Diversification Requirements for Variable Annuity, Endowment, and Life Insurance Contracts, 9869-9872 [05-3825]
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Federal Register / Vol. 70, No. 39 / Tuesday, March 1, 2005 / Rules and Regulations
species by catcher/processors listed in
paragraphs 208(e)(1) through (e)(20) and
section 209 of the AFA in non-pollock
target fisheries divided by the sum of
the catch of that species in 1995 through
1997 multiplied by the TAC of that
species available for harvest by catcher/
processors in the year in which the
harvest limit will be in effect.
(ii) If the amount of a species
calculated under paragraph (a)(4)(i) of
this section is determined by the
Regional Administrator to be
insufficient to meet bycatch needs for
AFA catcher/processors in other
directed fisheries for groundfish, the
Regional Administrator will prohibit
directed fishing for that species by AFA
catcher/processors and establish the
sideboard amount equal to the amount
of that species caught by AFA catcher/
processors incidental to directed fishing
for other groundfish species.
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(b) Harvesting sideboards for AFA
catcher vessels. The Regional
Administrator will restrict the ability of
AFA catcher vessels to engage in
directed fishing for other groundfish
species to protect participants in other
groundfish fisheries from adverse effects
resulting from the AFA and from fishery
cooperatives in the BS subarea directed
pollock fishery.
*
*
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(3) How will groundfish sideboard
limits be calculated? Except for Aleutian
Islands pollock, the Regional
Administrator will establish annual
AFA catcher vessel harvest limits for
each groundfish species or species
group in which a TAC is specified for
an area or subarea of the GOA and BSAI
as follows:
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19. In § 679.65, paragraphs (a) and (b)
are revised to read as follows:
I
§ 679.65
Crab processing sideboard limits.
(a) What is the purpose of crab
processing limits? The purpose of crab
processing sideboard limits is to protect
processors not eligible to participate in
the BS subarea directed pollock fishery
from adverse effects as a result of the
AFA and the formation of fishery
cooperatives in the BS subarea directed
pollock fishery.
(b) To whom do the crab processing
sideboard limits apply? The crab
processing sideboard limits in this
section apply to any AFA inshore or
mothership entity that receives pollock
harvested in the BS directed pollock
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fishery by a fishery cooperative
established under § 679.61 or § 679.62.
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[FR Doc. 05–3788 Filed 2–24–05; 2:55 pm]
BILLING CODE 3510–22–S
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 9185]
RIN 1545–BB77
Diversification Requirements for
Variable Annuity, Endowment, and Life
Insurance Contracts
Internal Revenue Service (IRS),
Treasury.
ACTION: Final regulations.
AGENCY:
SUMMARY: This document contains final
regulations removing provisions of the
Income Tax Regulations that apply a
look-through rule to assets of a
nonregistered partnership for purposes
of satisfying the diversification
requirements of section 817(h) of the
Internal Revenue Code.
DATES: Effective Date: These regulations
are effective as of March 1, 2005.
However, arrangements in existence on
March 1, 2005, will be considered to be
adequately diversified if: (i) Those
arrangements were adequately
diversified within the meaning of
section 817(h) prior to March 1, 2005,
and (ii) by December 31, 2005, the
arrangements are brought into
compliance with the final regulations.
Applicability Date: For dates of
applicability, see § 1.817–5(i).
FOR FURTHER INFORMATION CONTACT:
James Polfer, (202) 622–3970 (not a tollfree number).
SUPPLEMENTARY INFORMATION:
Background
Under section 817(h), a variable
contract based on a segregated asset
account is not treated as an annuity,
endowment, or life insurance contract
unless the segregated asset account is
adequately diversified. For purposes of
testing diversification, section 817(h)(4)
and § 1.817–5(f) of the regulations
provide a look-through rule for assets
held through certain investment
companies, partnerships, or trusts.
Section 1.817–5(f)(2)(i) provides that
look-through treatment is available with
respect to any investment company,
partnership, or trust only if all the
beneficial interests in the investment
company, partnership, or trust are held
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9869
by one or more segregated asset
accounts of one or more insurance
companies, and public access to such
investment company, partnership, or
trust is available exclusively (except as
otherwise permitted by section 1.817–
5(f)(3)) through the purchase of a
variable contract. Under § 1.817–
5(f)(2)(ii), the look-through rule applies
to a partnership interest that is not
registered under a Federal or state law
regulating the offering or sale of
securities. Unlike § 1.817–5(f)(2)(i),
satisfaction of the nonregistered
partnership look-through rule of
§ 1.817–5(f)(2)(ii) is not explicitly
conditioned on limiting the ownership
of interests in the partnership to certain
specified holders.
On July 30, 2003, the Treasury
Department and the IRS published a
notice of proposed rulemaking (REG–
163974–02) under section 817 in the
Federal Register (68 FR 44689). The
proposed regulations would remove the
rule that applies specifically to
nonregistered partnerships for purposes
of testing diversification. The proposed
regulations also would remove an
example that illustrates that rule.
The application of § 1.817–5(f)(2)(i) to
interests in nonregistered partnerships
will be unchanged by the removal of
§ 1.817–5(f)(2)(ii). Thus, look-through
treatment will be available for interests
in a nonregistered partnership if all the
beneficial interests in the partnership
are held by one or more segregated asset
accounts of one or more insurance
companies and public access to the
partnership is available exclusively
(except as otherwise permitted by
§ 1.817–5(f)(3)) through the purchase of
a variable contract.
