Insurer remains owner of pension separate-account assets after restructuring

Plain-English summary

An insurance company funded group pension annuity contracts through a separate
account holding real estate investments. It proposed contributing most of those
assets to an operating partnership that would invest through real estate
investment trusts, while retaining a stated portion as directly held assets. A
separate direct-investment fund would hold an interest in the operating
partnership but would not admit qualified pension plans. Pension contract owners
could not direct investments, influence investment selection or returns, or own
any separate-account or partnership assets. Their rights were limited to claims
against the insurer under their contracts, and public access to the separate
account was available only through pension plan contracts. The IRS concluded
that neither the investor-control nor public-availability branch of the investor
control doctrine made the contract owners owners of the assets. The insurer
would remain the owner of the separate-account assets for federal income tax
purposes after the restructuring.

Ruling snapshot

• Question: After the proposed restructuring, will the insurer or the
  pension contract owners own the separate-account assets for federal income
  tax purposes?
• Outcome: Approved, the insurer remains the owner
• Key authorities: IRC §§ 817 and 818; Rev. Ruls. 77-85, 80-274,
  81-225, 82-54, 2003-91, and 2003-92

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202041005 Third Party Communication: None
Release Date: 10/9/2020 Date of Communication: Not Applicable
Index Number: 61.00-00, 817.00-00
Person To Contact:
--------------- ---------------------, ID No. -----------------
------------------------------------ Telephone Number:
--------------------------------------------- --------------------
--------------------- Refer Reply To:
----------------------------------------- CC:FIP:B01
PLR-117915-16
Date:
July 13, 2020

Taxpayer = ---------------------------------------------
Parent = ----------------------------------------
Affiliate = ------------------------------------------------
Separate Account = -------------------------------------------
Operating Partnership = -------------------------------------------------
Newco GP = -------------------------------------------
State 1 = ------
State 2 = -------------
v = --
w = ---
x = -----

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

  This letter is in response to the submission by your authorized representatives,

requesting a ruling on whether the assets held by the Separate Account are owned by
the Taxpayer for federal income tax purposes.

                                                FACTS

    Taxpayer is an insurance company within the meaning of § 816(a) of the Internal

Revenue Code (the “Code”) and is taxable under Subchapter L of the Code. Taxpayer
is a stock life insurance company incorporated under the laws of State 1. Taxpayer is a
wholly owned indirect subsidiary of Parent. Taxpayer and Parent file a consolidated
federal income tax return on a calendar year basis, and Taxpayer’s overall method of
accounting is an accrual method.

A. The Pension Contracts and the Separate Accoun

   Taxpayer issues group annuity contracts, which are pension plan contracts within

the meaning of § 818(a) (“Pension Contracts”), to pension plans, including qualified
plans and Employee Retirement Income Security Act of 1974, as amended (“ERISA”)
plans, state and local government pension plans, church plans, and Taft-Hartley plans
(“Qualified Plans”). The Qualified Plans are either defined benefit plans or defined
contribution plans.

   The Pension Contracts are funded by real estate assets held in the Separate

Account, which is sponsored by Taxpayer and managed by Affiliate, a wholly owned
indirect subsidiary of Parent. The Separate Account invests primarily in high quality,
well-leased real estate properties in the multifamily, industrial, office, retail, and hotel
sectors in the United States. The Separate Account’s real estate assets (collectively,
“Real Estate Assets”) are typically held in single-member limited liability companies
wholly owned by Taxpayer. However, the Real Estate Assets may be owned in fee
simple, with Taxpayer as titleholder of record, or in a joint venture managed by
Taxpayer’s joint venture partner.

   Taxpayer charges the Separate Account annual investment management fees

ranging from w to x basis points of the net asset value of assets under management.
Taxpayer accepts investments in the Separate Account each business day (in the
absence of a contribution queue) and generally permits withdrawals each business day.
However, Taxpayer may impose withdrawal limitations for larger investors in the
Separate Account on an investor-by-investor basis from time to time based on the size
of pending withdrawal requests and for all investors based on lack of liquidity or during
times of financial crisis. Otherwise, there is generally no lockout period for withdrawal
by investors.

