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17990 Federal Register / Vol. 71, No.

68 / Monday, April 10, 2006 / Rules and Regulations

SOCIAL SECURITY ADMINISTRATION DEPARTMENT OF THE TREASURY information has been reviewed in
accordance with the Paperwork
20 CFR Part 405 Internal Revenue Service Reduction Act (44 U.S.C. 3507) and,
pending receipt and evaluation of
RIN 0960–AG31 26 CFR Parts 1 and 602 public comments, approved by the
[TD 9257] Office of Management and Budget under
Administrative Review Process for control number 1545–1990.
Adjudicating Initial Disability Claims; RIN 1545–AY49 The collection of information is in
Correction §§ 1.338–11T(e)(2), 1.338(i)–1(c),
Application of Section 338 to 1.381(c)(22)–1(c), 1.1060–1(a)(2). This
Insurance Companies information is required by the IRS to
AGENCY: Social Security Administration.
AGENCY: Internal Revenue Service (IRS), allow an insurance company permission
ACTION: Final rule; correction. to cease using its historical loss
Treasury.
ACTION: Final and temporary payment pattern and to allow parties to
SUMMARY: The Social Security a transaction under section 338, to an
regulations.
Administration is correcting a final rule applicable asset acquisition under
that appeared in the Federal Register on SUMMARY: This document contains final section 1060, or to a distribution or
March 31, 2006 (71 FR 16424). The regulations that apply to a deemed sale reorganization to which section 381
document amends our administrative or acquisition of an insurance applies to file a retroactive election to
review process for applications for company’s assets pursuant to an apply these regulations to transactions
benefits that are based on whether you election under section 338 of the completed before the effective dates of
are disabled under title II of the Social Internal Revenue Code, to a sale or these regulations. The likely
Security Act (the Act), or applications acquisition of an insurance trade or recordkeepers are business or other for-
for supplemental security income (SSI) business subject to section 1060, and to profit institutions.
payments that are based on whether you the acquisition of insurance contracts The estimated burden is as follows:
are disabled or blind under title XVI of through assumption reinsurance. It also Estimated total annual reporting and/
the Act. contains final regulations under section or recordkeeping burden: 12 hours.
381 concerning the effect of certain Estimated average annual burden per
DATES: Effective August 1, 2006. corporate liquidations and respondent: 1 hour.
reorganizations on certain tax attributes Estimated number of respondents: 12.
FOR FURTHER INFORMATION CONTACT: Estimated annual frequency of
Richard Bresnick, Social Insurance of insurance companies. This document
also contains temporary regulations responses: once.
Specialist, Office of Regulations, Social Comments concerning the accuracy of
under section 197 relating to the
Security Administration, 100 Altmeyer this burden estimate and suggestions for
determination of adjusted basis of
Building, 6401 Security Boulevard, amortizable section 197 intangibles with reducing this burden should be sent to
Baltimore, MD 21235–6401, (410) 965– respect to insurance contracts, section the Office of Management and Budget,
1758 or TTY (410) 966–5609 for 338 relating to increases in reserves after Attn: Desk Officer for the Department of
information about this notice. For a deemed asset sale and sections 338 the Treasury, Office of Information and
information on eligibility or filing for and 846 relating to the effect of a section Regulatory Affairs, Washington, DC
benefits, call our national toll-free 338 election on a section 846(e) 20503, with copies to the Internal
number, 1–800–772–1213 or TTY 1– election. The text of the temporary Revenue Service, Attn: IRS Reports
800–325–0778, or visit our Internet site, regulations also serves as the text of the Clearance Officer,
Social Security Online, at http:// proposed regulations set forth in the SE:W:CAR:MP:T:T:SP, Washington, DC
www.socialsecurity.gov. notice of proposed rulemaking on this 20224. Any such comments should be
subject in the Proposed Rules section in submitted not later than June 9, 2006.
SUPPLEMENTARY INFORMATION: In FR Doc. this issue of the Federal Register. The An agency may not conduct or
06–3011 appearing on page 16424 in the final and temporary regulations apply to sponsor, and a person is not required to
Federal Register of Friday, March 31, insurance companies. respond to, a collection of information
2006, the following correction is made: unless the collection of information
DATES: Effective Date: The final and
displays a valid control number
§ 405.601 [Corrected] temporary regulations are effective on assigned by the Office of Management
April 10, 2006. and Budget.
■ On page 16456, in the third column, Applicability Dates: For dates of
Books or records relating to a
in § 405.601, in paragraph (b), applicability of these regulations, see
collection of information must be
‘‘§§ 404.989(a)(1) and 416.989(a)(1)’’ is §§ 1.197–2(g)(5)(iv), 1.338(i)–1(c), and
retained as long as their contents may
corrected to read ‘‘§§ 404.989(a)(1) and 1.1060–1(a)(2). The applicability of
become material in the administration
416.1489(a)(1)’’. §§ 1.197–2T(g)(5)(ii), 1.338–11T(d), and
of any internal revenue law. Generally,
1.338–11T(e) will expire on April 7,
Dated: April 4, 2006. tax returns and tax return information
2009.
Gregory Zwitch, are confidential, as required by 26
FOR FURTHER INFORMATION CONTACT: U.S.C. 6103.
Social Security Regulations Officer. Mark Weiss, (202) 622–7790 (not a toll-
[FR Doc. 06–3388 Filed 4–7–06; 8:45 am] free number). Background and Explanation of
Provisions
BILLING CODE 4191–02–P SUPPLEMENTARY INFORMATION:
On March 8, 2002, the IRS and the
Paperwork Reduction Act
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Department of Treasury published a


The collection of information in these notice of proposed rulemaking in the
final regulations was not proposed in Federal Register (REG–118861–00,
the preceding notice of proposed 2002–1 C.B. 651 [67 FR 10640]) (the
rulemaking. The collection of proposed regulations) that sets forth

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Federal Register / Vol. 71, No. 68 / Monday, April 10, 2006 / Rules and Regulations 17991

rules applying to taxable acquisitions they can be extrapolated from the amortized over the period specified by
and dispositions of insurance known elements with a reasonable section 848 rather than the longer
businesses, including those that are degree of accuracy. However, when the period under section 197. To achieve
deemed to occur when an election assumption reinsurance transaction this result, the adjusted basis of the
under section 338 of the Internal occurs as part of a larger acquisitive amortizable section 197 intangible
Revenue Code (Code) is made. transaction, the total consideration paid resulting from an assumption
The proposed regulations generally by the purchaser is not solely for the reinsurance transaction is recognized
treat the transfer of insurance or annuity acquisition of insurance contracts and only to the extent that the amount paid
contracts and the assumption of related the liabilities assumed are not solely for or incurred by the acquirer for the
reserve liabilities that are deemed to the risk on the insurance contracts. In relevant contracts exceeds the DAC
occur when an election under section these circumstances, the extrapolated taken into account under section 848 as
338 is made consistently with the values would not accurately reflect the a result of the transaction.
treatment of assumption reinsurance amount of the items. Accordingly, the The proposed regulations provide
transactions entered into in the ordinary proposed regulations modify the general rules to determine the amounts paid or
course of business under § 1.817–4(d) rules for assumption reinsurance incurred for amortizable section 197
(and other provisions of subchapter L of transactions to account for these intangibles with respect to contracts
chapter 1, subtitle A of the Code and the differences. acquired as a result of assumption
regulations promulgated thereunder). Written comments were received in reinsurance transactions occurring as
The proposed regulations provide response to the proposed regulations, part of transactions governed by section
similar rules for acquisitions of and a public hearing was held on 1060 or section 338. The proposed
insurance businesses governed by September 18, 2002. Two commentators regulations also provide rules for
section 1060, whether effected through requested to speak at the hearing. After purposes of determining the DAC
assumption or indemnity reinsurance. consideration of all the comments, the amounts for the transactions. See
Thus, in the case of both a deemed and proposed regulations are adopted as proposed § 1.197–2(g)(5).
an actual transfer of an insurance amended by this Treasury decision. In Under the proposed regulations, the
business, the proposed regulations general, the final regulations follow the amount paid or incurred by the acquirer
provide that the ceding company (in the approach of the proposed regulations under the assumption reinsurance
case of a section 338 election, old target) with some revisions. The more transaction in a transaction governed by
is treated as having income in the significant comments and revisions are section 338 or 1060 is the amount of
amount of the reduction in its reserves discussed in the order in which they adjusted grossed up basis (AGUB) or
and having a deduction for the appear in the regulations. In addition to consideration allocable to the insurance
consideration paid for the reinsurer’s the revisions discussed, the final contracts under the residual method.
assumption of those liabilities, and the regulations revise the language of the The amount required to be capitalized
reinsurer (in the case of a section 338 proposed regulations in some places to under section 848 in connection with
election, new target) is treated as clarify the intent of the IRS and the assumption reinsurance transaction
receiving premium income for its Treasury Department or to make the is determined by multiplying the
assumption of reserve liabilities and regulations better conform to the acquirer’s specified policy acquisition
having a deduction for its increase in terminology and usage of the general expenses for the taxable year by a
reserves (the latter usually offsetting in section 338 regulations. fraction, the numerator of which is the
amount the former). The proposed total tentative positive capitalization
A. Determination of Adjusted Basis of amount for the relevant group of
regulations also provide that the
Amortizable Section 197 Intangibles acquired insurance contracts and the
consideration allocated to the value of
With Respect to Insurance Contracts denominator of which is the total
the insurance contracts acquired in the
Under Section 197(f)(5) tentative required capitalization amount
assumption reinsurance transaction is
treated as an amount paid by the Section 197(f)(5) provides that, in the for the taxable year for all specified
reinsurer to purchase intangible assets case of any amortizable section 197 insurance contracts. The tentative
and as ordinary income to the ceding intangible resulting from an assumption positive capitalization amount for the
company. reinsurance transaction, the amount relevant group of acquired insurance
The proposed regulations depart from taken into account as the adjusted basis contracts is the net positive
the rules governing assumption of such intangible is the excess of (A) consideration received for the contracts
reinsurance transactions effected in the the amount paid or incurred by the in the assumption reinsurance
ordinary course of business in some acquirer under the assumption transaction multiplied by the percentage
circumstances to account for differences reinsurance transaction over (B) the factor applicable to the contracts under
that occur because the assumption amount required to be capitalized under section 848(c).
reinsurance transaction occurs as part of section 848 in connection with the An insurance company’s DAC amount
a larger acquisitive transaction. In an transaction. Under section 848, an may not exceed the company’s general
assumption reinsurance transaction insurance company is required to deductions for the taxable year. See
effected in the ordinary course of capitalize an amount of otherwise section 848(c). The amortization of
business, the total consideration paid deductible expenses equal to a intangibles under section 197 is a
for the transfer of insurance contracts percentage of the net premiums for the general deduction relevant in
and assumption of related liabilities is taxable year for certain categories of computing DAC. However, the amount
known. Furthermore, the rules in insurance contracts. The capitalized of amortization under section 197
§ 1.817–4(d) assume that the only amounts, commonly referred to as cannot be calculated until section
intangible asset transferred in such an deferred acquisition costs, or ‘‘DAC,’’ 197(f)(5) is applied. To avoid complex
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assumption reinsurance transaction is are amortized on a straight-line basis calculations, for purposes of calculating
the insurance in force which can then over 120 months. the basis of amortization, the proposed
be valued using the residual method. Section 197(f)(5) is designed to ensure regulations presume that one-half of the
Thus, if premiums and ceding that the DAC amounts attributable to an consideration allocated to the insurance
commissions are not separately stated, assumption reinsurance transaction are contracts is amortizable under section

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17992 Federal Register / Vol. 71, No. 68 / Monday, April 10, 2006 / Rules and Regulations

