[Federal Register Volume 66, Number 9 (Friday, January 12, 2001)]
[Proposed Rules]
[Pages 2852-2854]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-271]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-125237-00]
RIN 1545-AY60


Debt Instruments With Original Issue Discount; Annuity Contracts

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

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SUMMARY: This document contains proposed regulations relating to the 
federal income tax treatment of annuity contracts issued by certain 
insurance companies. These proposed regulations provide guidance on 
whether certain annuity contracts are excluded from the definition of a 
debt instrument under the original issue discount provisions of the 
Internal Revenue Code. This document also provides a notice of public 
hearing on the proposed regulations.

DATES: Written or electronically generated comments must be received by 
April 12, 2001. Requests to speak (with outlines of oral comments to be 
discussed) at the public hearing scheduled for May 30, 2001, at 10 a.m. 
must be submitted by May 9, 2001.

ADDRESSES: Send submission to: CC:M&SP:RU (REG-125237-00), room 5226, 
Internal Revenue Service, POB 7604, Ben Franklin Station, Washington, 
DC 20044. Submissions may be hand delivered between the hours of 8 a.m. 
and 5 p.m. to: CC:M&SP:RU (REG-125237-00), Courier's Desk, Internal 
Revenue Service, 1111 Constitution Ave., NW., Washington, DC. 
Alternatively, taxpayers may submit comments electronically via the 
Internet by selecting the ``Tax Regs'' option on the IRS Home Page, or 
by submitting comments directly to the IRS internet site at http://www.irs.gov/tax_regs/regslist.html. The public hearing will be held in 
room 4718, 1111 Constitution Ave., NW., Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Patrick E. 
White, (202) 622-3920; concerning submissions of comments, the hearing, 
and/or to be placed on the building access list to attend the hearing, 
contact LaNita VanDyke, (202) 622-7180 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

    Sections 163(e) and 1271 through 1275 of the Internal Revenue Code 
(Code) provide rules for the treatment of debt instruments with 
original issue discount (OID). Section 1275(a)(1)(A) defines the term 
``debt instrument'' to include a bond, debenture, note or certificate 
or other evidence of indebtedness. Sections 1275(a)(1)(B)(i) and (ii), 
however, exclude certain annuity contracts from the definition of a 
debt instrument.
    On February 2, 1994, the IRS and Treasury published in the Federal 
Register (59 FR 4799) final regulations concerning a variety of issues 
under the OID provisions. On January 8, 1998, the IRS and Treasury 
published in the Federal Register (63 FR 1054) final regulations 
concerning the life annuity exception of section 1275(a)(1)(B)(i). This 
document contains proposed rules concerning the exception for annuities 
described in section 1275(a)(1)(B)(ii).

Explanation of Provisions

    In general, the OID provisions apply to issuers and holders of debt 
instruments. The term debt instrument generally means any instrument or 
contractual arrangement that constitutes indebtedness under general 
principles of income tax law. See section 1275(a)(1)(A) and 
Sec. 1.1275-1(d).
    If a contract is a debt instrument with OID, section 1272 generally 
requires the holder of the contract to include OID in income currently 
on a constant yield basis, regardless of the holder's overall method of 
accounting. By contrast, the holder of an annuity contract to which 
section 72 applies generally is allowed to defer recognizing 
economically earned income until distributions are made on the 
contract.
    Section 1275(a)(1)(B) excepts two types of annuity contracts from 
the definition of a debt instrument. First, section 1275(a)(1)(B)(i) 
excepts an annuity contract to which section 72 applies if the contract 
``depends (in whole or in substantial part) on the life expectancy of 1 
or more individuals.'' Second, section 1275(a)(1)(B)(ii) excepts an 
annuity contract to which section 72 applies under certain 
circumstances if the contract ``is issued by an insurance company 
subject to tax under subchapter L (or by an entity described in section 
501(c) and exempt from tax under section 501(a) which would be subject 
to tax under subchapter L were it not so exempt).''
    The legislative history of section 1275(a)(1)(B)(ii) is limited. 
This exception to the OID rules first appeared when the bill emerged 
from the Conference Committee in 1984. H.R. 4170, 98th Cong., 2d Sess. 
Sec. 41 (1984). At that time, section 1275(a)(1)(B)(ii) applied to 
certain annuity contracts issued by an insurance company subject to tax 
under subchapter L. The 1984 Conference Report does not elaborate on 
the meaning of the phrase ``an insurance company subject to tax under 
subchapter L,'' nor does it explain the purpose of the provision. H.R. 
Conf. Rep. No. 861, 98th Cong., 2d Sess. 802-05 (1984), 1984-3 (Vol. 2) 
C.B. 56-59. In 2000, a technical correction to section 
1275(a)(1)(B)(ii) was enacted. The technical correction clarified that 
section 1275(a)(1)(B)(ii) also applied to annuity contracts issued by 
``an entity described in section 501(c) and exempt from tax under 
section 501(a) which would be subject to tax under subchapter L were it 
not so exempt.'' Consolidated Appropriations Act, 2001, Public Law 106-
554 (114 Stat. 2763).
    In 1998, the IRS and Treasury promulgated Sec. 1.1275-1(j), 
interpreting the life annuity exception of section 1275(a)(1)(B)(i). 
Commentators had also requested guidance on the scope of the section 
1275(a)(1)(B)(ii) exception, particularly with regard to foreign 
insurers not engaged in a trade or business in the U.S.
    The proposed regulations provide that an annuity contract issued by 
a foreign insurance company is treated as issued by an insurance 
company subject to tax under subchapter L if the insurance company is 
subject to tax under subchapter L with respect to income earned on the 
annuity contract. The IRS and Treasury believe that this is the most 
natural application of the language of section 1275(a)(1)(B)(ii) and is 
consistent with the use of that phrase elsewhere in the Code and 
regulations. See, e.g., sections 953(e)(3)(C) and 1297(b)(2)(B); 
Sec. 1.848-2(h). The IRS and Treasury also believe that the exception

