You have requested a letter ruling on behalf of _______ ("Bank") concerning a transaction under which Bank will become a wholly-owned subsidiary of ("Holding"), a bank holding company. Your question is whether Holding will qualify as a security corporation in G.L. c. 63, § 38B(b). The facts as set out in your ruling request are as follows.
Subject to shareholder and applicable regulatory approval, Bank will organize Holding as a bank holding company, incorporated in Delaware, and will become a wholly-owned subsidiary of Holding. By organizing Holding, Bank will gain various business advantages afforded by a bank holding company structure, including advantages in connection with the acquisitions of other banks.
Under the Bank Holding Company Act of 1956, 12 U.S.C. § 1841 et seq., a bank holding company may engage in numerous activities, many of which go beyond those limited activities which a security corporation may engage in under G.L. c. 63, § 38B(b). Holding plans to limit its activities to the following:
- Holding board of directors meetings, stockholder meetings, preparing and distributing stockholder reports preparing financial statements, and maintaining accounting records;
- managing its securities portfolio and its other cash management functions;
- issuing and repurchasing its own common stock, preferred stock, debentures, bonds, warrants and similar instruments, as long as the proceeds therefrom are used for the purpose of financing permissible securities acquisitions within the meaning of G.L. c. 63, § 38B(b), and not, for example, for the purpose of making loans to its subsidiaries;
- analyzing and making acquisitions;
- forming new operating subsidiaries;
- responding to takeover proposals with respect to its own stock;
- hiring accountants, investment bankers, attorneys and other consultants to assist in its various activities as long as their activities are related to and limited to the permissible activities listed;
- making equity contributions to subsidiaries; 1
- making bank deposits in various banks including Bank on terms available to the public and as long as the deposits do not acquire the nature of a loan.
Based on the description of activities Holding will engage in, we conclude that Holding will be entitled to be classified as a security corporation under G.L. c. 63, § 38B(b), because it will engage exclusively in buying, selling, dealing in, or holding securities on its own behalf and not as a broker.
The statute governing the taxation of security corporations that are also bank holding companies is G.L. c. 63, § 38B(b):
Every domestic business corporation or foreign corporation, which is engaged exclusively in buying, selling, dealing in, or holding securities on its own behalf and not as a broker, except securities of a corporation defined in this chapter as a DISC, and is a regulated investment or bank holding company under the Federal Internal Revenue Code, as amended and in effect for the taxable year, and which either applies to the commissioner to be classified as a security corporation before the end of the taxable year and is so classified, or has been so classified by the commissioner for a prior taxable year, shall pay, on account of each taxable year, an excise equal to thirty-three one hundredths per cent of the gross income, as defined in section thirty of this chapter, received by such corporation during the taxable year or two hundred and twenty-eight dollars, whichever is greater.
To qualify for treatment under § 38B(b), then, a corporation must meet three requirements. First, it must engage "exclusively" in buying, selling, dealing in, or holding securities (other than securities of a DISC) on its own behalf. Second, it must qualify as a regulated investment company or as a bank holding company under the Internal Revenue Code. Third, the Commissioner must have classified the corporation as a "security corporation."
1. The Security Corporation Requirements
The first and third requirements identified above are intertwined. If a corporation engages exclusively in buying, selling, dealing in, or holding securities on its own behalf, it is, by definition, a security corporation, and the Commissioner will classify it as such. See DOR Directive 86-33. The classification procedure is the same whether the taxpayer seeks treatment under § 38B(b) (for RICs and bank holding companies) or § 38B(a) (for corporations that are not RICs or bank holding companies).
For § 38B purposes, a security must be a marketable security acquired in the normal course of investment. See State Tax Comm'n v. PoGM Co., 369 Mass. 611, 613 (1976); Industrial Fin. Corp. v. State Tax Comm'n, 367 Mass. 360, 364, 367 (1975); DOR Directives 86-34, 86-35. It may not be a note, installment or otherwise, acquired as a means of financing the sale of the corporation's assets. See PoGM Co., supra; DOR Directive 86-34. Nor may it be a loan, whether evidenced by a promissory note or made at market rates of interest, to a shareholder, director, officer, or employee of the corporation. See Industrial Fin. Corp., supra; DOR Directive 86-35.
