Part I. Rulings — Internal Revenue Bulletin 2001-26

Section 301.—Distributions of Property

26 CFR 1.301–1: Rules applicable with respect to distributions of money and other property.

The revenue ruling obsoletes Rev. Rul. 77–316 (1977–2 C.B. 53), which provided that losses paid by a captive insurance company pursuant to a relatedparty transaction deemed not to be insurance were viewed, to the extent of available earnings and profits, as distributions under IRC § 301 to the respective parent. See Rev. Rul. 2001–31, on this page.

Section 355.—Distribution of Stock and Securities of a Controlled Corporation

26 CFR 1.355–3: Active conduct of a trade or business. (Also: § 856)

REIT and section 355(b) active conduct of a trade or business. A REIT can be engaged in the active conduct of a trade or business within the meaning of section 355(b) of the Code solely by virtue of functions with respect to rental activity that produces income qualifying as rents from real property within the meaning of section 856(d) of the Code.

Rev. Rul. 2001–29

ISSUE

Can a real estate investment trust (REIT) be engaged in the active conduct of a trade or business within the meaning of § 355(b) of the Internal Revenue Code solely by virtue of functions with respect to rental activity that produces income qualifying as rents from real property within the meaning of § 856(d)?

LAW AND ANALYSIS

Sections 355(a)(1)(C) and (b) require that both the distributing and controlled corporations be engaged, immediately after a distribution, in the active conduct of a trade or business that has been actively conducted throughout the five year period ending on the date of the distribution. Section 1.355–3(b)(2)(iii) of the Income Tax Regulations provides that the determination of whether a trade or business is actively conducted is made from all the facts and circumstances. Generally, a corporation is treated as actively

Section 118.—Contributions to the Capital of a Corporation

26 CFR 1.118–1: Contributions to the capital of a corporation.

The revenue ruling obsoletes Rev. Rul. 77–316 (1977–2 C.B. 53), which provided that payments between related parties that were disallowed as deductions for insurance premiums should be recharacterized as contributions to capital under I.R.C. § 118. See Rev. Rul. 2001–31, on this page.

Section 162.—Trade or Business Expenses

26 CFR 1.162–1: Business expenses.

The revenue ruling announces that the Service will not raise the economic family theory, originally set forth in Rev. Rul. 77–316 (1977–2 C.B. 53), in determining whether payments between related parties are deductible insurance premiums. See Rev. Rul. 2001–31, on this page.

26 CFR 1.162–1: Business expenses. (Also §§ 118, 165, 301, 801, 831; 1.118–1, 1.165–1, 1.301–1, 1.801–3, 1.831–3.)

This ruling explains that the Service will no longer raise the “economic family theory” set forth in Rev. Rul. 77–316 (1977–2 C.B. 53), in addressing whether captive insurance transactions constitute valid insurance. Rather, the Service will address captive insurance transactions on a case-by-case basis.

Rev. Rul. 2001–31

In Rev. Rul. 77–316 (1977–2 C.B. 53), three situations were presented in which a taxpayer attempted to seek insurance coverage for itself and its operating subsidiaries through the taxpayer’s whollyowned captive insurance subsidiary. The ruling explained that the taxpayer, its noninsurance subsidiaries, and its captive insurance subsidiary represented one “economic family” for purposes of analyzing whether transactions involved sufficient risk shifting and risk distribution to constitute insurance for federal income tax purposes. See Helvering v. Le Gierse, 312 U.S. 531 (1941). The ruling concluded that the transactions were not insurance to the extent that risk was retained within that economic family. Therefore, the premiums paid by the taxpayer and its non-insurance subsidiaries to the captive insurer were not deductible.

No court, in addressing a captive insurance transaction, has fully accepted the economic family theory set forth in Rev. Rul. 77–316. See, e.g., Humana, Inc. v. Commis- sioner, 881 F.2d 247 (6 ^th Cir. 1989); Clougherty Packing Co. v. Commissioner, 811 F.2d 1297 (9 ^th Cir. 1987) (employing a balance sheet test, rather than the economic family theory, to conclude that transaction between parent and subsidiary was not insurance); Kidde Industries, Inc. v. United States, 40 Fed. Cl. 42 (1997). Accordingly, the Internal Revenue Service will no longer invoke the economic family theory with respect to captive insurance transactions.

