Rev. Rul. 71-311

The purpose of this Revenue Ruling is to update and restate, under the current statute and regulations, the position set forth in Revenue Ruling 46, C.B. 1953-1, 287. The question presented is whether the qualification of an employees' trust is affected if such trust borrows capital and invests it in the securities of, or enters into transactions with, the employer by which it was established and from whom it has received or does receive contributions, or with an entity closely related to the employer.

Section 401(a) of the Internal Revenue Code of 1954 provides that a trust forming part of a stock bonus, pension, or profit-sharing plan of an employer for the exclusive benefit of his employees or their beneficiaries shall constitute a qualified trust if certain requirements are met. Section 501(a) of the Code provides that a trust described in 401(a) shall be exempt from taxation unless such exemption is denied because the trust entered into a prohibited transaction or operated as a feeder organization.

There is no prohibition in the Code or in the regulations promulgated thereunder against a trust borrowing funds to purchase investments. The borrowing of funds by a trust and investing them in the securities of, or entering into transactions with, the employer or an entity closely related to the employer do not disqualify a trust as one for the exclusive benefit of employees unless the borrowing is undertaken for the purpose of benefiting the employer as, for example, borrowing in order to furnish capital or property for use in the employer's business at a time when the employer's financial condition is such that it is unable to borrow money from usual financial sources. However, a qualified employees' trust is subject to tax on unrelated business taxable income under section 511 of the Code. In this connection see sections 512(b)(4) and 514 of the Code, which require inclusion of certain debt financed income in unrelated business taxable income.

Where investments in the securities of, or transactions with, the employer or an entity closely related to the employer yield returns to a trust higher than could be obtained in an arm's-length transaction and result, in effect, in contributions to the trust in excess of the applicable limitations imposed under section 404(a) of the Code, the trust is not thereby disqualified. However, amounts paid to a trust, with respect to such investments or transactions by an employer or an entity closely related to the employer, to the extent that they exceed the applicable limitations imposed by section 404(a) of the Code, are not deductible under other sections of the Code if they are found not to be bona fide but to be part of a device to circumvent the limitations imposed by section 404(a).

Revenue Ruling 46 is hereby superseded since the position stated therein is restated under the current law and regulations in this Revenue Ruling.