Clifford, 309 U.S. 331 (1940). The Supreme
PLR-101429-13 5

Court summarized this principle in Corliss v. Bowers, 381 U.S. 376, 378 (1930), stating
that “taxation is not so much concerned with the refinements of title as it is with actual
command over the property taxed - the actual benefit for which the tax is paid.”

The Service applied these general tax ownership principles in a series of “investor
control” rulings. Rev. Rul. 77-85, 1977-1 C.B. 12, Rev. Rul. 80-274, 1980-2 C.B. 27,
Rev. Rul. 81-225, 1981-2 C.B. 12, Rev. Rul. 82-54, 1982-1 C.B. 11, Rev. Rul. 2003-91,
2003-2 C.B. 347, and Rev. Rul. 2003-92, 2003-2 C.B. 350. The rulings stand for the
proposition that contract holders possessing control over the investment of the separate
account assets (in addition to the other benefits and burdens of contract ownership) are
the owners of separate account assets for federal income tax purposes even if the
insurance company retains possession of and legal title to those assets.

In Rev. Rul. 77-85, the Service concluded that if the contract holder of an “investment
annuity” contract may select and control the investment assets in the separate account
of the life insurance company, then the contract holder is treated as the owner of those
assets for federal income tax purposes and is taxed on the income derived from the
investment assets. In the ruling, the individual contract holder of a variable annuity
contract retained the right to direct the custodian of the account supporting that variable
annuity to sell, purchase and exchange securities or other assets held in the custodial
account. The contract holder also was able to exercise an owner’s right to vote account
securities either through the custodian or individually. The Service found that the
contract holder possessed “significant incidents of ownership” over the assets held in
the custodial account, and thus, concluded that the policyholder was the owner of those
assets for federal income tax purposes.

In Rev. Rul. 80-274, the contract holder transferred existing investments to an insurance
company in return for an annuity contract and could withdraw all or a portion of the cash
surrender value of the contract at any time prior to the annuity starting date. The
Service, applying Rev. Rul. 77-85, concluded that the contract holder’s position was
substantially identical to what it would have been had the investment been directly
maintained or established, and thus, the contract holder was the owner of the
investment for federal income tax purposes.

In Rev. Rul. 81-225, the Service described four situations in which the contract holder is
considered the owner of mutual fund shares held by insurance companies in connection
with annuity contracts and one situation in which the insurance company is the owner of
the mutual fund shares for federal income tax purposes. In the four situations in which
the contract holder is considered the owner of the mutual fund shares, the shares are
available for purchase other than through the purchase of an annuity contract. In those
situations, the Service concluded that the contract holder had investment control over
the mutual fund shares and that the contract holder’s position in each situation was
substantially identical to what it would have been had the mutual fund shares been
purchased directly by the contract holders. Conversely, in the situation in which the
mutual fund shares were only available through the purchase of an annuity contract, the
insurance company was the owner for federal income tax purposes.
PLR-101429-13 6

In Rev. Rul. 82-54, the contract holder of certain annuity contracts could allocate
premium payments among three funds and had an unlimited right to change those
allocations prior to the maturity date of the annuity contract. Interests in the funds were
not available for purchase by the general public, but were instead only available through
the purchase of an annuity contract. The Service concluded that the purchaser’s ability
to choose among general investment strategies (for example, between stock, bonds, or
money market instruments) either at the time of the initial purchase or subsequent
thereto, did not constitute control sufficient to cause the contract holders to be treated
as the owners of the mutual fund shares for federal income tax purposes.

In 1984, the Eight Circuit addressed the tax ownership issue in the context of a variable
annuity contract. Christoffersen v. United States, 749 F.2d 513 (8th Cir. 1984). The
taxpayers, upon purchasing the contract, could allocate premiums among mutual funds
and could change the allocation at any time. The taxpayers bore the full investment risk
and could withdraw any or all of the investment upon seven days notice. In addition, the
taxpayer was not required to exercise the annuity feature of the contract. The Eighth
Circuit concluded that the taxpayers “surrendered few of the rights of ownership or
control over assets of the sub-account.” Id. at 515. The court held that, for federal
income tax purposes, the taxpayers, not the issuing insurance company, owned the
mutual fund shares that funded the variable annuity and, thus, the taxpayers were
required to include in gross income any gains, dividends, or other income derived from
the mutual fund shares.