    The Taxpayer represents that the Pension Contracts provide contract holders

with a contractual right to certain payments, but do not provide such investors with any
ownership interest in the Separate Account’s assets. The Separate Account is subjec
to the insurance law of State 1, and as such, must maintain its assets and liabilities,
including realized and unrealized gains and losses, separate from Taxpayer’s other
assets, maintain certain levels of operational reserves, observe certain valuation
policies, and make certain disclosures to investors.

B. Proposed Restructuring

   Taxpayer intends to restructure the Separate Account’s assets as follows:

   Taxpayer will contribute substantially all of the Separate Account’s Real Estate

Assets to Operating Partnership, a State 2 limited partnership, in exchange for a limited
partnership interest in Operating Partnership. Affiliate will organize Newco GP, a
State 2 single-member limited liability company, to act as the general partner of

Operating Partnership, and Newco GP will not have an economic interest in Operating
Partnership. Furthermore, Operating Partnership will contribute the Real Estate Assets
to one or more real estate investment trusts (“REITs”), in exchange for REIT shares.
After the restructuring, the Separate Account will generally maintain more than v
percent of its assets (other than cash and cash equivalents), tested, as of the end of
each calendar year or other date that the Separate Account may reasonably determine,
based on a 5 year rolling average of the prior 5 calendar years, directly and outside of
its ownership interests in Operating Partnership (the “Directly Held Assets”).

     Affiliate plans to create a State 2 limited partnership (“Direct Fund”) for which

Newco GP or another affiliate of Affiliate will act as the general partner. At all times,
Direct Fund’s sole investment will be a limited partnership interest in Operating
Partnership. Investment in Direct Fund will be limited to: (i) Institutional Investors,
(ii) high net-worth individuals, (iii) governmental plans that are not Qualified Plans, and
(iv) other investors that are not Qualified Plans. Taxpayer represents that Qualified
Plans will not be permitted to invest in Direct Fund.

   Direct Fund’s annual investment management fees will range from w to x basis

points of the net asset value of assets under management. Direct Fund may accep
capital contributions as frequently as daily, in exchange for additional units in Direc
Fund. Direct Fund will permit withdrawals on a daily basis, with limitations for larger
investors on an investor-by-investor basis and may limit withdrawals for all investors in
periods of reduced liquidity or during times of financial crisis.

C. Representations

  In addition to the facts presented above, Taxpayer has also made the following

representations:

   (1)    The Pension Contracts meet the definition of a “pension plan contract”
          under § 818(a).
   (2)    Taxpayer and Affiliate are fiduciaries (within the meaning of section 3(21)
          of ERISA) of the Separate Account.
   (3)    Pension Contract owners do not have any agreement with Taxpayer or
          Affiliate regarding the assets in which the Separate Account will invest in
          the future or regarding the Separate Account’s continued investment in
          specific Real Estate Assets.
   (4)    Taxpayer is not required to continue to invest the Separate Account in
          Operating Partnership or to invest future money available to the Separate
          Account in Operating Partnership or any other particular asset, and has
          not promised the Pension Contract owners that it will do so.
   (5)    All investment decisions concerning Operating Partnership will be made
          by Affiliate, and certain decisions are subject to approval by Affiliate’s
          investment committee. All investment decisions concerning the assets of

