PAYMENTS RECEIVED BY U.S. CITIZENS FROM SAUDI BENEFIT CANCELLATION PROGRAM ARE INCOME.

Rev. Rul. 89-104

ISSUE

Are benefit cancellation paymetns made by the Saudi Arabian General Organization for Social Insurance Corporation (GOSI) gross income under section 61(a) of the Internal Revenue Code of 1986?

FACTS

The General Organization for Social Insurance, a Saudi Arabian government corporation, administers the Saudi Arabian Social Insurance System (hereafter referred to as the GOSI or program).

The GOSI system is divided into two separate branches: the Occupational Hazards Branch, which provides insurance coverage for employment injuries and occupational diseases, and the Annuity Branch, which provides social insurance benefits in the case of invalidism, old age (retirement) and death.

The GOSI system is funded by a compulsory levy imposed by the Saudi Social Insurance Law. The required levy or contribution is different for each branch of the GOSI system. The contribution for the Occupational Hazards Branch is fixed at 2 percent of the wages of the insured employee and the employer is solely responsible for making this payment. The contribution to the Annuity Branch is fixed at 13 percent of the employee's wages, of which 8 percent is to be paid by the employer and 5 percent by the employee. The employer has primary responsibility for the full 13 percent contribution to the Annuity Branch, although the employer is authorized to withhold the employee's 5 percent portion of the contribution from their wages. Employees are credited for Saudi purposes if the employer contributes to the GOSI system.

Before 1987, both Saudi and non-Saudi wage-earning workers, who performed their services primarily within Saudi Arabia, were fully covered under the Saudi social security system. In March 1987, the Government of Saudi Arabia issued a royal decree that ended the inclusion of foreign workers in the Annuity Branch of the GOSI system.

The GOSI benefit cancellation plan calls for the exclusion of non-Saudi workers from participation in the GOSI system after March 10, 1987, and the termination, if possible, of benefit payment to current GOSI benefits recipients. In accordance with the benefit cancellation plan, non-Saudi recipients of GOSI benefits were given the option to continue receiving GOSI benefits or to receive a lump- sum benefit cancellation payment. The same option, however, was not available to those non-Saudi workers who were not yet collecting benefits. They were required to apply for the benefits. They were required to apply for the benefit cancellation payment or forfeit all claims to future GOSI benefits.

The Government of Saudi Arabia is now sending lump-sum benefit cancellation payments to United States taxpayers who irrevocably surrendered their GOSI benefits. The amount of the lump-sum payment consists of 5 percent of the non-Saudi worker's GOSI wage base plus a bonus. The benefit cancellation payment is based upon the number of years a non-Saudi worker was employed in Saudi Arabia and the amount of that worker's GOSI contribution. The Saudi Arabian government has not imposed a tax on the GOSI cancellation payment.

There is no income tax treaty or social security totalization agreement between the United States and Saudi Arabia.

LAW AND ANALYSIS

Section 61(a) of the Code states that, except as otherwise provided, gross income means all income from whatever source derived.

Section 72 of the Code states that, except as otherwise provided, gross income includes any amount received under an annuity, endowment, or life insurance contract. Subsections (b) and (e) of section 72 provide an exclusion from gross income of a portion of a payment received under an annuity, endowment, or life insurance contract to the extent the recipient has an investment in the contract.

Section 1001 of the Code provides that the gain from the disposition of property shall be the excess of the amount realized therefrom over the adjusted basis of the property. Section 1012 generally defines the basis of property as its cost.

U.S. taxation of GOSI benefit cancellation payments may be affected by (1) whether the taxpayer has an investment in a contract with respect to the GOSI payments for purposes of section 72 of the Code, or (2) whether the taxpayer has a basis in any property interest under the GOSI systems for purposes of section 1001. If the taxpayer's interest in the benefits provided by the GOSI system constitutes an annuity, endowment, or life insurance contract for purposes of section 72, then an exclusion from gross income is permitted to the extent of the taxpayer's investment in the contract. If the taxpayer's interest in the GOSI benefit system constitutes some other form of property interest that is exchanged for the benefit cancellation payment, then the benefit cancellation payment is includible in gross income only to the extent the payment exceeds the taxpayer's basis in such property. Thus, if a recipient of a GOSI benefit cancellation payment has neither an investment in a contract for purposes of section 72 nor a basis in any other form of property interest under the GOSI system, then the full amount of the GOSI benefit cancellation payment is includible in the recipient's gross income under section 61(a). Whether a taxpayer has an investment in a contract or basis in property depends upon the proper classification of the contributions previously made under the GOSI system.

