401(a) of such Code which is held on such date, paragraphs (2) and (3) of section 503 (h) of such Code shall be treated as satisfied if such requirements would have been satisfied if such obligation has been acquired on such date of enactment.

[T.D. 6493, 25 FR. 9216, Sept. 27, 1960, as amended by T.D. 6972, 33 F.R. 12904, Sept. 12, 1968]

§ 1.503 (h)-1 Certain loans by employees' trusts and supplemental unemployment benefit trusts.

(a) In general. (1) Section 503 (h) provides that the acquisition by an employees' trust described in section 401(a), or a supplemental unemployment benefit trust described in section 501(c) (17), of a bond, debenture, note, or certificate or other evidence of indebtedness shall not be treated as a loan made without the receipt of adequate security for purposes of section 503 (c) (1), relating to loans made without the receipt of adequate security and a reasonable rate of interest, if certain requirements are met. Those requirements are described in § 1.503 (h)−2.

(2) Section 503 (h) does not affect the requirement in section 503 (c) (1) of a reasonable rate of interest. Thus, although the acquisition of a certificate of indebtedness which meets all of the requirements of section 503 (h) and of § 1.503 (h)-2 will not be considered as a loan made without the receipt of adequate security, the acquisition of such an indebtedness does constitute a prohibited transaction if the indebtedness does not bear a reasonable rate of interest.

(3) The provisions of section 503 (h) do not limit the effect of section 401(a) and 1.401-2, relating to the use or diversion of corpus or income of an employees' trust, or the effect of the provisions of section 501(c) (17) (A) (i), relating to the diversion of the corpus or income of a supplemental unemployment benefit trust. Furthermore, the provisions of section 503 (h) do not limit the effect of any of the provisions of section 503 other than section 503 (c) (1). Thus, for example, although a loan made by an employees' trust described in section 401 (a) meets all the requirements of section 503 (h) and therefore is not treated as a loan made without the receipt of adequate security, an employees' trust making such a loan will lose its exempt status if the loan is not considered as made for the exclusive benefit of the employees or their beneficiaries. Similarly, a loan which meets the requirements of section 503 (h) will constitute a pro

hibited transaction within the meaning of section 503 (c) (6) if it results in a substantial diversion of the trust's income or corpus to a person described in section 503(c).

(b) Definitions. For purposes of section 503 (h):

"obligation"

(1) The term means bond, debenture, note, or certificate or other evidence of indebtedness.

(2) The term "issuer" includes any person described in section 503 (c) who issues an obligation.

(3) (1) The term "person independent of the issuer" means a person who is not related to the issuer by blood, by marriage, or by reason of any substantial business interests. Persons who will be considered not to be independent of the issuer include but are not limited to:

(a) The spouse, ancestor, lineal descendant, or brother or sister (whether by whole or half blood) of an individual who is the issuer of an obligation;

(b) A corporation controlled directly or indirectly by an individual who is the issuer, or directly or indirectly by the spouse, ancestor, lineal descendant, or brother or sister (whether by whole or half blood) of an individual who is the issuer;

(c) A corporation which directly or indirectly controls, or is controlled by, a corporate issuer;

(d) A controlling shareholder of a corporation which is the issuer, or which controls the issuer;

(e) An officer, director, or other employee of the issuer, of a corporation controlled by the issuer, or of a corporation which controls the issuer;

(f) A fiduciary of any trust created by the issuer, by a corporation which controls the issuer, or by a corporation which is controlled by the issuer; or

(g) A corporation controlled by a person who controls a corporate issuer.

(ii) For purposes of subdivision (1) of this subparagraph, the term "control" means, with respect to a corporation, direct or indirect ownership of 50 percent or more of the total combined voting power of all voting stock or 50 percent or more of the total value of shares of all classes of stock. If the aggregate amount of stock in a corporation owned by an individual and by the spouse, ancestors, lineal descendants, brothers and sisters (whether by whole or half blood) of the individual is 50 percent or more of the total combined voting power of all

voting stock or is 50 percent or more of the total value of all classes of stock, then each of these persons shall be coasidered as the controlling shareholder of the corporation.

