You have requested a letter ruling on behalf of ("Newco"), a Massachusetts corporation that is a wholly-owned subsidiary of (the "Company"). The Company owns other subsidiaries which serve as the principal underwriter, advisor, and manager of certain publicly held mutual funds (the "Funds"), which qualify as regulated investment companies for federal income tax purposes. Newco plans to invest in marketable securities including shares of the Funds.
Newco will purchase shares of Funds under the same terms as those shares are offered to the public. Investments in Fund shares will provide Newco with all of the rights and privileges of Fund shareholders, including the right to request redemption at any time. Newco plans to acquire Fund shares for long-term investment, but it may vary its investments in the Funds from time to time depending upon its investment needs and preferences.
Under the provisions of the Investment Company act of 1940, registered investment companies, including the Funds, must maintain a minimum net worth of $100,000 in order to offer their shares to the public. 15 USC § 80a-14. The Company and its affiliates (excluding Newco) have in the past and will continue to provide this "seed money" capital for the Funds. Although Newco will invest both in the shares of established Funds and shares of newly organized Funds, it will invest in any individual Fund only after the $100,000 net worth requirement for that Fund has been satisfied by Newco's affiliates or other sources.
II. Ruling Requested
You have asked the Department to rule whether Newco will be precluded from classification as a security corporation under G.L. c. 63, § 38B, if it holds shares of mutual funds for which its affiliates serve as advisor and/or principal underwriter. We conclude that the activities that you have described will not preclude Newco from security corporation classification.
Under G.L. c. 63, § 38B, Massachusetts extends favorable tax treatment to any domestic business corporation or foreign corporation "engaged exclusively in buying, selling, dealing in, or holding securities in its own behalf and not as a broker...." In determining whether a security corporation may hold a particular instrument, the Department has followed a two-step analysis. First, is the instrument in question a "security" within the generally understood meaning of that term? Second, if the instrument is a security, has it been acquired and held for investment purposes? State Tax Commission v. PoGM Co., 369 Mass. 611 (1976); Industrial Finance Corp. v. State Tax Commission, 376 Mass. 360 (1975).
We do not doubt that the shares of a publicly held mutual fund, acquired under the same terms as those shares are offered to the public, constitute "securities" of the general type the Legislature contemplated that a security corporation might hold in its adoption and amendment of G.L. c. 63, § 38B. See Letter Ruling 89-10. We must closely consider, however, whether Newco will acquire and hold the Fund shares for investment purposes under the facts of this ruling. In particular, we must examine whether Newco can be said to hold Fund shares for investment purposes when its parent and affiliates derive financial benefit from the establishment and continuation of the Funds.
The predecessor of G.L. c. 63, § 38B, was originally adopted in Massachusetts to encourage the incorporation of investment trusts in this state. Industrial Finance Corp. v. State Tax Commission, 367 Mass. 360 (1975). In light of this legislative purpose, the Supreme Judicial Court has held that security corporations must hold their securities for investment purposes and not as part of the conduct of a business. Id. In State Tax Commission v. PoGM, 369 Mass. 611 (1976), the Court found that an installment obligation held by a seller of real estate was held as a means of financing a sale and not for investment purposes. See also Letter Ruling 89-2. Similarly, notes of a corporation's officers and shareholders have been found to be held for accommodation rather than for investment. Edgerson Inc. v. Commissioner of Revenue, A.T.B. No. 141859 (October 6, 1989). In both PoGM and Edgerson, the taxpayers were disqualified from security corporation classification because they held an instrument for purposes other than investment.
Under the facts you have stated, we are persuaded that Newco will be investing its capital within the requirements of § 38B. The Fund shares that Newco will hold are registered, publicly marketed securities that have been acquired on terms available to the public. The Department will generally presume that marketable securities are held for investment purposes. See DOR Directive 86-34; Letter Ruling 91-3. The presence of a market establishes that the securities are purchased at arms' length and held by otherwise disinterested investors. If shares of the Funds are purchased as investments in transactions clearly conducted at arm's length, then Newco can also be said to purchase shares of the Funds for investment when it acquires them on the same terms. Furthermore, because Newco will not supply "seed money" necessary for the capitalization of individual Funds, it appears that Newco's motivation for its acquisition of Fund shares is investment, rather than any indirect benefit to the business operations of its parent or affiliates.
We conclude that, under the facts presented in this ruling, Newco will not be precluded from security corporation classification under G.L. c. 63, § 38B, by acquiring and holding shares of mutual finds for which the Company and its affiliates serve as principal underwriter and/or advisor.
Very truly yours,
Commissioner of Revenue
December 17, 1991