197. See proposed § 1.197– Under the temporary and proposed guidance should address other
2(g)(5)(i)(D)(2). Comments were rules, an acquirer will determine its situations or issues.
requested regarding alternative general deductions as if the entire Several commentators requested that
approaches to calculating the basis for amount paid or incurred for the the final regulations clarify when
DAC amounts and section 197 acquired contracts were allocable to an sufficient economic rights in a section
amortization. amortizable section 197 intangible. 197(f)(5) intangible are transferred
A number of comments were received If the acquirer has a capitalization through indemnity reinsurance as well
relating to the proposed regulations shortfall (i.e., the amount of general as additional examples to address
under section 197(f)(5). Commentators deductions allocable to the assumption situations relating to transfers through
requested that the final regulations reinsurance transaction is less than the indemnity reinsurance of less than 100
clarify that section 197(f)(5) applies only required capitalization amount for the percent of the insurance contracts that
to assumption reinsurance transactions, transaction), the temporary and gave rise to the section 197(f)(5)
and not to indemnity reinsurance proposed regulations permit the intangible. The IRS and Treasury
transactions. Commentators asked that acquirer and the ceding company to Department continue to believe that the
the final regulations clarify that the full elect under § 1.848–2(g)(8) to determine rules contained in these regulations
amount of consideration allocable to the the amount capitalized under section should refer to general tax principles,
reinsured contracts is currently 848 without regard to the general and will as needed, address these issues
deductible under section 848(g) when deductions limitation. The additional in future published guidance.
the provisions of section 848 apply to an amounts capitalized by the acquirer as
C. Reserve Increases by New Target
indemnity reinsurance transaction that a result of the election are treated as first
After the Deemed Asset Sale
occurs as part of a section 1060 reducing the adjusted basis of the
acquisition of an insurance business. amortizable section 197 intangible with When a section 338 election is made
Commentators also expressed concern regard to the insurance contracts for an insurance company, § 1.338–11(d)
that the proposed regulations could acquired in the assumption reinsurance of the proposed regulations provides
cause an acquirer’s DAC under section transaction, before reducing the that new target must capitalize its
848 to be subject to the general acquirer’s otherwise deductible increases in reserves for any acquired
deductions cap in section 848(c) despite expenses. The temporary and proposed contracts in the deemed asset sale.
the existence of a substantial ceding rules generally allow the acquirer to Similar principles apply for an
commission. Commentators requested amortize a larger amount over the applicable asset acquisition of an
that the final regulations clarify that the period specified by section 848 as insurance business under section 1060.
election under § 1.848–2(g)(8) is compared to the proposed regulations. The proposed regulations generally
available to allow old target and new The temporary and proposed require capitalization of increases in
target in a deemed asset sale governed regulations generally apply, on a cut-off reserves for the acquired contracts in
by section 338(h)(10) to determine the basis, to acquisitions and dispositions excess of cumulative annual increases of
amount of DAC attributable to the on or after April 10, 2006. Thus, there two percent per year from the
transaction without regard to the general is no adjustment under section 481(a). acquisition date reserves. However, the
deductions limitation. Taxpayers must make the change on proposed regulations do not require
The temporary and proposed their income tax return and should not capitalization to the extent the increases
regulations generally follow the file a Form 3115, Application for in reserves reflect the time value of
proposed rules under section 197(f)(5), Change in Accounting Method. money, to the extent the increases in
subject to several modifications. In Taxpayers are permitted, however, to reserves occur while new target is under
particular, the temporary and proposed apply the regulations to acquisitions state receivership, or to the extent the
rules build on the method under before that date on a transaction-by- deduction for the increases in reserves
§ 1.848–2(g) of the existing regulations transaction basis, with an adjustment is spread over the 10 succeeding taxable
for determining the amounts capitalized under section 481(a). The temporary years under section 807(f).
under section 848 for a reinsurance and proposed regulations provide a Many commentators objected to the
agreement. Under the temporary and procedure for taxpayers to obtain rule requiring capitalization for
proposed rules, the amount of expenses automatic consent of the Commissioner increases in reserves after the
capitalized under section 848 as a result to do so. transaction date. They questioned the
of an assumption reinsurance justification for the rule, stating that the
B. Recovery of Basis on Dispositions of rule was inconsistent with, and
transaction equals the lesser of (A) the
Acquired Insurance Contracts overrode, principles established under
required capitalization amount for the
transaction, or (B) the amount of general Proposed § 1.197–2(g)(5)(ii)(A)(2) subchapter L for determining losses
deductions allocable to the transaction. provides that basis recovery with incurred. Commentators argued that,
The temporary and proposed rules also respect to a section 197(f)(5) intangible under subchapter L principles, reserve
clarify that in the event that the acquirer transferred through indemnity liabilities are not treated like contingent
purchases more than one category of reinsurance is permitted when sufficient liabilities and that it was inappropriate
specified insurance contracts, the economic rights relating to the to treat the reserves as contingent
determination of the amount capitalized insurance contracts that gave rise to the liabilities even for the limited purposes
under section 848 is made as if each section 197(f)(5) intangible have been of the regulation. Commentators also
category were transferred in a separate transferred. Sufficient economic rights requested that the application of the
assumption reinsurance transaction. are treated as transferred when the rule be restricted to cases of abuse
The temporary and proposed ceding company transfers the right to because the ceding company’s reserves
regulations also modify the special rule future income on the contracts. The assumed in the transaction are fair and
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in the proposed regulations with respect proposed regulations also provide rules reasonable estimates under Subchapter
to the interplay between section governing the amount of loss recognized L as of the transaction date.
197(f)(5) and section 848 as regards the on the disposition of a section 197(f)(5) The commentators’ objections largely
determination of the acquirer’s general intangible. The proposed regulations ignore the fact that the proposed
deductions under section 848(c)(2). requested comments whether additional regulations blend elements of the asset

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Federal Register / Vol. 71, No. 68 / Monday, April 10, 2006 / Rules and Regulations 17993

purchase model common to most concern value is readily determinable) a necessary corollary to the rule in the
taxpayers that dispose of or acquire rather than the residual method of proposed regulations linking the
assets for consideration that includes § 1.817–4(d) to determine the value of amount of reinsurance deemed paid to
the discharge of liabilities and the insurance in force (which assumes that the amount of old target’s tax reserves
services model that generally applies to the value of all assets other than at the time of the assumption
insurance companies. Treating increases insurance in force is readily reinsurance transaction (with the
in reserves for acquired contracts determinable); concomitant result that new target has
similarly to contingent liabilities under (2) Treating the amount of old target’s no income). The logical implication of
the asset purchase model is just one tax reserves as a fixed liability as of the the commentators’ arguments would be
aspect of that amalgam. close of the acquisition date that is that the buyer should have premium
Under the asset purchase model, taken into account in determining the income in a bargain purchase. In
assumed contingent liabilities are an seller’s aggregate deemed sales price addition, without requiring
element of the consideration for which (ADSP) under § 1.338–4 and the buyer’s capitalization of at least some increases
a buyer acquires assets. Thus, a buyer AGUB under § 1.338–5; to reserves, there is an incentive for
includes the contingent liability in its (3) Treating certain of new target’s sellers to defer increases in reserves.
cost for the acquired assets. However, a increases in reserves for any insurance This incentive results from the fact that
buyer may not include the contingent contracts acquired in the deemed asset while the seller is generally indifferent
liability in its cost until the liability is sale as a contingent liability as of the to an increase in reserves (the
incurred for Federal income tax close of the acquisition date that immediate deduction to the seller
purposes. The buyer must capitalize the becomes fixed when new target would be offset by a corresponding
liability in the cost of the acquired increases its reserves; increase in amount realized of ADSP in
assets even if the buyer could have (4) Assuming that the amount of the sale), a buyer would be entitled to
currently deducted the liability had it reinsurance premium is equal to the an immediate deduction rather than
arisen in the buyer’s historic business. amount of old target’s tax reserves, even increased basis from an increase in the
Under the asset purchase model, the though the ceding company would have seller’s reserves.
buyer does not realize any income for to pay the reinsuring company an In response to comments, the IRS and
the assumption of the contingent amount greater than the tax reserves in Treasury Department have decided to
liability; the buyer merely has bought an arm’s length reinsurance transaction. issue temporary regulations with these
assets. See Commissioner v. Oxford This rule ensures that the acquirer of an final regulations that continue to require
Paper, 194 F.2d 190 (2d Cir. 1951). insurance business will not have capitalization (and concomitant
Under the services model, the seller immediate net taxable income merely as treatment as premium) of certain reserve
(or ceding company) is treated as paying a result of the acquisition; and increases, but further limit the
a premium to the buyer (or reinsurer) to (5) Not requiring capitalization for capitalization rule of the proposed
assume the risk on its insurance new target’s increases in reserves due to regulations in a manner consistent with
contracts. The reinsurer includes in the time value of money for any the application of subchapter L
income the receipt of the premium and insurance contracts acquired in the principles. See § 1.338–11T(d). After the
has a deduction for its increase in deemed asset sale. deemed asset sale, the temporary
reserves for the additional risks The proposed regulations generally regulations apply subchapter L
assumed in the transaction. The amount treat an insurance company’s principles to new target. Under the
of the premium income is generally assumption of contingent liabilities temporary regulations, capitalization is
equal to the consideration paid by the related to insurance contracts more required only for increases in reserves
ceding company, that is, the fair market favorably than a noninsurance that clearly reflect a so called ‘‘bargain
value of the assets that the ceding company’s assumption of a similar purchase’’ (that is, when the application
company transfers to the reinsurer in contingent liability. The proposed of the residual method clearly indicates
the transaction (though it may not be regulations also treat an insurance the initial understatement of the
less than the amount of the reinsurer’s company’s assumption of contingent reserve). The amount of the bargain
increase in tax reserves, see § 1.817– liabilities related to insurance contracts purchase is the amount of income the
4(d)(2)(iii)). Thus, when the fair market more favorably than subchapter L does. reinsurer would have otherwise
value of the assets that the ceding As discussed previously, under recognized under § 1.817–4(d) if the
company transfers exceeds the subchapter L, a reinsurer may have net final regulations (and proposed
reinsurer’s increase in tax reserves for income when entering into an regulations) had not adopted the
the additional risks assumed in the assumption reinsurance transaction. convention that the reinsurance
transaction, the reinsurer has net The amount of the income is the amount premium paid by the seller to the buyer
income. See § 1.817–4(d)(3) Example 4. of the bargain, that is, the excess of fair is deemed to equal the seller’s closing
Under the services model, no liabilities market value of the assets the seller tax reserves, and were it not necessary
are treated as contingent liabilities. The transfers over the amount of the to employ a residual method to account
reserve rules effectively treat increases consideration the buyer pays at closing for the presence of non-insurance
to reserves for new risks as fixed (in an assumption reinsurance intangible assets.
liabilities and increases to reserves for transaction, the latter measured by the Under the temporary regulations, new
existing risks as period expenses reinsurer’s increase in tax reserves for target is required to capitalize any
(similar to interest). the risks assumed in the transaction). increases in reserves for acquired
The proposed regulations blend the The proposed regulations, unlike contracts if the AGUB allocated to assets
asset purchase model and the services subchapter L, require income to be in Class I through Class V is less than
model by— recognized if there is an increase in the fair market value of the assets in
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(1) Using the residual method of certain reserves for the acquired those classes. Any deductions would
sections 338 and 1060 to determine the insurance contracts. continue to be capitalized until the basis
value of goodwill and going concern The IRS and Treasury Department of the assets in Class I through Class V
value (which assumes that the value of believe that a rule requiring is equal to their fair market value. This
all assets other than goodwill and going capitalization of increases to reserves is mechanism avoids the problem of

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17994 Federal Register / Vol. 71, No. 68 / Monday, April 10, 2006 / Rules and Regulations

valuing Class VI and Class VII Ct. D. 2045). Moreover, in the context of F. Treatment of Shareholders Surplus
intangibles. The approach of the a transaction governed by section 338 or Accounts, Policyholders Surplus
temporary regulations essentially treats 1060, the use of old target’s tax reserves Accounts (PSA), and Other Accounts in
the ceding company as transferring no as a means of valuing the contracts is Transactions to Which Section 381
Class VI or Class VII assets to the consistent with both (i) the treatment of Applies
reinsurer for the reinsurer’s assumption old target’s closing tax reserves as a Section 1.381(c)(22)–1(b)(7)(i) of the
of the liabilities on the acquired liability in the computation of the proposed regulations provides that if
contracts. Because the temporary seller’s ADSP and the buyer’s AGUB, one corporation distributes or transfers
regulations limit the total amount of and (ii) the general rule of § 1.817– a substantial portion (50 percent or
capitalization for increases in reserves 4(d)(2)(iii), which treats the assuming more) of an insurance business to
for acquired contracts, the IRS and company in an assumption reinsurance another corporation in a transaction to
Treasury Department believe that it is transaction as receiving premium which section 381 applies, then the
no longer necessary to provide a time income equal to at least the increase in acquiring corporation succeeds to the
limit on when increases in reserves for its reserves. distributor or transferor corporation’s
acquired contracts are to be capitalized
shareholders surplus account,
or to provide a floor below which E. Effect of Section 338 Election on
policyholders surplus account, and
increases in reserves are not capitalized. Section 846(e) Election by Old Target other accounts. However, under
However the temporary regulations
The proposed regulations do not § 1.381(c)(22)–1(b)(7)(ii) of the proposed
retain the other limits on capitalization
provide any special rules under section regulations, if an acquiring corporation
in the proposed regulations.
846 for new target to apply old target’s in the section 381 transaction acquires
D. Allocation of ADSP and AGUB to historical loss payment pattern as a less than 50 percent of the distributor or
Specific Insurance Contracts result of a section 846(e) election made transferor corporation’s insurance
Proposed § 1.338–11(b)(2) provides a by old target because new target is business, then the acquiring corporation
rule that for purposes of allocating generally treated as a new corporation succeeds only to a ratable portion
AGUB and ADSP, the fair market value that may adopt its own accounting (determined by reference to reserves) of
of a specific insurance contract or group methods without regard to the methods the distributor or transferor
of insurance contracts is the amount of corporation’s shareholders surplus
used by old target. See § 1.338–1(b).
the ceding commission a willing account, policyholders surplus account,
reinsurer would pay a willing ceding Commentators believed that this and other accounts.
company in an arm’s length transaction result was inconsistent with the purpose Commentators questioned whether
for the reinsurance of the contracts if the of allowing a company to make a section the IRS and Treasury Department have
gross reinsurance premium for the 846(e) election. Commentators noted the authority to relate the carryover of
contracts were equal to old target’s tax that a section 846(e) election is made for PSA to the percentage of business that
reserves for the contracts. all eligible lines of business, determined was transferred to the acquiring
Commentators questioned the reliance by reference to the accident years for the corporation in a section 381 transaction.
of the proposed regulations upon tax line of business shown on the insurance The IRS and Treasury Department
reserves as a basis for valuing the company’s annual statement. believe that the rule in the proposed
contracts and asked that the value of the Additionally, commentators noted that regulations is appropriate and that there
contracts be based on GAAP or statutory the availability of the election should is sufficient authority for the proposed
reserves, or an amount upon which the not depend upon the tax identity of new rule. The legislative history to the 1984
parties agree. The IRS and Treasury target after the section 338 election Tax Reform Act indicates that the term
Department believe that using tax because the historical loss payment indirect distribution is to be interpreted
reserves as a basis for valuing the pattern is not a tax account, the pattern broadly to include any use of PSA funds
contracts is consistent with other areas is determined by reference to nontax for the indirect benefit of shareholders.
in which tax reserves, not GAAP or factors, and new target continues to H.R. Rep. No. 432, pt. 2, 98th Cong., 2d
statutory reserves, are used to compute operate in the same manner and legal Sess. at 1410–11; Staff of the Joint
taxable income. See, e.g., section 807 form as old target. Committee on Taxation, 98th Cong., 2d
(prescribing rules for taking life Sess., General Explanation of the
In response to these comments, the
insurance reserves and certain other Revenue Provisions of the Tax Reform
reserves into account for purposes of temporary regulations contain a new
Act of 1984, at 594 (1984), as well as
computing life insurance company rule that treats new target and old target
Bankers Life and Casualty Co. v. United
taxable income); section 846 as the same corporation for purposes of States, 79 AFTR2d (RIA) 1726 (N.D. Ill.
(prescribing a methodology for a section 846(e) election to use an 1996), aff’d on other grounds, 142 F.3d
discounting unpaid loss reserves for insurance company’s historical loss 973 (7th Cir. 1998), cert denied, 525
purposes of computing insurance payment pattern. See § 1.338– U.S. 961 (1998) (section 338(g)
company taxable income); and Rev. 1T(b)(2)(vii). Therefore, if old target has transaction results in an indirect
Proc. 90–36, (1990–2 C.B. 357) a section 846(e) election in effect, new distribution of old target’s PSA).
(computing up-front ceding commission target will continue to use the historical Accordingly, the final regulations adopt
paid by a reinsurer as the increase in the loss payment pattern of old target to the rule as proposed in §§ 1.338–11(f)
reinsurer’s tax reserve liabilities discount unpaid losses, unless new and 1.381(c)(22)–1(b)(7).
resulting from the reinsurance target chooses to revoke the election. If
transaction, minus the value of the net new target revokes old target’s section G. Treatment of DAC in Transactions to
assets received, for purposes of 846(e) election, new target will use the Which Section 381 Applies
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capitalizing ceding commissions to industry-wide factors determined by the Section 1.381(c)(22)–1(b)(13) of the
comply with the Supreme Court Secretary to discount unpaid losses proposed regulations provides that any
decision in Colonial American Life incurred in accident years beginning on remaining balances of DAC or excess
Insurance Company v. Commissioner, or after the acquisition date. See negative DAC carry over to a successor
491 U.S. 244 (1989), (1989–2 C.B. 110, § 1.338–11T(e)(2). insurance company in a section 381

