Internal Revenue Service
Revenue Ruling
Rev. Rul. 2003-91
Rev. Rul. 2003-91, 2003-33 I.R.B. 347, 2003-2 C.B. 347
Internal Revenue Service (I.R.S.)
Revenue Ruling
INVESTOR CONTROL DOCTRINE
Released: July 23, 2003
Published: August 18, 2003
Section 817.--Treatment of Variable Contracts
A revenue ruling describes the tax treatment of the assets in a variable
contract's segregated asset account.
Section 61.--Gross Income Defined, 26 CFR 1.61-1: Gross income.
(Also s 801.)
Investor control doctrine. This ruling presents guidance on the investor
control doctrine by presenting a factual scenario in which a variable
contract holder does not have control over segregated account assets
sufficient to be deemed the owner of the assets. In this manner, this
ruling presents a "safe harbor" from which taxpayers may operate.
Investor control doctrine. This ruling presents guidance on the investor
control doctrine by presenting a factual scenario in which a variable
contract holder does not have control over segregated account assets
sufficient to be deemed the owner of the assets. In this manner, this
ruling presents a "safe harbor" from which taxpayers may operate.
ISSUE
Under the facts set forth below, will the holder of a variable contract
be considered to be the owner, for federal income tax purposes, of the
assets that fund the variable contract? Will income earned on those assets
be included in the income of the holder in the year in which it is earned?
FACTS
Situation 1: IC is a life insurance company subject to tax under s 801
of the Internal Revenue Code. In states where it is authorized to do so,
IC offers variable life and variable annuity contracts that qualify as
variable contracts under s 817(d) ("Contracts").
The assets that fund the Contracts are segregated from the assets that
fund IC's traditional life insurance products. IC maintains a separate
account ("Separate Account") for the assets funding the Contracts, and the
income and liabilities associated with the Separate Account are maintained
separately from IC's other accounts.
The Separate Account is divided into various sub-accounts
("Sub-accounts"). Each Sub-account's assets and liabilities are maintained
separately from the assets and liabilities of other Sub-accounts.
Interests in the Sub-accounts are not available for sale to the public.
Rather, interests in the Sub-accounts are available solely through the
purchase of a Contract. IC engages an independent investment advisor
("Advisor") to manage the investment activities of each Sub-account. [FN1]
Each Sub-account will at all times meet the asset diversification test set
forth in s 1.817-5(b)(1) of the Income Tax Regulations.
Twelve sub-accounts are currently available under the Contracts, but IC
may increase or decrease this number at any time. However, there will
never be more than 20 Sub-accounts available under the Contracts. Each
Sub-account offers a different investment strategy. The currently available
Sub-accounts include a bond fund, a large company stock fund, an
international stock fund, a small company stock fund, a mortgage backed
securities fund, a health care industry fund, an emerging markets fund, a
money market fund, a telecommunication fund, a financial services industry
fund, a South American stock fund, an energy fund and an Asian markets
fund.
An individual ("Holder") purchases a life insurance Contract ("LIC"). At
the time of purchase, Holder specifies the allocation of premium paid
among the then available Sub-accounts. Holder may change the allocation of
premiums at any time, and Holder may transfer funds from one Sub-account
to another. Holder is permitted one transfer between Sub-accounts without
charge per thirty-day period. Any additional transfers during this period
are subject to a fee assessed against the cash value of LIC.
There is no arrangement, plan, contract, or agreement between Holder and
IC or between Holder and Advisor regarding the availability of a
particular Sub-account, the investment strategy of any Sub-account, or the
assets to be held by a particular sub-account. Other than Holder's right to
allocate premiums and transfer funds among the available Sub-accounts as
described above, all investment decisions concerning the Sub-accounts are
made by IC or Advisor in their sole and absolute discretion. Specifically,
Holder cannot select or recommend particular investments or investment
strategies. Moreover, Holder cannot communicate directly or indirectly
with any investment officer of IC or its affiliates or with Advisor
regarding the selection, quality, or rate of return of any specific
investment or group of investments held in a Sub-account. Holder has no
legal, equitable, direct, or indirect interest in any of the assets held
by a Sub-account. Rather, Holder has only a contractual claim against IC
to collect cash from IC in the form of death benefits, or cash surrender
values under the Contract.
All decisions concerning the choice of Advisor or the choice of any of
IC's investment officers that are involved in the investment activities of
Separate Account or any of the Sub-accounts, and any subsequent changes
thereof, are made by IC in its sole and absolute discretion. Holder may
not communicate directly or indirectly with IC concerning the selection or
substitution of Advisor or the choice of any IC's investment officers that
are involved in the investment activities of Separate Account or any of
the Sub-accounts.
Situation 2: The facts are the same as Situation 1 except that Holder
purchases an annuity Contract ("Annuity").
LAW
Section 61(a) provides that the term "gross income" means all income
from whatever source derived, including gains derived from dealings in
property, interest and dividends.
