Rev. Rul. 75-382

Advice has been requested as to the Federal income tax consequences of the transaction described below involving life insurance companies.

X corporation is a foreign mutual life insurance company subject to taxation with respect to its United States insurance business under section 802 of the Internal Revenue Code of 1954. It conducts its insurance business in two foreign countries and several states of the United States including state R. X desired to increase its insurance business in the United States, but certain laws of state R had extra-territorial application that created a major impediment to X's objective. Therefore, X determined that it was necessary to relinquish its license to do business in state R.

As part of a plan to relinquish its business in state R, X transferred to Y, a newly formed stock life insurance company incorporated under the law of state R and subject to taxation under section 802 of the Code, cash and other assets in exchange for all of Y's stock. Shortly after Y commenced operations in state R, X, with the policyholders' consent, entered an assumption reinsurance agreement with Y under which Y assumed X's liabilities on insurance contracts issued to X's state R policyholders. As consideration for Y's assumption of X's liabilities under the transferred insurance contracts, X transferred to Y assets (other than the reinsured contracts) with a fair market value equal to the amount of the decrease in X's reserves (which amount is equal to the increase in Y's reserves). Upon completion of the transaction, Y became solely liable to X's state R policyholders on the reinsured policies, and both X and Y continued to operate as life insurance companies.

Section 351 of the Code provides, in part, that no gain or loss will be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock or securities in such corporation and immediately after the exchange such person or persons are in control (as defined in section 368(c)) of the corporation.

Section 357(c) of the Code provides, in part, that if the sum of the amount of liabilities assumed exceeds the total adjusted basis of the property transferred in a section 351 exchange, then the excess shall be considered as a gain from the sale or exchange of a capital asset or of property that is not a capital asset, as the case may be.

Rev. Rul. 54-96, 1954-1 C.B. 111, holds that if individual steps of a transaction are part of a prearranged plan, the steps should not be viewed separately but should be viewed as a single transaction. See Rev. Rul. 73-16, 1973-1 C.B. 186; Rev. Rul. 70-255, 1970-1 C.B. 80. See also American Bantam Car Co., 11 T.C. 397 (1948), aff'd, 177 F.2d 513 (3d Cir. 1949), cert. denied, 339 U.S. 920 (1950), which states that one of the tests for viewing several steps as part of a single transaction is whether the steps are so mutually interdependent that the legal relations created by one transaction would have been fruitless without a completion of the series.

Section 806(a) of the Code provides, in effect, that where liabilities under life insurance contracts are transferred from one taxpayer to another, the means of the reserves and the means of the assets shall be appropriately adjusted as provided in section 806 to reflect the amounts involved in the transfer.

Section 809(c)(1) of the Code provides, in part, that the computation of gain and loss from operations, under section 809(b), shall include the gross amount of premiums and other consideration, including consideration in respect of assuming liabilities under contracts not issued by the taxpayer, on insurance and annuity contracts.

Section 809(c)(2) of the Code provides that the computation of gain and loss from operations, under section 809(b), shall include each net decrease in reserves that is required by sections 810 or 811(b)(2) to be taken into account.

Section 809(d)(2) of the Code allows a deduction in computing gain or loss from operations, under section 809(b), for the net increase in reserves that is required by section 810 to be taken into account.

Section 809(d)(7) of the Code allows a deduction, in computing gain or loss from operations, under section 809(b), for the consideration paid in respect to the assumption by another person of liabilities under insurance or annuity contracts.

Section 1.817-4(d)(1) of the Income Tax Regulations provides, in part, that for any taxable year beginning after December 31, 1958, the reinsurance of all or part of the insurance contracts of a particular type by a life insurance company, in either a single transaction, or in a series of related transactions, occurring in any such taxable year, whereby the reinsuring company or companies assume all the liabilities under such contracts, shall not be treated as the sale or exchange of a capital asset but shall be subject to the provisions of sections 806(a) and 809 of the Code, and the regulations thereunder. However, if in connection with a transaction described in the preceding sentence, the reinsured or reinsurer transfers an asset that is a capital asset within the meaning of section 1221 (as modified by section 817(a)(2)), such transfer shall be treated as the sale or exchange of a capital asset by the transferor.

Accordingly, since the transfer of cash and assets by X to Y in return for all of Y's stock and the assumption of X's liabilities by Y should be viewed as steps in a single transaction, section 351 of the Code applies to the entire transfer, and X will not recognize gain or loss on the assets it transfers to Y unless the liabilities assumed by Y exceed the total adjusted basis of the property transferred by X to Y, then X will recognize gain in an amount equal to that excess under section 357(c).

In the year it established the reserves underlying the insurance contracts transferred to Y, X was allowed a deduction, under section 809(d)(2) of the Code, in an amount equal to such reserves. This deduction offset the insurance premiums that X received and included in gross income under section 809(c)(1). When X transferred the insurance contracts to Y, the necessity of maintaining reserves for those contracts were relinquished. When the reserves are released from the liability of policyholder claims, the amount of such reserves must be included in income of X under section 809(c)(2). Thus, the transaction between X and Y is governed by section 1.817-4(d) of the regulations insofar as that provision does not conflict with section 351.

Accordingly, the means of the life insurance reserves and the means of the assets of X and Y must be adjusted in accordance with section 806(a) of the Code and the regulations thereunder. Further, Y has income, under section 809(c)(1), to the extent of the fair market value of assets transferred as consideration and concurrently has a net increase in the reserves deductible, under section 809(d)(2), in connection with the assumption of the liabilities under the reinsurance agreement. See Example 4 of section 1.817-4(d)(3). X, on the other hand, will have a decrease in reserves, under section 809(c)(2), equal to the amount of reserves held with respect to the liabilities assumed by Y under the reinsurance agreement and may take into account as a deduction, under section 809(d)(7), the fair market value of assets transferred to Y as consideration for assumption of the liabilities under the contracts reinsured.