LOAN FEES TO FOREIGN INSURANCE COMPANY QUALIFY FOR TREATY EXEMPTION AS COMMERCIAL PROFITS.

UIL Number(s) 0894.00-00

                                             Date: March 7, 1988

This is in response to your letter of May 27, 1987 and your subsequent submissions requesting a ruling that certain fees paid by X to a Country Z life insurance company in connection with Y's loan of stock or securities will be exempt from United States taxation under Article of the Convention Between the United States and * * * for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income ("Treaty") * * *. The following relevant information has been submitted for consideration.

X, a domestic corporation, is a broker-dealer registered under the Securities Exchange Act of 1934. X engages in a broad range of activities in the financial services business, including the borrowing and lending of stocks and bonds of domestic and foreign corporations. X's stock and security borrowing and lending activities are regulated by various nontax statutes and regulations designed to limit stock and security borrowing and lending transactions to those with a valid purpose and to instill certain protections to stock loan transactions participants. We assume that the proposed transaction will fully comply with such statutes and regulations.

Y is a Country Z corporation that engages in the life insurance business in Country Z. * * *

X proposes to enter into a so-called securities lending agreement (the "Agreement") with Y. Pursuant to the Agreement, X will borrow securities from Y generally for the purpose of making delivery of the securities in connection with a short sale by a related or unrelated party (the "Borrower"). For purposes of this ruling, we assume that any transfer of securities pursuant to the Agreement meets the requirements of section 1058 (relating to the transfer of securities under certain agreements). Thus, we are offering no opinion regarding the treatment under the Treaty of any amounts (including Fees and Substitute Payments described herein) generated under the Agreement if a transfer of securities by Y to X is not a transfer described in section 1058. ¹

Procedurally, the borrowing would occur in a series of steps. First, X will receive the names of the securities that the Borrower wishes to borrow. Next, a representative of X located in the United States would call either Y or agents of Y located in the United States to inquire about the availability of the requested securities and to negotiate the fee (the Fee) as described below. X's representative would then request Y or its agent not to lend the specific securities to anyone else for a period, typically 24 hours. X's representative would then notify the Borrower that the securities were available; and the Borrower, if it wished, would sell the securities short and authorize X to borrow them.

Mechanically, the borrowing would occur by the use of depositories. Y will have a depository -- an agent, always located in Country Z and generally a financial institution --which has physical custody of the share certificates. Y would direct its depository to place share certificates for the loaned securities at the disposal of X. In CountrY Z, this would be done by physically delivering the certificates to X's depository in Country Z, which may be a corporation related to X acting as X's agent in arranging for the delivery.

X will then direct that the shares be transferred to the depositor of the Borrower (or in some cases, the transfer may be made directly from the depository of Y to the Borrower); and the Borrower will in turn direct that the share certificates be transferred to the depository of either (a) the person to whom it has reloaned them or (b) to whom it has made a short sale. (If the purchaser is the customer of a securities firm, transfer will be made to the depository of such firm). The ultimate owner may well request the issuer to reregister the shares in his name, and new certificates will be issued. In no circumstances will the old or new certificates leave Country Z.

At the time the Borrower is required to return the loaned securities, the process will be reversed: the Borrower will acquire securities identical to the loaned securities, and certificates for the securities so acquired will ultimately be retransferred to the depository of Y and reregistered in the name of Y.

Generally, the Agreement includes the following terms and conditions:

1. Y will furnish securities to X, and X will deliver collateral to Y. The collateral will be either cash, a letter of credit, Treasury obligations or similar security. The value of the collateral must generally equal at least 100% of the market value of the loaned securities throughout the term of the loan. An adjustment to the collateral amount must be made if its value at the close of any business day is less than 100% of the market value of such securities.

2. In consideration for the loan, X will pay the Fee to the Y (calculated as described below) and, in addition to the Fee, an amount equal to all distributions in respect of loaned securities (Substitute Payments) during the period in which the securities are borrowed by X.

3. During the period of the borrowing, X will have all incidents of ownership in the loaned securities, including voting rights and the right to transfer them to others.

4. Y may use or invest the collateral, if it consists of cash, at its own risk. Y cannot pledge, repledge, hypothecate, rehypothecate, lend, relend, commingle, with other collateral or with its own assets, the collateral, if such consists of other than cash.

5. Except in the case of a default, Y shall be obligated to return the collateral to X on termination of the loan upon tender to X of the loaned securities.