A long standing doctrine of taxation provides that "taxation is not so
much concerned with the refinements of title as it is with actual command
over the property taxed--the actual benefit for which the tax is paid."
Corliss v. Bowers, 281 U.S. 376 (1930). The incidence of taxation
attributable to ownership of property is not shifted if the transferor
continues to retain significant control over the property transferred,
Frank Lyon Company v. United States, 435 U.S. 561 (1978); Commissioner v.
Sunnen, 333 U.S. 591 (1948); Helvering v. Clifford, 309 U.S. 331 (1940),
without regard to whether such control is exercised through specific
retention of legal title, the creation of a new equitable but controlled
interest, or the maintenance of effective benefit through the
interposition of a subservient agency. Christoffersen v. U.S., 749 F.2d
513 (8th Cir.), rev'g 578 F. Supp. 398 (N.D. Iowa 1984).
Rev. Rul. 77-85, 1977-1 C.B. 12, considers a situation in which the
individual purchaser of a variable annuity contract retained the right to
direct the custodian of the account supporting that variable annuity to
sell, purchase, and exchange securities or other assets held in the
custodial account. The purchaser also was able to exercise an owner's
right to vote account securities either through the custodian or
individually. The Service concluded that the purchaser possessed
"significant incidents of ownership" over the assets held in the custodial
account. The Service reasoned that if a purchaser of an "investment
annuity" contract may select and control the investment assets in the
separate account of the life insurance company issuing the contract, then
the purchaser is treated as the owner of those assets for federal income
tax purposes. Thus, any interest, dividends, or other income derived from
the investment assets are included in the purchaser's gross income.
In Rev. Rul. 80-274, 1980-2 C.B. 27, the Service, applying Rev. Rul.
77-85, concludes that, if a purchaser of an annuity contract may select
and control the certificates of deposit supporting the contract, then the
purchaser is considered the owner of the certificates of deposit for
federal income tax purposes. Similarly, Rev. Rul. 81-225, 1981-2 C.B. 12,
concludes that investments in mutual fund shares to fund annuity contracts
are considered to be owned by the purchaser of the annuity if the mutual
fund shares are available for purchase by the general public. Rev. Rul.
81-225 also concludes that, if the mutual fund shares are available only
through the purchase of an annuity contract, then the sole function of the
fund is to provide an investment vehicle that allows the issuing insurance
company to meet its obligations under its annuity contracts and the mutual
fund shares are considered to be owned by the insurance company. Finally,
in Rev. Rul. 82- 54, 1982-1 C.B. 11, the purchaser of certain annuity
contracts could allocate premium payments among three funds and had an
unlimited right to reallocate contract value among the funds prior to the
maturity date of the annuity contract. Interests in the funds were not
available for purchase by the general public, but were instead only
available through purchase of an annuity contract. The Service concludes
that the purchaser's ability to choose among general investment strategies
(for example, between stock, bonds, or money market instruments) either at
the time of the initial purchase or subsequent thereto, does not
constitute control sufficient to cause the contract holders to be treated
as the owners of the mutual fund shares.
In Christoffersen v. U.S., the Eighth Circuit considered the federal
income tax consequences of the ownership of the assets supporting a
segregated asset account. The taxpayers in Christoffersen purchased a
variable annuity contract that reflected the investment return and market
value of assets held in an account that was segregated from the general
asset account of the issuing insurance company. The taxpayers had the
right to direct that their premium payments be invested in any one of six
publicly traded mutual funds. The taxpayers could reallocate their
investment among the funds at any time. The taxpayers also had the right
upon seven days notice to withdraw funds, surrender the contract, or apply
the accumulated value under the contract to provide annuity payments.
The Eighth Circuit held that, for federal income tax purposes, the
taxpayers, not the issuing insurance company, owned the mutual fund shares
that funded the variable annuity. The court concluded that the taxpayers
"surrendered few of the rights of ownership or control over the assets of
the sub-account," that supported the annuity contract. Christoffersen, 749
F.2d at 515. According to the court, "the payment of annuity premiums,
management fees and the limitation of withdrawals to cash [did] not reflect
a lack of ownership or control as the same requirements could be placed on
traditional brokerage or management accounts." Id. at 515-16. Thus, the
taxpayers were required to include in gross income any gains, dividends, or
other income derived from the mutual fund shares.
Section 817, which was enacted by Congress as part of the Deficit
Reduction Act of 1984 (Pub. L. No. 98-369) (the "1984 Act"), provides
rules regarding the tax treatment of variable life insurance and annuity
contracts. Section 817(d) defines a "variable contract" as a contract that
provides for the allocation of all or part of the amounts received under
the contract to an account that, pursuant to State law or regulation, is
segregated from the general asset accounts of the company and that provides
for the payment of annuities, or is a life insurance contract. In the
legislative history of the 1984 Act, Congress expressed its intent to deny
life insurance treatment to any variable contract if the assets supporting
the contract include funds publicly available to investors:
The conference agreement allows any diversified fund to be used as the
basis of variable contracts so long as all shares of the funds are owned
by one or more segregated asset accounts of insurance companies, but only
if access to the fund is available exclusively through the purchase of a
variable contract from an insurance company.... In authorizing Treasury to
prescribe diversification standards, the conferees intend that the
standards be designed to deny annuity or life insurance treatment for
investments that are publicly available to investors ...