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transaction. One commentator 2006 if all taxable years for which the It has been determined that the
questioned whether a nonlife insurance consequences of the section 338 election temporary regulations issued with
company may succeed to DAC attributes affect the computation of tax are open. respect to sections 197 and 338 are not
under § 1.381(c)(22)–1. Another In the case of a section 338 election for a significant regulatory action as defined
commentator believed positive DAC which a section 338(h)(10) election is in Executive Order 12866. Therefore a
should not be carried over to a successor made (or a section 338 election for a regulatory assessment is not required.
corporation in a section 381 transaction. foreign target), new target’s ability to These regulations provide guidance
The IRS and Treasury Department elect to retroactively apply the final relating to the taxable acquisition and
believe that in a section 381 transaction, regulations does not depend upon old disposition of insurance companies.
positive DAC, like negative DAC, is an target making the election. Similarly, Additionally, these regulations provide
attribute that is carried over to the old target’s ability to elect to rules by which a party to the transaction
acquiring corporation. Thus, the final retroactively apply the final regulations may elect to apply these rules to
regulations retain the rule in the does not depend upon new target transactions which occur prior to April
proposed regulations that the remaining making the election. However, in the 10, 2006. Based on these considerations,
balances of DAC or excess negative DAC case of a section 338 election for a it is determined that these temporary
carry over to a successor insurance domestic target for which no section regulations will provide taxpayers with
company in a section 381 transaction. 338(h)(10) election is made, the the necessary guidance and authority to
See § 1.381(c)(22)–1(b)(13). However, purchasing corporation generally ensure equitable administration of the
the IRS and Treasury Department controls both the filing of new target’s tax laws. Because of the need for
believe that a proportionality rule returns and old target’s final return. immediate guidance, notice and public
similar to the one the final regulations Accordingly, when no section procedure are impracticable and
adopt at § 1.381(c)(22)–1(b)(7) for 338(h)(10) election is made and the contrary to the public interest pursuant
policyholder surplus accounts is target is a domestic corporation, new to 5 U.S.C. 533(b) and the delayed
appropriate because DAC is a tax target and old target must both elect to effective date is not required pursuant to
accounting convention that relates to a retroactively apply the final regulations. 5 U.S.C. 553(d). For applicability of the
line of business. Thus, the final If one of new target or old target cannot Regulatory Flexibility Act to these
regulations provide that when the make the election, the other is not temporary regulations, please refer to
acquiring corporation acquires 50 permitted to make the election. See the cross-reference notice of proposed
percent or more of the distributor or § 1.338(i)–1(c). rulemaking published elsewhere in this
transferor corporation’s insurance Federal Register. Pursuant to section
business (measured by its reserves for Special Analyses
7805(f) of the Code, these temporary
all of its contracts immediately before It has been determined that the final regulations will be submitted to the
the earlier of the distribution or transfer regulations issued with respect to Chief Counsel for Advocacy of the Small
or the adoption of the plan of section 197 and section 338 are not a Business Administration for comment
liquidation or reorganization), the significant regulatory action as defined on their impact on small business.
acquiring corporation will succeed to in Executive Order 12866. Therefore, a It has been determined that the final
the distributor or transferor regulatory assessment is not required. It regulations issued with respect to
corporation’s entire positive or negative is hereby certified that the collection of sections 381, 846 and 1060 are not a
DAC amount. To the extent an acquiring information requirement in these significant regulatory action as defined
corporation in the section 381 regulations will not have a significant in Executive Order 12866. Therefore, a
transaction acquires less than 50 percent economic impact on a substantial regulatory assessment is not required. It
of the distributor or transferor number of small entities. This has also been determined that section
corporation’s insurance business, then certification is based on the fact that 553(b) of the Administrative Procedure
only that percentage of positive or these regulations do not have a Act (5 U.S.C. chapter 5) does not apply
negative DAC remains. In addition, substantial economic impact because to these regulations, and, because the
because some attributes under section they merely provide guidance about the regulations do not impose a collection
381(c)(22) and § 1.381(c)(22)–1 are operation of the tax law in the context of information on small entities, the
equally relevant for life and nonlife of acquisitions of insurance companies Regulatory Flexibility Act (5 U.S.C.
insurance companies, the final and businesses. Moreover, they are chapter 6) does not apply. Therefore, a
regulations clarify that, except as expected to apply predominantly to Regulatory Flexibility Analysis under
otherwise provided, the rules in transactions involving larger businesses. the Regulatory Flexibility Act (5 U.S.C.
§ 1.381(c)(22)–1 apply to any insurance In addition, the collection of chapter 6) is not required. Under section
company, whether a life or a nonlife information requirement merely 7805(f) of the Code, the notice of
company. requires a taxpayer to prepare a written proposed rulemaking preceding this
representation that contains minimal regulation was submitted to the Chief
H. Effective Date of Regulations information relating to the making of an Counsel for Advocacy of the Small
The final and temporary regulations election. Therefore, a Regulatory Business Administration for comment
are effective for transactions on or after Flexibility Analysis under the on its impact on small business. The
April 10, 2006. Commentators asked for Regulatory Flexibility Act (5 U.S.C. Chief Counsel for Advocacy did not
an election to apply the final regulations chapter 6) is not required. Under section submit any comments on the
to transactions completed before April 7805(f) of the Code, the notice of regulations.
10, 2006. The IRS and Treasury proposed rulemaking preceding this
Department believe that the elective regulation was submitted to the Chief Drafting Information
retroactivity of the final regulations is Counsel for Advocacy of the Small The principal author of the final
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warranted and administrable. Thus, the Business Administration for comment regulations is Mark J. Weiss, Office of
final regulations permit new target and on its impact on small business. The Chief Counsel (Corporate), IRS.
old target an election to apply the final Chief Counsel for Advocacy did not However, other personnel from the IRS
regulations, in whole, to qualified stock submit any comments on the and Treasury Department participated
purchases occurring before April 10, regulations. in their development.

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List of Subjects § 1.197–2T Amortization of goodwill and section 197(f)(5) intangible. For this
certain other intangibles (temporary). purpose, a section 197(f)(5) intangible is
26 CFR Part 1 (a) through (g)(5)(i) [Reserved]. an amortizable section 197 intangible
Income taxes, Reporting and (ii) Determination of adjusted basis of the basis of which is determined under
recordkeeping requirements. amortizable section 197 intangible section 197(f)(5).
26 CFR Part 602 resulting from an assumption
reinsurance transaction. (A) Disposition—(1) In general. A
Reporting and recordkeeping (A) In general. disposition of a section 197 intangible is
requirements. (B) Amount paid or incurred by any event as a result of which, absent
Adoption of Amendments to the acquirer (reinsurer) under the section 197, recovery of basis is
Regulations assumption reinsurance transaction. otherwise allowed for Federal income
(C) Amount required to be capitalized tax purposes.
■ Accordingly, 26 CFR parts 1 and 602 under section 848 in connection with (2) Treatment of indemnity
are amended as follows: the transaction. reinsurance transactions. The transfer
(1) In general. through indemnity reinsurance of the
PART 1—INCOME TAXES (2) Required capitalization amount.
(3) General deductions allocable to right to the future income from the
■ Paragraph 1. The authority citation insurance contracts to which a section
for part 1 is amended by adding entries the assumption reinsurance transaction.
(4) Treatment of a capitalization 197(f)(5) intangible relates does not
in numerical order to read in part as
shortfall allocable to the reinsurance preclude the recovery of basis by the
follows:
agreement. ceding company, provided that
Authority: 26 U.S.C. 7805 * * * (i) In general. sufficient economic rights relating to the
Section 1.197–2 also issued under 26
U.S.C. 197.
(ii) Treatment of additional reinsured contracts are transferred to the
Section 1.197–2T also issued under 26 capitalized amounts as the result of an reinsurer. However, the ceding company
U.S.C. 197.* * * election under § 1.848–2(g)(8). is not permitted to recover basis in an
Section 1.338–11 also issued under 26 (5) Cross references and special rules. indemnity reinsurance transaction if it
U.S.C. 338. (D) Examples. has a right to experience refunds
Section 1.338–11T also issued under 26 (E) Effective date. reflecting a significant portion of the
U.S.C. 338.* * * (g)(5) (iii) through (l) [Reserved].
Section 1.846–2(d) is also issued under 26 future profits on the reinsured contracts,
■ Par. 3. Section 1.197–2 is amended by
U.S.C. 846.* * * or if it retains an option to reacquire a
revising paragraph (g)(5) to read as
■ Par. 2. In § 1.197–0, the entries in the significant portion of the future profits
follows:
table of contents for § 1.197–2, on the reinsured contracts through the
paragraph (g)(5) are revised and § 1.197– § 1.197–2 Amortization of goodwill and exercise of a recapture provision. In
2T is added to read as follows: certain other intangibles. addition, the ceding company is not
* * * * * permitted to recover basis in an
§ 1.197–0 Table of contents.
(g) * * * indemnity reinsurance transaction if the
This section lists the headings that (5) Treatment of certain insurance reinsurer assumes only a limited portion
appear in §§ 1.197–2 and 1.197–2T. contracts acquired in an assumption of the ceding company’s risk relating to
§ 1.197–2 Amortization of goodwill and reinsurance transaction—(i) In general. the reinsured contracts (excess loss
certain other intangibles. Section 197 generally applies to reinsurance).
* * * * * insurance and annuity contracts
(B) Loss. The loss, if any, recognized
(g) * * * acquired from another person through
by a taxpayer on the disposition of a
(5) Treatment of certain insurance an assumption reinsurance transaction.
section 197(f)(5) intangible equals the
contracts acquired in an assumption See § 1.809–5(a)(7)(ii) for the definition
reinsurance transaction. of assumption reinsurance. The transfer amount by which the taxpayer’s
(i) In general. of insurance or annuity contracts and adjusted basis in the section 197(f)(5)
(ii) Determination of adjusted basis of the assumption of related liabilities intangible immediately before the
amortizable section 197 intangible deemed to occur by reason of a section disposition exceeds the amount, if any,
resulting from an assumption 338 election for a target insurance that the taxpayer receives from another
reinsurance transaction. company is treated as an assumption person for the future income right from
(iii) Application of loss disallowance the insurance contracts to which the
reinsurance transaction. The transfer of
rule upon a disposition of an insurance section 197(f)(5) intangible relates. In
a reinsurance contract by a reinsurer
contract acquired in an assumption determining the amount of the
(transferor) to another reinsurer
reinsurance transaction. taxpayer’s loss on the disposition of a
(A) Disposition. (acquirer) is treated as an assumption
(1) In general. reinsurance transaction if the section 197(f)(5) intangible through a
(2) Treatment of indemnity transferor’s obligations are extinguished reinsurance transaction, any effect of the
reinsurance transactions. as a result of the transaction. transaction on the amounts capitalized
(B) Loss. (ii) Determination of adjusted basis of by the taxpayer as specified policy
(C) Examples. amortizable section 197 intangible acquisition expenses under section 848
(iv) Effective dates. resulting from an assumption is disregarded.
(A) In general.
(B) Application to pre-effective date reinsurance transaction. For further (C) Examples. The following
acquisitions and dispositions. guidance, see § 1.197–2T(g)(5)(ii). examples illustrate the principles of this
(C) Change in method of accounting. (iii) Application of loss disallowance
paragraph (g)(5)(iii):
(1) In general. rule upon a disposition of an insurance
(2) Acquisitions and dispositions on contract acquired in an assumption
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or after effective date. reinsurance transaction. The following Example 1. (i) Facts. In a prior taxable year,
(3) Acquisitions and dispositions rules apply for purposes of applying the as a result of a section 338 election with
before the effective date. loss disallowance rules of section respect to T, new T was treated as purchasing
* * * * * 197(f)(1)(A) to the disposition of a all of old T’s insurance contracts that were