(iii) In determining family relationships for purposes of subdivision (1) of this subparagraph, a legally adopted child of an individual shall be treated as a child of such individual by blood.

(4) The term "issue" means all the obligations of an issuer which are offered for sale on substantially the same terms. Obligations shall be considered offered for sale on substantially the same terms if such obligations would, at the same time and under the same circumstances, be traded on the market at the same price. On the other hand, if the terms on which obligations are offered for sale differ in such manner as would cause such obligations to be traded on the market at different prices, then such obligations are not part of the same issue. The following are examples of terms which, if different, would cause obligations to be traded on the market at different prices: (1) Interest rate;

(ii) Maturity date;
(iii) Collateral; and

(iv) Conversion provisions.

The fact that obligations are offered for sale on different dates will not preclude such obligations from being part of the same issue if they all mature on the same date and if the terms on which they are offered for sale are otherwise the same, since such obligations would, at the same time and under the same conditions, be traded on the market at the same price. Obligations shall not be considered part of the same issue merely because they are part of the same authorization or because they are registered as part of the same issue with the Securities and Exchange Commission. [T.D. 6493, 25 FR. 9216, Sept. 27, 1960, as amended by T.D. 6972, 33 F.R. 12904, Sept. 12, 1968]

section 501 (c) (17) must acquire the obligation on the market, by purchase from an underwriter, or by purchase from the issuer, in the manner described in subparagraph (2), (3), or (4) of this paragraph.

(2) On the market. (1) An obligation is acquired on the market when it is purchased through a national securities exchange which is registered with the Securities and Exchange Commission, or when it is purchased in an over-thecounter transaction. For purposes of the preceding sentence, securities purchased through an exchange which is not a national securities exchange registered with the Securities and Exchange Commission shall be treated as securities purchased in an over-the-counter transaction.

(ii) (a) If the obligation is listed on a national securities exchange registered with the Securities and Exchange Commission, it must be purchased through such an exchange or in an over-thecounter transaction at a price not greater than the price of the obligation prevailing on such an exchange at the time of the purchase by the employees' trust or supplemental unemployment benefit trust.

(b) For purposes of section 503 (h), the price of the obligation prevailing at the time of the purchase means the price which accurately reflects the market value of the obligation. In the case of an obligation purchased through a national securities exchange which is registered with the Securities and Exchange Commission, the price paid for the obligation will be considered the prevailing price of the obligation. In the case of an obligation purchased in an over-thecounter transaction, the prevailing price may be the price at which the last sale of the obligation was effected on such national securities exchange immediately before the trust's purchase of such obligation on the same day or may be the mean between the highest and lowest prices at which sales were effected on such exchange on the same day or on the immediately preceding day or on the last day during which there were sales of such obligation or may be a price determined by any other method which accurately reflects the market value of the obligation.

(iii) (a) If the obligation is not listed on a national securities exchange which is registered with the Securities and Exchange Commission, it must be pur

chased in an over-the-counter transaction at a price not greater than the offering price for the obligation as established by current bid and asked prices quoted by persons independent of the issuer.

(b) For purposes of section 503 (h), the offering price for the obligation at the time of the purchase means the price which accurately reflects the market value of the obligation. The offering price may be the price at which the last sale of the obligation to a person independent of the issuer was effected immediately before the trust's purchase of such obligation on the same day or may be the mean between the highest and lowest prices at which sales to persons independent of the issuer were effected on the same day or on the immediately preceding day or on the last day during which there were sales of such obligation or may be a price determined by any other method which accurately reflects the market value of the obligation. The offering price for an obligation must be a valid price for the amount of the obligations which the trust is purchasing. For example, if an employees' trust described in section 401(a) purchases 1,000 bonds of the employer corporation at the offering price established by current prices for a lot of 10 such bonds, such offering price may not be a valid price for 1,000 bonds and the purchase may therefore not meet the requirements of this subdivision. For a purchase of an obligation to qualify under this subdivision, there must be sufficient current prices quoted by persons independent of the issuer to establish accurately the current value of the obligation. Thus, if there are no current prices quoted by persons independent of the issuer, an over-thecounter transaction will not qualify under this subparagraph although the obligation was purchased in an arm's length transaction from a person independent of the issuer.