In Rev. Rul. 2003-91, the Service concluded that the variable contract holder did not
have sufficient control over segregated account assets to be deemed the owner of the
assets. The variable contract was funded by a separate account that was divided into
twelve subaccounts. Each subaccount offered a different investment strategy. Interests
in the subaccounts were available solely through the purchase of a variable life or
variable annuity contract that qualified as a variable contract under § 817(d). The
investment activities of each subaccount were managed by an independent investment
adviser. There was no arrangement, plan, contract, or agreement between the contract
holder and the issuing insurance company or between the contract holder and the
independent investment adviser regarding the availability of a particular subaccount, the
investment strategy of any subaccount, or the assets to be held by a particular
subaccount. Other than a contract holder’s right to allocate premiums and transfer
funds among the available subaccounts, all investment decisions concerning the
subaccounts were made by the issuing insurance company or the independent
investment adviser in their sole and absolute discretion. A contract holder had no legal,
equitable, direct, or indirect interest in any of the assets held by a subaccount but had
only a contractual claim against the issuing insurance company to collect cash in the
form of death benefits or cash surrender values under the contract. The Service
concluded that, based on all the facts and circumstances, the contract holder did not
have direct or indirect control over the separate account or any subaccount asset, and
therefore the contract holder did not possess sufficient incidents of ownership over the
assets supporting the variable contracts to be deemed the owner of the assets for
federal income tax purposes.
PLR-101429-13 7

In Revenue Ruling 2003-92, the purchasers of variable annuity and variable life
insurance contracts were able to allocate their premiums among ten different sub-
accounts. Each sub-account invested in a partnership. In the factual scenario in which
the partnership interests were available other than through the purchase of a variable
annuity or life insurance contract, the Service concluded that the contract holders were
the owners of the interests in the partnerships. In contrast, if the partnership interests
were only available through the purchase of a variable annuity or life insurance contract,
the Service concluded that the insurance company was the owner of the interests in the
partnerships.

Section 4982
Section 4982(a) imposes a tax on every regulated investment company for each
calendar year equal to 4 percent of the excess (if any) of — (1) the required distribution
for such calendar year, over (2) the distributed amount for such calendar year.

Section 4982(f)(2) and (f)(4) provides exemptions from such excise tax for any calendar
year if at all times during such calendar year each shareholder in such company was a
segregated asset account of a life insurance company held in connection with variable
contracts (as defined in § 817(d)) or another regulated investment company described
in § 4982(f).

                                   ANALYSIS

In the revenue rulings discussed above, the Service took the position that if the holder
of a variable life insurance policy or variable annuity contract possesses sufficient
incidents of ownership over the assets supporting the policy or contract, the contract
holder is viewed for federal income tax purposes as the owner of the underlying assets
and, as a result, is currently taxed on any income and gains attributable to the
underlying assets. The determination of whether the holder of a variable life insurance
policy or variable annuity contract possesses sufficient incidents of ownership over the
assets of the separate account underlying the variable life insurance contract or variable
annuity contract depends on all the relevant facts and circumstances. See Rev. Rul.
2003-91.

In the instant case, the Variable Contract holders do not have any control over Fund’s
investments, including Fund’s investments in Public Funds. The investment decisions
of Fund are made by Fund’s adviser and subadvisers in their sole and absolute
discretion and are subject to change without notice to or approval by the Variable
Contract holders. The Variable Contract holders in this case do not have any more
control over the assets held under their contract than was the case in Rev. Rul. 82-54 or
Rev. Rul. 2003-91. Fund is not an indirect means of allowing a Variable Contract holder
to invest in a Public Fund.
PLR-101429-13 8

                                  CONCLUSION

Based on the representations and facts presented by the taxpayer, Fund’s investments
in Public Funds will not cause the Variable Contract holders to be treated as the owners
of Fund’s shares for federal income tax purposes.

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 referenced in
this letter.

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.

Temporary or final regulations pertaining to one or more of the issues addressed in this
ruling have not yet been adopted. Therefore, this ruling will be modified or revoked by
the adoption of temporary or final regulations, to the extent the regulations are
inconsistent with any conclusion in the letter rulings. See § 11.04 of Rev. Proc. 2012-1;
2012-1 I.R.B. 1, 50-51. However, when the criteria in § 11.06 of Rev. Proc. 2012-1;
2012-1 I.R.B. 1, 51 are satisfied, a ruling is not revoked or modified retroactively except
in rare or unusual circumstances.

In accordance with the Power of Attorney on file with this office, a copy of this letter is
being sent to your authorized representative.

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. This office has not verified any of the material submitted in
support of the request for rulings and it is subject to verification on examination.

                                       Sincerely,



                                       Donald J. Drees, Jr.
                                       Senior Technician Reviewer, Branch 4
                                       (Financial Institutions & Products)

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