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in force on the acquisition date in an (ii) Analysis. The indemnity reinsurance definition of when an issue is under
assumption reinsurance transaction. Under agreement between new T and R does not consideration, see, Rev. Proc. 97–27
§§ 1.338–6 and 1.338–11(b)(2), the amount of represent a disposition because it does not (1997–1 C.B. 680); and, § 601.601(d)(2)
AGUB allocable to the future income right involve the transfer of sufficient economic
of this chapter). A taxpayer changing its
from the purchased insurance contracts was rights with respect to the future income on
$15, net of the amounts required to be the reinsured contracts. Therefore, new T method of accounting in accordance
capitalized under section 848 as a result of may not recover its basis in the section with this paragraph (g)(5)(iv)(C)(3) must
the assumption reinsurance transaction. At 197(f)(5) intangible to which the contracts follow the applicable administrative
the beginning of the current taxable year, as relate and must continue to amortize ratably procedures for obtaining the
a result of amortization deductions allowed the adjusted basis of the section 197(f)(5) Commissioner’s automatic consent to a
by section 197(a), new T’s adjusted basis in intangible over the remainder of the 15-year change in method of accounting (for
the section 197(f)(5) intangible resulting from recovery period and cannot apply any further guidance, see, for example, Rev.
the assumption reinsurance transaction is portion of this adjusted basis to offset the
Proc. 2002–9 (2002–1 C.B. 327) as
$12. During the current taxable year, new T ceding commission received from R in the
enters into an indemnity reinsurance indemnity reinsurance transaction. modified and clarified by
agreement with R, another insurance Announcement 2002–17 (2002–1 C.B.
company, in which R assumes 100 percent of
(iv) Effective dates—(A) In general— 561), modified and amplified by Rev.
the risk relating to the insurance contracts to This paragraph (g)(5) applies to Proc. 2002–19 (2002–1 C.B. 696), and
which the section 197(f)(5) intangible relates. acquisitions and dispositions on or after amplified, clarified and modified by
In the indemnity reinsurance transaction, R April 10, 2006. For rules applicable to Rev. Proc. 2002–54 (2002–2 C.B. 432);
agrees to pay new T a ceding commission of acquisitions and dispositions before that and, § 601.601(d)(2) of this chapter),
$10 in exchange for the future profits on the date, see § 1.197–2 in effect before that except, for purposes of this paragraph
underlying reinsured policies. Under the date (see 26 CFR part 1, revised April 1,
indemnity reinsurance agreement, new T (g)(5)(iv)(C)(3), any limitations in such
2001). administrative procedures for obtaining
continues to administer the reinsured
(B) Application to pre-effective date the automatic consent of the
policies, but transfers investment assets equal
to the required reserves for the reinsured acquisitions and dispositions. A Commissioner shall not apply.
policies together with all future premiums to taxpayer may choose, on a transaction- However, if the taxpayer is under
R. The indemnity reinsurance agreement by-transaction basis, to apply the examination, before an appeals office, or
does not contain an experience refund provisions of this paragraph (g)(5) to before a Federal court, the taxpayer
provision or a provision allowing new T to property acquired and disposed of must provide a copy of the application
terminate the reinsurance agreement at its before April 10, 2006.
sole option. New T retains the insurance to the examining agent(s), appeals
(C) Change in method of accounting— officer, or counsel for the government,
licenses and other amortizable section 197
(1) In general—A change in a taxpayer’s as appropriate, at the same time that it
intangibles acquired in the deemed asset sale
and continues to underwrite and issue new treatment of all property acquired and files the copy of the application with the
insurance contracts. disposed under paragraph (g)(5) is a National Office. The application must
(ii) Analysis. The indemnity reinsurance change in method of accounting to contain the name(s) and telephone
agreement constitutes a disposition of the which the provisions of sections 446 number(s) of the examining agent(s),
section 197(f)(5) intangible because it and 481 and the regulations thereunder appeals officer, or counsel for the
involves the transfer of sufficient economic apply.
rights attributable to the insurance contracts
government, as appropriate. For
(2) Acquisitions and dispositions on purposes of From 3115, ‘‘Application
to which the section 197(f)(5) intangible or after effective date. A Taxpayer is
relates such that recovery of basis is allowed. for Change in Accounting Method,’’ the
For purposes of applying the loss
granted the consent of the designated number for the automatic
disallowance rules of section 197(f)(1) and Commissioner under section 446(e) to accounting method change authorized
paragraph (g) of this section, new T’s loss is change its method of accounting to by this paragraph (g)(5)(iv)(C)(3) is ‘‘98.’’
$2 (new T’s adjusted basis in the section comply with this paragraph (g)(5) for A change in method of accounting in
197(f)(5) intangible immediately before the acquisitions and dispositions on or after accordance with this paragraph
disposition ($12) less the ceding commission April 10, 2006. The change must be (g)(5)(iv)(C)(3) requires an adjustment
($10)). Therefore, new T applies $10 of the made on a cut-off basis with no section
adjusted basis in the section 197(f)(5)
under section 481(a).
481(a) adjustment. Notwithstanding * * * * *
intangible against the amount received from
§ 1.446–1(e)(3), a taxpayer should not
R for the future income right on the reinsured ■ Par. 4. Section 1.197–2T is added to
policies and increases its basis in the file a Form 3115, ‘‘Application for
Change in Accounting Method,’’ to read as follows:
amortizable section 197 intangibles that it
acquired and retained from the deemed asset obtain the consent of the Commissioner § 1.197–2T Amortization of goodwill and
sale by $2, the amount of the disallowed loss. to change its method of accounting certain other intangibles (temporary).
The amount of new T’s disallowed loss under under this paragraph (g)(5)(iv)(C)(2). (a) through (g)(5)(i) [Reserved]. For
section 197(f)(1)(A) is determined without Instead, a taxpayer must make the further guidance, see § 1.197–2(a)
regard to the effect of the indemnity change by using the new method on its
reinsurance transaction on the amounts
through (g)(5)(i).
federal income tax returns. (g)(5)(ii) Determination of adjusted
capitalized by new T as specified policy
acquisition expenses under section 848.
(3) Acquisitions and dispositions basis of amortizable section 197
Example 2. (i) Facts. Assume the same before the effective date. For the first intangible resulting from an assumption
facts as in Example 1, except that under the taxable year ending after April 10, 2006, reinsurance transaction—(A) In general.
indemnity reinsurance agreement R agrees to a taxpayer is granted consent of the Section 197(f)(5) determines the basis of
pay new T a ceding commission of $5 with Commissioner to change its method of an amortizable section 197 intangible
respect to the underlying reinsured contracts. accounting for all property acquired in for insurance or annuity contracts
In addition, under the indemnity reinsurance transactions described in paragraph acquired in an assumption reinsurance
agreement, new T is entitled to an experience (g)(5)(iv)(B) to comply with this transaction. The basis of such intangible
refund equal to any future profits on the
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reinsured contracts in excess of the ceding


paragraph (g)(5) unless the proper is the excess, if any, of—
commission plus an annual risk charge. New treatment of any such property is an (1) The amount paid or incurred by
T also has a right to recapture the business issue under consideration in an the acquirer (reinsurer) under the
at any time after R has recovered an amount examination, before an Appeals office, assumption reinsurance transaction;
equal to the ceding commission. or before a Federal Court. (For the over

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(2) The amount, if any, required to be determining the general deductions acquisition expenses, net premiums,
capitalized under section 848 in allocable to the assumption reinsurance and net consideration, see section 848(c)
connection with such transaction. transaction. For purposes of allocating and (d), and § 1.848–2(a) and (f).
(B) Amount paid or incurred by its general deductions under § 1.848– However, the following special rules
acquirer (reinsurer) under the 2(g)(6), the reinsurer includes premiums apply for purposes of this paragraph
assumption reinsurance transaction. received on the acquired specified (g)(5)(ii)(C)—
The amount paid or incurred by the insurance contracts after the assumption (i) The amount required to be
acquirer (reinsurer) under the reinsurance transaction in determining capitalized under section 848 in
assumption reinsurance transaction is— the amount required under section connection with the assumption
(1) In a deemed asset sale resulting 848(c)(1) on specified insurance reinsurance transaction cannot be less
from an election under section 338, the contracts that the reinsurer has issued than zero;
amount of the AGUB allocable thereto directly. If the reinsurer has entered into (ii) For purposes of determining the
(see §§ 1.338–6 and 1.338–11(b)(2)); multiple reinsurance agreements during company’s general deductions under
(2) In an applicable asset acquisition the taxable year, the reinsurer section 848(c)(2) for the taxable year of
within the meaning of section 1060, the determines the general deductions the assumption reinsurance transaction,
amount of the consideration allocable allocable to each reinsurance agreement the reinsurer takes into account a
thereto (see §§ 1.338–6, 1.338–11(b)(2), (including the assumption reinsurance tentative amortization deduction under
and 1.1060–1(c)(5)); and transaction) by allocating the general section 197(a) as if the entire amount
(3) In any other transaction, the excess deductions allocable to reinsurance paid or incurred by the reinsurer for the
of the increase in the reinsurer’s tax agreements under § 1.848–2(g)(6) to specified insurance contracts were
reserves resulting from the transaction each reinsurance agreement with a allocated to an amortizable section 197
(computed in accordance with sections positive required capitalization amount. intangible with respect to insurance
807, 832(b)(4)(B), and 846) over the (4) Treatment of a capitalization contracts acquired in an assumption
value of the net assets received from the shortfall allocable to the reinsurance reinsurance transaction; and
ceding company in the transaction. agreement—(i) In general. The reinsurer (iii) Any reduction of specified policy
(C) Amount required to be capitalized determines any capitalization shortfall acquisition expenses pursuant to an
under section 848 in connection with allocable to the assumption reinsurance election under § 1.848–2(i)(4) (relating
the transaction—(1) In general. The transaction in the manner provided in to an assumption reinsurance
amount required to be capitalized under §§ 1.848–2(g)(4) and 1.848–2(g)(7). If the transaction with an insolvent insurance
section 848 for specified insurance reinsurer has a capitalization shortfall company) is disregarded.
contracts (as defined in section 848(e)) allocable to the assumption reinsurance (D) Examples. The following
acquired in an assumption reinsurance transaction, the ceding company must examples illustrate the principles of this
transaction is the lesser of— reduce the net negative consideration paragraph (g)(5)(ii):
(i) The reinsurer’s required (as determined under § 1.848–2(f)(2)) for Example 1. (i) Facts. On January 15, 2006,
capitalization amount for the the transaction by the amount described P acquires all of the stock of T, an insurance
assumption reinsurance transaction; or in § 1.848–2(g)(3) unless the parties company, in a qualified stock purchase and
(ii) The reinsurer’s general deductions make the election provided in § 1.848– makes a section 338 election for T. T issues
(as defined in section 848(c)(2)) 2(g)(8) to determine the amounts individual life insurance contracts which are
allocable to the transaction. capitalized under section 848 in specified insurance contracts as defined in
(2) Required capitalization amount. connection with the transaction without section 848(e)(1). P and new T are calendar
The reinsurer determines the required regard to the general deductions year taxpayers. Under §§ 1.338–6 and 1.338–
capitalization amount for an assumption limitation of section 848(c)(2). 11(b)(2), the amount of AGUB allocated to
reinsurance transaction by multiplying (ii) Treatment of additional old T’s individual life insurance contracts is
the net positive or net negative $300,000. On the acquisition date, the tax
capitalized amounts as the result of an
consideration for the transaction by the reserves for old T’s individual life insurance
election under § 1.848–2(g)(8). The contracts are $2,000,000. After the
applicable percentage set forth in additional amounts capitalized by the acquisition date, new T receives $1,000,000
section 848(c)(1) for the category of reinsurer as the result of the election of net premiums with respect to new and
specified insurance contracts acquired under § 1.848–2(g)(8) reduce the renewal individual life insurance contracts
in the transaction. See § 1.848–2(g)(5). If adjusted basis of any amortizable and incurs $100,000 of general deductions
more than one category of specified section 197 intangible with respect to under 848(c)(2) through December 31, 2006.
insurance contracts is acquired in an specified insurance contracts acquired New T engages in no other reinsurance
assumption reinsurance transaction, the in the assumption reinsurance transactions other than the assumption
required capitalization amount for each transaction. If the additional capitalized reinsurance transaction treated as occurring
category is determined as if the transfer by reason of the section 338 election.
amounts exceed the adjusted basis of
(ii) Analysis. The transfer of insurance
of the contracts in that category were the amortizable section 197 intangible, contracts and the assumption of related
made under a separate assumption the reinsurer must reduce its deductions liabilities deemed to occur by reason of the
reinsurance transaction. See § 1.848– under section 805 or section 832 by the election under section 338 is treated as an
2(f)(7). amount of such excess. The additional assumption reinsurance transaction. New T
(3) General deductions allocable to capitalized amounts are treated as determines the adjusted basis under section
the assumption reinsurance transaction. specified policy acquisition expenses 197(f)(5) for the life insurance contracts
The reinsurer determines the general attributable to the premiums and other acquired in the assumption reinsurance
deductions allocable to the assumption consideration on the assumption transaction as follows. The amount paid or
reinsurance transaction in accordance reinsurance transaction and are incurred for the individual life insurance
with the procedure set forth in § 1.848– contracts is $300,000. To determine the
deducted ratably over a 120-month amount required to be capitalized under
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2(g)(6). Accordingly, the reinsurer must period as provided under section section 848 in connection with the
allocate its general deductions to the 848(a)(2). assumption reinsurance transaction, new T
amount required under section 848(c)(1) (5) Cross references and special rules. compares the required capitalization amount
on specified insurance contracts that the In general, for rules applicable to the for the assumption reinsurance transaction
reinsurer has issued directly before determination of specified policy with the general deductions allocable to the