Written comments were received in
response to the notice of proposed
rulemaking. A public hearing on the
notice of proposed rulemaking was held
on April 1, 2004. After consideration of
all the comments and the hearing
testimony, the proposed regulations are
adopted as amended by this Treasury
decision.
Explanation and Summary of
Comments
In addition to requesting comments
on the clarity of the proposed rule and
how the rule could be made easier to
understand, the Treasury Department
and the IRS specifically requested
comments on: (1) Whether revocation of
§ 1.817–5(f)(2)(ii) necessitates other
changes to the look-through rules of
§ 1.817–5(f), in particular whether the
list of holders permitted by § 1.817–
5(f)(3) should be amended or expanded,
and whether a non-pro-rata distribution
of the investment returns of a segregated
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Federal Register / Vol. 70, No. 39 / Tuesday, March 1, 2005 / Rules and Regulations
asset account should be permitted to
take account of certain bonus payments
to investment managers commonly
referred to as incentive payments, (2)
whether § 1.817–5 should be updated to
take account of changes to variable
contracts since the final regulations
were published in 1986, and (3) whether
regulations are needed to address when
a holder of a variable contract will be
treated as the owner of assets held in a
segregated asset account and, therefore,
required to include earnings on those
assets in income.
1. Comments on the Proposed
Regulations
Two comments on the proposed
regulation concerned the definition of
‘‘security’’ in § 1.817–5(h)(6). Under
§ 1.817–5(b)(1)(ii)(A), all securities of
the same issuer are treated as one
investment for the purposes of satisfying
the diversification requirements.
Section 1.817–5(h)(6) provides that the
term security includes ‘‘a cash item and
any partnership interest registered
under a Federal or state law regulating
the offering or sale of securities,’’ but
does not include ‘‘any other
partnership interest.’’ The
commentators stated that the definition
of ‘‘security’’ that applies to § 1.817–5
should be amended to include an
interest in a non-registered partnership.
The Treasury Department and the IRS
agree that, in light of the revocation of
former § 1.817–5(f)(2)(ii), the definition
of security should be modified to
remove the distinction between
registered and nonregistered partnership
interests. The final regulations reflect
this change.
A number of commentators also
suggested that the regulation should be
clarified by adding to or otherwise
revising the examples contained in
§ 1.817–5(g). In response to these
comments, the final regulations revise
§ 1.817–5(g) Example 1 to remove the
reference to partnership P as a publicly
registered partnership. The Treasury
Department and the IRS believe that,
with this change, the examples
contained in § 1.817–5(g) adequately
explain the application of § 1.817–5 to
partnership interests. Any questions
concerning the application of § 1.817–5
to more specific factual scenarios may
be addressed by the letter ruling process
or by subsequent published guidance.
Two commentators urged that existing
arrangements either should be
grandfathered in some fashion or should
be given additional time to be brought
into compliance with the final
regulations. The notice of proposed
rulemaking provided that arrangements
in existence on the effective date of the
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revocation of § 1.817–5(f)(2)(ii) will be
considered to be adequately diversified
if: (i) Those arrangements were
adequately diversified within the
meaning of section 817(h) prior to the
revocation of § 1.817–5(f)(2)(ii), and (ii)
by the end of the last day of the second
calendar quarter ending after the
effective date of the regulation, the
arrangements are brought into
compliance with the final regulations.
The Treasury Department and the IRS
do not believe it is appropriate to
grandfather existing arrangements
indefinitely. In response to these
comments, however, the transition
period for existing arrangements to be
brought into compliance with the
regulations is two calendar quarters
longer than the period provided in the
proposed regulations.
Finally, one commentator questioned
the authority of the Treasury
Department and the IRS to enact this
final regulation because ‘‘the only
substantive impetus for the regulation is
a general statement in the legislative
history.’’ Congress enacted the
diversification requirements of section
817(h) to ‘‘discourage the use of taxpreferred variable annuity and variable
life insurance primarily as investment
vehicles,’’ H.R. Conf. Rep. No. 98–861,
at 1055 (1984), and granted the
Secretary broad regulatory authority to
develop rules to carry out this intent.
The Treasury Department and the IRS
have determined that this final
regulation and the rest of the regulations
contained in § 1.817–5 were prescribed
within the delegation of authority
provided by Congress.
2. Comments on § 1.817–5 More
Generally
Many comments concerned the list of
permitted investors under § 1.817–
5(f)(3). Notwithstanding the limitations
on public access to an investment
company, partnership, or trust that is
subject to look-through treatment under
§ 1.817–5(f), § 1.817–5(f)(3) permits
look-through treatment if the beneficial
interests of the investment company,
partnership, or trust are held by certain
other ‘‘permitted investors,’’ including
the general account of a life insurance
company (if certain requirements are
met), the manager or a corporation
related to the manager (if certain
requirements are met), or the trustee of
a qualified plan. Commentators
suggested that the list of permitted
investors be expanded to include, for
example, qualified tuition programs
described in section 529; segregated
asset accounts of foreign insurance
companies; foreign pension plans;
persons or entities related to the
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manager of an investment company,
partnership, or trust in a manner
specified in section 707(b); certain
investment professionals operating as
service providers; or persons who
receive interests in a partnership as a
result of inadvertent transfers, such as
by bankruptcy or death of the permitted
investor. The sole speaker at the public
hearing on the notice of proposed
rulemaking testified that the list of
investors permitted by § 1.817–5(f)(3)
should be expanded to include ‘‘floor
specialists’’ as that term is defined in
section 1236(d)(2).