[[Page 2853]]

from the OID rules was intended to preserve a balance between the tax 
treatment of holders of annuity contracts under section 72 and the tax 
treatment of issuers of such contracts. This balance does not exist 
when the annuity contract is issued by a foreign person that is not 
required to calculate its income with respect to the contract under 
subchapter L.

Proposed Effective Date

    The proposed regulations are proposed to apply for interest 
accruals on or after the date that is 30 days after final regulations 
are published in the Federal Register on annuity contracts held on or 
after that date. The regulations will not apply to an annuity contract 
that was purchased before January 12, 2001. Special rules are provided 
for additional investments after January 12, 2001 with respect to an 
annuity contract held as of that date. This effective date framework is 
similar to that provided in Sec. 1.1275-1(j)(8) with respect to the 
life annuity exception of section 1275(a)(1)(B)(i).

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in Executive Order 
12866. Therefore, a regulatory assessment is not required. It also has 
been determined that section 553(b) of the Administrative Procedure Act 
(5 U.S.C. chapter 5) does not apply to these regulations, and because 
these regulations do not impose a collection of information on small 
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not 
apply. Pursuant to section 7805(f) of the Internal Revenue Code, this 
notice of proposed rulemaking will be submitted to the Chief Counsel 
for Advocacy of the Small Business Administration for comment on its 
impact on small business.

Comments and Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any electronic or written comments (a 
signed original and eight (8) copies of written comments) that are 
submitted timely (in the manner described in the ADDRESSES portion of 
this preamble) to the IRS. The IRS and Treasury request comments on the 
clarity of the proposed rules and how they may be made easier to 
understand. All comments will be available for public inspection and 
copying.
    A public hearing has been scheduled for May 30, 2001, beginning at 
10 a.m. in room 4718, Internal Revenue Building, 1111 Constitution 
Avenue, NW., Washington, DC. Due to building security procedures, 
visitors must enter at the 10th Street entrance, located between 
Constitution and Pennsylvania Avenues, NW. In addition, all visitors 
must present photo identification to enter the building. Because of 
access restrictions, visitors will not be admitted beyond the immediate 
entrance area more than 15 minutes before the hearing starts. For 
information about having your name placed on the building access list 
to attend the hearing, see FOR FURTHER INFORMATION CONTACT.
    The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons who 
wish to present oral comments at the hearing must submit written 
comments and an outline of topics to be discussed and the time to be 
devoted to each topic (signed original and eight (8) copies) by May 9, 
2001. A period of 10 minutes will be allotted to each person making 
comments. An agenda showing the scheduling of the speakers will be 
prepared after the deadline for receiving outlines has passed. Copies 
of the agenda will be available free of charge at the hearing.

Drafting Information

    The principal author of these regulations is Patrick E. White, 
Office of the Associate Chief Counsel (Financial Institutions & 
Products). However, other personnel from the IRS and Treasury 
Department participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

    Authority: 26 U.S.C. 7805 * * *

    Par. 2. Section 1.1271-0 is amended by adding entries for 
paragraphs (k) through (k)(3) to Sec. 1.1275-1 to read as follows:


Sec. 1.1271-0  Original issue discount; effective dates; table of 
contents.