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transaction. The required capitalization care insurance contracts is $250,000. The T’s adjusted basis of the amortizable section
amount for the assumption reinsurance amount of T’s tax reserves for the qualified 197 intangible with respect to the insurance
transaction is $130,900, which is determining long-term care contracts on the acquisition contracts acquired in the assumption
by multiplying the $1,700,000 net positive date is $7,750,000. Following the acquisition, reinsurance transaction. Accordingly, new
consideration for the transaction ($2,000,000 new T’s receives net premiums of $500,000 T’s adjusted basis of the section 197
reinsurance premium less $300,000 ceding with respect to qualified long-term care intangible with regard to the insurance
commission) by the applicable percentage contracts and incurs general deductions of contracts is reduced from $196,833
under section 848(c)(1) for the acquired $75,000 through December 31, 2006. ($250,000¥$53,167) to $0. Because the
individual life insurance contracts (7.7%). To (ii) Analysis. The transfer of insurance additional $524,333 capitalized pursuant to
determine its general deductions, new T contracts and the assumption of related the § 1.848–2(g)(8) election exceeds the
takes into account a tentative amortization liabilities deemed to occur by reason of the $196,833 adjusted basis of the section 197
deduction under section 197(a) as if the election under section 338 is treated as an intangible before the reduction, new T is
entire amount paid or incurred for old T’s assumption reinsurance transaction. New T required to reduce its deductions under
individual life insurance contracts ($300,000) determines the adjusted basis under section section 805 by the $327,500 ($524,333–
were allocable to an amortizable section 197 197(f)(5) for the insurance contracts acquired 196,833).
intangible with respect to insurance contracts in the assumption reinsurance transaction as
acquired in the assumption reinsurance follows. The amount paid or incurred for the (E) Effective date. This section applies
transaction. Accordingly, for the year of the insurance contracts is $250,000. To to acquisitions and dispositions of
assumption reinsurance transaction, new T is determine the amount required to be insurance contracts on or after April 10,
treated as having general deductions under capitalized under section 848 in connection 2006. The applicability of this section
section 848(c)(2) of $120,000 ($100,000 + with the assumption reinsurance transaction, expires on or before April 7, 2009.
$300,000/15). Under § 1.848–2(g)(6), these new T compares the required capitalization (g)(5)(iii) through (l) [Reserved]. For
general deductions are first allocated to the amount for the assumption reinsurance further guidance, see § 1.197–2(g)(5)(iii)
$77,000 capitalization requirement for new transaction with the general deductions
T’s directly written business ($1,000,000 × allocable to the transaction. The required
through (l).
.077). Thus, $43,000 ($120,000¥$77,000) of capitalization amount for the assumption ■ Par. 5. Section 1.338–0 is amended by
the general deductions are allocable to the reinsurance transaction is $577,500, which is adding entries to the outline of topics
assumption reinsurance transaction. Because determining by multiplying the $7,500,000 for § 1.338–11, § 1.338–11T and
the general deductions allocable to the net positive consideration for the transaction § 1.338(i)–1 to read as follows:
assumption reinsurance transaction ($43,000) ($7,750,000 reinsurance premium less
are less than the required capitalization $250,000 ceding commission) by the § 1.338–0 Outline of topics.
amount for the transaction ($130,900), new T applicable percentage under section 848(c)(1) * * * * *
has a capitalization shortfall of $87,900 for the acquired insurance contracts (7.7%).
($130,900¥$43,000) with regard to the To determine its general deductions, new T § 1.338–11 Effect of section 338 election
transaction. Under § 1.848–2(g), this takes into account a tentative amortization on insurance company targets.
capitalization shortfall would cause old T to deduction under section 197(a) as if the (a) In general.
reduce the net negative consideration taken entire amount paid or incurred for old T’s
into account with respect to the assumption insurance contracts ($250,000) were allocable
(b) Computation of ADSP and AGUB.
reinsurance transaction by $1,141,558 to an amortizable section 197 intangible with (1) Reserves taken into account as a
($87,900÷.077) unless the parties make the respect to insurance contracts acquired in the liability.
election under § 1.848–2(g)(8) to capitalize assumption reinsurance transaction. (2) Allocation of ADSP and AGUB to
specified policy acquisition expenses in Accordingly, for the year of the assumption specific insurance contracts.
connection with the assumption reinsurance reinsurance transaction, new T is treated as (c) Application of assumption
transaction without regard to the general having general deductions under section reinsurance principles.
deductions limitation. If the parties make the 848(c)(2) of $91,667 ($75,000 + $250,000/15). (1) In general.
election, the amount capitalized by new T Under § 1.848–2(g)(6), these general (2) Reinsurance premium.
under section 848 in connection with the deductions are first allocated to the $38,500 (3) Ceding commission.
assumption reinsurance transaction would be capitalization requirement for new T’s
$130,900. The $130,900 capitalized by new T directly written business ($500,000 × .077).
(4) Examples.
under section 848 would reduce new T’s Thus, $53,167 ($91,667¥$38,500) of general (d) Reserve increases by new target
adjusted basis of the amortizable section 197 deductions are allocable to the assumption after the deemed asset sale.
intangible with respect to the specified reinsurance transaction. Because the general (e) Effect of section 338 election on
insurance contracts acquired in the deductions allocable to the assumption section 846(e) election.
assumption reinsurance transaction. reinsurance transaction ($53,167) are less (f) Effect of section 338 election on
Accordingly, new T would have an adjusted than the required capitalization amount for old target’s capitalization amounts
basis under section 197(f)(5) with respect to the transaction ($577,500), new T has a under section 848.
the individual life insurance contracts capitalization shortfall of $524,333 (1) Determination of net consideration
acquired from old T of $169,100 ($300,000 ¥ ($577,500¥$53,167) with regard to the
130,900). New T’s actual amortization transaction. Under § 1.848–2(g), this
for specified insurance contracts.
deduction under section 197(a) with respect capitalization shortfall would cause old T to (2) Determination of capitalization
to the amortizable section 197 intangible for reduce the net negative consideration taken amount.
insurance contracts acquired in the into account with respect to the assumption (3) Section 381 transactions.
assumption reinsurance transaction would be reinsurance transaction by $6,809,519 (g) Effect of section 338 election on
$11,273 ($169,100÷15). ($524,333÷.077) unless the parties make the policyholders surplus account.
Example 2. (i) Facts. The facts are the same election under § 1.848–2(g)(8) to capitalize (h) Effect of section 338 election on
as Example 1, except that T only issues specified policy acquisition expenses in section 847 special estimated tax
accident and health insurance contracts that connection with the assumption reinsurance payments.
are qualified long-term care contracts under transaction without regard to the general
section 7702B. Under section 7702B(a)(5), T’s deductions limitation. If the parties make the § 1.338–11T Effect of section 338 election
qualified long-term care insurance contracts election, the amount capitalized by new T on insurance company targets (temporary).
are treated as guaranteed renewable accident under section 848 in connection with the
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and health insurance contracts, and, assumption reinsurance transaction would


(a) through (c) [Reserved].
therefore, are considered specified insurance increase from $53,167 to $577,500. Pursuant (d) Reserve increases by new target
contracts under section 848(e)(1). Under to § 1.197–2(g)(5)(ii)(C)(4), the additional after the deemed asset sale.
§§ 1.338–6 and 1.338–11(b)(2), the amount of $524,333 ($577,500¥$53,167) capitalized by (1) In general.
AGUB allocable to T’s qualified long-term new T under section 848 would reduce new (2) Exceptions.

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(3) Amount of additional premium. § 1.338–1T General principles; status of allocable to insurance contracts
(i) In general. old target and new target (temporary). acquired in the deemed asset sale.
(ii) Increases in unpaid loss reserves. (a) through (b)(2)(vi) [Reserved]. For (c) Application of assumption
(iii) Increases in other reserves. further guidance, see § 1.338–1(a) reinsurance principles—(1) In general. If
(4) Limitation on additional premium. through (b)(2)(vi). a target is an insurance company, the
(5) Treatment of additional premium (b)(2)(vii) Section 846(e) (relating to deemed sale of insurance contracts is
under section 848. an election to use an insurance treated for Federal income tax purposes
(6) Examples. as an assumption reinsurance
company’s historical loss payment
(7) Effective dates. transaction between old target, as the
(i) In general. pattern).
■ Par. 8. Section 1.338–11 is added to
reinsured or ceding company, and new
(ii) Application to pre-effective date
read as follows: target, as the reinsurer or acquiring
increases to reserves.
company, at the close of the acquisition
(e) Effect of section 338 election on
§ 1.338–11 Effect of section 338 election date. The Federal income tax treatment
section 846(e) election.
(1) In general.
on insurance company targets. of the assumption reinsurance
(2) Revocation of existing section (a) In general. This section provides transaction is determined under the
846(e) election. rules that apply when an election under applicable provisions of subchapter L,
(f ) through (h) [Reserved]. section 338 is made for a target that is chapter 1, subtitle A of the Internal
an insurance company. The rules in this Revenue Code, as modified by the rules
§ 1.338(i)–1 Effective dates. section apply in addition to those set forth in this section.
(a) In general. generally applicable upon the making of (2) Reinsurance premium. Old target
(b) Section 338(h)(10) elections for S an election under section 338. In the is deemed to pay a gross amount of
corporation targets. case of a conflict between the provisions premium in the assumption reinsurance
(c) Section 338 elections for insurance of this section and other provisions of transaction equal to the amount of old
company targets. the Internal Revenue Code or target’s tax reserves for the insurance
(1) In general. regulations, the rules set forth in this contracts that are acquisition date assets
(2) New target election for retroactive section determine the Federal income (acquired contracts). New target is
election. tax treatment of the parties and the deemed to receive a reinsurance
(i) Availability of election. transaction when a section 338 election premium in the amount of old target’s
(ii) Time and manner of making the tax reserves for the acquired contracts.
is made for an insurance company
election for new target. See paragraph (d) of this section for
(3) Old target election for retroactive target.
(b) Computation of ADSP and circumstances in which new target is
election. deemed to receive additional premium.
(i) Availability of election. AGUB—(1) Reserves taken into account
as a liability. Old target’s tax reserves See § 1.817–4(d)(2) for old target’s and
(ii) Time and manner of making the new target’s treatment of the premium.
election for old target. are the reserves for Federal income tax
purposes for any insurance, annuity, (3) Ceding commission. Old target is
■ Par. 6. Section 1.338–1 is amended deemed to receive a ceding commission
by: and reinsurance contracts deemed sold
by old target to new target in the in an amount equal to the amount of
■ 1. Revising the last two sentences of ADSP allocated to the acquired
paragraph (a)(2). deemed asset sale. The amount of old
target’s tax reserves is the amount that contracts, as determined under
■ 2. Adding a sentence before the last §§ 1.338–6 and 1.338–7 and paragraph
sentence of paragraph (a)(3). is properly taken into account by old
target for the contracts at the close of the (b) of this section. New target is deemed
■ 3. Redesignating existing paragraph
taxable year that includes the deemed to pay a ceding commission in an
(b)(2)(vii) as paragraph (b)(2)(viii) and amount equal to the amount of AGUB
adding new paragraph (b)(2)(vii). sale tax consequences (before giving
effect to the deemed asset sale and allocated to the acquired contracts, as
The revisions read as follows: determined under §§ 1.338–6 and
assumption reinsurance transaction).
§ 1.338–1 General principles; status of old Old target’s tax reserves are a liability of 1.338–7 and paragraph (b) of this
target and new target. old target taken into account in section. See § 1.817–4(d)(2) for old
(a) * * * determining ADSP under § 1.338–4 and target’s and new target’s treatment of the
(2) * * * For example, if the target is a liability of new target taken into ceding commission.
an insurance company for which a (4) Examples. The following examples
account in determining AGUB under
section 338 election is made, the illustrate this paragraph (c):
§ 1.338–5.
deemed asset sale results in an (2) Allocation of ADSP and AGUB to Example 1. (i) Facts. On January 1, 2003,
assumption reinsurance transaction for specific insurance contracts. For T, an insurance company, has the following
the insurance contracts deemed purposes of allocating AGUB and ADSP assets with the following fair market values:
transferred from old target to new target. $10 cash, $30 of securities, $10 of equipment,
under §§ 1.338–6 and 1.338–7, the fair a life insurance contract having a value,
See, generally, § 1.817–4(d), and for market value of a specific insurance,
special rules regarding the acquisition of under paragraph (b)(2) of this section, of $17,
reinsurance or annuity contract or group and goodwill and going concern value. T has
insurance company targets, § 1.338–11. of insurance, reinsurance or annuity tax reserves of $50 and no other liabilities.
(3) * * * Section 1.338–11 provides contracts (insurance contracts) is the On January 1, 2003, P purchases all of the
special rules for insurance company amount of the ceding commission a stock of T for $16 and makes a section 338
targets. * * * willing reinsurer would pay a willing election for T. For purposes of the
* * * * * ceding company in an arm’s length capitalization requirements of section 848,
(b) * * * transaction for the reinsurance of the assume new T has $20 of general deductions
(2) * * * in its first taxable year ending on December
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contracts if the gross reinsurance 31, 2003, and earns no other premiums
(vii) [Reserved] premium for the contracts were equal to during the year.
* * * * * old target’s tax reserves for the (ii) Analysis. (A) For Federal income tax
■ Par. 7. Section 1.338–1T is added to contracts. See § 1.197–2(g)(5) for rules purposes, the section 338 election results in
read as follows: concerning the treatment of the amount a deemed sale of the assets of old T to new

