Rev. Rul. 77-248

Advice has been requested as to the application of section 815 of the Internal Revenue Code of 1954 as a result of the merger of two life insurance companies as part of the overall transaction described below.

The taxpayer, P, is a stock life insurance company taxable under section 802 of the Code. P is engaged principally in the business of writing credit life and credit disability insurance on an individual and group basis. All of the outstanding stock of P is owned by H, a holding company.

P owns all of the outstanding stock in S-1, a corporation with no business operations other than its ownership of all the stock of S-2, a corporation engaged in business as an insurance agent, and L, a stock life insurance company also engaged in the business of writing credit life and credit disability insurance on an individual and group basis.

In order to simplify the corporate structure, all of the life insurance assets were consolidated into one life insurance company and the two non-life insurance companies were reorganized into a direct parent-subsidiary relationship. This was accomplished by the merger of S-1 into P followed by the merger of L into P, which qualified as distributions in complete liquidation of S-1 and L within the meaning of section 332(a) of the Code. Neither of the plans of liquidation of S-1 and L was adopted within the 2-year period after P first acquired at least 80 percent of the stock in S-1 and L, respectively, and as a result, the basis of the property in the hands of the distributee, P, is determined under section 334(b)(1) and not section 334(b)(2). P, the surviving corporation in each merger, acquired all of the assets and assumed all of the liabilities of S-1 and L in exchange for all of the outstanding stock of each respectively. All of the stock of S-1 and L was then cancelled.

Following the merger of L into P, P distributed to H all of the stock of S-2.

Also, immediately prior to the close of the date of the merger, the combined balances in the policyholders surplus account of P and L did not exceed the maximum limitations of section 815(d)(4) of the Code.

The mergers of S-1 and L into P resulted in the elimination of multiple life insurance company filings with the various state and federal regulatory agencies and facilitated the consolidation of the non-life insurance company corporate tax returns, and the isolation of corporate profit centers by product lines.

Section 802(b)(3) of the Code provides, in part, that the term "life insurance company taxable income" includes the amount subtracted from the policyholders surplus account for the taxable year, as determined under section 815.

Section 815(a) of the Code provides, in part, that for purposes of section 802(b)(3), any distribution to shareholders after December 31, 1958, shall be treated as made--

(1) first out of the shareholders surplus account, to the extent thereof,

(2) then out of policyholders surplus account, to the extent thereof, and

(3) finally out of other accounts.

Section 815(d)(4) of the Code provides a limitation on the amount that any life insurance company may accumulate in its policyholders surplus account. Any excess of the limitation shall be treated as a subtraction from the policyholders surplus account as of the end of the taxable year. The amount so treated as subtracted (less the amount of tax imposed with respect to such amount by reason of section 802(b)(3)) shall be added to the shareholders surplus account (that represents essentially amounts on which tax has been paid) as of the beginning of the succeeding taxable year.

Section 815(f) of the Code provides, with certain exceptions not pertinent here, that the term "distribution" includes any distribution in redemption of stock or in partial or complete liquidation of the corporation.

Section 381(a) of the Code provides, in part, that in the case of the acquisition of assets of a corporation by another corporation in a distribution to such other corporation to which section 332 (relating to liquidation of subsidiaries) applies, except in a case in which the basis of the assets distributed is determined under section 334(b)(2), the acquiring corporation shall succeed to and take into account, as of the close of the day of distribution or transfer, the items described in section 381(c) of the distributor and transferor corporation, subject to certain conditions and limitations.

Among the items allowed to be carried over under section 381(c) of the Code are those described in paragraph (22) which provides as follows:

If the acquiring corporation is an insurance company taxable under subchapter L, there shall be taken into account (to the extent proper to carry out the purposes of this section and of subchapter L, and under such regulations as may be prescribed by the Secretary or his delegate) the items required to be taken into account for purposes of subchapter L in respect of the distributor or transferor corporation.

Section 1.381(c)(22)-1(b) provides, in part, as follows:

(b) Items required to be taken into account by acquiring corporation. If the transaction meets the requirements of paragraph (a) of this section, the acquiring corporation shall, except as otherwise provided, take into account as of the close of the date of distribution or transfer the following items of the distributor or transferor corporation:

* * * * *

(7)(i) The dollar balances in the shareholders surplus account, policyholders surplus account, and other accounts provided, however, that the acquiring corporation is a stock life insurance company. The dollar balance in the policyholders surplus account shall reflect the amount (if any) treated as a subtraction from such account by reason of the application of the limitation provided under section 815(d)(4) immediately prior to the close of the date of distribution or transfer.

The balances in the shareholders surplus account, policyholders surplus account, and other accounts of L will be carried over to P under section 381(c)(22) because the basis of the assets received by P in the merger with L is not determined under section 334(b)(2) of the Code both P and L are stock life insurance companies, and the combined policyholders surplus account of P and L does not exceed the maximum limitations of section 815(d)(4).

Accordingly, under the above circumstances, there will not be a distribution of policyholders or shareholders surplus accounts for purposes of section 815(f) of the Code, nor will there be any life insurance company taxable income under section 802(b)(3), as result of the liquidation of L into P.