Other comments suggested guidance
on non-pro-rata manager compensation.
In order for the manager (or a
corporation related in a manner
specified in section 267(b) to the
manager) of an investment company,
partnership, or trust, to be a permitted
investor under § 1.817–5(f)(3)(ii), (1) its
interest must be held in connection with
the creation or management of the
investment company, partnership, or
trust; (2) the return on such interest
must be computed in the same manner
as the return on an interest held by a
segregated asset account is computed
(determined without regard to expenses
attributable to variable contracts); and
(3) there must be no intent to sell such
interest to the public. A number of
commentators stated that the
requirement that the return on a
manager’s interest be computed in the
same manner as the return on a
segregated asset account’s interest—
essentially a pro-rata distribution
requirement—is inconsistent with
prevailing market practices concerning
manager bonuses, discourages the
creation of insurance dedicated funds,
and is not necessary to prevent abuse of
the look-through rules contained in
§ 1.817–5(f).
Some comments stated there is a need
to clarify the consequences to a variable
contract and variable contract holder
when the contract’s segregated asset
account contains an asset in which
beneficial interests are held by investors
(such as qualified plans) that qualified
as permitted investors in § 1.817–5(f)(2)
or (3) at the time of initial investment,
but subsequently lose their status.
Similarly, one commentator urged that
if an insurance company has a
reasonable basis to believe that an
investment company, partnership, or
trust satisfies the requirements of
§ 1.817–5(f)(2), a variable contract of
that insurance company should be
permitted to look-through that entity for
purposes of testing a segregated asset
account on which that contract is based,
even if the investment company,
partnership, or trust has investors not
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Federal Register / Vol. 70, No. 39 / Tuesday, March 1, 2005 / Rules and Regulations
described in § 1.817–5(f)(2) or (3). The
commentator suggested that this
standard would be consistent with the
standard of determination often used in
the Federal securities laws.
Other comments included a request
for clarification of the treatment of fundof-funds and master-feeder
arrangements for purposes of testing
diversification; the desirability of an
updated correction procedure for failure
to satisfy the diversification
requirements of section 817(h) and
§ 1.817–5; guidance concerning the use
of independent investment advisors;
and extension of the special
diversification rules for United States
Treasury securities under section
817(h)(3) and § 1.817–5(b)(3) to variable
annuity contracts. (The latter comment
presumably would require a change to
section 817(h)(3), as well as to the
regulations.)
Although the comments on § 1.817–5
generally are not adopted in this
Treasury decision, the Treasury
Department and IRS will consider these
comments in the event of future
published guidance. For example, Rev.
Rul. 2005–7 (2005–6 I.R.B.) (see
§ 601.601 (d)(2)(ii)(b) of this chapter)
provides guidance on the application of
the diversification look-through rule to
tiered investment companies.
3. Comments on Investor Control
Finally, some comments concerned
the need for additional guidance
addressing circumstances under which
the holder of a variable contract will be
treated as the owner of assets held by a
segregated asset account by virtue of the
control the contract holder has over
those assets. Under Rev. Rul. 81–225,
1981–2 C.B. 12 (see § 601.601(d)(2)(ii)(b)
of this chapter), the owner of a variable
annuity contract funded by publicly
available mutual fund shares is treated
as the owner of those shares. Rev. Rul.
2003–92, 2003–33 I.R.B. 350 (see
§ 601.601(d)(2)(ii)(b) of this chapter),
clarified and amplified Rev. Rul. 81–225
by applying the same rule to variable
life insurance contracts, and by treating
as publicly available a nonregistered
partnership, interests in which are sold
only to qualified purchasers that are
accredited investors or to no more than
one hundred accredited investors. See
also Rev. Rul. 2003–91, 2003–33 I.R.B.
347; Rev. Rul. 82–54, 1982–1 C.B. 11;
Rev. Rul. 80–274, 1980–2 C.B. 27; Rev.
Rul. 77–85, 1977–1 C.B. 12.;
Christoffersen v. U.S., 749 F.2d 513 (8th
Cir. 1984), rev’g 578 F. Supp. 398 (N.D.
Iowa 1984). See § 601.601(d)(2)(ii)(b) of
this chapter.
One commentator urged that Rev. Rul.
2003–92 should not be applied
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retroactively to treat certain investors as
the ‘‘general public’’ as that term is used
in Rev. Rul. 81–225. Specifically, the
commentator requested relief for
investments in real estate partnerships,
interests in which are held directly by
(1) organizations described in section
501(c)(3), and (2) such partnerships’
investment managers, if those managers
are not described in § 1.817–5(f)(3)(ii)
because of bonus payment
arrangements. The commentator
believed such relief is warranted
because of uncertainty concerning the
meaning of ‘‘general public’’ as that
term is used in Rev. Rul. 81–225.
