Court rules on sale of ownership rights in insurance company demutualization.

• Author: Beavers, James

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Applying the open transaction doctrine, the Court of Federal Claims held that a trust was entitled to a refund of taxes paid on the proceeds of the sale of stock the trust received in exchange for its ownership rights in a mutual life insurance company when the company was demutualized.

Facts

In December 1999, the holders of participating life insurance policies (the policyholders) issued by Sun Life Assurance Company (Sun Life), a mutual life insurance and financial services company based in Canada, approved a demutualization plan for the company that was effective in March 2000. Under the plan, the policyholders were to receive stock in the successor company to Sun Life in exchange for the voting and liquidation rights (ownership rights) in Sun Life they held by virtue of being participating policyholders. The plan included a cash election option, under which policyholders who had held their policies on January 27, 1998, could receive cash instead of stock by authorizing Sun Life to sell the stock they were issued under the plan immediately in connection with the company's public offering.

The Seymour P. Nagan Irrevocable Trust (whose trustee was Eugene Fisher) was a holder of a participating Sun Life policy on January 27, 1998. The trust made the cash election and in 2000 received $31,759 from the sale of its stock in the successor company. After demutualization, the trust continued to hold its insurance policy, and its dividend and other rights under the policy (other than its ownership rights) remained the same.

The trust reported the full amount of the proceeds from the sale as income on its 2000 tax return and paid $5,725 tax on the income. In 2004, the trust filed a claim for refund for the tax paid on the proceeds from the sale. The IRS denied the claim, maintaining that the trust received the stock it sold in return for its ownership rights in Sun Life; because the trust had a zero basis in those ownership rights, it likewise had a zero basis in the stock and the entire proceeds from the sale of the stock were taxable gain. The IRS asserted that the ownership rights had a zero basis because they had no value when the trust acquired its insurance policy from Sun Life in 1990. The trust subsequently filed a refund suit in the Court of Federal Claims.

The Parties' Arguments

The trust argued that it had a basis in the ownership rights from the time it originally purchased the Sun Life policy. According to the...