REVENUE RULING 71-233
1971-1 C.B. 113

[IRS Annotation]
A merger of a mutual life insurance company into a newly organized stock life insurance company under state law, whereby policyholders exchange their proprietary interests for preferred stock, is a reorganization under section 368(a)(1)(A) of the Code.

Rev. Rul. 71-233
Advice has been requested with respect to the Federal income tax consequences of the merger of a mutual life insurance company into a stock life insurance company under the circumstances described below.

Corporation X is a mutual life insurance company with no excess of gain from operations over taxable investment income. It is subject to tax imposed by section 802 of the Internal Revenue Code of 1954. Pursuant to a plan of reorganization, X will be [114] merged under state law into corporation Y, a newly organized life insurance company taxable under section 802 of the Code.

Y will acquire all of the assets, subject to all of the liabilities of X, including all liabilities under the outstanding insurance policies issued by X. Consequently, the contractual rights of the policyholders of X with respect to their outstanding insurance contracts will be unaffected by the merger except that Y will become the insurer of such contracts.

Upon consummation of the merger, Y corporation will issue solely all of its four percent nonvoting cumulative preferred stock to the policyholders of X in exchange for their proprietary interests in its assets. Since both participating and nonparticipating policyholders of X are the owners of the assets of X, both will be entitled to receive preferred stock of Y on the exchange, and none will receive less than one share.

By operation of state law all of the policyholders of a mutual insurance company have a dual legal relationship to the company: (1) as members of a membership corporation they have proprietary interests, and (2) as policyholders they possess the contractual rights provided for in their insurance contracts. See, for example, Duffy v. Mutual Benefit Life Insurance Co., 272 U.S. 613 (1926), T.D. 3959, C.B. VI-1, 278 (1927), Ohio State Life Insurance Co. v. Clark, 274 F.2d 771 (1960); State v. Willett, 171 Ind. 296. 86 N.E. 68 (1908). See also section 7701(a)(7) and section 7701(a)(8) of the Code.

Payment by each policyholder of the premiums called for by the insurance contracts issued by X represents payment for the cost of insurance and an investment in his contract but not an investment in the assets of X. His proprietary interest in the assets of X arises solely by virtue of the fact that he is a policyholder of X. Therefore, the basis of each policyholder's proprietary interest in X is zero.

Section 368(a)(1)(A) of the Code defines the term "reorganization" as a statutory merger or consolidation. However, an otherwise qualified transaction does not constitute a reorganization within the meaning of the Code unless the continuity of interest requirement of section 1.368-1(b) of the Income Tax Regulations is satisfied.

In the instant case, since the policyholders of X received solely preferred stock of Y in exchange for their proprietary interest in X, the continuity of interest requirement is met.

Accordingly the merger of X into Y in compliance with state law is a reorganization under section 368(a)(1)(A) of the Code. Both X and Y will be parties to the reorganization pursuant to section 368(b) of the Code. No gain or loss will be recognized to either X or Y because of the application of sections 361(a) and 1032(a) of the Code. No gain or loss will be recognized to the policyholder-members of X upon the exchange of their proprietary interests in X for the preferred stock of Y pursuant to section 354(a)(1) of the Code. Pursuant to the provisions of section 358(a) of the Code, each policyholder will have a zero basis in the preferred stock issued to him by Y since the basis in his proprietary interest exchanged therefor was zero.

The instant transaction is one to which section 381(c) of the Code applies. Pursuant to section 381(c)(22) of the Code and section 1.381(c)(22)-1 of the Income Tax Regulations, the acquiring life insurance company is required to take into account the appropriate items that the transferor was required to take into account for purposes of part I, subchapter L, chapter 1 of the Code. The acquiring life insurance company also is required to take into account the items described in paragraphs (2) through (21), other than paragraphs (14), (15), and (17) of section 381(c) of the Code. For example, the acquiring life insurance company must take into account the reserves described in section 810(c) of the Code transferred to it as of the close of the date of transfer by the transferor life insurance company in accordance with the provisions of section 381(c)(4) of the Code and the regulations thereunder.

Further, consistent with section 806(a) of the Code the mean of such reserves and the mean of the assets will be appropriately adjusted on a daily basis to reflect the amounts involved in the transfer.

The earnings and profits of X will, pursuant to section 381(c)(2) of the Code, carry over and be added to the earnings and profits of Y. The accumulated earnings and profits of X at the date of the merger will be not less than the amount of its total surplus, including the mandatory securities valuation reserve and any other surplus reserves on that date.