* * * * *


Sec. 1.1275-1  Definitions.

* * * * *
    (k) Exception under section 1275(a)(1)(B)(ii) for annuities issued 
by an insurance company subject to tax under subchapter L.
    (1) Rule.
    (2) Examples.
    (3) Effective date.
* * * * *
    Par. 3. Section 1.1275-1 is amended by adding paragraph (k) to read 
as follows:


Sec. 1.1275-1  Definitions.

* * * * *
    (k) Exception under section 1275(a)(1)(B)(ii) for annuities issued 
by an insurance company subject to tax under subchapter L--(1) Rule. 
For purposes of section 1275(a)(1)(B)(ii), an annuity contract issued 
by a foreign insurance company is considered as issued by an insurance 
company subject to tax under subchapter L if the insurance company is 
subject to tax under subchapter L with respect to income earned on the 
annuity contract.
    (2) Examples. The following examples illustrate the rule of 
paragraph (k)(1) of this section. Each example assumes that the annuity 
contract is a contract to which section 72 applies and was issued in a 
transaction where there is no consideration other than cash or another 
qualifying annuity contract, pursuant to the exercise of an election 
under an insurance contract by a beneficiary thereof on the death of 
the insured party, or in a transaction involving a qualified pension or 
employee benefit plan. The examples are as follows:

    Example 1.  Company X is an insurance company that is organized, 
licensed and doing business in Country Y. Company X does not have a 
U.S. trade or business and is not, under section 842, subject to 
U.S. income tax under subchapter L with respect to income earned on 
annuity contracts. A, a U.S. taxpayer, purchases an annuity contract 
from Company X in Country Y. The annuity contract is not excepted 
from the definition of a debt instrument by section 
1275(a)(1)(B)(ii).
    Example 2.  The facts are the same as in Example 1, except that 
Company X has a U.S. trade or business. A purchased the annuity from 
Company X's U.S. trade or business. Under section 842(a), Company X 
is subject to tax under subchapter L with respect to income earned 
on the annuity contract. Under these facts, the annuity contract is 
excepted from the definition of a debt instrument by section 
1275(a)(1)(B)(ii).
    Example 3.  The facts are the same as in Example 2, except that 
there is a tax treaty between Country Y and the United States. 
Company X is a resident of Country Y for purposes of the U.S.-
Country Y tax treaty. Company X's activities in the U.S. do not 
constitute a permanent establishment under the U.S.-Country Y tax 
treaty. Because Company X does not have a U.S. permanent 
establishment, Company X is not subject to tax under subchapter L 
with respect to income earned on the annuity contract. Thus, the 
annuity contract is not excepted from the

[[Page 2854]]

definition of a debt instrument by section 1275(a)(1)(B)(ii).
    Example 4.  The facts are the same as in Example 1, except that 
Company X is a foreign insurance corporation controlled by a U.S. 
shareholder. Company X does not make an election under section 
953(d) to be treated as a domestic corporation. The controlling U.S. 
shareholder is required under sections 953 and 954 to include income 
earned on the annuity contract in its taxable income under subpart 
F. However, Company X is not subject to tax under subchapter L with 
respect to income earned on the annuity contract. Thus, the annuity 
contract is not excepted from the definition of a debt instrument by 
section 1275(a)(1)(B)(ii).
    Example 5.  The facts are the same as in Example 4, except that 
Company X properly elects under section 953(d) to be treated as a 
domestic corporation. By reason of its election, Company X is 
subject to tax under subchapter L with respect to income earned on 
the annuity contract. Thus, the annuity contract is excepted from 
the definition of a debt instrument by section 1275(a)(1)(B)(ii).

    (3) Effective date. This paragraph (k) is applicable for interest 
accruals on or after the date that is 30 days after final regulations 
are published in the Federal Register. This paragraph (k) does not 
apply to an annuity contract that was purchased before January 12, 
2001. For purposes of this paragraph (k), if any additional investment 
in a contract purchased before January 12, 2001 is made on or after 
January 12, 2001, and the additional investment is not required to be 
made under a binding written contractual obligation that was entered 
into before that date, then the additional investment is treated as the 
purchase of a contract after January 12, 2001.

David A. Mader,
Acting Deputy Commissioner of Internal Revenue.
[FR Doc. 01-271 Filed 1-11-01; 8:45 am]
BILLING CODE 4830-01-P