The Service may, however, continue to challenge certain captive insurance transactions based on the facts and circumstances of each case. See, e.g., Malone & Hyde v. Com- missioner, 62 F.3d 835 (6 ^th Cir. 1995) (concluding that brother-sister transactions were not insurance because the taxpayer guaranteed the captive’s performance and the captive was thinly capitalized and loosely regulated); Clougherty Packing Co. v. Commissioner (concluding that a transaction between parent and subsidiary was not insurance).

EFFECT ON OTHER DOCUMENTS

Rev. Rul. 77–316, 1977–2 C.B. 53; Rev. Rul. 78–277, 1978–2 C.B. 268; Rev. Rul. 88–72, 1988–2 C.B. 31; and Rev. Rul. 89–61, 1989–1 C.B. 75, are obsoleted. Rev. Rul. 78–338, 1978–2 C.B. 107; Rev. Rul. 80–120, 1980–1 C.B. 41; Rev. Rul. 92–93, 1992–2 C.B. 45; and Rev. Proc. 2000–3, 2000–1 I.R.B. 103, are modified.

DRAFTING INFORMATION

The principal author of this revenue ruling is Robert A. Martin of the Office of Associate Chief Counsel (Financial Institutions & Products). For further information regarding this revenue ruling, contact Mr. Martin at (202) 622-3970 (not a toll-free call).

Section 165.—Losses

26 CFR 1.165–1: Losses.

The revenue ruling obsoletes Rev. Rul. 77–316 (1977–2 C.B. 53), which provided that losses paid by a captive insurance company pursuant to a related-party transaction deemed not to be insurance were deductible by the captive insurer’s respective parent or affiliate under IRC § 165(a). See Rev. Rul. 2001–31, on this page.

June 25, 2001 1348 2001–26 I.R.B.

conducting a trade or business only if it performs active and substantial management and operational functions. Generally, activities performed by the corporation do not include activities performed by persons outside the corporation, including independent contractors. However, a corporation may satisfy the active trade or business test through the activities it performs itself, even though some of its activities are performed by others. For an illustration of active and substantial management and operational functions in the context of the rental of real property, see generally Rev. Rul. 79–394, 1979–2 C.B. 141, as amplified by Rev. Rul. 80–181, 1980–2 C.B. 121.

In Rev. Rul. 73–236, 1973–1 C.B. 183, X, an unincorporated domestic trust qualifying as an association taxable as a corporation under § 7701(a)(3), was engaged for more than five years in the sale of real estate that it developed and improved, and in the leasing of buildings that it constructed. In order to raise capital, X intended to convert to a REIT, as defined in § 856. In order to satisfy certain requirements of § 856, X had to dispose of property that it held primarily for sale to customers in the ordinary course of business. To accomplish this, X transferred this property to Y, a newly formed corporation, in exchange for all of the Y stock, which X distributed to its beneficiaries pro rata . Immediately following the Y stock distribution and as part of an overall plan, X elected REIT status. In order to ensure that it would meet the requirements of § 856(c), X managed and operated its real estate leasing operations through independent contractors so as to qualify all of its rental income as “rents from real property” within the meaning of § 856(d). Section 856(d)(3), as in effect when Rev. Rul. 73–236 was issued, excluded from the term “rents from real property” amounts received with respect to such property “if the real estate investment trust furnishes or renders services to the tenants of such property, or manages or operates such property, other than through an independent contractor from whom the trust itself does not derive or receive any income.” (In 1976, this provision was redesignated § 856(d)(2)(C). See Tax Reform Act of 1976, Pub. L. No. 94–455, § 1604(b), 90 Stat. 1520, 1749 (1976).)

