Rev. Rul. 55-629

Advice has been requested (1) with respect to the qualification, under section 165(a) of the Internal Revenue Code of 1939, of the pension plan of a parent corporation to the extent that the plan is adopted by one of its separately incorporated, wholly-owned subsidiaries at a time when the adopting subsidiary has no employees who are eligible for participation under the plan; (2) whether the plan, once it has qualified under section 165(a) as the plan of a subsidiary, may continue in effect, without termination, as a qualified plan of the subsidiary after such time as the subsidiary shall cease to have any employees, active or retired, who are covered under the plan; and (3) whether the parent corporation, after one of its participating employees has transferred to employment by (and participation under the plan as adopted by) one of the subsidiaries, but before the benefit based on the past service of such employee has been fully funded, may complete the funding of such prior service benefit for its former employee and properly claim a deduction for such prior service.

A corporation has numerous wholly-owned subsidiaries operating as retail outlets in a number of different states. It established an employees' pension plan providing prior and future service benefits for those of its employees who had rendered a minimum of five years of service and who had attained 30 years of age. The plan as adopted by the parent corporation has been held to meet the requirements of section 165(a) of the Code. A number of the subsidiary corporations with employees eligible for participation have also adopted the plan. Upon such adoption, employees of those subsidiaries were afforded the same rights under the plan as employees of the parent corporation. Accordingly, an employee moving from employment by one of the adopting employers to employment by another of the same group would have no interruption of his participation in the plan, or break in service to be counted toward eligibility for participation or benefits under the plan. This type of a plan seemed best suited to the purpose of creating an incentive for continued employment and to attracting and keeping employees of the quality needed by the various affiliated employers. In order that they might likewise benefit from the incentives afforded by the plan, several of the subsidiary corporations petitioned the parent corporation for permission to adopt the plan for their employees even though at that time they had no employees then eligible, or who would soon become eligible, to participate under the plan.

Section 165(a) of the Code provides, in effect, that a trust forming a part of an employer's pension plan for the exclusive benefit of his employees or their beneficiaries shall not be taxable if, among other things, as provided in paragraph (1) thereof, contributions were made to the trust by the employer, or employees, or both, for the purpose of distributing to such employees or their beneficiaries the corpus and income of the fund accumulated by the trust in accordance with the plan and, as required by paragraph (3) thereof, the trust was designated as a part of a plan which benefits either a specified percentage of all of the employees of such employer or such employees of the employer as qualify under a classification set up by the employer and found by the Commissioner of Internal Revenue not to be discriminatory in favor of employees who are officers, shareholders, persons whose principal duties consist in supervising the work of other employees, or highly compensated employees.

While an employer may take the necessary action to adopt a pension plan for employees long before such employer has any employees eligible to participate thereunder, an employer could not have in effect a plan which met all of the requirements of section 165(a) of the 1939 Code unless and until such employer had one or more employees who not only satisfied the eligibility requirements of the plan but were also actually covered by it so that they might ultimately be eligible for benefits thereunder. Aside from the evident over-all purpose and intent of section 165(a) of the Code, it seems clear that a plan completely lacking in covered employees was not, during the continuance of such condition, a plan which satisfied the requirements of paragraphs (1) and (3), in particular, of that section. It is equally evident that a plan established by an employer and found to meet all of the requirements of section 165(a) of the Code failed to meet all such requirements from and after such subsequent date as of which the plan ceased to cover any employees of that employer. To hold otherwise would result in permitting a trust to qualify for tax exemption under section 165(a) of the Code which had no potential beneficiaries, but which held a substantial corpus (consisting entirely of forfeitures by former participants who had terminated their services with the employer before acquiring a vested interest in any of the employer's contributions to the trust on their behalf) and continued to enjoy a tax-exempt status with respect to its earnings. Any funds remaining in an employer's trust after the trust ceases to cover any present or former employees of the grantor should be treated as amounts remaining in the trust because of "erroneous actuarial computations" after "the satisfaction of all liabilities with respect to employees and their beneficiaries under the trust," within the meaning of those expressions as used in section 165(a)(2) of the Code and section 39.165-2 of Regulations 118. As such, the funds so remaining in the trust should be regarded as having reverted to the employer involved and, whether or not actually distributed to the employer, should be treated as income to the employer in the taxable year of the employer during which the plan ceased to cover any of such employer's current or former employees.

Under section 23(p)(1)(A)(iii) of the Code, but subject to certain limitations therein, an employer who had a pension plan in effect which satisfied all of the applicable requirements of section 165(a) of the Code and which, in addition to current service pension or annuity credits, also provided past service or other supplementary pension or annuity credits, may, to the extent that the cost of such credits had been contributed or "paid" by the employer, claim a deduction of an amount equal to the normal cost of the plan, plus an amount not in excess of 10 percent of the cost which would be required to completely fund or purchase such past service or other supplementary pension or annuity credits as of the date when they were included in the plan. If at the time a particular employee first became eligible to participate under the instant plan he was a bona fide employee of the parent corporation and, promptly upon such employee's becoming a participant under the plan, the employer funded in full the entire prior service benefit cost for such employee, the employer, in addition to being entitled to a deduction annually for the normal cost (if paid) of the plan as to such employee so long as he continued to be employed by such employer and to be covered by the plan, could properly claim deductions under such section 23(p)(1)(A)(iii) for such past service cost at the rate of 10 percent thereof per year until the full amount thereof had been deducted. That would be so even though the employee left the service of the employer shortly after the employer had funded such past service cost. That being so, and since it is possible, as provided in section 39.165-1(a)(5) of Regulations 118, for an employer to establish a qualified plan for former employees, a corporation may, if the terms of its plan so permit, fund, or complete the funding of, past service benefits for a former employee after such employee has transferred to employment by an affiliated employer, and it may properly claim a deduction for such past service cost the same as if the employee had remained in the service of the funding employer, provided that the contributions or benefits for the former employee do not result in prohibited discrimination.

In view of the foregoing, it is held, where a parent corporation has in effect a pension plan for its employees which may also be adopted by any subsidiary of the parent for the eligible employees of the latter, that a subsidiary cannot adopt the plan for its employees and have the plan "qualify" under section 165(a) of the Code at a time when the subsidiary has no employees eligible for participation under the plan; nor will the plan, after it has once qualified under such section 165(a), continue to meet the requirements of that section after the date on which the employer ceases to have any employees, active or retired, who are actually covered by the plan. It is further held that a corporation may deduct its contributions to a pension plan to complete the funding of prior service benefit costs for one of its former employees who has transferred to employment by a related participating corporation