Insurance rehabilitation exchanges were not designated events

Plain-English summary

A consolidated group's regulated insurance subsidiary was operating through separate accounts after one account entered rehabilitation. A proposed exit plan involved issuing secured notes, exchanging cash and notes for existing notes and deferred insurance claim amounts, and exchanging certain insured bonds for existing notes. The taxpayer asked whether those transactions would be “designated events” under Notice 2004-37, which was relevant to the subsidiary's continued treatment within the affiliated group. The IRS ruled that none of the three transaction categories was a designated event. It expressly declined to decide whether the existing notes, new notes, subsidiary note, deferred amounts, or insured bonds were debt for federal tax purposes.

Ruling snapshot

• Question: Would the proposed note issuances and exchanges under the rehabilitation exit plan be designated events under Notice 2004-37?
• Outcome: Approved; none of the three described transaction categories was a designated event.
• Key authorities: IRC § 1504; Notice 2004-37.

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201815008 Third Party Communication: None
Release Date: 4/13/2018 Date of Communication: Not Applicable
Index Number: 1504.00-00, 1504.02-00
Person To Contact:
---------------- ---------------------, ID No. ------------------
------------------------------------------- Telephone Number:
----------------------------------------------------------- ----------------------
-------------------------------- Refer Reply To:
-------------------------------------------- CC:CORP:2
PLR-123266-17
Date:
January 11, 2018

     TY: -------

Legend
Taxpayer = -----------------------------------------

Sub = ---------------------------------------------------

State A = ---------------

Regulator = ----------------------------------------------------------------------

Preferred Stock = ----------------------------------------------------------------------------------------
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----------------------------------------------------------------------------

Business = ----------------------------------------------------------------------------------------
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Court = ------------------------------------------------------

Rehabilitator = ----------------------------------------------------

Account 1 = ----------------------------

Account 2 = ------------------------

X Notes = ----------------------------------------------------------------------------------------
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PLR-123266-17 2

                 ----------------

Y Notes = ----------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------
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----------------------------

Y Notes = ----------------------------------------------------------------------------------------
Security ----------------------------------------------------------------------------------------
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----------------------------------------------------------------------------------------
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SPV = ----------------------------------------------------------------------------------------
--------------------------------

Sub Note = --------------

Sub Note = ----------------------------------------------------------------------------------------
Security ----------------------------------------------------------------------------------------
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Deferred = ----------------------------------------------------------------------------------------
Amounts

Closing = ----------------------------------------------------------------------------------------
Agreement ----------------------------------------------------------------------------------------
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------------------

Private Letter = -----------------------
Ruling

Date 1 = ----------------------

Date 2 = ------------------

Date 3 = ------------------

PLR-123266-17 3

Date 4 = ------------------------

Date 5 = --------------

Date 6 = --------------------

Date 7 = -------------------

a = ----

b = ----

c = ----------------

d = ------------------

e = --------

f = --------

g = --------

h = ------

k = ------

Dear ------------:

This letter responds to a letter dated July 26, 2017 from your authorized representative
requesting rulings on certain federal income tax consequences under section 1504 of
the Internal Revenue Code due to Notice 2004-37, 2004-1 C.B. 947. The information
submitted in the request is summarized below.

The rulings contained in this letter are based upon information and representations
submitted by the taxpayer and accompanied by a penalties of perjury statement
executed by an appropriate party. While this office has not verified any of the material
submitted in support of the request for rulings, it is subject to verification on
examination.

                                    SUMMARY OF FACTS

Taxpayer is a publicly-held U.S. corporation and the common parent of an affiliated
group of corporations that file a consolidated federal income tax return (the “Taxpayer
Consolidated Group”). Taxpayer owns all of the common stock of Sub, a State A

PLR-123266-17 4

insurance company regulated by Regulator. Sub has outstanding Preferred Stock, all of
which is held by third parties. When it was issued, the Preferred Stock represented
stock described in section 1504(a)(4). Sub is included as a member of the Taxpayer
Consolidated Group and primarily is engaged in Business.

