[Code of Federal Regulations]
[Title 26, Volume 7]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.503(f)-1]

[Page 61-62]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.503(f)-1  Loans by employers who are prohibited from pledging assets.

    (a) In general. (1) Section 503(f) provides that section 503(b)(1) 
shall not apply to a loan made to the employer by an employees' trust 
described in section 401(a) if the loan bears a reasonable rate of 
interest and certain conditions are met. Section 503(f) also applies to 
the renewal of loans to the employer and, in the case of demand loans, 
to the continuation of such loans.
    (2) The provisions of section 503(f) do not limit the effect of 
section 401(a) and Sec. 1.401-2, relating to use or diversion of corpus 
or income of an employees' trust, or the effect of any of the provisions 
of section 503 other than section 503(b)(1). Consequently, although a 
loan made by an employees' trust described in section 503(a)(1)(B) meets 
all the requirements of section 503(f) 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(f) will constitute a prohibited transaction within the meaning of 
section 503(b)(6) if it results in a substantial diversion of the 
trust's income or corpus to a person described in section 503(b).
    (b) Conditions. (1) Section 503(f) applies to a loan only if, with 
respect to the making or renewal of the loan, the conditions described 
in paragraphs (b) (2), (3), and (4) of this section are met. For purpose 
of this paragraph, the mere continuance of a demand loan is not 
considered as the making or renewal of such a loan.
    (2) The employer must be prohibited (at the time of the making or 
renewal of the loan) by any law of the United States or regulations 
thereunder from directly or indirectly pledging, as security for such a 
loan, a particular class

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or classes of his assets the value of which (at such time) represents 
more than one-half of the value of all his assets. If a loan is made or 
renewed when the employer is prohibited by a law of the United States 
(or the regulations thereunder) from pledging a class of his assets, the 
qualification of such a loan under section 503(f) will not be affected 
by a subsequent change in such law or regulations permitting the 
employer to pledge such assets, unless such loan is renewed after such 
change. See section 8(a) of the Securities Exchange Act of 1934, as 
amended (15 U.S.C. 78h(a)), which prohibits certain persons from 
pledging a class of assets as security for loans, and 12 CFR 220.5(a) 
(credit by brokers, dealers, and members of national securities 
exchanges).
    (3) The making or renewal, as the case may be, must be approved in 
writing as an investment which is consistent with the exempt purposes of 
the trust by a trustee who is independent of the employer, and such 
written approval must not have been previously refused by any other such 
trustee. A trustee is independent of the employer, for purposes of this 
subparagraph, if he is entirely free of influence or controlled by the 
employer. For example, if the employer is a partnership, then a partner 
in such partnership, or a member of a partner's family would not be 
considered independent of the employer. Similarly, an employee of the 
employer would not be considered independent of the employer. For 
purposes of this subparagraph, the term trustee means, with respect to 
any trust for which there are two trustees who are independent of the 
employer, both of such trustees and, with respect to any trust for which 
there are more than two such independent trustees, a majority of the 
trustees independent of the employer.
    (4)(i) Immediately following the making or renewal, as the case may 
be, the aggregate amount lent by the trust to the employer, without the 
receipt of adequate security must not exceed 25 percent of the value of 
all the assets of the trust.
    (ii) For purposes of paragraph (b)(4)(i) of this section, the 
determination as to whether any amount lent by the trust to the employer 
is a loan made without the receipt of adequate security shall be made 
without regard to section 503(e). Thus, if an employees' trust makes a 
loan on January 2, 1959, to the employer without adequate security (but 
which loan is not considered as made without adquate security under 
section 503(e)), and if immediately after making such loan 10 percent of 
the value of all its assets is invested in such loan, then the trust may 
on that day invest not more than an additional 15 percent of its assets 
in a loan which would be considered made without adequate security if it 
were not for the provisions of section 503(f).
    (iii) For purposes of paragraph (b)(4)(i) of this section, in 
determining the value of all the assets of the trust, there shall be 
used the fair market value of those assets on the day of the making or 
renewal.
    (c) Reasonable rate of interest. Section 503(f) only applies if, in 
addition to meeting the conditions described in paragraph (b) of this 
section, the loan bears a reasonable rate of interest when it is made, 
renewed, or, in the case of demand loans, during the period of its 
existence.
    (d) Change of terms of loan. A change in the terms of a loan 
(including a reduction in the security for a loan) is considered as the 
making of a new loan. If such a new loan is not adequately secured, the 
requirements of section 503(f) must be met at the time the terms of the 
loan are changed for such section to be applicable to such new loan.
    (e) Effective date. (1) This section and section 503(f) are 
effective for taxable years ending after September 2, 1958, but only 
with respect to periods after such date. Thus, if a loan was made on or 
before September 2, 1958, without the receipt of adequate security and 
if, when such loan was made, it met all of the requirements of section 
503(f) and this section, then the loan is not subject to section 
503(b)(1) after September 2, 1958, and would not consitite a prohibited 
transaction after that date because of a lack of adequate security.
    (2) See paragraph (b)(2) of Sec. 1.503(b)-1 for the effective dates 
for application of the definition of adequate security.

[T.D. 7428, 41 FR 34626, Aug. 16, 1976]

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