The only issue that Rev. Rul. 73–236 considered was whether X, after the dis

tribution and while qualifying as a REIT under § 856, was engaged in the active conduct of a trade or business within the meaning of § 355(b). Because X’s rental activities conducted as a REIT were designed to qualify all of its rental income as “rents from real property” within the meaning of § 856(d), Rev. Rul. 73–236 concluded that X did not directly perform substantial management and operational activities and, therefore, that X was not engaged in an active trade or business within the meaning of § 355(b) immediately after the distribution of the Y stock.

Section 663 of the Tax Reform Act of 1986, Pub. L. No. 99–514, 100 Stat. 2085, 2302 (1986), amended § 856(d)(2)(C). Under the statute, as amended, amounts that would qualify as rents from real property under § 512(b)(3) if received by an organization described in § 511(a)(2) are not excluded from rents from real property under § 856(d)(2)(C). Section 512(b)(3) excludes rents from real property from unrelated business taxable income. Section 1.512(b)–1(c)(5) interprets § 512(b)(3) to permit an organization to treat rental income as rents from real property even if, in connection with the rental activity, it furnishes certain services that are not primarily for the convenience of the occupant and are usually or customarily rendered in connection with the rental of real property. Such services include, for example, the furnishing of heat and light; the cleaning of public entrances, exits, stairways, and lobbies; and the collection of trash. Consequently, as a result of the 1986 amendment, a REIT is permitted to perform activities that can constitute active and substantial management and operational functions with respect to rental activity that produces income qualifying as rents from real property under § 856(d).

HOLDING

A REIT can be engaged in the active conduct of a trade or business within the meaning of § 355(b) solely by virtue of functions with respect to rental activity that produces income qualifying as rents from real property within the meaning of § 856(d).

EFFECT ON OTHER REVENUE RULING

Rev. Rul. 73–236 is obsoleted. The obsolescence of Rev. Rul. 73–236, which denied § 355 treatment to a distribution of stock by a C corporation that converted to a REIT because the REIT was

not engaged in the active conduct of a trade or business, does not imply a view as to whether a distribution of stock involving a REIT election by the distributing or controlled corporation would otherwise satisfy the requirements of § 355, including the corporate business purpose requirement of § 1.355–2(b).

DRAFTING INFORMATION

The principal author of this revenue ruling is Richard Passales of the Office of Associate Chief Counsel (Corporate). For further information regarding this revenue ruling, contact Mr. Passales at (202) 622-7530 (not a toll-free call).

Section 801.—Tax Imposed

26 CFR 1.801–3: Definitions.

The revenue ruling obsoletes Rev. Rul. 77–316 (1977–2 C.B. 53), which provided that certain captive insurance companies were not taxable as insurance companies pursuant to IRC §§ 801, 831, and the applicable regulations because the related-party transactions could not be considered “insurance” for purposes of determining whether the captive insurer was “primarily and predominantly engaged in the insurance business,” as required in Treas. Reg. § 1.801–3(a). See Rev. Rul. 2001–31, page 1348.

Section 831.—Tax on Insurance Companies Other Than Life Insurance Companies

26 CFR 1.831–3: Tax on insurance companies (other than life or mutual), mutual marine insurance companies, mutual fire insurance companies issuing perpetual policies, and mutual fire or flood insurance companies operating on the basis of premium deposits; taxable years beginning after December 31, 1962.

Section 856.—Definition of Real Estate Investment Trust

26 CFR 1.856–1: Definition of real estate investment trust.

REIT & § 355(b) active conduct of a trade or business: The ruling holds that a REIT can be engaged in the active conduct of a trade or business within the

2001–26 I.R.B. 1349 June 25, 2001

Rounded to the nearest full percent, the federal short-term rate based on daily compounding determined during the month of April 2001 is 4 percent. Accordingly, an overpayment rate of 7 percent (6 percent in the case of a corporation) and an underpayment rate of 7 percent are established for the calendar quarter beginning July 1, 2001. The overpayment rate for the portion of a corporate overpayment exceeding $10,000 for the calendar quarter beginning July 1, 2001, is 4.5 percent. The underpayment rate for large corporate underpayments for the calendar quarter beginning July 1, 2001, is 9 percent. These rates apply to amounts bearing interest during that calendar quarter.