          the Separate Account will be made by Affiliate, and certain decisions are
          subject to approval by Taxpayer’s investment committee.
   (6)    A Pension Contract owner will not be able to direct the Separate Account’s
          or Operating Partnership’s investment in any particular asset or
          recommend a particular investment or investment strategy, and there will
          not be any agreement between a Pension Contract owner and Taxpayer
          or Affiliate regarding a particular investment of the Separate Account or
          Operating Partnership.
   (7)    No Pension Contract owner will be able to influence directly or indirectly
          Taxpayer’s or Affiliate’s decisions concerning the selection, quality, or rate
          of return on any specific investment or group of investments held by the
          Separate Account or Operating Partnership.
   (8)    A Pension Contract owner will not have any legal, equitable, direct, or
          indirect ownership interest in any of the assets of the Separate Account or
          Operating Partnership. Rather, a Pension Contract owner only will have a
          contract claim against Taxpayer to collect cash under the terms of the
          Pension Contract.
   (9)    Neither Taxpayer nor Affiliate solicits Pension Contract owners or
          prospective Pension Contract owners to make recommendations abou
          the selection, quality, or rate of return of any specific investment or group
          of investments held in the Separate Account or in Operating Partnership.
   (10)   Public access to the Separate Account will be available exclusively
          through the purchase of a pension plan contract within the meaning of
          § 818(a).

                                        LAW

   The Service has issued a series of “investor control” rulings that address when

the holder of a variable life insurance contract or variable annuity contract will be treated
as the owner of the assets held by a separate account that funds the contract. See
Rev. Rul. 77-85, 1977-1 C.B. 12, Rev. Rul. 80-274, 1980-2 C.B. 27, Rev. Rul. 81-225,
1981-2 C.B. 12, Rev. Rul. 82-54, 1982-1 C.B. 11, Rev. Rul. 2003-91, 2003-2 C.B. 347,
and Rev. Rul. 2003-92, 2003-2 C.B. 350. Under these rulings, a contract holder will be
treated as the owner of the separate account assets if: (1) the contract holder
possesses sufficient control over the investments made by the separate account (the
“investor control prong”), or (2) the separate account assets are not available
exclusively through the purchase of a life insurance or annuity contract (the “public
availability prong”).

   In Rev. Rul. 77-85, the Service concluded that a policyholder of an investmen

annuity contract issued by a life insurance company was the owner of the custodial
account assets that were used to fund the annuity payments for federal income tax
purposes. The policyholder maintained investment control over the account by retaining
the power to direct the custodian in writing at any time to sell, purchase, or exchange
securities or other assets held in the custodial account. The policyholder could also

exercise his right to vote the securities through the custodian or personally. Although
the policyholder could not receive amounts directly from the account and could no
receive distribution of assets in kind, the policyholder could surrender the policy in full or
in part prior to the annuity starting date, which would require the insurance company to
sell all or part of the custodial account assets and make a payment to the policyholder
equal to the proceeds that the insurance company received from the sale, less any cash
surrender charges. Furthermore, the policyholder enjoyed any increase or suffered any
decrease in the value of the custodial account assets.

    In Rev. Rul. 80-274, an insurance company sold annuity contracts to depositors

of participating savings and loan associations. Each depositor paid premiums in
exchange for an annuity contract. The premiums could be cash, an existing passbook
savings and loan account, or certificates of deposit. The insurance company deposited
the premiums less any fees into a separate account of the savings and loan association
of depositor, and the amounts deposited were invested in certificates of deposit for a
term designated by the policyholder. Interest earned on the investments was credited
to each annuity account, and a policyholder could withdraw all or a portion of the cash
surrender value of the contract at any time prior to the annuity starting date. The cash
surrender value equaled the amount deposited plus interest credited less a charge for
withdrawal. The Service ruled that the policyholder, and not the insurance company,
was the owner of the certificates of deposit for federal income tax purposes because the
policyholder’s position was substantially identical to what the policyholder’s position
would have been had the investment been established directly with the savings and
loan association. The insurance company was little more than a conduit between the
policyholder and the savings and loan association.