Several other commentators suggested
that regulations under section 817
should clarify that the permitted
investors under § 1.817–5(f)(3) do not
constitute the ‘‘general’’ public as that
term is used in Rev. Rul. 2003–92 and
Rev. Rul. 81–225. According to these
commentators, it would be anomalous
for ownership by a permitted investor
under § 1.817–5(f)(3) to result in a
variable contract holder being treated as
the owner of an investment company,
partnership, or trust, when the lookthrough rule itself appears to endorse
ownership by that same investor for
purposes of testing diversification. Still
another commentator noted that when
determining whether a contract holder
is treated as the owner of segregated
account assets, communications
between investment advisors or officers
and variable contract holders should be
permitted if the communications are
consistent with Federal securities and
commodities laws.
One commentator suggested that the
preamble to this Treasury decision
should confirm the intended scope of
Rev. Proc. 99–44, 1999–2 C.B. 598.
Under Rev. Proc. 99–44, a contract is
treated as an annuity contract described
in sections 403(a), 403(b), or 408(b),
notwithstanding that contract premiums
are invested at the direction of the
contract holder in publicly available
securities, so long as certain
requirements are met. Those
requirements include a limitation that
no additional Federal tax liability would
have been incurred if the employer of
the contract holder had instead paid
amounts into a custodial account in an
arrangement that satisfied the
requirements of section 403(b)(7)(A) or
no additional Federal tax liability would
have been incurred if the consideration
for the contract had instead been held
as part of a trust that would satisfy the
requirements of section 408(a), as
applicable. The commentator urged that
the preamble to this Treasury decision
clarify that the ‘‘no additional Federal
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9871
tax liability’’ limitation was intended to
apply only to tax on unrelated business
income. Finally, one commentator noted
that, given the inherent factual nature of
the determination whether a contract
holder is treated as the owner of
segregated account assets, the issue is
better addressed by letter ruling or
revenue ruling, rather than by
regulations.
Although the comments on investor
control are not adopted in this Treasury
decision, they are responsive to the
request for comments in the July 30,
2003, notice of proposed rulemaking
and will receive careful attention in the
event of further guidance on investor
control.
Special Analyses
It has been determined that this
Treasury decision is not a significant
regulatory action as defined in
Executive Order 12866. Therefore, a
regulatory assessment is not required. It
also has been determined that section
553(b) of the Administrative Procedure
Act (5 U.S.C. chapter 5) does not apply
to these regulations, and because the
regulations do not impose a collection
of information on small entities, the
Regulatory Flexibility Act (5 U.S.C.
chapter 6) does not apply. Pursuant to
section 7805(f) of the Internal Revenue
Code, the notice of proposed rulemaking
preceding these regulations was
submitted to the Small Business
Administration for comment on its
impact on small business.
Drafting Information
The principal author of these
regulations is James Polfer, Office of the
Associate Chief Counsel (Financial
Institutions and Products), Office of
Chief Counsel, Internal Revenue
Service. However, personnel from other
offices of the Treasury Department and
the IRS participated in their
development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and
recordkeeping requirements.
Adoption of Amendment to the
Regulations
Accordingly, 26 CFR part 1 is amended
as follows:
I
PART 1—INCOME TAX
Paragraph 1. The authority citation for
part 1 continues to read in part as
follows:
I
Authority: 26 U.S.C. 7805 * * *
Section 1.817–5 also issued under 26
U.S.C. 817(h). * * *
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Federal Register / Vol. 70, No. 39 / Tuesday, March 1, 2005 / Rules and Regulations
I Par. 2. Section 1.817–5 is amended as
follows:
I 1. Paragraphs (f)(2)(ii) and (g) Example
3 are removed.
I 2. Paragraph (f)(2)(iii) is redesignated
as paragraph (f)(2)(ii).
I 3. The first sentence of paragraph (g)
Example 1 is revised.
I 4. Paragraph (g) Example 4 is
redesignated as paragraph (g) Example 3.
I 5. Paragraph (h)(6) is revised.
I 6. New paragraph (i)(2)(v) is added.
The revisions read as follows:
§ 1.817–5 Diversification requirements for
variable annuity, endowment, and life
insurance contracts.
*
*
*
(g) * * *
*
*
Example 1. (i) The assets underlying
variable contracts issued by a life insurance
company consist of two groups of assets: (a)
a diversified portfolio of debt securities and
(b) interests in P, a partnership. * * *
*
*
*
*
*
(h) * * *
(6) Security. The term security shall
include a cash item and any partnership
interest, whether or not registered under
a Federal or State law regulating the
offering or sale of securities. The term
shall not include any interest in real
property, or any interest in a
commodity.
*
*
*
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*
(i) * * *
(2) * * *
(v) A segregated asset account in
existence before March 1, 2005, will be
considered to be adequately diversified
if—
(A) As of March 1, 2005, the account
was adequately diversified within the
meaning of section 817(h) and this
regulation as in effect prior to that date;
and
(B) By December 31, 2005, the
account is adequately diversified within
the meaning of section 817(h) and this
regulation.
Mark E. Matthews,
Deputy Commissioner for Services and
Enforcement.
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40 CFR Part 62
[R01–OAR–2004–ME–0002a; A–1–FRL–
7876–8 ]
Approval and Promulgation of Air
Quality Implementation Plans; Maine;
Control of Total Reduced Sulfur From
Kraft Pulp Mills
Environmental Protection
Agency (EPA).
