On August 6, 2008, the Internal Revenue Service issued Revenue Ruling 2008-45, holding that the transfer of a qualified retirement plan from an employer to an unrelated taxpayer is impermissible under the exclusive benefit rule of Internal Revenue Code § 401(a) if the transfer is not in connection with a transfer of business assets, operations or employees. In a related development, the Treasury Department, in association with the Department of Labor, the Commerce Department and the Pension Benefit Guaranty Corporation, released a framework of principles to guide Congress in developing legislation that would allow similar transfers of qualified plans within certain parameters.
Following a practice allowable in the U.K., there has been a recent discussion of a financial institution or other entity acquiring a U.S. business that holds only an underfunded defined benefit plan and liquid assets approximately equal to the underfunding. In such a transaction, the acquirer’s goal is to generate a profit through efficient management of the plan and the acquired assets; the seller is able to remove the liability for the plan from its books. The revenue ruling seeks to stop these transactions by holding that the plan will cease to be qualified upon the transfer to the acquirer.
The ruling presents the hypothesis of a corporation that transfers its frozen, underfunded defined benefit plan to a wholly owned-subsidiary. The subsidiary is not engaged in any trade or business, has no employees and has nominal assets; the parent corporation transfers to it only the plan and cash and marketable securities approximately equal to the amount of the plan’s underfunding, with a (presumably modest) margin. Subsequently, at least 80% of the subsidiary’s stock is transferred to an unrelated corporation, and the subsidiary ceases to be a member of its original parent’s controlled group. In addition, the transfer of the subsidiary is not in connection with the transfer of any business assets, operations or employees from the original parent’s controlled group.
The IRS evaluated whether the transfer would cause the plan to violate the requirement under Code § 401(a) that a qualified retirement plan must be for the exclusive benefit of an employer’s employees or their beneficiaries. Specifically, a qualified plan must be established and maintained by an employer to provide retirement benefits to employees or their beneficiaries. The ruling focuses on this requirement, questioning whether a benefit plan transferred to an entity outside of the controlled group in which the participants are employed can be said to be “maintained by an employer.”
The IRS noted that Code § 414(b) provides that all employees of entities within the same controlled group of corporations are treated as employed by a single employer for purposes of Code § 401. The ruling concluded that the subsidiary to which the plan was transferred was an employer under Code § 414(b) while it remained within the parent’s controlled group. Once it was disconnected from the parent’s controlled group in a transaction that covered no employees and no operating business assets, however, it could not be treated as the employer of the plan’s participants, and the plan no longer satisfied the exclusive benefit rule of Code § 401(a). The ruling was extended to cover situations in which some employees and/or some business assets are transferred to the new controlled group, saying that the transfer will still fail the exclusive benefit rule if substantially all the business risks and opportunities under the transaction are associated with the transfer of the sponsorship of the plan.
In conjunction with the ruling, the Administration put forth a “framework of principles.” This framework, it is thought, will serve as a guide in the development of legislation permitting transactions such as the one described in the ruling in which frozen pension plans are transferred to unrelated entities. The Administration set out certain conditions aimed at protecting participants, including providing for advance notice to participants and regulators, requiring a demonstration that the transfer would be in the best interest of participants and limiting transfers in the face of undue risk. In addition, only financially strong, regulated entities would be permitted to acquire plans, and transferees would assume full responsibility for plan liabilities and reporting and fiduciary obligations.
These two developments reflect a determination by the Administration that current law does not, but should as a matter of policy, permit these transfers.
- While the revenue ruling gamely undertakes to do so, it is challenging under existing law to make principled and workable distinctions between conventional business combinations and the transfers in question.
- The Administration’s offer to develop a specific and joint resolution with Congress was met skeptically at least by Congressman Earl Pomeroy (D-N.D.), who is a member of the Ways and Means Committee, and who has been actively engaged on this issue. He said in a separate statement that he does not anticipate legislation permitting such transfers.