    In Rev. Rul. 81-225, the Service described five situations in which an individual

purchased a deferred variable annuity contract from a life insurance company and the
premiums under the contract were allocable to a variable account (or sub-accounts). In
four of the situations, the sole asset of the account were shares in mutual funds tha
were directly available to the public (Situations 1, 2 and 3) or indirectly available to the
public through the purchase of an investment plan account described in Rev. Rul. 70-
525, 1970-2 C.B. 144, that invested in the mutual fund (Situation 4). In those situations,
the Service concluded that the contract holder had investment control over the mutual
fund shares and that the contract holder’s position in each situation was substantially
identical to what it would have been had the mutual fund shares been purchased
directly by the contract holders. Conversely, in the situation in which the mutual fund
shares were only available through the purchase of an annuity contract (Situation 5), the
insurance company was the owner of the shares for federal income tax purposes.

   In Rev. Rul. 82-54, a life insurance company issued variable payment and fixed

payment deferred annuity contracts that were funded through a separate account of the
insurance company. The assets of the separate account were invested, as a
policyholder directed, in shares of three mutual funds that were available only to
segregated asset accounts established by the life insurance company. Shares of the

mutual funds were not available to investment plan accounts described in Rev. Rul. 70-

525. Each mutual fund offered a different investment strategy. Even though a
     policyholder was permitted to allocate his or her purchase payments among the three
     mutual funds, the Service ruled that the insurance company, and not the policyholders,
     was the owner of the mutual fund shares held by the separate account because the
     ability of the policyholders to choose among broad investment strategies offered by
     each mutual fund was insufficient to conclude that the policyholders would be treated for
     federal income tax purposes as the owners of mutual fund shares that were no
     available to the general public.

     In Christofferson v. U.S., 749 F.2d 513 (8th Cir. 1984), the taxpayers purchased
     

     a variable annuity contract from an insurance company, and the premium paid for the
     contract was invested in shares of a mutual fund held by a sub-account of the issuing
     insurance company’s separate account. The Eighth Circuit held that the taxpayers were
     the beneficial owners of the investment funds held by the sub-account because the
     taxpayers selected the mutual fund to invest in and could change to another fund at any
     time, bore full investment risk, and could withdraw their investment upon seven days
     notice. Id. at 515. Furthermore, the court noted that the “payment of annuity premiums,
     management fees and the limitation of withdrawals to cash, rather than shares, do no
     reflect a lack of ownership or control.” Id. at 515-16.

     Congress enacted § 817 as part of the Deficit Reduction Act of 1984 (Pub. L. No.
     

     98-369). Section 817(h)(1) provides that a variable contract (other than a pension plan
     contract) based on a segregated asset account is not treated as an annuity,
     endowment, or life insurance contract unless the investments made by the account are
     adequately diversified in accordance with regulations provided by the Secretary.
     According to the Conference Report, the conferees intended for the diversification
     standards to be “designed to deny annuity or life insurance treatment for investments
     that are publicly available to investors and investments which are made, in effect, at the
     direction of the investor.” H.R. Conf. Rep. No. 98-861, at 1055 (1984).

     Approximately two years after the enactment of § 817(h), the Treasury
     Department issued proposed and temporary regulations regarding the diversification
     requirements for variable annuity, endowment, and life insurance contracts. The
     preamble to the temporary regulations states as follows:

     The temporary regulations in this document do not address any issues other
     than the diversification standards applicable to variable annuity,
     endowment, and life insurance contracts. In particular, they 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, bu
     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
     contract.

T.D. 8101, 51 FR 32633 (September 15, 1986). The text of the temporary regulations
served as the text of the proposed regulations, 51 FR 32664 (September 15, 1986), and
the final regulations adopted the text of the temporary regulations with certain revisions
not relevant to investor control. T.D. 8242, 54 FR 8728 (March 2, 1989).