ACTION: Direct final rule.
AGENCY:
SUMMARY: The EPA is approving a
revision to Maine’s plan for controlling
air pollution according to section 111(d)
of the Clean Air Act (i.e., a ‘‘111(d)
plan’’). This revision changes state
regulations controlling the emission of
total reduced sulfur (‘‘TRS’’) from
existing kraft paper mills by making
April 17, 2007 the compliance date for
brownstock washers. This action is
being taken in accordance with section
111(d) of the Clean Air Act (‘‘CAA’’).
DATES: This direct final rule will be
effective May 2, 2005, unless EPA
receives adverse comments by March
31, 2005. If adverse comments are
received, EPA will publish a timely
withdrawal of the direct final rule in the
Federal Register informing the public
that the rule will not take effect.
ADDRESSES: Comments may be mailed to
Lucy Edmondson, acting Unit Manager,
Air Permits, Toxics and Indoor Program
Unit, Office of Ecosystem Protection
(mail code CAP), U.S. Environmental
Protection Agency, EPA New England
Regional Office, One Congress Street,
Suite 1100, Boston, MA 02114–2023.
Comments may also be submitted
electronically, or through hand
delivery/courier. Please follow the
detailed instructions described in Part
(I)(B)(1)(i) through (iii) of the
SUPPLEMENTARY INFORMATION section.
FOR FURTHER INFORMATION CONTACT: Ian
D. Cohen, Air Permits, Toxics, and
Indoor Air Programs Unit, U.S.
Environmental Protection Agency, EPA
New England Regional Office, One
Congress Street, Suite 1100 (CAP),
Boston, MA 02114–2023,
cohen.ian@epa.gov.
SUPPLEMENTARY INFORMATION:
I. General Information
Approved: February 15, 2005.
Eric Solomon,
Acting Deputy Assistant Secretary of the
Treasury.
[FR Doc. 05–3825 Filed 2–28–05; 8:45 am]
BILLING CODE 4830–01–P
ENVIRONMENTAL PROTECTION
AGENCY
A. How Can I Get Copies of This
Document and Other Related
Information?
1. The Regional Office has established
an official public rulemaking file
available for inspection at the Regional
Office. EPA has established an official
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public rulemaking file for this action
under R01–OAR–2004–ME–0002. The
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documents specifically referenced in
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rulemaking file is the collection of
materials that is available for public
viewing at the Office of Ecosystem
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Protection Agency, EPA New England
Regional Office, One Congress Street,
Suite 1100, Boston, MA. EPA requests
that if at all possible, you contact the
contact listed in the FOR FURTHER
INFORMATION CONTACT section to
schedule your inspection. The Regional
Office’s official hours of business are
Monday through Friday, 8:30 to 4:30
excluding Federal holidays.
2. Copies of the State submittal and
EPA’s technical support document are
also available for public inspection
during normal business hours, by
appointment at the State Air Agency.
Department of Environmental
Protection, First Floor of the Tyson
Building, Augusta Mental Health
Institute Complex, Augusta, ME 04333–
0017; Division of Air Quality Control.
3. Electronic Access. You may access
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For public commenters, it is
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inspection.
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[Federal Register Volume 70, Number 39 (Tuesday, March 1, 2005)]
[Rules and Regulations]
[Pages 9869-9872]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 05-3825]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 9185]
RIN 1545-BB77
Diversification Requirements for Variable Annuity, Endowment, and
Life Insurance Contracts
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations.
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SUMMARY: This document contains final regulations removing provisions
of the Income Tax Regulations that apply a look-through rule to assets
of a nonregistered partnership for purposes of satisfying the
diversification requirements of section 817(h) of the Internal Revenue
Code.
DATES: Effective Date: These regulations are effective as of March 1,
2005. However, arrangements in existence on March 1, 2005, will be
considered to be adequately diversified if: (i) Those arrangements were
adequately diversified within the meaning of section 817(h) prior to
March 1, 2005, and (ii) by December 31, 2005, the arrangements are
brought into compliance with the final regulations.
Applicability Date: For dates of applicability, see Sec. 1.817-
5(i).
FOR FURTHER INFORMATION CONTACT: James Polfer, (202) 622-3970 (not a
toll-free number).
SUPPLEMENTARY INFORMATION:
Background
Under section 817(h), a variable contract based on a segregated
asset account is not treated as an annuity, endowment, or life
insurance contract unless the segregated asset account is adequately
diversified. For purposes of testing diversification, section 817(h)(4)
and Sec. 1.817-5(f) of the regulations provide a look-through rule for
assets held through certain investment companies, partnerships, or
trusts. Section 1.817-5(f)(2)(i) provides that look-through treatment
is available with respect to any investment company, partnership, or
trust only if all the beneficial interests in the investment company,
partnership, or trust are held by one or more segregated asset accounts
of one or more insurance companies, and public access to such
investment company, partnership, or trust is available exclusively
(except as otherwise permitted by section 1.817-5(f)(3)) through the
purchase of a variable contract. Under Sec. 1.817-5(f)(2)(ii), the
look-through rule applies to a partnership interest that is not
registered under a Federal or state law regulating the offering or sale
of securities. Unlike Sec. 1.817-5(f)(2)(i), satisfaction of the
nonregistered partnership look-through rule of Sec. 1.817-5(f)(2)(ii)
is not explicitly conditioned on limiting the ownership of interests in
the partnership to certain specified holders.
