Internal Revenue Service
Revenue Ruling

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 Rev. Rul. 68-85

1968-1 C.B. 97

Sec. 171
Sec. 263
Sec. 818
Sec. 822

IRS Headnote

Interest equalization taxes paid by life insurance companies upon the acquisition of notes purchased at par from a foreign corporation qualify as amortizable bond premium for purposes of section 818(b) of the Internal Revenue Code of 1954. Such taxes paid by mutual insurance companies (other than life) qualify as amortizable bond premium for purposes of section 822(d)(2) of the Code. In the case of both types of insurance companies, interest equalization taxes that are reimbursed by the borrower are deductible as ordinary and necessary expenses to the extent the reimbursements are included in gross income. This deduction must, however, be reduced by the amount of the adjustment made under section 818(b) or section 822(d)(2) of the Code for interest equalization tax that qualified as amortizable bond premium.

Full Text

Rev. Rul. 68-85

Advice has been requested whether interest equalization taxes paid upon the acquisition at par of a foreign corporation's debt obligations, by life insurance companies subject to the tax imposed by section 802 of the Internal Revenue Code of 1954 and by mutual insurance companies (other than life) subject to the tax imposed by section 821 of the Code, qualify as amortizable bond premium as defined under section 171(b) of the Code.

Certain life insurance companies and mutual casualty insurance companies agreed in 1965 to purchase from a foreign corporation, at par, up to 5.5 x dollars principal amount of freely transferable notes.

The foreign corporation will pay the total amount necessary to cover (1) the principal amount borrowed, (2) the interest equalization tax paid, and (3) interest on the total amount of principal plus interest equalization tax paid.

Section 263(a)(3) of the Code states the general rule that no deduction shall be allowed for the payment of interest equalization tax. However, if an amount paid as interest equalization tax creates amortizable bond premium, within the meaning of section 171(b) of the Code, such premium will be deductible under subsection (a) of section 171. House Report No. 1046, Eighty-eighth Congress, First Session, C.B. 1964-2, 708, 759-760, and Senate Report No. 1267, Eighty-eighth Congress, Second Session, C.B. 1964-2, 767, 783-784.

Section 171(d) of the Code includes in the definition of the term of `bond,' for purposes of section 171, a note issued by any corporation and bearing interest.

Section 1.171-2(a)(1) of the Income Tax Regulations, in applying section 171(b)(1) of the Code, defines bond premium as the excess of the amount of the basis of the bond over the amount payable at maturity. Section 171(b)(2) of the Code provides that the amortizable bond premium for the taxable year shall be the amount of the bond premium attributable to such year.

In the case of a life insurance company, section 818(b)(1) of the Code provides an adjustment to appropriate items of income, deductions, and adjustments to reflect the appropriate amortization of bond premium. Section 818(b)(2)(A) of the Code further states that in the case of any bond (as defined in section 171(d) of the Code) acquired after December 31, 1957, the amount of bond premium, and the amortizable bond premium for the taxable year, shall be determined under section 171(b) as if the election (to amortize bond premium) set forth in section 171(c) of the Code had been made. See also, section 1.818-3 of the regulations.

In the case of mutual insurance companies (other than life), section 822(d)(2) of the Code provides a similar adjustment in computing taxable investment income. See also, section 1.822-10 of the regulations.

The notes purchased by the insurance companies in this case are bonds as defined in section 171(d) of the Code. As the notes were purchased at par, the addition to the basis of the notes of the interest equalization taxes paid will create bond premium in the amount of the taxes.

Accordingly, interest equalization taxes paid by life insurance companies upon the acquisition of notes purchased at par from a foreign corporation qualify as amortizable bond premium for purposes of section 818(b) of the Code. Such taxes paid by mutual insurance companies (other than life) qualify as amortizable bond premium for purposes of section 822(d)(2) of the Code. In the case of both types of insurance companies, interest equalization taxes that are reimbursed by the borrower are deductible as ordinary and necessary expenses to the extent the reimbursements are included in gross income. This deduction must, however, be reduced by the amount of the adjustment made under section 818(b) or section 822(d)(2) of the Code for interest equalization tax that qualified as amortizable bond premium. See sections 818(f) and 822(d)(3) of the Code, which prevent the same item from being deducted more than once. Compare section 263(d) of the Code applicable to taxpayers other than insurance companies.