Interest factors for daily compound interest for annual rates of 4.5 percent, 6 percent, 7 percent, and 9 percent are published in Tables 14, 17, 19, and 23 of Rev. Proc. 95–17, 1995–1 C.B. 556, 568, 571, 573, and 577. Annual interest rates to be compounded daily pursuant to § 6622 that apply for prior periods are set forth in the tables accompanying this revenue ruling.

DRAFTING INFORMATION

The principal author of this revenue ruling is Raymond Bailey of the Office of Associate Chief Counsel (Procedure & Administration), Administrative Provisions & Judicial Practice Division. For further information regarding this revenue ruling, contact Mr. Bailey at (202) 622-6226 (not a toll-free call).

meaning of § 355(b) solely by virtue of functions with respect to rental activity that produces income qualifying as rents from real property within the meaning of § 856(d). See Rev. Rul. 2001–29, page 1348.

Section 6621.—Determination of Interest Rate

26 CFR 301.6621–1: Interest rate.

Interest rates; underpayments and over- payments. The rate of interest determined under section 6621 of the Code for the calendar quarter beginning July 1, 2001, will be 7 percent for overpayments (6 percent in the case of a corporation), 7 percent for underpayments, and 9 percent for large corporate underpayments. The rate of interest paid on the portion of a corporate overpayment exceeding $10,000 will be 4.5 percent.

Rev. Rul. 2001–32

Section 6621 of the Internal Revenue Code establishes the rates for interest on tax overpayments and tax underpayments. Under § 6621(a)(1), the overpayment rate beginning July 1, 2001, is the sum of the federal short-term rate plus 3 percentage points (2 percentage points in the case of a corporation), except the rate for the portion of a corporate overpayment of tax exceeding $10,000 for a taxable period is the sum of the federal short-term rate plus 0.5 of a percentage point for interest computations made after December 31, 1994. Under § 6621(a)(2), the underpayment rate is the sum of the federal short-term rate plus 3 percentage points.

Section 6621(c) provides that for purposes of interest payable under § 6601 on any large corporate underpayment, the underpayment rate under § 6621(a)(2) is determined by substituting “5 percentage points” for “3 percentage points.” See § 6621(c) and § 301.6621–3 of the Regulations on Procedure and Administration for the definition of a large corporate underpayment and for the rules for determining the applicable date. Section 6621(c) and § 301.6621–3 are generally effective for periods after December 31, 1990.

Section 6621(b)(1) provides that the Secretary will determine the federal short-term rate for the first month in each calendar quarter.

Section 6621(b)(2)(A) provides that the federal short-term rate determined under § 6621(b)(1) for any month applies during the first calendar quarter beginning after such month.

Section 6621(b)(3) provides that the federal short-term rate for any month is the federal short-term rate determined during such month by the Secretary in accordance with § 1274(d), rounded to the nearest full percent (or, if a multiple of 1/2 of 1 percent, the rate is increased to the next highest full percent).

Notice 88–59, 1988–1 C.B. 546, announced that, in determining the quarterly interest rates to be used for overpayments and underpayments of tax under § 6621, the Internal Revenue Service will use the federal short-term rate based on daily compounding because that rate is most consistent with § 6621 which, pursuant to § 6622, is subject to daily compounding.