On July 30, 2003, the Treasury Department and the IRS published a
notice of proposed rulemaking (REG-163974-02) under section 817 in the
Federal Register (68 FR 44689). The proposed regulations would remove
the rule that applies specifically to nonregistered partnerships for
purposes of testing diversification. The proposed regulations also
would remove an example that illustrates that rule.
The application of Sec. 1.817-5(f)(2)(i) to interests in
nonregistered partnerships will be unchanged by the removal of Sec.
1.817-5(f)(2)(ii). Thus, look-through treatment will be available for
interests in a nonregistered partnership if all the beneficial
interests in the partnership are held by one or more segregated asset
accounts of one or more insurance companies and public access to the
partnership is available exclusively (except as otherwise permitted by
Sec. 1.817-5(f)(3)) through the purchase of a variable contract.
Written comments were received in response to the notice of
proposed rulemaking. A public hearing on the notice of proposed
rulemaking was held on April 1, 2004. After consideration of all the
comments and the hearing testimony, the proposed regulations are
adopted as amended by this Treasury decision.
Explanation and Summary of Comments
In addition to requesting comments on the clarity of the proposed
rule and how the rule could be made easier to understand, the Treasury
Department and the IRS specifically requested comments on: (1) Whether
revocation of Sec. 1.817-5(f)(2)(ii) necessitates other changes to the
look-through rules of Sec. 1.817-5(f), in particular whether the list
of holders permitted by Sec. 1.817-5(f)(3) should be amended or
expanded, and whether a non-pro-rata distribution of the investment
returns of a segregated
[[Page 9870]]
asset account should be permitted to take account of certain bonus
payments to investment managers commonly referred to as incentive
payments, (2) whether Sec. 1.817-5 should be updated to take account
of changes to variable contracts since the final regulations were
published in 1986, and (3) whether regulations are needed to address
when a holder of a variable contract will be treated as the owner of
assets held in a segregated asset account and, therefore, required to
include earnings on those assets in income.
1. Comments on the Proposed Regulations
Two comments on the proposed regulation concerned the definition of
``security'' in Sec. 1.817-5(h)(6). Under Sec. 1.817-5(b)(1)(ii)(A),
all securities of the same issuer are treated as one investment for the
purposes of satisfying the diversification requirements. Section 1.817-
5(h)(6) provides that the term security includes ``a cash item and any
partnership interest registered under a Federal or state law regulating
the offering or sale of securities,'' but does not include `` any other
partnership interest.'' The commentators stated that the definition of
``security'' that applies to Sec. 1.817-5 should be amended to include
an interest in a non-registered partnership. The Treasury Department
and the IRS agree that, in light of the revocation of former Sec.
1.817-5(f)(2)(ii), the definition of security should be modified to
remove the distinction between registered and nonregistered partnership
interests. The final regulations reflect this change.
A number of commentators also suggested that the regulation should
be clarified by adding to or otherwise revising the examples contained
in Sec. 1.817-5(g). In response to these comments, the final
regulations revise Sec. 1.817-5(g) Example 1 to remove the reference
to partnership P as a publicly registered partnership. The Treasury
Department and the IRS believe that, with this change, the examples
contained in Sec. 1.817-5(g) adequately explain the application of
Sec. 1.817-5 to partnership interests. Any questions concerning the
application of Sec. 1.817-5 to more specific factual scenarios may be
addressed by the letter ruling process or by subsequent published
guidance.
Two commentators urged that existing arrangements either should be
grandfathered in some fashion or should be given additional time to be
brought into compliance with the final regulations. The notice of
proposed rulemaking provided that arrangements in existence on the
effective date of the revocation of Sec. 1.817-5(f)(2)(ii) will be
considered to be adequately diversified if: (i) Those arrangements were
adequately diversified within the meaning of section 817(h) prior to
the revocation of Sec. 1.817-5(f)(2)(ii), and (ii) by the end of the
last day of the second calendar quarter ending after the effective date
of the regulation, the arrangements are brought into compliance with
the final regulations. The Treasury Department and the IRS do not
believe it is appropriate to grandfather existing arrangements
indefinitely. In response to these comments, however, the transition
period for existing arrangements to be brought into compliance with the
regulations is two calendar quarters longer than the period provided in
the proposed regulations.
Finally, one commentator questioned the authority of the Treasury
Department and the IRS to enact this final regulation because ``the
only substantive impetus for the regulation is a general statement in
the legislative history.'' Congress enacted the diversification
requirements of section 817(h) to ``discourage the use of tax-preferred
variable annuity and variable life insurance primarily as investment
vehicles,'' H.R. Conf. Rep. No. 98-861, at 1055 (1984), and granted the
Secretary broad regulatory authority to develop rules to carry out this
intent. The Treasury Department and the IRS have determined that this
final regulation and the rest of the regulations contained in Sec.
1.817-5 were prescribed within the delegation of authority provided by
Congress.
2. Comments on Sec. 1.817-5 More Generally
Many comments concerned the list of permitted investors under Sec.