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T. Old T’s ADSP is $66 ($16 amount realized fair market value of T’s securities are $60. (e) Effect of section 338 election on
for the T stock plus $50 liabilities). New T’s Thus, to reinsure the contract in an arm’s section 846(e) election. For further
AGUB also is $66 ($16 basis for the T stock length transaction, T would have to pay the guidance, see § 1.338–11T(e)
plus $50 liabilities). See paragraph (b)(1) of reinsurer a reinsurance premium in excess of (f) Effect of section 338 election on old
this section. Each of the AGUB and ADSP is T’s $50 of tax reserves for the contract.
(ii) Analysis. (A) For Federal income tax
target’s capitalization amounts under
allocated under the residual method of
§ 1.338–6 to determine the purchase or sale purposes, the section 338 election results in section 848—(1) Determination of net
price of each asset transferred. Each of the a deemed sale of the assets of old T to new consideration for specified insurance
AGUB and ADSP is allocated as follows: $10 T. Old T’s ADSP is $66 ($16 amount realized contracts. For purposes of applying
to cash (Class I), $30 to the securities (Class for the T stock plus $50 liabilities). New T’s section 848 and § 1.848–2(f) to the
II), $10 to equipment (Class V), $16 to the life AGUB also is $66 ($16 basis for the T stock deemed assumption reinsurance
insurance contract (Class VI), and $0 to plus $50 liabilities). See paragraph (b)(1) of transaction, old target’s net
goodwill and going concern value (Class VII). this section. Each of the AGUB and ADSP is consideration (either positive or
(B) Under section 1001, old T’s amount allocated under the residual method of
§ 1.338–6 to determine the purchase or sale
negative) for each category of specified
realized for the securities is $30 and for the
equipment is $10. As a result of the deemed price of each asset transferred. Each of the insurance contracts is an amount equal
asset sale, there is an assumption reinsurance AGUB and ADSP is allocated as follows: $10 to—
transaction between old T (as ceding to cash (Class I), $56 to the securities (Class (i) The allocable portion of the ceding
company) and new T (as reinsurer) at the II), $0 to the equipment (Class V), $0 to the commission (if any) relating to contracts
close of the acquisition date for the life life insurance contract (Class VI), and $0 to in that category; less
insurance contract issued by old T. See goodwill and going concern value (Class VII). (ii) The amount by which old target’s
paragraph (c)(1) of this section. Although the (B) Under section 1001, old T’s amount tax reserves for contracts in that
assumption reinsurance transaction results in realized for the securities is $56 and for the category has been reduced as a result of
a $50 decrease in old T’s reserves, which is equipment is $0. As a result of the deemed
the deemed assumption reinsurance
taxable income to old T, the reinsurance asset sale, there is an assumption reinsurance
transaction between old T (as ceding transaction.
premium paid by old T is deductible by old (2) Determination of capitalization
T. Under paragraph (c)(2) of this section, old company) and new T (as reinsurer) at the
T is deemed to pay a reinsurance premium close of the acquisition date for the life amount. Except as provided in
equal to the reserve for the life insurance insurance contract issued by old T. See § 1.381(c)(22)–1(b)(13)—
contract immediately before the deemed asset paragraph (c)(1) of this section. Although the (i) If, after the deemed asset sale, old
sale ($50) and is deemed to receive a ceding assumption reinsurance transaction results in target has an amount otherwise required
commission from new T. Under paragraph a $50 decrease in old T’s reserves, which is to be capitalized under section 848 for
(c)(3) of this section, the portion of the ADSP taxable income to old T, the reinsurance the taxable year or an unamortized
allocated to the life insurance contract is $16; premium deemed paid by old T to new T is balance of specified policy acquisition
thus, the ceding commission is $16. Old T, deductible by old T. Under paragraph (c)(2)
of this section, old T is deemed to pay a
expenses from prior taxable years, then
therefore, is deemed to pay new T a old target deducts such remaining
reinsurance premium of $34 ($50 ¥ $16 = reinsurance premium equal to the reserve for
the life insurance contract immediately amount or unamortized balance as an
$34). Old T also has $34 of net negative
consideration for purposes of section 848. before the deemed asset sale ($50), and is expense incurred in the taxable year
See paragraph (f) of this section for rules deemed to receive from new T a ceding that includes the deemed sale tax
relating to the effect of a section 338 election commission equal to the amount of AGUB consequences; and
on the capitalization of amounts under allocated to the life insurance contract ($0), (ii) If, after the deemed asset sale, the
section 848. as provided in paragraph (c)(3) of this negative capitalization amount resulting
(C) New T obtains an initial basis of $30 section. Old T also has $50 of net negative from the reinsurance transaction
in the securities and $10 in the equipment. consideration for purposes of section 848.
See paragraph (f) of this section for rules
exceeds the amount that old target can
New T is deemed to receive a reinsurance deduct under section 848(f)(1), then old
premium from old T in an amount equal to relating to the effect of a section 338 election
on capitalization amounts under section 848. target’s capitalization amount is treated
the $50 of reserves for the life insurance
(C) New T obtains an initial basis of $56 as zero at the close of the taxable year
contract and to pay old T a $16 ceding
commission for the contract. See paragraphs in the securities (with a fair market value of that includes the deemed sale tax
$60) and $0 in the equipment (with a fair consequences.
(c)(2) and (3) of this section. Accordingly,
market value of $10). New T is deemed to (3) Section 381 transactions. For
new T includes $50 of premium in income
receive a reinsurance premium from old T in transactions described in section 381,
and deducts $50 for its increase in reserves.
an amount equal to the $50 of reserves for the see § 1.381(c)(22)–1(b)(13).
For purposes of section 848, new T has $34
life insurance contract. Accordingly, new T
of net positive consideration for the deemed (g) Effect of section 338 election on
includes $50 of premium in income and
assumption reinsurance transaction. Because policyholders surplus account. Except
deducts $50 for its increase in reserves. For
the only contract involved in the deemed as specifically provided in
purposes of section 848, new T has $50 of net
assumption reinsurance transaction is a life § 1.381(c)(22)–1(b)(7), the deemed asset
positive consideration for the deemed
insurance contract, new T must capitalize sale effects a distribution of old target’s
assumption reinsurance transaction. Because
$2.62 ($34 × 7.7% = $2.62) under section the only contract involved in the assumption
848. New T will amortize the $2.62 as
policyholders surplus account to the
reinsurance transaction is a life insurance extent the grossed-up amount realized
provided under section 848. New T’s contract, new T must capitalize $3.85 ($50 ×
adjusted basis in the life insurance contract, on the sale to the purchasing
7.7%) under section 848 from the transaction
which is an amortizable section 197 corporation of the purchasing
and deducts the remaining $16.15 of its
intangible, is $13.38, the excess of the $16 general deductions. Because new T allocates corporation’s recently purchased target
ceding commission over the $2.62 capitalized $0 of the AGUB to the insurance contract, no stock (as defined in § 1.338–4(c))
under section 848. See section 197 and amount is amortizable under section 197 exceeds old target’s shareholders
§ 1.197–2(g)(5). New T deducts the $2.62 of with respect to the insurance contract. See surplus account under section 815(c).
the ceding commission that is not § 1.338–11T(d) for rules on adjustments (h) Effect of section 338 election on
amortizable under section 197 because it is required if new T increases its reserves for, section 847 special estimated tax
reflected in the amount capitalized under or reinsures at a loss, the acquired life
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section 848 and also deducts the remaining


payments. If old target had elected to
insurance contract. claim an additional deduction under
$17.38 of its general deductions.
Example 2. (i) Facts. Assume the same (d) Reserve increases by new target section 847 for the taxable year that
facts as in Example 1, except the life after the deemed asset sale. For further includes the deemed sale tax
insurance contract has a value of $0 and the guidance, see § 1.338–11T(d). consequences or any earlier years, the

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amount remaining in old target’s special (ii) It is required by section 807(f) to reserve increases by new target in prior
loss discount account under section spread the reserve increase over the 10 taxable years).
847(3) must be reduced to the extent it succeeding taxable years. (5) Treatment of additional premium
relates to contracts transferred to new (3) Amount of additional premium— under section 848. If a portion of the
target and the amount of such reduction (i) In general. The additional premium positive amounts described in
must be included in old target’s gross taken into account under this paragraph paragraphs (d)(3)(ii) and (iii) are
income for the taxable year that (d) is an amount equal to the sum of the attributable to an increase in reserves for
includes the deemed sale tax positive amounts described in specified insurance contracts (as
consequences. Old target may apply the paragraphs (d)(3)(ii) and (d)(3)(iii). defined in section 848(e)), new target
balance of its special estimated tax However, the additional premium takes an allocable portion of the
account as a credit against any tax cannot exceed the limitation described additional premium in determining its
resulting from such inclusion in gross in paragraph (d)(4). specified policy acquisition expenses
income. Any special estimated tax (ii) Increases in unpaid loss reserves. under section 848(c) for the taxable year
payments remaining after this credit are The positive amount with respect to of the reserve increase.
voided and, therefore, are not available unpaid loss reserves is computed using (6) Examples. The following examples
for credit or refund. Under section the formula A/B x (C¥[D + E]) where— illustrate this paragraph (d):
847(1), new target is permitted to claim (1) A equals old target’s discounted Example 1. (i) Facts On January 1, 2006, P
a section 847 deduction for losses unpaid losses (determined under purchases all of the stock of T, a non-life
incurred before the deemed asset sale, section 846) included in AGUB under insurance company, for $120 and makes a
subject to the general requirement that § 1.338–11(b)(1); section 338 election for T. On the acquisition
new target makes timely special (2) B equals old target’s undiscounted date, old T has total reserve liabilities under
state law of $725, consisting of undiscounted
estimated tax payments equal to the tax unpaid losses (determined section unpaid losses of $625 and unearned
benefit resulting from this deduction. 846(b)(1) as of the close of the premiums of $100. Old T’s tax reserves on
See § 1.381(c)(22)–1(c)(14) regarding the acquisition date; the acquisition date are $580, which consist
carryover of the special loss discount (3) C equals new target’s of discounted unpaid losses (as defined in
account attributable to contracts undiscounted unpaid losses section 846) of $500 and unearned premiums
transferred in a section 381 transaction. (determined under section 846(b)(1) at (as computed under section 832(b)(4)(B)) of
the end of the taxable year that are $80. Old T has Class I through Class V assets
■ Par. 9. Section 1.338–11T is added to with a fair market value of $800. Old T also
read as follows: attributable to losses incurred by old
has a Class VI asset with a fair market value
target on or before the acquisition date; of $75, consisting of the future profit stream
§ 1.338–11T Effect of section 338 election and of certain insurance contracts. During 2006,
on insurance company targets (temporary). (4) D (which may be a negative new T makes loss and loss adjustment
(a) through (c) [Reserved]. For further number) equals old target’s expense payments of $200 with respect to the
guidance, see § 1.338–11(a) through (c). undiscounted unpaid losses as of the unpaid losses incurred by old T before the
close of the acquisition date, reduced by acquisition date. As of December 31, 2006,
(d) Reserve increases by new target the cumulative amount of losses, loss new T reports undiscounted unpaid losses of
after the deemed asset sale—(1) In adjustment expenses, and reinsurance $475 attributable to losses incurred before the
general. If in new target’s first taxable acquisition date. The related amount of
premiums paid by new target through discounted unpaid losses (as defined in
year or any subsequent year, new target the end of the taxable year for losses
increases its reserves for any acquired section 846) for those losses is $390.
incurred by old target on or before the (ii) Computation and allocation of AGUB.
contracts, new target is treated as acquisition date; and Under § 1.338–5 and § 1.338–11(b)(1), as of
receiving an additional premium, which
(5) E equals the amount obtained by the acquisition date, AGUB is $700, reflecting
is computed under paragraph (d)(3), in the sum of the amount paid for old T’s stock
dividing the cumulative amount of
the assumption reinsurance transaction ($120) and the tax reserves assumed by new
reserve increases taken into account
described in § 1.338–11(c)(1). New T in the transaction ($580). The fair market
under this paragraph (d) in prior taxable
target includes the additional premium value of old T’s Class I through V assets is
years by A/B.
in gross income for the taxable year in $800, whereas the AGUB available for such
(iii) Increases in other reserves. The assets under § 1.338–6 is $700. There is no
which new target increases its reserves
positive amount with respect to reserves AGUB available for old T’s Class VI assets,
for acquired contracts. New target’s
other than discounted unpaid loss even though such assets have a fair market
increase in reserves for the insurance
reserves is the net increase of those value of $75 on the acquisition date.
contracts acquired in the deemed asset
reserves due to changes in estimate, (iii) Adjustments for increases in reserves
sale is a liability of new target not for unpaid losses. Under paragraph (d) of this
methodology, or other assumptions used
originally taken into account in section, new T must determine whether there
to compute the reserves (including the
determining AGUB that is subsequently are any amounts by which it increased its
adoption by new target of a
taken into account. Thus, AGUB is unpaid loss reserves that will be treated as
methodology or assumptions different an additional premium and an increase in
increased by the amount of the
from those used by old target). AGUB. New T applies the formula of
additional premium included in new
(4) Limitation on additional premium. paragraph (d)(3) of this section, where A
target’s gross income. See §§ 1.338–
The additional premium taken into equals $500, B equals $625, C equals $475,
5(b)(2)(ii) and 1.338–7. Old target has no
account by new target under paragraph D equals $425 ($625–$200), and E equals $0.
deduction under this paragraph (d) and Under this formula, new T is treated as
(d)(1) is limited to the excess, if any,
makes no adjustments under §§ 1.338– having increased its reserves for discounted
of—
4(b)(2)(ii) and 1.338–7. unpaid losses attributable to losses incurred
(i) The fair market value of old target’s
(2) Exceptions. New target is not assets acquired by new target in the by old T by $40 ($500/$625 x ($475
treated as receiving additional premium ¥[$425+0]). The limitation under paragraph
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deemed asset sale (other than Class VI (d)(5) based on the difference between the
under paragraph (d)(1) if— and Class VII assets), over fair market value of old T’s Class I through
(i) It is under state receivership as of (ii) The AGUB allocated to those Class V assets and the AGUB allocated to
the close of the taxable year for which assets (including increases in AGUB such assets is $100. Accordingly, new T
the increase in reserves occurs; or allocated to those assets as the result of includes an additional premium of $40 in

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gross income for 2006, and increases the AGUB allocated to such assets (which § 1.338(i)–1 Effective dates.
AGUB allocated to old T’s Class I through includes the $40 addition to AGUB in 2006 * * * * *
Class V assets to reflect this additional and the $40 addition to AGUB in 2007). (c) Section 338 elections for insurance
premium. Thus, New T includes $20 in additional company targets—(1) In general. The
Example 2. (i) Facts. Assume the same premium, and increases the AGUB allocated
facts as in Example 1. Further assume that to the Class I through V assets acquired from
rules of § 1.338–11 apply to qualified
during 2007 new T deducts total loss and old T by $20. As a result of these stock purchases occurring on or after
loss expense payments of $375 with respect adjustments, the limitation under paragraph April 10, 2006.
to losses incurred by old T before the (d)(4) is reduced to zero. (2) New target election for retroactive
acquisition date. On December 31, 2007, new application—(i) Availability of election.
T reports undiscounted unpaid losses of $150 (7) Effective dates—(i) In general. This New target may make an irrevocable
with respect to losses incurred before the section applies to increases to reserves election to apply the rules in §§ 1.338–
acquisition date. The related amount of made by new target after a deemed asset 11 and 1.338–11T(d) (including the
discounted unpaid losses (as defined in sale occurring on or after April 10, 2006. applicable provisions in §§ 1.197–
section 846) for those unpaid losses is $125. The applicability of the section expires
(ii) Analysis. New T must determine
2(g)(5), 1.197–2T(g)(5)(ii), 381(c)(22)–1,
on or before April 7, 2009. and 846) in whole, but not in part, to a
whether any amounts by which it increased
its unpaid losses during 2007 will be treated (ii) Application to pre-effective date qualified stock purchase occurring
as an additional premium under paragraph increases to reserves. If either new target before April 10, 2006 for which a
(d)(3) of this section. New T applies the makes an election under § 1.338(i)– section 338 election is made, provided
formula under paragraph (d)(3) of this 1(c)(2) or old target makes an election that new target’s first taxable year and
section, where A equals $500, B equals $625, under § 1.338(i)–1(c)(3) to apply the all subsequent affected taxable years are
C equals $150, D equals $50 ($625–$575), rules of § 1.338–11, in whole, to a years for which an assessment of
and E equals $50 ($40 divided by .8). Under qualified stock purchase occurring deficiency or a refund for overpayment
paragraph (d)(3) of this section, new T is before April 10, 2006 then the rules is not prevented by any law or rule of
treated as increasing its reserves for
discounted unpaid losses by $40 during 2007
contained in this section shall apply in law. In the case of a section 338 election
with respect to losses incurred by old T whole to the qualified stock purchase. for which a section 338(h)(10) election
($500/$625 x ($150 ¥ [$50 + $50]). New T (e) Effect of section 338 election on is made (or a section 338 election for a
determines the limitation of paragraph (d)(5) section 846(e) election—(1) In general. foreign target), new target may make the
of this section by comparing the $800 fair New target and old target are treated as election to apply the regulations
market value of the Class I through V assets the same corporation for purposes of an retroactively without regard to whether
on the acquisition date to the $740 AGUB election by old target to use its historical old target makes the election. In the case
allocated to such assets (which includes the loss payment pattern under section of a section 338 election for a domestic
$40 addition to AGUB included during target for which no section 338(h)(10)
2006). Thus, new T recognizes $40 of
846(e). See § 1.338–1T(b)(2)(vii).
Therefore, if old target has a section election is made, new target may make
additional premium as a result of the
increase in reserves during 2007, and adjusts 846(e) election in effect on the the election to apply the regulations
the AGUB allocable to the Class I through V acquisition date, new target will retroactively only if old target also
assets acquired from old T to reflect such continue to use the historical loss makes the election. Paragraph (c)(2)(ii)
additional premium. payment pattern of old target to of this section prescribes the time and
Example 3. (i) Facts. The facts are the same discount unpaid losses incurred in manner of the election for new target.
as Example 2, except that on January 1, 2008, accident years covered by the election, (ii) Time and manner of making the
new T reinsures the outstanding liability unless new target elects to revoke the election for new target. New target may
with respect to losses incurred by old T make an election described in paragraph
before the acquisition date through a
section 846(e) election. In addition, new
target may consider old target’s (c)(2)(i) of this section by attaching a
portfolio reinsurance transaction with R, statement to its original or amended
another non-life insurance company. R agrees historical loss payment pattern when
determining whether to make the income tax return for its first taxable
to assume any remaining liability relating to
losses incurred by old T before the section 846(e) election for a year. The statement must be entitled
acquisition date in exchange for a determination year that includes or is ‘‘Election to Retroactively Apply the
reinsurance premium of $200. Accordingly, subsequent to the acquisition date. Rules in §§ 1.338–11 and 1.338–11T(d)
as of December 31, 2008, new T reports no (2) Revocation of existing section (including the applicable provisions in
undiscounted unpaid losses with respect to
846(e) election. New target may revoke §§ 1.197–2(g)(5), 1.197–2T(g)(5)(ii),
losses incurred by old T before the 1.381(c)(22)–1 and 846) in whole to a
acquisition date. old target’s section 846(e) election to use
transaction completed before April 10,
(ii) Analysis. New T must determine its historical loss payment pattern to
2006’’ and must include the following
whether any amount by which it increased discount unpaid losses. If new target
information—
its unpaid loss reserves will be treated as an elects to revoke old target’s section (A) The name and E.I.N. for new
additional premium under paragraph (d) of 846(e) election, new target will use the target; and
this section. New T applies the formula of industry-wide patterns determined by
paragraph (d)(3) of this section, where A
(b) The following declaration (or a
the Secretary to discount unpaid losses substantially similar declaration): New
equals $500, B equals $625, C equals $0, and incurred in accident years beginning on
D equals-$150 ($625 ¥ ($575 + $200), and E target has amended its income tax
or after the acquisition date through the returns for its first taxable year and for
equals $100 ($80 divided by .8). Thus, new
T is treated as having increased its subsequent determination year. New all affected subsequent years to reflect
discounted unpaid losses by $40 in 2008 target may revoke old target’s section the rules in §§ 1.338–11 and 1.338–
with respect to losses incurred by old T 846(e) election by attaching a statement 11T(d) (including the applicable
before the acquisition date ($500/$625 × (0 ¥ to new target’s original tax return for its provisions in §§ 197–2(g)(5), 1.197–
[¥$150 + $100]). New T includes this first taxable year. 2t(g)(5)(ii), 1.381(c)(22)–1 and 846). All
positive amount in gross income, subject to (f) through (h) [Reserved]. For further
rwilkins on PROD1PC63 with RULES