Employee contributions into other foreign social security systems have been classified as taxes for United States federal income tax purposes, Rev. Rul. 72-579, 1972-2 C.B. 441 (United Kingdom); Rev. Rul. 69-338, 1969-1 C.B. 194 (Venezuela); Rev. Rul. 67-328, 1967-2 C.B. 257 (Canada), as have contributions into State retirement, unemployment, and disability funds. Rev. Rul. 75-444, 1975-2 C.B. 66, and Rev. Rul. 75-156, 1975-1 C.B. 66. A tax has generally been defined as an enforced and involuntary contribution, exacted pursuant to legislative authority in the exercise of the taxing power, and imposed and collected for the purpose of raising revenue to be used for public or governmental purposes. Rev. Rul. 61- 152, 1961-2 C.B. 42. The GOSI assessment was a compulsory levy imposed pursuant to the law-making authority and in the exercise of the taxing powers of the Government of Saudi Arabia. In addition, the GOSI assessment was levied for the purpose of providing social insurance in the aid of the general welfare of all those employed and providing services within Saudi Arabia. Consequently, contributions into the GOSI system are taxes for United States federal income tax purposes.

Because taxes are imposed by unilateral government action and are subject to control and change solely at the discretion of the state, they cannot be considered payments made pursuant to a contract. New Jersey v. Anderson, 203 U.S. 483, 493 (1906). Since the GOSI contributions are tax payments, the GOSI contributions do not create an investment in a contract for purposes of section 72 of the Code. Similarly, a tax is not a cost that is paid in exchange for any general welfare benefit subsequently received from a government. Thus, payments of the GOSI tax do not create basis for purposes of section 1001 in any other form of property interest that the taxpayer may have held under the GOSI system. To reach a contrary result would effectively allow at taxpayer a double income tax benefit, since generally taxes paid to a foreign government are either deductible under section 164 (although no determination is made herein as to whether GOSI taxes are creditable income tax for purposes of section 901).

Rev. Rul. 66-34, 1966-1 C.B. 22 and Rev. Rul. 76-121, 1976-1 C.B. 24 do not support the proposition that section 72 of the Code automatically provides an exclusion from gross income with respect to payments received under a foreign social security system. Rev. Rul. 66-34 provides that payments received by a taxpayer under the social security system of the Federal Republic of Germany are includible in gross income under section 61. Rev. Rul. 76-121 provides that payments received by a taxpayer under the social security system of the United Kingdom are includible in gross income under section 61. Although section 72 was cited in both rulings, the application of section 72 in each ruling was limited to the recovery of the taxpayer's cost IF ANY in the payments. Since the taxpayers who have participated in the GOSI system have no investment or cost in any payments received from the GOSI system, these revenue rulings provide no authority for the exclusion of the GOSI cancellation payments under section 72.

Because neither section 72 of the Code nor section 1001 provides an exclusion from gross income in the present case, recipients must report the full amount of a GOSI benefit cancellation payment as gross income under section 61 in the year received. The manner in which United States taxpayers reported the receipt of GOSI tax on their United States tax returns in prior years does not affect the obligation to report the receipt of the GOSI cancellation payment as gross income.

Since this ruling concludes that the GOSI assessments are taxes and do not create an investment in a contract under section 72 of the Code or basis for purposes of section 1001, it is not necessary to determine whether the payment is received as an annuity or whether it is received an annuity, endowment, or life insurance contract for purposes of section 72.

Furthermore, this ruling does not address whether GOSI contributions satisfy the standards for an income tax for purposes of section 901 of the Code nor the person considered as paying such taxes for the purposes of that section. In any event, no foreign tax redetermination shall be required under section 905(c) on the receipt of the benefit cancellation payment.

HOLDING

Contributions to the GOSI system do not constitute an investment in a contract for purposes of section 72(b) of the Code or section 72(e), and do not create basis for purposes of section 1001. Accordingly, GOSI benefit cancellation payments are fully includible in the recipient's gross income under section 61 of the year received.

DRAFTING INFORMATION

The principal author of this revenue ruling is John J. Brady of the Office of the Associate Chief Counsel (International). For further information about this revenue ruling, call Mr. Brady at (202) 287-4851 (not a toll-free call).