Both the Supreme Judicial Court and the Department interpret strictly the "exclusively" requirement of § 38B. See Chatham Corp. v. State Tax Commission, 362 Mass. 216, 219 (1972); PoGM Co., supra 369 Mass. at 612; Letter Ruling 86-1. The requirement is not satisfied where only a portion of a corporation's activities involve buying, selling, dealing in, or holding securities on its own behalf. PoGM Co., supra, 369 Mass. at 612; Chatham Corp. v. State Tax Comm'n, supra 362 Mass. at 220; DOR Directives 86-34, 86-35. A corporation with responsibility for managing the business entities in which it invests will not satisfy the requirement. See Letter Ruling 82-8. On the other hand, a security corporation may, of course, do what must be done to carry on any business--incur and pay business expenses, own assets used in the conduct of its investment business, retain insurance on the lives of key officers of the corporation--without being disqualified under § 38B. Letter Ruling 86-1. In determining whether a corporation's activities cross the line, the Department will distinguish between activities in which an ordinary investor in the securities market would engage, and activities that an ordinary investor would not pursue, such as participating in the management of a business or providing capital in the form of loans. Letter Ruling 85-23.
2. The Bank Holding Company Requirement
Section 38B(b) refers to the Internal Revenue Code in defining what qualifies as a "bank holding company." Code § 1103(a), in turn, defines "bank holding company" as one within the meaning of the Bank Holding Company Act, 12 U.S.C. § 1841 et seq. Under the Bank Holding Company Act, a bank holding company is defined generally as a company that has power over 25% of a bank's voting securities or controls the election of a majority of the bank's directors or trustees or is found to have a controlling influence over the bank's management or policies. See 12 U.S.C. § 1841(a). The federal statute thus requires a bank holding company to have the power to exercise control over a bank's (or another bank holding company's) activities, although it need not necessarily exercise that control. Beyond this, the Bank Holding Company Act does not dictate what a bank holding company must do; it does, however, restrict what a bank holding company may do. See 12 U.S.C. § 1843.
The Board of Governors of the Federal Reserve System has stated that a bank holding company has an obligation to "serve as a source of financial and managerial strength to its subsidiary banks and shall not conduct its operation in an unsafe or unsound manner." Regulation Y Bank Holding Companies and Change in Bank Control, 12 C.F.R. § 225.4(a)(1). Regulation Y was promulgated by the Board under the authority of the Bank Holding Company Act.
3. Interaction of the Requirements of § 38B(b)
As the statutory language indicates, a corporation must meet all three of the requirements under § 38B(b) to qualify for treatment under that provision. If a corporation is not a RIC or bank holding company but is a security corporation (i.e., it engages exclusively in buying, selling, dealing in, or holding securities on its own behalf), it will qualify for treatment under § 38B(a) rather than § 38B(b), entitling it to a tax rate of 1.32% as compared to the tax rate of .33% under § 38B(b). On the other hand, if a corporation is not a security corporation, it will not qualify for treatment under either § 38B(a) or § 38B(b). This is true whether or not the corporation is a bank holding company or a RIC.
4. The Requirements of § 38B(b) Applied to Holding
Turning to the facts you have presented in your request for a ruling, we must determine whether Holding will engage exclusively in buying, selling, dealing in, or holding securities on its own behalf so as to qualify as a security corporation under § 38B. If it does, Holding would be entitled to treatment under § 38B(b), assuming, as you represent, that it is a bank holding company under the Internal Revenue Code and assuming that Holding timely applies to the Commissioner and obtains classification as a security corporation.
The question, then, is whether Holding will engage in activities other than those in which an ordinary investor in a securities market would engage. The answer to this question depends in large part upon the facts and circumstances of Holding's actual activities, rather than upon general descriptions of what Holding may do. Based on the list of proposed activities you have set out in your request, we conclude that Holding is entitled to security corporation classification as long as the activities Holding ultimately engages in are precisely the proposed activities described in its ruling request. Should Holding engage in any activity beyond engaging exclusively in buying, selling, dealing in, or holding securities on its own behalf, the impermissible activity will be the basis for revocation of security corporation status.
Very truly yours,
/s/Stephen W. Kidder
Stephen W. Kidder
Commissioner of Revenue
November 3, 1988