    The Service provided additional guidance under the investor control doctrine in

Rev. Rul. 2003-91 and Rev. Rul. 2003-92. In Rev. Rul. 2003-91, the Service set forth a
factual scenario under which a variable life insurance and a variable annuity contrac
holder would not have sufficient control over a separate account’s assets to be treated
as the owner of the assets. The variable contract was funded by a separate accoun
that was divided into twelve sub-accounts. The issuing insurance company could
increase or decrease the number of sub-accounts at any time, but there would never be
more than 20 sub-accounts available under the contracts. Each sub-account offered a
different investment strategy. Interests in the sub-accounts were available solely
through the purchase of a variable life insurance or variable annuity contract tha
qualified as a variable contract under § 817(d). The investment activities of each sub-
account were managed by an independent investment adviser. There was no
arrangement, plan, contract, or agreement between the contract holder and the issuing
insurance company or between the contract holder and the independent investmen
adviser 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 a
contract holder's right to allocate premiums and transfer funds among the available sub-
accounts, all investment decisions concerning the sub-accounts were made by the
issuing insurance company or the independent investment adviser in their sole and
absolute discretion. A contract holder had no legal, equitable, direct, or indirect interes
in any of the assets held by a sub-account but had only a contractual claim against the
issuing insurance company to collect cash in the form of death benefits or cash
surrender values under the contract. The Service concluded that, based on all the facts
and circumstances, the contract holder did not have direct or indirect control over the
separate account or any sub-account asset, and therefore the contract holder did no
possess sufficient incidents of ownership over the assets supporting the variable
contracts to be the owner of the assets for federal income tax purposes.

   In Rev. Rul. 2003-92, a life insurance company offered variable annuity and

variable life insurance contracts to certain investors. In Situations 1 and 2, the contracts
were funded by a segregated asset account that was divided into 10 sub-accounts, and
each sub-account invested in interests in a nonregistered partnership that were
available for purchase by the general public. Each sub-account was adequately

diversified under § 1.817-5(b)(1).1 A contract holder could not independently own any
interest in a partnership offered under the annuity or life insurance contract. Because
the partnership interests were available for purchase other than by purchasers of
variable annuity contracts, variable life insurance contracts, or other variable contracts
from insurance companies, the Service concluded that the contract holder is the owner
of the interests in the partnerships held by the sub-accounts for federal income tax
purposes. However, in Situation 3, in which the partnership interests were only
available through the purchase of a variable annuity contract, variable life insurance
contract, or other variable contracts from insurance companies, the Service concluded
the insurance company is the owner of the partnership interests.

    In Webber v. Commissioner, 144 T.C. 324 (2015), the Tax Court ruled tha

petitioner, who established grantor trusts to purchase private placement variable life
insurance policies on the lives of two elderly relatives, was the owner of the assets held
by the separate accounts that funded the benefits under the policies. The cour
concluded that petitioner retained sufficient control over the investments by retaining the
power to direct investments made by the separate account, the power to vote shares
and exercise other options regarding the investments, the power to extract cash at will
from the separate accounts, and the power to derive other benefits from the separate
accounts (i.e., financing investments that were a source of personal pleasure, and using
the separate account to complement the investments in his own portfolio). Id. at 361-

369. Furthermore, the court concluded that the diversification requirements set forth in
     § 817(h) did not displace the investor control principles in Rev. Rul. 77-85. Id. at 373-

370. The court did not address how the § 817(h) diversification requirements interac
     with the public availability prong of the investor control rulings. Id. at 374 n.19.

                                              ANALYSIS
     
      Under the investor control doctrine, a variable annuity contract holder can be
     

     treated as the owner of the assets held by a separate account that fund the contract,
     even when a separate account is adequately diversified or is not required to be
     diversified. Under § 817(h), investments upon which the Pension Contracts are based
     are not required to be adequately diversified. Whether the Pension Contract owners
     possess sufficient incidents of ownership over the Separate Account after the
     restructuring to be treated as the owner of the Separate Account’s assets depends on
     all of the relevant facts and circumstances. The Pension Contract owners will be
     treated as the owner of the Separate Account’s assets if either the investor control
     prong or the public availability prong of the investor control doctrine applies.

