Third-Party Purchaser’s E&P Reduced by Interest on Loan Incurred to Acquire Life Insurance Policy


Revenue Ruling 2009-25 (the “Ruling”), 2009-38 I.R.B., addresses the issue of when interest that is disallowed as a deduction under Section 264(a)(4) of the Internal Revenue Code (the “Code”) is taken into account in determining earnings and profits (“E&P”) of a third-party purchaser (the “Purchaser”) of a life insurance contract. The Ruling concludes that interest, even though disallowed under Code Section 264(a)(4), reduces the Purchaser’s E&P for the tax year in which the interest would have been allowable as a deduction. However, the Ruling also determines that when the death benefit is received under a life insurance contract, E&P cannot be further reduced.

The Ruling is likely to be most relevant to a U.S. shareholder of a controlled foreign corporation (“CFC”) that has “subpart F” income. Although E&P is used to determine whether a corporation’s distributions to shareholders are treated as “dividend” income for U.S. federal income tax purposes, the same concept is also relevant to the U.S. shareholders of a CFC, who must annually include their pro rata shares of the corporation’s subpart F income in their U.S. tax returns up to the amount of the CFC’s E&P. In confirming that the E&P of a CFC is reduced currently by items of disallowed interest expense, the IRS took a position that is consistent with the view of E&P as a reflection of the CFC’s ability to pay dividends.

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