6. Y may terminate the loan upon notice of 5 business days.

Typically, the Fee that X will pay to Y will vary depending on market conditions and the securities involved. The more scarce the supply of securities available for borrowing, the higher the Fee Y will demand. The form in which X will pay the Fee will depend upon the type of collateral it uses. If X uses cash collateral, it will obtain from Y a return on that collateral calculated as a percent of a publicly-known interest rate -- for example, the London interbank offering rate known as LIBOR. In a typical situation, where the borrowed securities are not particularly scarce, X might receive a rate of 85 percent of LIBOR as in effect from time to time. This is independent of the return Y may obtain on such collateral, and is less than the rate X could have obtained by investing the collateral for its own account. In situations of extreme scarcity, X could obtain a return on its cash collateral as low as 20 percent of the interest rate used.

If a letter of credit or government securities are used as collateral, X will pay Y an amount in Fees calculated in terms of basis points. One hundred basis points equals one percent. Thus, if the Fee is 125 basis points and the securities are worth $1 million, X will pay Fees at the rate of $12,500 per year.

Section 61 of the Code provides that gross income means all income from whatever source derived. Section 894(a) provides that income of any kind, to the extent required by any treaty obligation of the United States, shall not be included in gross income and is exempt from taxation by the United States. The Fees do not constitute items of income dealt with separately in any Article of the Treaty except possibly Article * * * relating to industrial or commercial profits. Article * * * of the Treaty provides that industrial or commercial profits of Y are exempt from tax by the United States unless Y is engaged in industrial or commercial activity in the United States through a permanent establishment in the United States. Thus, assuming that Y has no permanent establishment in the United States, the Fees X pays to Y will be exempt from United States taxation if they are industrial or commercial profits within the meaning of the Treaty.

Article * * * of the Treaty defines industrial or commercial profits to include income derived from insurance activities. Such term also includes income derived from real property and natural resources, dividends, interest, royalties (as defined in paragraph * * * and capital gains, as those terms are defined in the Treaty, which are effectively connected with a permanent establishment of a Country Z resident maintained in the United States. Assuming that Y does not have a permanent establishment in the United States, the issue is whether the Fees are income derived from an insurance activity.

The term "insurance activities" is not defined within the Treaty. However, * * * "term 'industrial or commercial profits' is defined by setting forth several examples of activities which constitute the active conduct of a trade or business . . . ". * * * Thus, the Fees are industrial and commercial profits if the activity that generates the Fees constitutes the active conduct of an insurance business.

Generally, insurance companies earn two types of income, underwriting income and investment income. While the activity of loaning securities described above may not constitute the active conduct of a trade or business for many businesses, for purposes of the Treaty such activity does constitute the active conduct of a life insurance business. The nature of a life insurance business is such that underwriting income alone does not cover a life insurance company's cost of its business. Rather, a life insurance company must also generate investment income to enable it to cover anticipated future claims. Loaning securities is one way for Y to maximize its return on its investment portfolio. Therefore, we find that generating Fees through security loans pursuant to the Agreement is part of an active trade or business for a life insurance company under the Treaty and, hence, the Fees constitute industrial or commercial profits for purposes of Article * * * of the Treaty.

Accordingly, based solely upon the facts and the representations submitted, and assuming Y does not have a permanent establishment in the United States and the Agreement meets the requirements of section 1058, it is held that the Fees paid by X to Y under the Agreement will be exempt from United States taxation under Article of the Treaty.

No opinion is expressed regarding the tax treatment of the proposed transaction under other sections of the Code or regulations that may be applicable or the tax treatment of any conditions existing at the time of, or facts resulting from, the proposed transaction that are not specifically covered by the above ruling. Thus, for example, no opinion is expressed regarding the tax treatment of the Substitute Payments including their source and character under the Treaty and the Code, whether Y has a permanent establishment in the United States or, if it did, whether the Fees would be exempt from United States taxation, or the class of gross income that the Fees should be allocated to, for example for purposes of computing the foreign tax credit limitation under section 904.

This ruling is directed only to the taxpayer who requested it. Section 6110(j)(3) of the Code provides that this ruling may not be used or cited as precedent.

A copy of this ruling letter should be attached to the federal income tax return of the taxpayer involved for the taxable year in which the transaction is consummated.

Pursuant to a power of attorney on file in this office, this letter and the taxpayer's copy is being sent to you as X's authorized representative.

                                   Sincerely yours,