[Federal Register Volume 59, Number 188 (Thursday, September 29, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-24012]
[[Page Unknown]]
[Federal Register: September 29, 1994]
=======================================================================
-----------------------------------------------------------------------
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 8564]
RIN 1545-AR59
Computation of Equity Base
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations.
-----------------------------------------------------------------------
SUMMARY: This document contains final regulations relating to the
determination of the equity base for purposes of computing the
differential earnings amount and recomputed differential earnings
amount, which are used in determining the deduction for policyholder
dividends of a mutual life insurance company. The final regulations
provide that the equity base includes the amount of any asset valuation
reserve and the amount of any interest maintenance reserve reported on
the annual statement prescribed by the National Association of
Insurance Commissioners (NAIC) for filing with the insurance regulatory
authorities of a state. The regulations affect life insurance
companies.
DATES: These final regulations are effective September 29, 1994.
These final regulations are applicable for taxable years beginning
after December 31, 1991.
FOR FURTHER INFORMATION CONTACT: Katherine Ann Hossofsky, (202) 622-
3477 (not a toll-free number).
SUPPLEMENTARY INFORMATION:
Background
On September 7, 1993, temporary regulations (TD 8484) relating to
the determination of the equity base of a life insurance company under
section 809 of the Internal Revenue Code (Code) were published in the
Federal Register (58 FR 47060). A notice of proposed rulemaking (FI-29-
93) cross-referencing the temporary regulations was published in the
Federal Register (58 FR 47089) on the same day. The proposed and
temporary regulations provide that the equity base includes the amount
of any asset valuation reserve and the amount of any interest
maintenance reserve reported on the annual statement prescribed by the
NAIC for filing with the insurance regulatory authorities of a state.
Three comments on the proposed regulations were received, and a
public hearing on the regulations was held on December 3, 1993. After
consideration of the comments, the proposed regulations are adopted
without change by this Treasury decision.
Explanation of Provision
Section 809(a) of the Code provides that, in the case of any mutual
life insurance company, the amount of the deduction allowable under
section 808 for policyholder dividends is reduced (but not below zero)
by the differential earnings amount. For purposes of the computations
under section 809, a life insurance company must determine its equity
base. The equity base of a life insurance company includes the capital
and surplus of the company as well as any mandatory securities
valuation reserve, deficiency reserve, and voluntary reserve or similar
liability.
The mandatory securities valuation reserve is the first reserve
listed in section 809(b)(5). From the time section 809 was enacted
through 1991, the mandatory securities valuation reserve was required
to be reported on the NAIC annual statement filed by all life insurance
companies. During these years, the NAIC annual statement required
insurers to allocate surplus to fund the mandatory securities valuation
reserve. Though shown as a liability account on the annual statement,
the mandatory securities valuation reserve was not an actual liability
in the sense of a debt to another party; rather, it represented a fund
of allocated surplus, earmarked as a contingency reserve against
fluctuations in the values of a company's investments in stocks and
bonds.
For NAIC annual statements covering 1992 and later years, the NAIC
replaced the mandatory securities valuation reserve with the asset
valuation reserve and interest maintenance reserve. This change
reflected the recognition by the NAIC that life insurance companies
need to protect against fluctuations in value in mortgages, real
estate, and other investments as well as fluctuations in value in
stocks and bonds and that interest-related changes in asset values
might appropriately be differentiated from other changes. Accordingly,
the new reserves cover an expanded class of assets and differentiate
between (1) equity and credit-related capital gains and losses, and (2)
interest-related capital gains and losses.
The asset valuation reserve reflects changes in the value of equity
investments and also changes in the value of debt investments where the
changes are credit-related. Both realized and unrealized capital gains
and losses are reflected in the asset valuation reserve.
The interest maintenance reserve reflects realized capital gains
and losses from bonds, mortgages, and other fixed-income obligations to
the extent that they are interest-related. Because the value of U.S.
Government securities, together with the value of securities of
agencies backed by the full faith and credit of the U.S. Government,
are safe from credit-related risks and are subject only to interest-
related risks, the capital gains and losses on those securities are
allocated solely to the interest maintenance reserve.
The proposed and temporary regulations provide that the equity base
includes the amount of any asset valuation reserve and the amount of
any interest maintenance reserve reported on the NAIC annual statement.
Three comments were received on the proposed regulations.
The first commentator agreed that inclusion of the asset valuation
reserve and the interest maintenance reserve in the section 809 equity
base is consistent with Congress' decision to include the mandatory
securities valuation reserve in the equity base. The commentator stated
that, by providing in section 809(b)(5)(A) that the equity base
includes the amount of the mandatory securities valuation reserve,
Congress determined that the allocation of surplus represented by this
reserve, which included credit-related capital gains as well as
interest-related capital gains, was properly part of the equity base.
The commentator concluded that, absent a legislative change, allocated
surplus should continue to be included in the equity base
notwithstanding the change in the name of the reserve or the method of
allocating surplus to the reserve. Alternatively, the commentator
stated that the unaccrued market value increase or decrease in an
insurer's liabilities as reflected in the interest maintenance reserve
should be included in the equity base because the Conference Report
underlying section 809 indicates that Congress intended the equity base
to include any reserve for potential or unaccrued liabilities. H.R.