H. R. Conf. Rep. No. 98-861, at 1055 (1984).
Section 817(h)(1) provides that a variable contract based on a
segregated asset account shall not be treated as an annuity, endowment, or
life insurance contract unless the segregated asset account is adequately
diversified in accordance with regulations prescribed by the Secretary. If
a segregated asset account is not adequately diversified, income earned by
that segregated asset account is treated as ordinary income received or
accrued by the policyholders.
Approximately two years after enactment of s 817(h), the Treasury
Department issued proposed and temporary regulations prescribing the
minimum level of diversification that must be met for an annuity or life
insurance contract to be treated as a variable contract within the meaning
of s 817(d). The preamble to the regulations stated as follows:
The temporary regulations ... do not provide guidance concerning the
circumstances in which investor control of the investments of a segregated
asset account may cause the investor, rather than the insurance company,
to be treated as the owner of the assets in the account. For example, the
temporary regulations provide that in appropriate cases a segregated asset
account may include multiple sub-accounts, but do not specify the extent
to which policyholders may direct their investments to particular
sub-accounts without being treated as owners of the underlying assets.
Guidance on this and other issues will be provided in regulations or
revenue rulings under section 817(d), relating to the definition of
variable contracts.
T.D. 8101, 1986-2 C.B. 97 [51 FR 32633] (Sept. 15, 1986). The text of the
temporary regulations served as the text of proposed regulations in the
notice of proposed rule-making. See LR-295-84, 1986-2 C.B. 801 [51 FR
32664] (Sept. 15, 1986). The final regulations adopted, with certain
revisions not relevant here, the text of the proposed regulations.
ANALYSIS
The determination of whether Holder possesses sufficient incidents of
ownership over Sub-account assets to be deemed the owner of the assets
supporting LIC and Annuity depends on all of the relevant facts and
circumstances.
Holder may not select or direct a particular investment to be made by
either the Separate Account or the Sub-accounts. Holder may not sell,
purchase, or exchange assets held in the Separate Account or the
Sub-accounts. All investment decisions concerning the Separate Account and
the Sub-accounts are made by IC or Advisor in their sole and absolute
discretion.
The investment strategies of the Sub-accounts currently available are
sufficiently broad to prevent Holder from making particular investment
decisions through investment in a Sub-account. Only IC may add or
substitute Sub-accounts or investment strategies in the future. No
arrangement, plan, contract, or agreement exists between Holder and IC or
between Holder and Advisor regarding the specific investments or investment
objective of the Sub-accounts. In addition, Holder may not communicate
directly or indirectly with Advisor or any of IC's investment officers
concerning the selection, quality, or rate of return of any specific
investment or group of investments held by Separate Account or in a
Sub-account.
Investment in the Sub-accounts is available solely through the purchase
of a Contract, thus, Sub-accounts are not publicly available. The ability
to allocate premiums and transfer funds among Sub-accounts alone does not
indicate that Holder has control over either Separate Account or
Sub-account assets sufficient to be treated as the owner of those assets
for federal income tax purposes.
Based on all the facts and circumstances, Holder does not have direct or
indirect control over the Separate Account or any Sub-account asset.
Therefore, Holder does not possess sufficient incidents of ownership over
the assets supporting either LIC or Annuity to be deemed the owner of the
assets for federal income tax purposes. So long as LIC and Annuity
continue to satisfy the diversification requirements of s 817(h) and IC's
and Holder's future conduct is consistent with the facts of this ruling,
Holder will not be required to include the earnings on the assets held in
Separate Account or any of the Sub-accounts in income under s 61(a).
HOLDING
Under the facts set forth above, the holder of a variable contract will
not be considered to be the owner, for federal income tax purposes, of the
assets that fund the variable contract. Therefore, any interest,
dividends, or other income derived from the assets that fund the variable
contract is not included in the holder's gross income in the year in which
the interest, dividends, or other income is earned.
DRAFTING INFORMATION
The principal author of this revenue ruling is James Polfer of the
Office of Associate Chief Counsel (Financial Institutions and Products).
For further information regarding this revenue ruling, contact Mr. Polfer
at (202) 622- 3970 (not a toll-free call).
FN1. For these purposes, the term investment officer refers to anyone
whose responsibilities include giving investment advice or making
investment decisions relating to assets held in a Sub-account and to any
person who directly or indirectly supervises the work performed by such
individual.
Rev. Rul. 2003-91, 2003-33 I.R.B. 347, 2003-2 C.B. 347