(iv) For purposes of this section, an over-the-counter transaction is one not executed on a national securities exchange which is registered with the Securities and Exchange Commission. An over-the-counter transaction may be made through a dealer or an exchange which is not such a national securities exchange or may be made directly from the seller to the purchaser.

(3) From an underwriter. An obligation may be purchased from an under

writer if it is purchased at a price not greater than:

(i) The public offering price for the obligation as set forth in a prospectus or offering circular filled with the Securities and Exchange Commission, or

(1) The price at which a substantial portion of the issue including such obligation is acquired by persons independent of the issuer,

whichever is the lesser price. For purposes of this subparagraph, a portion of the issue will be considered substantial if the purchases of such portion by persons independent of the issuer are sufficient to establish the fair market value of the obligations included in such issue. In determining whether the purchases are sufficient to establish the fair market value, all the surrounding facts and circumstances will be considered, including the number of independent purchasers, the aggregate amount purchased by each such independent purchaser, and the number of transactions. In the case of a large issue, purchases of a small percentage of the outstanding obligations may be considered purchases of a substantial portion of the issue; whereas, in the case of a small issue, purchases of a larger percentage of the outstanding obligations will ordinarily be required. The requirement in subdivision (11) of this subparagraph contemplates purchase of the obligations by persons independent of the issuer contemporaneously with the purchase by the employees' trust or supplemental unemployment benefit trust. If a substantial portion has been purchased at diferent prices, the price of the portion may be based on the average of such prices, and if several substantial portions have been sold to persons independent of the issuer, the price of any of the substantial portions may be used for purposes of this subparagraph.

(4) From the issuer. An obligation may be purchased directly from the issuer at a price not greater than the price paid currently for a substantial portion of the same issue by persons independent of the issuer. This requirement contemplates purchase of a substantial portion of the same issue by persons independent of the issuer contemporaneously with the purchase by the employees' trust or supplemental unemployment benefit trust. For purposes of this subparagraph, a portion of the issue wi. be considered substantial if the

purchases of such portion by persons independent of the issuer are sufficient to establish the fair market value of the obligations included in such issue. In determining whether the purchases are sufficient to establish the fair market value, all the surrounding facts and circumstances will be considered, including the number of independent purchasers, the aggregate amount purchased by each such independent purchaser, and the number of transactions. In the case of a large issue, purchases of a small percentage of the outstanding obligations may be considered purchases of a substantial portion of the issue; whereas, in the case of a small issue, purchases of a larger percentage of the outstanding obligations will ordinarily be required. The price paid for a substantial portion of the issue may be determined in the manner provided in subparagraph (3) of this paragraph.

(c) Limitations on holdings of obligations. (1) Immediately following acquisition of the obligation by the employees' trust or the supplemental unemployment benefit trust:

(1) Not more than 25 percent of the aggregate amount of the obligations issued in such issue and outstanding_immediately after acquisition by the trust may be held by the trust, and

(ii) At least 50 percent of such aggregate amount must be held by persons independent of the issuer.

(2) (1) For purposes of subparagraph (1) of this paragraph, an obligation is not considered as outstanding if it is held by the issuer. For example, if an obligation which has been issued and outstanding is repurchased and held by the issuer, without cancellation or retirement, such an obligation is not considered outstanding.

(ii) For purposes of subparagraph (1) of this paragraph, the amounts of the obligations held by the trust and by persons independent of the issuer shall be computed on the basis of the face amount of the obligations.

(d) Limitation on amount invested in obligations. (1) (1) Immediately following acquisition of the obligation, not more than 25 percent of the assets of the trust may be invested in all obligations of all persons described in section 503(c). For purposes of determining the amount of the trust's assets which are invested in obligations of persons described in section 503 (c) immediately following

acquisition of the obligation, those obligations shall be valued as follows:

(a) Those obligations included in the acquisition in respect of which the percentage test in the first sentence of this subdivision is being applied shall be valued at their adjusted basis, as provided in section 1011, relating to adjusted basis for determining gain or loss; and

(b) All other obligations of persons described in section 503 (c) which were part of the trust's assets immediately before the acquisition of the obligations described in (a) of this subdivision shall be valued at their fair market value on the day that the obligations described in (a) of this subdivision were acquired. For purposes of determining the total amount of the assets of the trust (including obligations of persons described in section 503(c)), there shall be used the fair market value of those assets on the day the obligation is acquired.

