Rev. Rul. 73-280

Advice has been requested as to the interest equalization tax (IET) consequences of the transaction described below.

The taxpayer, T, is a stock casualty insurance company taxable under section 831 of the Internal Revenue Code of 1954. It is engaged, directly and through ownership of stock in affiliated corporations, in the business of writing fire, marine, casualty, surety, and fidelity insurance and reinsurance. It transacts its business throughout the United States and various foreign countries.

P is primarily a holding company that owns 100 percent of the outstanding stock of T.

In the interest of improved efficiency of operations, T transferred its world-wide reinsurance business to S.

P, S, and T are domestic corporations. The transfer included foreign securities and cash equal to (1) the insurance reserves applicable to the transferred business, including the unearned premium reserve and unpaid loss reserve applicable thereto, and (2) an appropriate amount of capital. In exchange S issued to T all of its outstanding shares of its authorized common stock and assumed all of the liabilities and obligations of T with respect to T's then outstanding foreign reinsurance contracts relating to the business transferred. As between T and S, the latter will be solely liable under such contracts, but so far as the persons reinsured are concerned, T will continue to be primarily liable until S is licensed to do business in the various jurisdictions, at which time S will negotiate its own reinsurance contracts. S will be subject to taxation under section 831 of the Code.

Pursuant to section 4914(e) of the Code, T in 1964 established a fund of assets with respect to foreign risks insured and reinsured by it under contracts the proceeds of which are payable only in the currency of a foreign country. As part of such fund, T initially designated foreign securities having an aggregate basis of 15,000x dollars. At such time T's allowable reserve, as defined in section 4914(e)(4) of the Code was 45,000x dollars. Thereafter, from time to time T has made additional acquisitions of foreign stock and foreign debt obligations and designated them as part of such fund of assets. Although such fund of assets has substantially increased, this fund always has been less than 110 percent of T's allowable reserve.

Within 30 days of the transfer of T's reinsurance business to S, S designated the foreign stock and debt obligations that had formed a part of T's designated fund as part of its (S's) own fund of assets maintained with regard to foreign risks reinsured pursuant to section 4914(e) of the Code.

Following the transfer of its world-wide reinsurance business, T distributed the stock of S to P in exchange for some of P's voting stock. Thus, henceforth S will carry on, as a wholly owned subsidiary of P, the reinsurance business previously carried on by T.

Section 4914(e) of the Code exempts a domestic insurance company from the interest equalization tax imposed by section 4911 of the Code with respect to certain acquisitions of stock or debt obligation of a foreign issuer or obligor if such stock or debt obligation is designated as part of a fund of assets established and maintained with respect to foreign risks insured or reinsured by the company under contracts the proceeds of which are payable only in the currency of a foreign country.

After an initial designation of assets constituting part of such a fund, an insurance company may designate subsequent acquisitions of foreign stock or debt as part of the fund. However, the adjusted basis of the assets held in such fund may not exceed 10 percent of the "allowable reserve". Such term is defined by section 4914(e)(4)(A)(ii) of the Code in the case of an insurance company other than a life insurance company to mean the sum of the company's unearned premiums under section 832(b)(4) of the Code and unpaid losses under section 832(b)(5) of the Code which relate to the foreign risks insured or reinsured and which are taken into account in computing taxable income under section 832 of the Code.

Section 4914(j)(2) of the Code provides that where an insurance company sells or otherwise disposes of stock or a debt obligation which it previously designated as part of a fund of assets under section 4914(e) of the Code, the insurance company shall not, with respect to that stock or debt obligation, be considered a United States person.

Section 4912(b)(3) of the Code provides in relevant part, that an acquisition of stock or a debt obligation of a domestic corporation formed or availed of for the principal purpose of obtaining funds for a foreign issuer or obligor shall be deemed to be an acquisition of stock or a debt obligation of such foreign issuer or obligor.

Since under the stated facts S will, itself, be an insurance company subject to tax under section 831 of the Code that will be carrying on the former foreign reinsurance business of T, section 4914(e) of the Code is applicable to S in the same manner as it was applicable to T and section 4914(j)(2) of the Code has no effect.

Accordingly, it is held that the transfer by T to S of foreign stock and debt obligations that formed a part of T's designated fund under section 4914(e) of the Code will not be subject to the interest equalization tax since S designated such stock and obligations as constituting part of its (S's) fund of assets pursuant to section 4914(e)(4) of the Code. In determining the "allowable reserve" of S within the meaning of section 4914(e)(4) of the Code there will be included the unearned premiums and unpaid losses of S attributable to the outstanding reinsurance contracts assumed which will be the same amount as T's unearned premiums and unpaid losses with respect to such contracts immediately prior to the transfer.

In addition, it is held that the exchange by T of S's stock for part of P's stock will not be an acquisition by P that is subject to interest equalization tax since under the stated facts S was not formed for the principal purpose of obtaining funds for a foreign issuer.