     The public availability prong of the investor control doctrine generally provides
     that when the sole asset held by a separate account is available for purchase other than

1 The prior version of § 1.817-5(f)(2)(ii) permitted the look-through rule in § 1.817-5(f)(1) to apply to a

partnership interest that was not registered under a Federal or state law regulating the offering or sale of
securities. T.D. 8242, 54 FR 8728 (March 2, 1989). The prior version of § 1.817-5(f)(2)(ii) was removed
in T.D. 9185, 70 FR 9869 (March 1, 2005).

through the purchase of variable annuity or life insurance contracts, or other variable
contracts from insurance companies, the contract holder will be treated as owner of the
asset held by the separate account. See Rev. Rul. 81-225; Rev. Rul. 2003-92. In such
circumstances, the contract holder’s position is substantially identical to what his or her
position would have been if he or she had directly or indirectly (as in Situation 4 of Rev.
Rul. 81-225) purchased an interest in the asset held by the separate account.

   After the restructuring, the assets of the Separate Account will primarily consist of

ownership interests in Operating Partnership. However, the Separate Account will
generally maintain more than v percent of its assets as Directly Held Assets, which are
separate from its ownership interests in Operating Partnership. In addition, Taxpayer is
not required to invest future money available to the Separate Account in Operating
Partnership or any other particular asset, and has not promised the Pension Contrac
owners that it will do so. As such, a Pension Contract owner’s position is no
substantially identical to what its position would have been if it had purchased an
interest in Direct Fund (the only asset of which is an interest in Operating Partnership).

   Investment in the Separate Account is available solely through the purchase of a

Pension Contract. The possibility that the Separate Account may make investments
that are also available to the general public does not cause the Pension Contrac
owners to be treated as the owner of the Separate Account’s assets for federal income
tax purposes. The public availability prong of the investor control doctrine set forth in
Rev. Rul. 81-225 and Rev. Rul. 2003-92 will not apply to treat the Pension Contrac
owners as the owner of the assets held by the Separate Account.

  Furthermore, the investor control prong will not apply to the treat the Pension

Contract owners as the owner of the Separate Account’s assets. The Pension Contrac
owners may not select or direct a particular investment to be made with respect to the
Separate Account. The Pension Contract owners may not sell, purchase, or exchange
assets held in the Separate Account. All investment decisions concerning the assets of
the Separate Account will be made by Affiliate, and certain decisions are subject to
approval by Taxpayer’s investment committee.

   The investment strategy of the Separate Account of investing in real estate

assets is sufficiently broad to prevent the Pension Contract owners from making
particular investment decisions through investment in the Separate Account. Only
Taxpayer or Affiliate may add or substitute investment strategies in the future. Neither
Taxpayer nor Affiliate is permitted to solicit the Pension Contract owners to make
recommendations about the selection, quality, or rate of return of any specific
investment or group of investments held in the Separate Account. The Pension
Contract owners will not have any more control over the assets of the Separate Accoun
than the contract owners in Rev. Rul. 82-54 or Rev. Rul. 2003-91.

                                  CONCLUSION

  Following the proposed restructuring described above, Taxpayer will be the

owner of the assets held by the Separate Account for federal income tax purposes.

   The use of the term “restructuring” in this ruling is for descriptive convenience

only and is not intended to have any substantive legal effect.

  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.

   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. In particular, no opinion is expressed or implied regarding
whether Operating Partnership is treated as a partnership for federal tax purposes. The
rulings contained in this letter are based upon information and representations
submitted by the taxpayer and accompanied by a penalty 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.

     In accordance with the Power of Attorney on file with this office, a copy of this

letter is being sent to your authorized representatives.

                                   Sincerely,



                                   Alexis A. MacIvor
                                   Branch Chief, Branch 4
                                   Office of Associate Chief Counsel
                                   (Financial Institutions & Products)

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