the limitation of paragraph (d)(4). The


other parties whose income tax
guidance, see § 1.338–11(f) through (h). liabilities are affected by new target’s
limitation of paragraph (d)(4) equals $20,
which is computed by comparing the $800 ■ Par. 10. Section 1.338(i)–1 is amended election have amended their income tax
fair market value of the Class I through V by adding new paragraph (c) to read as returns for all affected years to reflect
assets acquired from old T with the $780 follows: the rules in §§ 1.338–11 and 1.338–

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11T(d) (including the applicable the rules in §§ 1.338–11 and 1.338– treatment of its remaining policyholders
provisions in §§ 1.197–2(g)(5), 1.197– 11Td) (including the applicable surplus account. For all other
2T(g)(5)(ii), 1.381(c)(22)–1 and 846). provisions in §§ 1.197–2(g)(5), 1.197– transactions subject to this paragraph,
(3) Old target election for retroactive 2T(g)(5)(ii), 1.381(c)(22)–1 and 846). the distributor or transferor must take
application—(i) Availability of election. ■ Par. 11. Section 1.381(c)(22)–1 is into account as income its remaining
Old target may make an irrevocable amended by: policyholders surplus account to the
election to apply the rules in §§ 1.338– ■ 1. Revising the first sentence of extent the fair market value of its assets
11 and 1.338–11T(d) (including the paragraph (a). (net of liabilities) distributed or
applicable provisions in §§ 1.197– ■ 2. Adding a sentence to the end of transferred to the acquiring corporation
2(g)(5), 1.197–2T(g)(5)(ii), 1.381(c)(22)–1 paragraph (b)(7)(i). or to the transferor’s shareholders
and 846) in whole, but not in part, to a ■ 3. Redesignating existing (b)(7)(ii) as pursuant to the plan of liquidation or
qualified stock purchase occurring paragraph (b)(7)(iv) and adding new reorganization exceeds the distributor’s
before April 10, 2006 for which a paragraphs (b)(7)(ii) and (b)(7)(iii). or transferor’s remaining shareholders
section 338 election is made, provided ■ 4. Adding paragraphs (b)(7)(v), (b)(13), surplus account.
that old target’s taxable year that (b)(14), and (c). (iii) If, pursuant to a plan in existence
includes the deemed sale tax The revisions read as follows: at the time of the liquidation or
consequences and all subsequent reorganization, the acquiring
affected taxable years are years for § 1.381(c)(22)-1 Successor insurance
company. corporation transfers any insurance or
which an assessment of deficiency or a annuity contract it received in the
refund for overpayment is not prevented (a) Carryover requirement. If in a
liquidation or reorganization to another
by any law or rule of law. In the case taxable year beginning after December
person, then, for purposes of paragraph
of a section 338 election for which a 31, 1957, a distributor or transferor
(b)(7)(ii) of this section, that contract
section 338(h)(10) election is made (or corporation which is an insurance
shall be deemed to have been
a section 338 election for a foreign company is acquired by a corporation
transferred by the transferor to that
target), old target may make the election which is an insurance company in a
other person after the adoption of the
to apply the regulations retroactively transaction to which section 381(a)
plan of liquidation or reorganization. If
without regard to whether new target applies, section 381(c)(22) provides that
the transferor is an old target within the
makes the election. In the case of a the acquiring corporation shall take into
meaning of § 1.338(h)(10)-1(d)(2), any
section 338 election for a domestic account the appropriate items which the
transfer by the acquiring corporation to
target for which no section 338(h)(10) distributor or transferor corporation was
the purchasing corporation (as defined
election is made, old target may make required to take into account for
in § 1.338–2(c)(11)) or to any person
the election to apply the regulations purposes of part I, subchapter L, chapter
related to the purchasing corporation
retroactively only if new target also 1 of the Internal Revenue Code. * * *
(b) * * * within the meaning of section
makes the election. Paragraph (c)(3)(ii) 197(f)(9)(C) within two years of the
of this section prescribes the time and (7)(i) * * * However, any amounts
attributable to money or other property transfer described in section 381(a) will
manner of the election for old target. be presumed to have been pursuant to
(ii) Time and manner of making the not permitted to be received without the
recognition of gain (i.e., boot) a plan in existence at the time of the
election for old target. Old target may liquidation or reorganization.
make an election described in paragraph distributed to a person other than the
(c)(3)(i) of this section by attaching a acquiring corporation under section * * * * *
statement to each affected party’s 381(a) shall be treated as a distribution (v) The provisions of this paragraph
original or amended income tax return under section 815. (b)(7) are illustrated by the following
for the taxable year that includes the (ii) Notwithstanding paragraph examples:
deemed sale tax consequences. The (b)(7)(i) of this section, if the distributor Example 1. P buys the stock of insurance
statement must be entitled ‘‘Election to or transferor corporation distributes or company target, T, from S for $16, and P and
Retroactively Apply the Rules in transfers less than 50 percent of its S make a section 338(h)(10) election for T. T
insurance business to the acquiring transfers no insurance contracts to S, or any
§§ 1.338–11 and 1.338–11T(d) related party, in connection with the
(including the applicable provisions in corporation, then the acquiring
transaction. Further, assume that T had $10
§§ 1.197–2(g)(5), 1.197–2T(g)(5)(ii), corporation shall succeed to a ratable in its policyholders surplus account and no
1.381(c)(22)–1 and 846) to a transaction portion of the dollar balances in the balance in its shareholders surplus account
completed before April 10, 2006’’ and distributor’s or transferor’s shareholders or other accounts. Immediately before the
must include the following surplus account, policyholders surplus deemed asset sale, old T is required to
information— account, and other accounts. The include as ordinary income the $10 in the
(A) The name and E.I.N. for old target; percentage of the accounts to which the policyholders surplus account.
and acquiring corporation succeeds is Example 2. Assume the same facts as in
(B) The following declaration (or a determined by the ratio of the Example 1, except that T holds a block of life
insurance contracts P does not wish to
substantially similar declaration): Old distributor’s or transferor’s insurance acquire, and, immediately before the sale of
target has amended its income tax reserves for the contracts transferred to T stock, S causes T to distribute the
returns for the taxable year that includes the acquiring corporation, as maintained unwanted block of insurance contracts to S.
the deemed sale tax consequences and under section 816(b), to the distributor’s Further, assume that S is an insurance
for all affected subsequent years to or transferor’s reserves for all of its company, that the distribution of contracts is
reflect the rules in §§ 1.338–11 and contracts maintained under section one of series of distributions in complete
1.338–11T(d) (including the applicable 816(b) immediately before the earlier of cancellation or redemption of all of its stock
provisions in §§ 1.197–2(g)(5), 1.197– the distribution or transfer or the (the others occurring under § 1.338(h)(10)-
1(d)(4)(i)) that qualifies as a complete
rwilkins on PROD1PC63 with RULES

2T(g)(5)(ii), 1.381(c)(22)–1 and 846). All adoption of the plan of liquidation or liquidation under section 332, and that old
other parties whose income tax reorganization. For transactions in T’s tax reserves with respect to the
liabilities are affected by old target’s which the distributor liquidates distributed contracts represent one-tenth of
election have amended their income tax pursuant to an election under section old T’s tax reserves with respect to all of its
returns for all affected years to reflect 338(h)(10), see § 1.338–11(f) for the life insurance contracts. Because T transfers

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less than 50 percent of its life insurance reorganization, the acquiring acquisition of assets in a transaction to
business to S in a transaction to which corporation transfers any insurance or which section 381 applies. The
section 381(a) applies, S succeeds to a ratable annuity contract it received in the statement must be entitled ‘‘Election to
portion of old T’s policyholders surplus
liquidation or reorganization to another retroactively apply the rules of section
account ($1), and old T includes as ordinary
income the remaining $9 of that account. person, then, for purposes of paragraph 1.381(c)(22)–1 to a transaction
Example 3. Assume the same facts as in (b)(13)(ii) of this section, that contract completed before April 10, 2006’’ and
Example 2, except that 14 months after the shall be deemed to have been must include the following
deemed asset sale, S and X, a person related transferred by the transferor to that information—
to new T under section 197(f)(9)(C), engage other person after the adoption of the (i) The name and EIN of the
in an indemnity reinsurance transaction plan of liquidation or reorganization. If distributor or transferor and the
involving the contracts transferred to S from the transferor is an old target within the acquiring corporation; and
old T. Because X is related to the purchasing (ii) The following declaration (or a
meaning of § 1.338(h)(10)–1(d)(2), any
corporation (P) under section 197(f)(9)(C),
and X receives contracts from the acquiring transfer by the acquiring corporation to substantially similar declaration): The
corporation (S) that S acquired from old T the purchasing corporation (as defined distributor or transferor and the
within two years of the transfer from old T in § 1.338–2(c)(11)) or to any person acquiring corporation have each
to S, the contracts are presumed to have been related to the purchasing corporation amended its income tax returns for the
transferred pursuant to a plan in existence at within the meaning of section taxable year that includes the
the time of old T’s liquidation. If S cannot 197(f)(9)(C) within two years of the acquisition of assets in a transaction to
establish otherwise, old T is treated as having transfer described in section 381(a) will which section 381 applies and for all
distributed the remainder of its policyholders
be presumed to have been pursuant to affected subsequent years to reflect the
surplus account. In that case, in the taxable
year of the indemnity reinsurance a plan in existence at the time of the rules in paragraphs (a), (b)(7), (b)(13),
transaction, S takes into account as ordinary liquidation or reorganization. and (b)(14) of section 1.381(c)(22)–1.
income the portion of old T’s accounts ($9) (14) The special loss discount * * * * *
that old T or S has not previously taken into account, provided, however, that the
■ Par. 12. Section 1.846–0 is amended
account as income. acquiring corporation will succeed to
by:
* * * * * the special loss discount account only to ■ 1. Adding a new entry in the table of
(13)(i) The transferor’s unamortized the extent that it is attributable to the contents for § 1.846–2(d).
policy acquisition expenses or positive portion of the transferor’s insurance ■ 2. Revising the entry in the table of
or negative capitalization requirements business acquired by the acquiring contents for § 1.846–4.
on its specified insurance contracts. corporation in the section 381 ■ 3. Adding a new entry in the table of
(ii) Notwithstanding paragraph transaction. contents for § 1.846–4T.
(b)(13)(i) of this section, if the (c) Effective dates—(1) In general. The revisions and additions read as
distributor or transferor corporation This section applies to the acquisition of follows:
transfers less than 50 percent of its assets of an insurance company by
insurance business to the acquiring another insurance company in a § 1.846–0 Outline of provisions.
corporation, then the acquiring transaction to which section 381 applies * * * * *
corporation shall succeed to a ratable for taxable years beginning after
portion of the transferor’s unamortized December 31, 1957. § 1.846–2 Election by taxpayer to use its
(2) Special rules for section 381 own historical loss payment pattern.
policy acquisition expenses or positive
or negative capitalization requirements transactions. Paragraphs (a), (b)(7), * * * * *
on its specified insurance contracts. The (b)(13), and (b)(14) of this section apply (d) Effect of section 338 election on
percentage of such acquisition expenses to the acquisition of assets of an section 846(e) election.
or positive or negative capitalization insurance company by another § 1.846–2T Election by taxpayer to use its
requirements to which the acquiring insurance company in a transaction to own historical loss payment pattern
corporation succeeds is determined by which section 381 applies on or after (temporary).
the ratio of the distributor’s or April 10, 2006. (a) through (c) [Reserved].
transferor’s insurance reserves for the (3) Joint retroactive election. The (d) Effect of section 338 election on
contracts transferred to the acquiring distributor or transferor and the section 846(e) election.
corporation, as maintained under acquiring corporation may jointly make
an irrevocable election to apply * * * * *
section 816(b), to the distributor’s or
transferor’s reserves for all of its paragraphs (a), (b)(7), (b)(13), and (b)(14) § 1.846–4 Effective dates.
contracts maintained under section of this section to a transaction to which (a) In general.
816(b) immediately before the earlier of section 381 applies occurring before (b) Section 338 election.
the distribution or transfer or the April 10, 2006 provided that the taxable
adoption of the plan of liquidation or year that includes the acquisition and § 1.846–4T Effective dates (temporary).
reorganization. For amounts of the all subsequent affected taxable years of (a) [Reserved].
distributor’s or transferor’s unamortized both the distributor or transferor and the (b) Section 338 election.
policy acquisition expenses or positive acquiring corporation are years for * * * * *
or negative capitalization requirements which an assessment of deficiency or a ■ Par. 13. Section 1.846–2 is amended
on its specified insurance contracts to refund for overpayment is not prevented by adding paragraph (d) to read as
which the acquirer does not succeed to by any law or rule of law. follows:
under this paragraph, and, for (4) Time and manner of making the
transactions in which the transferor joint election. The distributor or § 1.846–2 Election by taxpayer to use its
transferor and the acquiring corporation own historical loss payment pattern.
liquidates pursuant to an election under
* * * * *
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section 338(h)(10), see § 1.338–11(f) for may make an election described in


the treatment of its capitalized amounts paragraph (c)(2) of this section by each (d) Effect of section 338 election on
under section 848. attaching a statement to its original or section 846(e) election. [Reserved]. For
(iii) If, pursuant to a plan in existence amended income tax return for the further guidance, see § 1.846–2T(d).
at the time of the liquidation or taxable year that includes the * * * * *