TABLE OF INTEREST RATES PERIODS BEFORE JUL. 1, 1975 - PERIODS ENDING DEC. 31, 1986

OVERPAYMENTS AND UNDERPAYMENTS

In 1995–1 C.B. PERIOD RATE DAILY RATE TABLE Before Jul. 1, 1975 6% Table 2, pg. 557 Jul. 1, 1975—Jan. 31, 1976 9% Table 4, pg. 559 Feb. 1, 1976—Jan. 31, 1978 7% Table 3, pg. 558 Feb. 1, 1978—Jan. 31, 1980 6% Table 2, pg. 557 Feb. 1, 1980—Jan. 31, 1982 12% Table 5, pg. 560 Feb. 1, 1982—Dec. 31, 1982 20% Table 6, pg. 560 Jan. 1, 1983—Jun. 30, 1983 16% Table 37, pg. 591 Jul. 1, 1983—Dec. 31, 1983 11% Table 27, pg. 581 Jan. 1, 1984—Jun. 30, 1984 11% Table 75, pg. 629 Jul. 1, 1984—Dec. 31, 1984 11% Table 75, pg. 629 Jan. 1, 1985—Jun. 30, 1985 13% Table 31, pg. 585 Jul. 1, 1985—Dec. 31, 1985 11% Table 27, pg. 581 Jan. 1, 1986—Jun. 30, 1986 10% Table 25, pg. 579 Jul. 1, 1986—Dec. 31, 1986 9% Table 23, pg. 577

June 25, 2001 1350 2001–26 I.R.B.

2001–26 I.R.B. 1351 June 25, 2001

TABLE OF INTEREST RATES

FROM JANUARY 1, 1999 - PRESENT

NONCORPORATE OVERPAYMENTS AND UNDERPAYMENTS

1995–1 C.B. RATE TABLE PAGE

Jan. 1, 1999—Mar. 31, 1999 7% 19 573 Apr. 1, 1999—Jun. 30, 1999 8% 21 575 Jul. 1, 1999—Sep. 30, 1999 8% 21 575 Oct. 1, 1999—Dec. 31, 1999 8% 21 575 Jan. 1, 2000—Mar. 31, 2000 8% 69 623 Apr. 1, 2000—Jun. 30, 2000 9% 71 625 Jul. 1, 2000—Sep. 30, 2000 9% 71 625 Oct. 1, 2000—Dec. 31, 2000 9% 71 625 Jan. 1, 2001—Mar. 31, 2001 9% 23 577 Apr. 1, 2001—Jun. 30, 2001 8% 21 575 Jul. 1, 2001—Sep. 30, 2001 7% 19 573

June 25, 2001 1352 2001–26 I.R.B.

TABLE OF INTEREST RATES FOR

LARGE CORPORATE UNDERPAYMENTS

FROM JANUARY 1, 1991 - PRESENT

1995–1 C.B. RATE TABLE PG

Jan. 1, 1991—Mar. 31, 1991 13% 31 585 Apr. 1, 1991—Jun. 30, 1991 12% 29 583 Jul. 1, 1991—Sep. 30, 1991 12% 29 583 Oct. 1, 1991—Dec. 31, 1991 12% 29 583 Jan. 1, 1992—Mar. 31, 1992 11% 75 629 Apr. 1, 1992—Jun. 30, 1992 10% 73 627 Jul. 1, 1992—Sep. 30, 1992 10% 73 627 Oct. 1, 1992—Dec. 31, 1992 9% 71 625 Jan. 1, 1993—Mar. 31, 1993 9% 23 577 Apr. 1, 1993—Jun. 30, 1993 9% 23 577 Jul. 1, 1993—Sep. 30, 1993 9% 23 577 Oct. 1, 1993—Dec. 31, 1993 9% 23 577 Jan. 1, 1994—Mar. 31, 1994 9% 23 577 Apr. 1, 1994—Jun. 30, 1994 9% 23 577 Jul. 1, 1994—Sep. 30, 1994 10% 25 579 Oct. 1, 1994—Dec. 31, 1994 11% 27 581 Jan. 1, 1995—Mar. 31, 1995 11% 27 581 Apr. 1, 1995—Jun. 30, 1995 12% 29 583 Jul. 1, 1995—Sep. 30, 1995 11% 27 581 Oct. 1, 1995—Dec. 31, 1995 11% 27 581 Jan. 1, 1996—Mar. 31, 1996 11% 75 629 Apr. 1, 1996—Jun. 30, 1996 10% 73 627 Jul. 1, 1996—Sep. 30, 1996 11% 75 629 Oct. 1, 1996—Dec. 31, 1996 11% 75 629 Jan. 1, 1997—Mar. 31, 1997 11% 27 581 Apr. 1, 1997—Jun. 30, 1997 11% 27 581 Jul. 1, 1997—Sep. 30, 1997 11% 27 581 Oct. 1, 1997—Dec. 31, 1997 11% 27 581 Jan. 1, 1998—Mar. 31, 1998 11% 27 581 Apr. 1, 1998—Jun. 30, 1998 10% 25 579 Jul. 1, 1998—Sep. 30, 1998 10% 25 579 Oct. 1, 1998—Dec. 31, 1998 10% 25 579 Jan. 1, 1999—Mar. 31, 1999 9% 23 577 Apr. 1, 1999—Jun. 30, 1999 10% 25 579 Jul. 1, 1999—Sep. 30, 1999 10% 25 579 Oct. 1, 1999—Dec. 31, 1999 10% 25 579 Jan. 1, 2000—Mar. 31, 2000 10% 73 627 Apr. 1, 2000—Jun. 30, 2000 11% 75 629 Jul. 1, 2000—Sep. 30, 2000 11% 75 629 Oct. 1, 2000—Dec. 31, 2000 11% 75 629 Jan. 1, 2001—Mar. 31, 2001 11% 27 581 Apr. 1, 2001—Jun. 30, 2001 10% 25 579 Jul. 1, 2001—Sep. 30, 2001 9% 23 577