In response to Sub’s deteriorating financial condition and at the request of Regulator,
Sub established Account 1 on Date 1. Sub allocated to Account 1 certain of Sub’s
assets and liabilities with material projected losses, including insurance policies (the
“Policies,” or individually, a “Policy”) on certain bonds issued by third parties (the
“Insured Bonds”). Also on Date 1, in response to a petition by Regulator, Court entered
an Order for Rehabilitation, placing Account 1 into rehabilitation pursuant to State A
statute. Court appointed Rehabilitator as rehabilitator of Account 1. Rehabilitator
received full operational control and decision-making authority over Account 1. Sub’s
remaining assets and liabilities are in Account 2, subject to oversight by Regulator.

On Date 2, Account 2 issued the X Notes. Payment on the X Notes is subject to the
approval of Regulator and is subordinate to insurance policy claims and other
indebtedness of Sub upon any rehabilitation, liquidation, conservation, or dissolution or
similar proceeding relating to Sub.

On Date 3, Sub had failed to make timely payments of dividends on the Preferred Stock
for six consecutive dividend payment dates (the “Date 3 Event”). As a result, under the
terms of the Preferred Stock, the holders of the Preferred Stock received the right to
vote for two new members of Sub’s board of directors within a days of the Date 3 Event.
The holders of the Preferred Stock did not exercise this right. Notwithstanding this right,
the common stock of Sub held by Taxpayer would have continued to satisfy the voting
requirement under section 1504(a)(2) because the election of two new board members
would represent less than 20 percent of Sub’s board of directors. Thus, after the Date 3
Event, Taxpayer continued to hold at least 80 percent of the total voting power of Sub’s
stock under section 1504(a)(2), regardless of whether the right was exercised or
becomes exercisable.

On Date 4, Court approved a plan of rehabilitation submitted by Rehabilitator that did
not take effect.

On Date 5, Taxpayer entered into Closing Agreement with the Commissioner. Pursuant
to Closing Agreement, the Commissioner and Taxpayer agreed that the Date 3 Event
did not cause Sub to fail to be a member of the “affiliated group” of which Taxpayer was
the common parent. In addition, the Commissioner agreed in Closing Agreement not to
challenge Taxpayer’s treatment of the X Notes as debt.

On Date 6, Court approved an amended plan of rehabilitation submitted by Rehabilitator
(the “Rehabilitation Plan”). Under the Rehabilitation Plan, Account 1 is required to pay b
percent of an approved claim on a Policy on an Insured Bond. The unpaid balance of
the approved claim, including accretion, is called a “Deferred Amount.” The Deferred

PLR-123266-17 5

Amount represents an amount owed on an Insured Bond, cannot be transferred
separately from the bond, and is payable at the discretion of Rehabilitator.

On Date 7, Taxpayer received Private Letter Ruling (PLR), which ruled that the Deferred
Amounts (including accretion, over time) are taken into account in computing “losses
incurred” under section 832(b)(5) and § 1.832-4(b).

Sub now seeks approval of Court to amend the Rehabilitation Plan so that Account 1
can exit rehabilitation (as amended, the “Rehabilitation Exit Plan”). The proposed
transactions, described below, are part of or conditions precedent to the effectiveness of
the Rehabilitation Exit Plan.

                         PROPOSED TRANSACTIONS

(1) SPV will issue the Y Notes with an aggregate principal amount of approximately
$d to Sub as consideration for the issuance of the Sub Note to the SPV. The Y
Notes will be secured by the Y Notes Security. As a holder of Deferred Amounts,
Sub will receive approximately $c of the Y Notes in the transaction described in
paragraph (3) below. The Sub Note will have the same principal amount, interest
rate, and payment date as the Y Notes received by Sub. The Sub Note will be
full recourse to Sub and will be secured by the Sub Note Security. The holders
of the Y Notes, the Sub and the SPV agree to treat the issuance of the Y Notes
and the Sub Note as the issuance by Sub of the Sub Note directly to the holders
of the Y Notes, the Y Notes as evidencing beneficial interests in the Sub Note,
and the Sub Note as indebtedness of Sub. The holders of the Y Notes will have
no right to participate in the management of Sub or SPV by virtue of holding the
Y Notes.