(i) The application of the rules in subdivision (1) of this subparagraph may be illustrated by the following example:

Example. On February 1, 1960, an exempt employees' trust described in section 401(a) purchases unsecured debentures issued by the employer corporation for $1,000. At the time of this purchase, such debentures have a fair market value of $1,200. Immediately after the purchase of such unsecured debentures, the assets of the trust consist of the following:

(a) Assets other than obligations of persons described in section

508 (c)

(b) Obligations of persons described in section 503 (c) acquired before Feb. 1, 1960. (c) Unsecured debentures of employer purchased on Feb. 1, 1980

Fair market value on Cost Feb. 1, 1960

(3) Total amount of trust's assets invested in obligations of persons described in section 503(c) ((1) plus (2))..

(4) Assets of the trust other than obligations of persons described in section 503 (c) (valued at fair market value on Feb. 1, 1960). (5) Obligations of persons described in section 503 (c) acquired before Feb. 1, 1960 (valued at fair market value on Feb. 1, 1960) (6) Unsecured debentures of employer purchased on Feb. 1, 1960 (valued at fair market value on Feb. 1, 1960) –

$2,000

$7,800

$1,000

$1,200

(2) In determining for purposes of subparagraph (1) of this paragraph the amount invested in obligations of persons described in section 503 (c), there shall be included amounts invested in any obligations issued by any such person, irrespective of whether the obligation is secured, and irrespective of whether the obligation meets the conditions of section 503 (h) or section 503 (i). Obligations of persons described in section 503 (c) other than the issuer of the obligation to which section 503(h) applies are also included within the 25percent limitation. For example, if on February 19, 1959, an exempt employees' trust described in section 401(a) purchases unsecured debentures issued by the employer corporation in a transaction effected on the New York Stock Exchange, and if immediately after the purchase 10 percent of the trust's assets is invested in such debentures and 20 percent of its assets is invested in a loan made with adequate security on January 12, 1959, to the wholly-owned subsidiary of the employer corporation, then the purchase of the employer's debentures will not qualify under section 503 (h), since 30 percent of the trust's assets are then invested in obligations of persons described in section 503(c).

(e) Change of terms of an obligation. A change in the terms of an obligation is considered as the acquisition of a new

(a) Section 503 (h) and §§ 1.503 (h)−1 and 1.503 (h)-2 are effective in the case of an employees' trust described in section 401(a) for taxable years ending after March 15, 1956. Thus, if during a taxable year ending before March 16, 1956, an employees' trust made a loan which meets the requirements of section 503 (h), such loan will not be treated as made without the receipt of adequate security and will not cause loss of exemption for taxable years ending after March 15, 1956, although such loan was not considered adequately secured when made.

(b) (1) In the case of obligations acquired by an employees' trust described in section 401(a) before September 2, 1958, which were held on that date, the requirements described in paragraphs (c) and (d) of § 1.503 (h)-2 which were not satisfied immediately following the acquisition shall be treated as satisfied at that time if those requirements would have been satisfied had the obligations been acquired on September 2, 1958. For example, on January 3, 1955, an employees' trust described in section 401(a) purchased through the New York Stock Exchange unsecured debentures issued by the employer corporation. Under section 503 (h) the acquisition of such debentures by the trust will not be treated for taxable years ending after March 15, 1956, as a loan made without the receipt of adequate security if the debentures were held by the employees' trust on September 2, 1958, and if the requirements of paragraphs (c) and (d) of § 1.503 (h)-2 which were not met on January 3, 1955, were met on September 2, 1958, as if that date were the date of acquisition.

(2) In the case of obligations acquired before September 2, 1958, which were not held by the employees' trust described in section 401(a) on that date, only the requirement described in paragraph (b) of § 1.503 (h)-2 must be satisfied for section 503 (h) to be applicable to such ac