1.817-5(f)(3). Notwithstanding the limitations on public access to an
investment company, partnership, or trust that is subject to look-
through treatment under Sec. 1.817-5(f), Sec. 1.817-5(f)(3) permits
look-through treatment if the beneficial interests of the investment
company, partnership, or trust are held by certain other ``permitted
investors,'' including the general account of a life insurance company
(if certain requirements are met), the manager or a corporation related
to the manager (if certain requirements are met), or the trustee of a
qualified plan. Commentators suggested that the list of permitted
investors be expanded to include, for example, qualified tuition
programs described in section 529; segregated asset accounts of foreign
insurance companies; foreign pension plans; persons or entities related
to the manager of an investment company, partnership, or trust in a
manner specified in section 707(b); certain investment professionals
operating as service providers; or persons who receive interests in a
partnership as a result of inadvertent transfers, such as by bankruptcy
or death of the permitted investor. The sole speaker at the public
hearing on the notice of proposed rulemaking testified that the list of
investors permitted by Sec. 1.817-5(f)(3) should be expanded to
include ``floor specialists'' as that term is defined in section
1236(d)(2).
Other comments suggested guidance on non-pro-rata manager
compensation. In order for the manager (or a corporation related in a
manner specified in section 267(b) to the manager) of an investment
company, partnership, or trust, to be a permitted investor under Sec.
1.817-5(f)(3)(ii), (1) its interest must be held in connection with the
creation or management of the investment company, partnership, or
trust; (2) the return on such interest must be computed in the same
manner as the return on an interest held by a segregated asset account
is computed (determined without regard to expenses attributable to
variable contracts); and (3) there must be no intent to sell such
interest to the public. A number of commentators stated that the
requirement that the return on a manager's interest be computed in the
same manner as the return on a segregated asset account's interest--
essentially a pro-rata distribution requirement--is inconsistent with
prevailing market practices concerning manager bonuses, discourages the
creation of insurance dedicated funds, and is not necessary to prevent
abuse of the look-through rules contained in Sec. 1.817-5(f).
Some comments stated there is a need to clarify the consequences to
a variable contract and variable contract holder when the contract's
segregated asset account contains an asset in which beneficial
interests are held by investors (such as qualified plans) that
qualified as permitted investors in Sec. 1.817-5(f)(2) or (3) at the
time of initial investment, but subsequently lose their status.
Similarly, one commentator urged that if an insurance company has a
reasonable basis to believe that an investment company, partnership, or
trust satisfies the requirements of Sec. 1.817-5(f)(2), a variable
contract of that insurance company should be permitted to look-through
that entity for purposes of testing a segregated asset account on which
that contract is based, even if the investment company, partnership, or
trust has investors not
[[Page 9871]]
described in Sec. 1.817-5(f)(2) or (3). The commentator suggested that
this standard would be consistent with the standard of determination
often used in the Federal securities laws.
Other comments included a request for clarification of the
treatment of fund-of-funds and master-feeder arrangements for purposes
of testing diversification; the desirability of an updated correction
procedure for failure to satisfy the diversification requirements of
section 817(h) and Sec. 1.817-5; guidance concerning the use of
independent investment advisors; and extension of the special
diversification rules for United States Treasury securities under
section 817(h)(3) and Sec. 1.817-5(b)(3) to variable annuity
contracts. (The latter comment presumably would require a change to
section 817(h)(3), as well as to the regulations.)
Although the comments on Sec. 1.817-5 generally are not adopted in
this Treasury decision, the Treasury Department and IRS will consider
these comments in the event of future published guidance. For example,
Rev. Rul. 2005-7 (2005-6 I.R.B.) (see Sec. 601.601 (d)(2)(ii)(b) of
this chapter) provides guidance on the application of the
diversification look-through rule to tiered investment companies.
3. Comments on Investor Control
Finally, some comments concerned the need for additional guidance
addressing circumstances under which the holder of a variable contract
will be treated as the owner of assets held by a segregated asset
account by virtue of the control the contract holder has over those
assets. Under Rev. Rul. 81-225, 1981-2 C.B. 12 (see Sec.
601.601(d)(2)(ii)(b) of this chapter), the owner of a variable annuity
contract funded by publicly available mutual fund shares is treated as
the owner of those shares. Rev. Rul. 2003-92, 2003-33 I.R.B. 350 (see
Sec. 601.601(d)(2)(ii)(b) of this chapter), clarified and amplified
Rev. Rul. 81-225 by applying the same rule to variable life insurance
contracts, and by treating as publicly available a nonregistered
partnership, interests in which are sold only to qualified purchasers
that are accredited investors or to no more than one hundred accredited
investors. See also Rev. Rul. 2003-91, 2003-33 I.R.B. 347; Rev. Rul.
82-54, 1982-1 C.B. 11; Rev. Rul. 80-274, 1980-2 C.B. 27; Rev. Rul. 77-
85, 1977-1 C.B. 12.; Christoffersen v. U.S., 749 F.2d 513 (8th Cir.
1984), rev'g 578 F. Supp. 398 (N.D. Iowa 1984). See Sec.
601.601(d)(2)(ii)(b) of this chapter.