Conf. Rep. No. 861, 98th Cong., 2d Sess. 1058 (1984).
This commentator also requested that the final regulations clarify
that both positive and negative interest maintenance reserves are
included in computing the equity base. Finally, while noting that the
proposed regulations do not address the treatment of interest-related
capital gains and losses in computing the section 809 earnings of a
life insurance company, the commentator indicated that for calendar
years prior to 1992 interest-related capital gains or losses have been
included in section 809 earnings no later than the year in which the
gains or losses were realized for tax purposes. The commentator stated
that this treatment should be continued in the absence of a legislative
change.
The second commentator did not take a position regarding the
inclusion of the amount of any interest maintenance reserve in the
section 809 equity base. Rather, this commentator noted that the
regulations deal with the determination of the equity base but are
silent on the extent to which interest-related capital gains are to be
included in section 809 earnings. If the current inclusion approach of
the proposed and temporary regulations is adopted in the final
regulations, then this commentator indicated that interest-related
capital gains and losses should be included currently in section 809
earnings. In addition, the commentator stated that there should be
consistency between the calculations of the equity base made on Form
1120L, U.S. Life Insurance Income Tax Return, and on Form 8390,
Information Return for Determination of Life Insurance Company Earnings
Rate Under Section 809.
The third commentator agreed that the interest maintenance reserve
must be treated consistently for equity base and earnings purposes.
However, this commentator urged that the interest maintenance reserve
not be included in the section 809 equity base. Instead, interest-
related capital gains and losses would be amortized into equity and
earnings over the remaining life of the asset sold. The commentator
stated that inclusion of the interest maintenance reserve in equity:
(1) Is inconsistent with the substance and theory of the interest
maintenance reserve, which is to treat interest-related realized
capital gains and losses as a substitute for future unearned income;
(2) fails to reduce the volatility of the life insurance companies'
earnings rates; (3) is inconsistent with the requirement under section
809 that all determinations generally be made on the basis of the
amounts required to be set forth on the annual statement; and (4) is
inconsistent with Sec. 1.809-9(a), which provides that neither the
differential earnings rate nor the recomputed differential earnings
rate may be negative.
No changes are being made to the regulations in response to these
comments. Inclusion of the interest maintenance reserve in the equity
base is consistent with the historical treatment of interest-related
capital gains and losses under section 809. By providing in section
809(b)(5)(A) that the equity base includes the amount of the mandatory
securities valuation reserve, Congress demonstrated its intent to
include interest-related capital gains and losses in the equity base.
Modification of the annual statement by the NAIC to eliminate and
replace the mandatory securities valuation reserve cannot override the
specific inclusion that Congress required for these gains and losses.
Section 809(g)(3) provides the regulatory authority to adjust under
section 809(b)(5) amounts set forth on the annual statement to continue
the inclusion of these gains and losses in the equity base. Since the
interest maintenance reserve represents an allocation of surplus from
interest-related capital gains and losses for which Congress made clear
its intentions and provided regulatory authority to preserve its
intentions, the inclusion of the interest maintenance reserve in the
equity base is appropriate.
The final regulations require any interest maintenance reserve
(whether positive or negative) to be included in an insurer's equity
base. The reduction of the equity base for any interest-related capital
losses reflected in a negative interest maintenance reserve is
consistent with the treatment of those losses prior to the replacement
of the mandatory securities valuation reserve with the asset valuation
reserve and the interest maintenance reserve. Before the change, any
interest-related capital losses reduced the amount of net income added
to capital and surplus. Thus, any negative interest maintenance reserve
should be included as a reduction to the equity base, consistent with
the treatment of interest-related capital losses prior to the change.
Under the final regulations, the asset valuation reserve and the
interest maintenance reserve must be included in the calculation of the
equity base for purposes of section 809. This requirement is reflected
on both Form 1120L and Form 8390. See Announcement 93-117, 1993-29
I.R.B. 85. Thus, there is consistency between the calculations of the
equity base on Form 1120L and on Form 8390. Finally, although the final
regulations do not specifically address this issue, interest-related
capital gains and losses continue to be included in section 809
earnings by virtue of section 809(g)(1)(C).
Special Analyses
It has been determined that this Treasury decision is not a
significant regulatory action as defined in EO 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)
and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do not apply to
these regulations, and, therefore, a Regulatory Flexibility Analysis is
not required. 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 of small business.
Drafting Information
The principal author of these regulations is Katherine Ann
Hossofsky of the Office of the Assistant Chief Counsel (Financial
Institutions and Products). However, other personnel from the IRS and
Treasury Department participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Adoption of Amendments to the Regulations
Accordingly, 26 CFR part 1 is amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 is amended by adding
an entry in numerical order to read as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.809-10 also issued under 26 U.S.C. 809(b)(2) and (g)(3).
* * *
Sec. 1.809-10T [Redesignated as Sec. 1.809-10]
Par. 2. Section 1.809-10T is redesignated as Sec. 1.809-10 and the
word ``(temporary)'' is removed from the section heading.
Michael P. Dolan,
Acting Commissioner of Internal Revenue .
Approved: September 9, 1994.
Leslie Samuels,
Assistant Secretary of the Treasury.
[FR Doc. 94-24012 Filed 9-28-94; 8:45 am]
BILLING CODE 4830-01-U