2001–26 I.R.B. 1353 June 25, 2001

TABLE OF INTEREST RATES FOR CORPORATE

OVERPAYMENTS EXCEEDING $10,000

FROM JANUARY 1, 1995 - PRESENT

1995–1 C.B. RATE TABLE PG

Jan. 1, 1995—Mar. 31, 1995 6.5% 18 572 Apr. 1, 1995—Jun. 30, 1995 7.5% 20 574 Jul. 1, 1995—Sep. 30, 1995 6.5% 18 572 Oct. 1, 1995—Dec. 31, 1995 6.5% 18 572 Jan. 1, 1996—Mar. 31, 1996 6.5% 66 620 Apr. 1, 1996—Jun. 30, 1996 5.5% 64 618 Jul. 1, 1996—Sep. 30, 1996 6.5% 66 620 Oct. 1, 1996—Dec. 31, 1996 6.5% 66 620 Jan. 1, 1997—Mar. 31, 1997 6.5% 18 572 Apr. 1, 1997—Jun. 30, 1997 6.5% 18 572 Jul. 1, 1997—Sep. 30, 1997 6.5% 18 572 Oct. 1, 1997—Dec. 31, 1997 6.5% 18 572 Jan. 1, 1998—Mar. 31, 1998 6.5% 18 572 Apr. 1, 1998—Jun. 30, 1998 5.5% 16 570 Jul. 1, 1998—Sep. 30, 1998 5.5% 16 570 Oct. 1, 1998—Dec. 31, 1998 5.5% 16 570 Jan. 1, 1999—Mar. 31, 1999 4.5% 14 568 Apr. 1, 1999—Jun. 30, 1999 5.5% 16 570 Jul. 1, 1999—Sep. 30, 1999 5.5% 16 570 Oct. 1, 1999—Dec. 31, 1999 5.5% 16 570 Jan. 1, 2000—Mar. 31, 2000 5.5% 64 618 Apr. 1, 2000—Jun. 30, 2000 6.5% 66 620 Jul. 1, 2000—Sep. 30, 2000 6.5% 66 620 Oct. 1, 2000—Dec. 31, 2000 6.5% 66 620 Jan. 1, 2001—Mar. 31, 2001 6.5% 18 572 Apr. 1, 2001—Jun. 30, 2001 5.5% 16 570 Jul. 1, 2001—Sep. 30, 2001 4.5% 14 568

June 25, 2001 1354 2001–26 I.R.B.