Webber v. Commissioner - Important Tax Court Ruling on the Application of the Investor
Control Doctrine for PPVUL and PPVA Investment Accounts
By Michael Liebeskind
Summary
On June 30, 2015, the Tax Court issued a ruling in the case of Webber v. Commissioner (T.C., No. 1433611, 144 T.C. No. 17, 6/30/15) affirming the enforceability of the Investor Control Doctrine.
Under the Investor Control Doctrine, the owner of a Private Placement Variable Universal Life (PPVUL)
or Private Placement Variable Annuity (PPVA) Investment Account cannot directly or indirectly influence
the investment manager of a fund held within the PPVUL or PPVA Investment Account. The critical issue
is whether the fund's investment manager exercised full discretion over the selection of specific assets
for the fund. If not, the Investor Control Doctrine is violated and the owner of the PPVUL or PPVA
Investment Account will be held liable for income tax on any investment gains realized on the assets of
the fund.
The decision in Webber v. Commissioner may be appealed, but if it holds up it may be regarded as a
seminal work for the PPVUL and PPVA Investment Accounts market, and we would expect it to be cited
frequently as precedent for future rulings that relate to the application of the Investor Control Doctrine.
In Webber v. Commissioner, the Tax Court drew the following conclusions:
-- The IRS pronouncements enunciating the Investor Control Doctrine are entitled to deference and
weight, and
-- The owner of the PPVUL Investment Account "retained control and incidents of ownership over the
assets," and was therefore "taxable on the income earned on those assets during the taxable years at
issue."
The Investor Control Doctrine helps to protect the basic income tax preferences accorded to life
insurance and annuities (the most important of which is the deferral or elimination of income tax on the
"inside buildup"), and the well-reasoned opinion in Webber v. Commissioner is therefore welcome news
for the PPVUL/PPVA market and for the life insurance industry in general. By providing clear guidance
about what is out-of-bounds, the Tax Court brightens the lines of demarcation that were developed by
the IRS for variable life and annuity investment accounts over four decades and which, in the words of
the Tax Court opinion, "have engendered stability and long-term reliance through the private ruling
process and otherwise."
Webber v. Commissioner is also a shot across the bow for PPVUL and PPVA Investment Account owners
and insurance companies whose activities violate the fundamental tenets of the Investor Control
Doctrine, and we would not be surprised to see the IRS take more aggressive enforcement action in light
of this ruling. Fortunately, the vast majority of PPVUL and PPVA Investment Accounts owned by high
net worth individuals and entities for the benefit of their families are being administered in compliance
with the Investor Control Doctrine and other boundaries established in various IRS pronouncements.
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Findings of Fact
-- Jeffrey T. Webber, referred to in the ruling as the "Petitioner," was a venture capital investor who
established a Grantor Trust that was the owner of several PPVUL Investment Accounts issued by
Lighthouse Capital Insurance Co. (Lighthouse), a Cayman Islands company. Mr. Webber and family
members were the beneficiaries of the Investment Accounts, and two elderly relatives of Mr.
Webber were the insureds.
-- The PPVUL Investment Accounts included enough life insurance coverage to conform with the
requirements of IRC 7702(a). However, the cash surrender value of the PPVUL Investment Accounts
was restricted to the cumulative net premium deposits (i.e. cost basis).
-- During the period at issue, 2006 and 2007, Butterfield Private Bank (Butterfield), a Bahamian bank,
served as the investment manager for separate accounts established by Lighthouse for the PPVUL
Investment Accounts. Butterfield was paid an annual fee of $500 for investment management
services. Lighthouse charged an annual fee equal to 1.25% of the separate account value for
administration of the PPVUL Investment Accounts.
-- Nearly all of the investments within the separate accounts consisted of nonpublicly-traded securities
in which Mr. Webber had a personal financial interest (e.g., by sitting on its board, by investing in its
securities personally or through an IRA, or by investing in its securities through a venture-capital fund
he managed).
-- All of the investments within the separate accounts consisted of securities recommended by Mr.
Webber's attorney, William Lipkind (who also served as the trustee for the Grantor Trust that owned
the PPVUL Investment Accounts), or Mr. Webber's personal accountant, Susan Chang, under a set of
procedures that were referred to as the "Lipkind Protocol." Mr. Lipkind is an experienced tax
attorney who had advised Mr. Webber not to appear to exercise any control over the investments
within the separate account. However, after examining the facts, including 70,000 emails to or from
Mr. Lipkind or Ms. Chang regarding investments "recommended" for the separate account (all of
which were acted upon with no independent research or due diligence by either Butterfield or
Lighthouse), the Tax Court concluded that "Mr. Lipkind and Ms. Chang served as conduits for the
delivery of instructions from petitioner."
-- With these facts in mind, the Tax Court determined that the "Lipkind Protocol" arrangement violated
the Investor Control Doctrine.
Investor Control Doctrine - History and Deference
-- The Tax Court noted that the Investor Control Doctrine has its roots in Supreme Court jurisprudence
dating to the early days of the Federal income tax, including Poe v. Seaborn, 282 U.S. 101, 109 (1930)
and Blair v. Commissioner, 300 U.S. 5, 12 (1937), which established the principle that "the tax liability
attaches to ownership." The Tax Court then provided a reminder that, as the Supreme Court stated
in Griffiths v. Helvering, 308 U.S. 355, 357-358 (1939), "taxation is not so much concerned with
refinements of title as it is with actual command over the property taxed" and "it makes no
difference that such 'command' may be exercised through specific retention of legal title or the
creation of a new equitable but controlled interest, or the maintenance of effective benefit through
the interposition of a subservient agency."
-- The Tax Court acknowledged that the Investor Control Doctrine for variable annuity investment
accounts was established with a series of revenue rulings dating back to 1977 (Rev. Rul. 77-85, 19771 C.B. 12, Rev. Rul. 80-274, 1980-2 C.B. 27, Rev. Rul. 81-225, 1981-2 C.B. 13, Rev. Rul. 82-54, 1982-1
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C.B. 11), and highlighted the Investor Control Doctrine safe harbors for both variable annuity and
variable life investment accounts articulated in Rev. Rul. 2003-91, 2003-2 C.B. 237:

The policyholder had the right to change the allocation of his premiums among the subaccounts
(i.e. funds offered only through variable annuity and life insurance investment accounts) at any
time and transfer funds among subaccounts.

All investment decisions regarding the subaccounts were made by an independent investment
manager engaged by the insurance company.

The policyholder "cannot select or recommend particular investments" for the subaccounts.

The policyholder "cannot communicate directly or indirectly with any investment
officer...regarding the selection...of any specific investment or group of investments" within the
subaccounts.

And there is "no arrangement, plan, contract, or agreement" between the policyholder and the
insurance company or investment manager "regarding the investment strategy of any
subaccount, or the assets to be held by any subaccount."
-- The Tax Court concluded that the Investor Control Doctrine revenue rulings over the past 38 years
deserve deference under Skidmore v. Swift & Co., 323 U.S. 134 (1944) because they "reflect a
consistent and well-considered process of development," and appear "nuanced and reasonable,
resolving particular fact patterns favorably or unfavorably to taxpayers in light of the bedrock
principles initially set forth." The Tax Court goes on to state that the IRS revenue rulings enunciating
the Investor Control Doctrine "have reasonably applied well-settled principles of Supreme Court
jurisprudence to a complex area of taxation," and that the legal framework suggested by the IRS
in Webber v. Commissioner is consistent with prior case law and would have been adopted by the
Tax Court regardless of deference.
Investor Control Doctrine - Enforceability
-- Mr. Webber made a series of counterarguments in Webber v. Commissioner, suggesting that the
Investor Control Doctrine was inapplicable in general or under the facts of this specific case. The Tax
Court rejected each one:

Mr. Webber argued that he was not in "Constructive Receipt" of the PPVUL Investment Assets
because access to those assets in excess of cost basis was restricted under the terms of the
contract with Lighthouse. The Tax Court concluded that "The Investor Control Doctrine
addresses a different problem, and a finding of Constructive Receipt is not a prerequisite to its
application." Tax Court cites Helvering v. Clifford, 309 U.S. 331, 60 S. Ct. 554 and states: "If
petitioner was the true owner, he is treated as having actually received what the separate
accounts actually received; resort to 'constructive receipt' is not necessary."