One commentator urged that Rev. Rul. 2003-92 should not be applied
retroactively to treat certain investors as the ``general public'' as
that term is used in Rev. Rul. 81-225. Specifically, the commentator
requested relief for investments in real estate partnerships, interests
in which are held directly by (1) organizations described in section
501(c)(3), and (2) such partnerships' investment managers, if those
managers are not described in Sec. 1.817-5(f)(3)(ii) because of bonus
payment arrangements. The commentator believed such relief is warranted
because of uncertainty concerning the meaning of ``general public'' as
that term is used in Rev. Rul. 81-225. Several other commentators
suggested that regulations under section 817 should clarify that the
permitted investors under Sec. 1.817-5(f)(3) do not constitute the
``general'' public as that term is used in Rev. Rul. 2003-92 and Rev.
Rul. 81-225. According to these commentators, it would be anomalous for
ownership by a permitted investor under Sec. 1.817-5(f)(3) to result
in a variable contract holder being treated as the owner of an
investment company, partnership, or trust, when the look-through rule
itself appears to endorse ownership by that same investor for purposes
of testing diversification. Still another commentator noted that when
determining whether a contract holder is treated as the owner of
segregated account assets, communications between investment advisors
or officers and variable contract holders should be permitted if the
communications are consistent with Federal securities and commodities
laws.
One commentator suggested that the preamble to this Treasury
decision should confirm the intended scope of Rev. Proc. 99-44, 1999-2
C.B. 598. Under Rev. Proc. 99-44, a contract is treated as an annuity
contract described in sections 403(a), 403(b), or 408(b),
notwithstanding that contract premiums are invested at the direction of
the contract holder in publicly available securities, so long as
certain requirements are met. Those requirements include a limitation
that no additional Federal tax liability would have been incurred if
the employer of the contract holder had instead paid amounts into a
custodial account in an arrangement that satisfied the requirements of
section 403(b)(7)(A) or no additional Federal tax liability would have
been incurred if the consideration for the contract had instead been
held as part of a trust that would satisfy the requirements of section
408(a), as applicable. The commentator urged that the preamble to this
Treasury decision clarify that the ``no additional Federal tax
liability'' limitation was intended to apply only to tax on unrelated
business income. Finally, one commentator noted that, given the
inherent factual nature of the determination whether a contract holder
is treated as the owner of segregated account assets, the issue is
better addressed by letter ruling or revenue ruling, rather than by
regulations.
Although the comments on investor control are not adopted in this
Treasury decision, they are responsive to the request for comments in
the July 30, 2003, notice of proposed rulemaking and will receive
careful attention in the event of further guidance on investor control.
Special Analyses
It has been determined that this Treasury decision is not a
significant regulatory action as defined in Executive Order 12866.
Therefore, a regulatory assessment is not required. It also has been
determined that section 553(b) of the Administrative Procedure Act (5
U.S.C. chapter 5) does not apply to these regulations, and because the
regulations do not impose a collection of information on small
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not
apply. Pursuant to section 7805(f) of the Internal Revenue Code, the
notice of proposed rulemaking preceding these regulations was submitted
to the Small Business Administration for comment on its impact on small
business.
Drafting Information
The principal author of these regulations is James Polfer, Office
of the Associate Chief Counsel (Financial Institutions and Products),
Office of Chief Counsel, Internal Revenue Service. However, personnel
from other offices of the Treasury Department and the IRS participated
in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Adoption of Amendment to the Regulations
0
Accordingly, 26 CFR part 1 is amended as follows:
PART 1--INCOME TAX
0
Paragraph 1. The authority citation for part 1 continues to read in
part as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.817-5 also issued under 26 U.S.C. 817(h). * * *
[[Page 9872]]
0
Par. 2. Section 1.817-5 is amended as follows:
0
1. Paragraphs (f)(2)(ii) and (g) Example 3 are removed.
0
2. Paragraph (f)(2)(iii) is redesignated as paragraph (f)(2)(ii).
0
3. The first sentence of paragraph (g) Example 1 is revised.
0
4. Paragraph (g) Example 4 is redesignated as paragraph (g) Example 3.
0
5. Paragraph (h)(6) is revised.
0
6. New paragraph (i)(2)(v) is added.
The revisions read as follows:
Sec. 1.817-5 Diversification requirements for variable annuity,
endowment, and life insurance contracts.
* * * * *
(g) * * *
Example 1. (i) The assets underlying variable contracts issued
by a life insurance company consist of two groups of assets: (a) a
diversified portfolio of debt securities and (b) interests in P, a
partnership. * * *
* * * * *
(h) * * *
(6) Security. The term security shall include a cash item and any
partnership interest, whether or not registered under a Federal or
State law regulating the offering or sale of securities. The term shall
not include any interest in real property, or any interest in a
commodity.
* * * * *
(i) * * *
(2) * * *
(v) A segregated asset account in existence before March 1, 2005,
will be considered to be adequately diversified if--
(A) As of March 1, 2005, the account was adequately diversified
within the meaning of section 817(h) and this regulation as in effect
prior to that date; and
(B) By December 31, 2005, the account is adequately diversified
within the meaning of section 817(h) and this regulation.
Mark E. Matthews,
Deputy Commissioner for Services and Enforcement.
Approved: February 15, 2005.
Eric Solomon,
Acting Deputy Assistant Secretary of the Treasury.
[FR Doc. 05-3825 Filed 2-28-05; 8:45 am]
BILLING CODE 4830-01-P
