Facts : A Massachusetts corporation (M) wholly owns a first tier Massachusetts subsidiary (Sub 1) which, in turn, wholly owns a second tier Massachusetts subsidiary (Sub 2). Sub 2 directly distributes property to M. The distribution to M is not in exchange for any goods or services rendered to Sub 2 by M. The earnings and profits of both subsidiaries are sufficient to make the property distributed constitute a dividend.

IssueS : Is the property distributed by Sub 2 to M a dividend for Massachusetts purposes? If so, is the dividend eligible for the Massachusetts dividends received deduction?

Directive : In distributing property directly to M, Sub 2 is considered to have made a constructive dividend to Sub 1. Sub 1 has dividend income and is entitled to the Massachusetts dividends received deduction. Sub 1, in turn, is considered to have made a constructive dividend to M. M has dividend income, in the same amount as distributed by Sub 2 to Sub 1, and is entitled to the Massachusetts dividends received deduction.

Discussion of Law :

For purposes of the corporate excise, Massachusetts gross income is (with certain exceptions not relevant here) gross income as defined under the provisions of the Federal Internal Revenue Code. G.L. c. 63, § 30(3). If a distribution of property is treated as a dividend under the Internal Revenue Code, it will be so treated for Massachusetts purposes. New York Times Sales, Inc. v. Commissioner, 40 Mass. App. Ct. 749 (1996), review denied, 423 Mass. 1108 (1996).

Under federal law, "[a] distribution by a corporation to a third party for the benefit of a shareholder is a constructive dividend, which will be taxed as a dividend to the shareholder for whose benefit the distribution is made." Rev. Rul. 73-605, 1973-2 C.B. 109. Since Sub 2 made a distribution to M, a third party, for the benefit of its shareholder Sub 1, the distribution is constructive dividend to Sub 1 and it taxed as such. In determining a corporation's taxable net income, Massachusetts generally allows a deduction from net income equal to 95% of the value of all dividends received. G.L. c. 63, § 38(a)(1). The deduction is not allowed, however, if the corporation receiving the dividend "owns less than fifteen per cent of the voting stock of the corporation paying such dividend." G.L. c. 63, § 38(a)(1)(iii). Since Sub 1 wholly owns Sub 2, dividends from Sub 2, including constructive dividends, are eligible for the Massachusetts dividends received deduction. Sub 1 can deduct 95% of the constructive dividend it is deemed to have received on account of Sub 2's distribution to M.

Moreover, the actual distribution that M receives from Sub 2 is treated under federal law as a constructive distribution from Sub 1. This distribution is taxable as a dividend to M to the extent of Sub 1's earnings and profits. Tollefsen v. Commissioner, 431 F.2d 511 (1970); Kaplan v. Commissioner, 43 T.C. 580 (1965). The constructive dividend that M receives from Sub 1 is eligible for the Massachusetts dividends received deduction since M wholly owns Sub 1. M can deduct 95% of the constructive dividend it is deemed to have received on account of Sub 2's actual distribution to M.

/s/Mitchell Adams
Mitchell Adams
Commissioner of Revenue

MA:HMP:smd

October 26, 1998

DD 98-3