Mr. Webber argued that the Investor Control Doctrine does not apply to life insurance
investment accounts, pointing out that Rev. Rul. 77-85 and its immediate successors addressed
variable annuity contracts. The Tax Court disagreed, pointing out statutory authority, IRC
817(d)(2), that defines a "variable contract" as a segregated asset account that "(A) provides for
the payment of annuities [or] (B) is a life insurance contract." The Tax Court hints at a broader
social benefit being served by the Investor Control Doctrine tax policy, asserting "To the extent
the Investor Control Doctrine seeks to limit misuse of tax-favored investment assets, there is no
good reason to limit its application to annuities."
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
Mr. Webber argued that the Investor Control Doctrine cannot be applied to a contract that
satisfies the statutory definition, under IRC 7702, of a life insurance policy. The Tax Court found
that conclusion illogical, stating that "petitioner's conclusion does not follow from his
premise...7702(a) does not determine, for Federal income tax purposes, who owns the separate
account assets that support the Policies."

Mr. Webber offers an alternative argument that if the Investor Control Doctrine is applied by
the Tax Court to treat him as the owner of the separate account assets, the tax result should be
dictated by section 7702(g), pointing back to the Constructive Receipt and Risk of Forfeiture
arguments that the Tax Court appears to have rejected moments earlier. The Tax Court recalls
that all parties are in agreement that the PPVUL Investment Accounts in this case meet the
requirements of 7702(a), thereby rendering 7702(g) irrelevant. But foreshadowing possible
future cases that may be brought before the Tax Court under which a PPVUL Investment
Account does not meet the requirements of 7702(a), the ruling rejects the idea of reliance on
7702(g) by concluding that "it would be illogical to find that petitioner owns the underlying
assets, then tax the income earned on those assets as if they were owned by the insurance
company."

Mr. Webber's final argument is that Congress intended Section 817(h), enacted into law in 1984,
to eliminate the Investor Control Doctrine altogether. The Tax Court points to the legislative
history, including the authority granted by Congress to the Department of Treasury to
implement temporary and final regulations. The preamble to the temporary regulations issued
in 1986 (in advance of final regulations issued in 1989) states that the "diversification
standards...do not provide guidance concerning the circumstances in which investor control of
the investments of a segregated asset account may cause the investor, rather than the
insurance company, to be treated as the owner of the assets in the account." The Tax Court
points out that in the 30 years since the enactment of Section 817(h), the IRS has continued to
issue revenue rulings, private letter rulings, and other pronouncements confirming that the
Investor Control Doctrine remains vital, and notes that "Congress has certainly evidenced no
disagreement with that position." The Tax Court specifically mentions the following
pronouncements, so professional advisors should take heed of each of them:
o Rev. Rul. 2003-91, 2003-2 C.B. 349-350
o Rev. Rul. 2003-92, 2003-2 C.B. 351-352
o Priv. Ltr. Rul. 201105012 (Feb, 4, 2011)
o Priv. Ltr. Rul. 200420017 (May 14, 2004)
o Priv. Ltr. Rul. 9433030 (Aug. 19, 1994)
o See also C.C.A. 200840043 (October 3, 2008)
If you have any questions about this Tax Court ruling, or about its application to PPVA and PPVUL
Investment Accounts, please don't hesitate to contact Michael Liebeskind at mliebeskind@sali.com.
Michael Liebeskind is a Principal of SALI Fund Services, Inc. Founded in 2002, SALI Fund Services provides
a turn-key solution for the creation and administration of Insurance-Dedicated Funds. For more
information, please visit www.sali.com.
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