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■ Par. 14. Section 1.846–2T is added to to apply the regulations retroactively (b) * * *
read as follows: without regard to whether the purchaser (9) Insurance Business.
also makes the election. For rules (c) * * *
§ 1.846–2T Election by taxpayer to use its applicable to asset acquisitions on or (5) Insurance Business.
own historical loss payment pattern
(temporary).
before March 15, 2001, see § 1.1060–1T * * * * *
in effect before March 16, 2001 (see 26 (b) * * *
(a) through (c) [Reserved]. For further CFR part 1 revised April 1, 2000). (9) Insurance business. The mere
guidance, see § 1.846–2(a) through (c). (ii) Time and manner of making the reinsurance of insurance contracts by an
(d) Effect of section 338 election on insurance company is not an applicable
election for the purchaser. The
section 846(e) election. For rules asset acquisition, even if it enables the
purchaser may make an election
regarding qualified stock purchases reinsurer to establish a customer
described in this paragraph (a)(2) by
occurring on or after April 10, 2006, see relationship with the owners of the
attaching a statement to its original or
§§ 1.338–1(b)(2)(vii) and 1.338–11T(e). reinsured contracts. However, a transfer
amended income tax return for the
* * * * * taxable year that includes the applicable of an insurance business is an
■ Par. 15. Section 1.846–4 is revised to asset sale. The statement must be applicable asset acquisition if the
read as follows: entitled ‘‘Election to Retroactively purchaser acquires significant business
Apply the Rules in §§ 1.338–11 and assets, in addition to insurance
§ 1.846–4 Effective dates. contracts, to which goodwill and going
1.338–11T(d) (Including the Applicable
(a) In general. Sections 1.846–1 Provisions in §§ 1.197–2(g)(5), 1.197– concern value could attach. For rules
through 1.846–3 apply to taxable years 2T(g)(5)(ii), 1.381(c)(22)–1, 846 and regarding the treatment of an applicable
beginning after December 31, 1986. 1060) to an Applicable Asset asset acquisition of an insurance
(b) Section 338 election. [Reserved]. Acquisition Completed Before April 10, business, see paragraph (c)(5) of this
For further guidance, see § 1.846–2T(d). 2006’’ and must include the following section.
■ Par. 16. Section 1.846–4T is added to information— (c) * * *
read as follows: (A) The name and E.I.N. for the (5) Insurance business. If the trade or
purchaser; and business transferred is an insurance
§ 1.846–4T Effective dates (temporary).
(B) The following declaration (or a business, the rules of this paragraph (c)
(a) [Reserved]. For further guidance, are modified by the principles of
substantially similar declaration): The
see § 1.846–2(a). § 1.338–11(a) through (d). However, in
(b) Section 338 election. Section purchaser has amended its income tax
returns for the taxable year that includes transactions governed by section 1060,
1.846–2(d) applies to section 846(e) such principles apply even if the
elections made with regard to a the applicable asset acquisition and for
all affected subsequent years to reflect transfer of the trade or business is
qualified stock purchase made on or effected in whole or in part through
after April 10, 2006. the rules in §§ 1.338–11 and 1.338–
11T(d) (Including the Applicable indemnity reinsurance rather than
* * * * * Provisions in §§ 1.197–2(g)(5), 1.197– assumption reinsurance, and, for the
■ Par. 17. Section 1060–1 is amended 2T(g)(5)(ii), 1.381(c)(22)–1,846 and insurer or reinsurer, an insurance
by: 1060). contract (including an annuity or
■ 1. Revising paragraph (a)(2). (iii) Time and manner of making the reinsurance contract) is a Class VI asset
■ 2. Adding new entries in paragraph election for the seller. The seller may regardless of whether it is a section 197
(a)(3) in the outline of topics for make an election described in this intangible. In addition, the principles of
paragraphs (b)(9) and (c)(5). paragraph (a)(2) by attaching a statement § 1.338–11(f) through (h) apply if the
■ 3. Adding new paragraphs (b)(9) and transfer occurs in connection with the
to its original or amended income tax
(c)(5). return for the taxable year that includes complete liquidation of the transferor.
The revision and additions read as the applicable asset sale. The statement * * * * *
follows: must be entitled ‘‘Election to
retroactively apply the rules in PART 602—OMB CONTROL NUMBERS
§ 1.1060–1 Special allocation rules for
certain asset acquisitions. §§ 1.338–11 and 1.338–11T(d) UNDER PAPERWORK REDUCTION
(including the applicable provisions in ACT
(a) * * *
(2) Effective dates—(i) In general. The §§ 1.197–2(g)(5), 1.197–2T(g)(5)(ii),
■ Par. 18. The authority citation for part
provisions of this section apply to any 1.381(c)(22)–1, 846 and 1060) to an
602 continues to read as follows:
asset acquisition occurring after March applicable asset acquisition completed
before April 10, 2006’’ and must include Authority: 26 U.S.C. 7805. * * *
15, 2001. However, paragraphs (b)(9)
and (c)(5) of this section apply only to the following information— ■ Par. 19. In § 602.101, paragraph (b) is
applicable asset acquisitions occurring (A) The name and E.I.N. for the seller; amended by revising the entry for
on or after April 10, 2006. A purchaser and ‘‘1.1060–1’’ and adding the following
or a seller may make an irrevocable (B) The following declaration (or a entries in numerical order to the table
election to apply the rules in §§ 1.338– substantially similar declaration): The to read as follows:
11 and 1.338–11T(d) (including the seller has amended its income tax
applicable provisions in §§ 1.197– returns for the taxable year that includes § 602.101 OMB Control numbers.
2(g)(5), 1.197–2T(g)(5)(ii), 1.381(c)(22)– the applicable asset acquisition and for * * * * *
1, 846 and 1060) to an applicable asset all affected subsequent years to reflect (b) * * *
acquisition occurring before April 10, the rules in §§ 1.338–11 and 1.338–
2006. Paragraph (a)(2)(ii) of this section 11T(d) (including the applicable CFR part or section where Current OMB
provisions in §§ 1.197–2(g)(5), 1.197– identified and described control No.
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describes the time and manner of the


election for the purchaser and paragraph 2T(g)(5)(ii), 1.381(c)(22)–1, 846 and
(a)(2)(iii) of this section prescribes the 1060). * * * * *
time and manner of the election for the (3) * * * 1.338–11T ............................. 1545–1990
seller. The seller may make the election * * * * *

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Federal Register / Vol. 71, No. 68 / Monday, April 10, 2006 / Rules and Regulations 18007

CFR part or section where Current OMB FOR FURTHER INFORMATION CONTACT: J. PART 2004—NATIONAL INDUSTRIAL
identified and described control No. William Leonard, Director, ISOO, at SECURITY PROGRAM DIRECTIVE NO.
202–357–5250. 1
* * * * *
1.338(i)–1 .............................. 1545–1990 The
SUPPLEMENTARY INFORMATION: Subpart A—Implementation and Oversight
proposed rule was published in the
Sec.
* * * * * January 27, 2006, Federal Register (71 2004.10 Responsibilities of the Director,
1.381(c)(22)–1 ...................... 1545–1990 FR 4541) for a 45-day public comment Information Security Oversight Office
period. NARA received no comments on (ISOO) [102(b)].
* * * * * the proposed rule. The final rule is 2004.11 Agency Implementing Regulations,
1.1060–1 ............................... 1545–1658 published without change. Internal Rules, or Guidelines [102(b)(3)].
1545–1990 2004.12 Reviews by ISOO [102(b)(4)].
This final rule is being issued
* * * * * pursuant to the provisions of section Subpart B—Operations
102(b)(1) of Executive Order 12829, 2004.20 National Industrial Security
Mark E. Matthews,
January 6, 2003 (58 FR 3479), as Program Operating Manual (NISPOM)
amended by Executive Order 12885, [201(a)].
Deputy Commissioner for Services and 2004.21 Protection of Classified Information
Enforcement.
December 14, 1993, (58 FR 65863). The
purpose of this Directive is to assist in [201(e)].
Approved: March 7, 2006. 2004.22 Operational Responsibilities
implementing the Order; users of the [202(a)].
Eric Solomon, Directive shall refer concurrently to that 2004.23 Cost Reports [203(d)].
Acting Deputy Assistant Secretary of the Order for guidance. As of November 17, 2004.24 Definitions.
Treasury (Tax Policy). 1995, ISOO became a part of NARA. The
[FR Doc. 06–3320 Filed 4–7–06; 8:45 am] Authority: Section 102(b)(1) of Executive
drafting, coordination, and issuance of Order 12829, January 6, 2003, 58 FR 3479, as
BILLING CODE 4830–01–P this Directive fulfills one of the amended by Executive Order 12885,
responsibilities of the implementation December 14, 1993, 58 FR 65863.
delegated to the ISOO Director. ISOO
maintains oversight over Executive Subpart A—Implementation and
NATIONAL ARCHIVES AND RECORDS Order 12958, as amended, and policy Oversight
ADMINISTRATION oversight over Executive Order 12829, § 2004.10 Responsibilities of the Director,
as amended. Nothing in this directive Information Security Oversight Office
Information Security Oversight Office
shall be construed to supersede the (ISOO) [102(b)].1
authority of the Secretary of Energy or The Director ISOO shall:
32 CFR Part 2004
the Nuclear Regulatory Commission (a) Implement EO 12829, as amended.
under the Atomic Energy Act of 1954, (b) Ensure that the NISP is operated
RIN 3095–AB34 as amended (42 U.S.C. 2011 et seq.), or as a single, integrated program across
the authority of the Director of Central the Executive Branch of the Federal
National Industrial Security Program Intelligence under the National Security
Directive No. 1 Government; i.e., that the Executive
Act of 1947, as amended, or Executive Branch departments and agencies
AGENCY: Information Security Oversight Order No. 12333 of December 8, 1981, adhere to NISP principles.
Office (ISOO), National Archives and or the authority of the Director of (c) Ensure that each contractor’s
Records Administration (NARA). National Intelligence under the implementation of the NISP is overseen
Intelligence Reform and Terrorism by a single Cognizant Security Authority
ACTION: Final rule.
Prevention Act of 2004. Requirements of (CSA), based on a preponderance of
SUMMARY: The Information Security the latter Act will necessitate additional classified contracts per agreement by the
Oversight Office (ISOO), National future changes to Executive Order 12829 CSAs.
Archives and Records Administration and this implementing Directive. The (d) Ensure that all Executive Branch
(NARA), is publishing this Directive interpretive guidance contained in this departments and agencies that contract
pursuant to section 102(b)(1) of rule will assist agencies in for classified work have included the
Executive Order 12829, as amended, implementing Executive Order 12829, Security Requirements clause, 52.204–2,
as amended. from the Federal Acquisition Regulation
relating to the National Industrial
This rule is not a significant (FAR), or an equivalent clause, in such
Security Program. This order establishes
regulatory action for the purposes of contract.
a National Industrial Security Program (e) Ensure that those Executive
(NISP) to safeguard Federal Government Executive Order 12866. The rule is not Branch departments and agencies for
classified information that is released to a major rule as defined in 5 U.S.C. which the Department of Defense (DoD)
contractors, licensees, and grantees of Chapter 8, Congressional Review of
Agency Rulemaking. As required by the serves as the CSA have entered into
the United States Government. agreements with the DoD that establish
Redundant, overlapping, or unnecessary Regulatory Flexibility Act, we certify the terms of the Secretary’s
requirements impede those interests. that this rule will not have a significant
responsibilities on behalf of those
Therefore, the NISP serves as the single, impact on a substantial number of small agency heads.
integrated, cohesive industrial security entities because it applies only to
program to protect classified Federal agencies. § 2004.11 Agency Implementing
information and to preserve our Regulations, Internal Rules, or Guidelines
List of Subjects in 32 CFR Part 2004 [102(b)(3)].
Nation’s economic and technological
interests. This Directive sets forth Classified information. (a) Reviews and Updates. All
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guidance to agencies to set uniform implementing regulations, internal


■ 1. For the reasons set forth in the
standards throughout the NISP that preamble, NARA amends Title 32 of the 1 Bracketed references pertain to related sections
promote these objectives. Code of Federal Regulations to add part of Executive Order 12829, as amended by E.O.
DATED: Effective Date: May 10, 2006. 2004 as follows: 12885.

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