(2) Sub will offer to repurchase a portion of the X Notes from third-party holders of
the X Notes in which the holders will receive $e in cash and $f in Y Notes for
each dollar of principal and accrued interest of X Notes exchanged and will agree
to take a discount of $g for each dollar of principal and accrued interest of the X
Notes exchanged. The X Notes not repurchased by Sub will remain outstanding.

(3) Sub will satisfy all Deferred Amounts held by Policyholders other than Taxpayer
(including Deferred Amounts held by Sub itself) in exchange for $e in cash and $f
in Y Notes for each dollar of Deferred Amounts paid and each Policyholder will
agree to take a discount of $g for each dollar of Deferred Amounts that it holds.
Sub will satisfy all Deferred Amounts held by Taxpayer in exchange for $h in Y
Notes for each dollar of Deferred Amounts it holds and Taxpayer will take a
discount of $k for each dollar of Deferred Amounts that it holds. All Deferred
Amounts will be satisfied in the transactions described in this paragraph (3).

(4) Sub will exchange a portion of the Insured Bonds that it holds for tendered X
Notes of equal value pursuant to an offer to exchange. Following amortization or

PLR-123266-17 6

   write-off in accordance with their terms, the Insured Bonds have no economic
   value aside from the Deferred Amounts.

None of the proposed transactions described above will alter the amount or terms of
Sub’s issued and outstanding equity.

                                     RULINGS

Based solely on the information submitted, we rule as follows:

1. The issuance of the Y Notes and Sub’s transfer of the Y Notes, together with
  cash consideration, in exchange for certain outstanding X Notes will not be a
  “designated event” for purposes of Notice 2004-37.

2. The issuance of the Y Notes and Sub’s transfer of the Y Notes, together with
  cash consideration, in satisfaction of the Deferred Amounts will not be a
  “designated event” for purposes of Notice 2004-37.

3. Sub’s exchange of the Insured Bonds for X Notes will not be a “designated
  event” for purposes of Notice 2004-37.

                                     CAVEATS

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax consequences of any aspect of any transaction or item discussed or referenced in
this letter. Specifically, no opinion is expressed as to whether the X Notes, the Y Notes,
the Sub Note, the Deferred Amounts, or the Insured Bonds constitute debt for federal
tax purposes.

                          PROCEDURAL STATEMENTS

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of the Code
provides that it may not be used or cited as precedent.

Temporary or final regulations pertaining to one or more of the issues addressed in this
ruling have not yet been adopted. Therefore, this ruling will be modified or revoked by
the adoption of temporary or final regulations, to the extent the regulations are
inconsistent with any conclusion in the letter ruling. See section 11.04 of Rev. Proc.
2017-1, 2017-1 I.R.B. 1, 60. However, when the criteria in section 11.06 of Rev. Proc.
2017-1, 2017-1 I.R.B. 1, 61 are satisfied, a ruling is not revoked or modified retroactively
except in rare or unusual circumstances.

In accordance with the Power of Attorney on file with this office, a copy of this letter is
being sent to your authorized representative.

PLR-123266-17 7

A copy of this letter must be attached to any income tax return to which it is relevant.
Alternatively, taxpayers filing their returns electronically may satisfy this requirement by
attaching a statement to their return that provides the date and control number of the
letter ruling.

                                   Sincerely,



                                   Gerald B. Fleming
                                   Senior Technician Reviewer, Branch 2
                                   (Corporate)

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