On behalf of the (Parent Company) and its subsidiaries, you have requested a letter ruling regarding the Massachusetts tax consequences of certain aspects of a proposed transaction that we describe below.
Parent Company is a [foreign] corporation with its headquarters in Massachusetts and business locations in several states. Parent Company has a number of wholly-owned first and second tier subsidiary corporations. Two of these subsidiaries have been classified as security corporations under G.L. c. 63, § 38B(a): (Security Corporation 1), which is a wholly-owned first-tier subsidiary; and (Security Corporation 2), a second-tier subsidiary.
The business group headed by the Parent Company is contemplating acquiring a [foreign] corporation, (Target Company), in a statutory merger. Specifically, a wholly-owned subsidiary of the Parent Company, (Tender Company) has issued a public tender offer for the securities of the Target Company, including its common and preferred stock and certain debt instruments issued by the Target Company (the Bonds). The Target Company's Bonds are registered with the SEC and are publicly traded. The Bonds are currently held by a diverse group of individuals and unrelated entities. The tender offer is conditioned upon Tender Company's receipt of at least ninety percent of all of the Target Company's securities, including the Bonds.
If the tender offer for the securities of the Target Company is accepted, the Parent Company proposes to execute the agreement in three steps. First, Security Corporation 1 and Security Corporation 2 will transfer cash to a newly-formed Massachusetts business trust (the Business Trust) in return for all of its beneficial interests. Second, Tender Company will assign its rights to acquire the Target Company's Bonds to the Business Trust, and the Business Trust will purchase and hold the Bonds. Third, in a separate transaction, the Parent Company will directly acquire 100 percent of the stock of the Target Company in exchange for shares of the Parent Company.
You represent that Security Corporations 1 and 2 will hold interests in the Business Trust and, indirectly, the Target Company's Bonds for investment. Specifically, you anticipate that the Business Trust will receive interest and principal payments from the Bonds, so that Security Corporations 1 and 2 will ultimately recognize income from their investment in the beneficial interests of the Trust.
II. Rulings Requested
You have requested rulings on the following issues:
- Whether the beneficial interests of the Business Trust held by Security Corporation 1 and Security Corporation 2 will constitute "securities" within the meaning of G.L. c. 63, § 38B.
- Whether the acquisition and holding of the beneficial interests of the Business Trust by Security Corporations 1 and 2 will satisfy the requirement of G.L. c. 63, § 38B, that a corporation classified under that section be engaged exclusively in buying, selling, dealing in, or holding securities on its own behalf, and not as a broker.
- Whether, assuming that the Parent Company consummates the acquisition of the stock of the Target Company, the Bonds held by the Trust will be "securities issued by affiliates" within the meaning of G.L. c. 62, § 8(b).
A. Security Corporation Classification
General Laws chapter 63, section 38B(a) provides favorable tax treatment to any corporation "engaged exclusively in buying, selling, dealing in, or holding securities in its own behalf and not as a broker." When determining whether a corporation classified under G.L. c. 63, § 38B, may acquire a particular instrument, a two-fold inquiry must be pursued: first, is the instrument a "security;" and, second, is it a security acquired and held for investment purposes? A corporation may be classified as a security corporation only if both of these questions are answered affirmatively. State Tax Commission v. PoGM Co., 369 Mass. 611 (1976).
The Department has recently ruled that the beneficial interests of a business trust may constitute securities for purposes of section 38B. Letter Ruling 91-3. Thus we need only consider whether Security Corporations 1 and 2 will hold interests in the Business Trust for investment purposes.
The Supreme Judicial Court has held that G.L. c. 63, § 38B, is intended to apply to corporations investing in securities. Industrial Finance Corp. v. State Tax Commission, 367 Mass. 360 (1975). Thus, assets that might be described as securities for some purposes may nevertheless fail to satisfy the requirements of § 38B because they were not acquired for investment. For example, notes acquired by a corporation engaged in the business of lending money are not securities for purposes of § 38B. Id. Similarly, corporations have failed to qualify for security corporation classification when they have held installment obligations acquired from the disposition of corporate assets, State Tax Commission v. PoGM Co., 369 Mass. 611 (1976), or notes receivable from corporate officers and shareholders, Edgerson, Inc. v. Commissioner of Revenue, A.T.B. No. 141859 (October 6, 1989).
The Department has generally presumed that marketable securities are held for investment purposes under G.L. c. 63, § 38B. See DOR Directive 86-34; Letter Ruling 89-2, 91-3. Securities representing a controlling interest in a subsidiary may also be held for investment, although the Department will closely scrutinize such "investments." See Letter Ruling 91-3. First, a security corporation must refrain from participating in the management of a subsidiary, providing capital in the form of loans, or otherwise engaging in activities that an ordinary investor would not pursue. Second, in the case of a security corporation holding beneficial interests in a business trust, the Department will examine the assets of the business trust - in this case the Target Company's Bonds - to insure that the trust is not used to circumvent the restrictions on the type of assets that security corporations may hold.
Under the facts you have presented, we conclude that Security Corporations 1 and 2 may hold the beneficial interests in the Business Trust for investment purposes provided that they restrict their activities with respect to the Business Trust to those of an ordinary investor. We are persuaded that the Business Trust is not being used to circumvent the restrictions of G.L. c. 63, § 38B, because the Bonds of the Target Company are publicly traded securities that could be acquired directly by the Security Corporations. 1
B. Securities of an Affiliate
Corporate trusts, defined by G.L. c. 62, § 1(j), as "any partnership, association, or trust, the beneficial interest of which is represented by transferable shares," are generally subject to taxation under G.L. c. 62, § 8(a). However, certain corporate trusts, including "holding companies," are exempted from taxation by the provisions of G.L. c. 62, § 8(b). Section 8(b) defines a holding company as follows:
As used in this paragraph, the term "holding company" means any corporate trust in which ninety per cent of the book value of its assets, at the end of the taxable year, are securities and at least seventy-five per cent of such securities are issued by affiliates and at least ninety per cent of its Massachusetts gross income is Part A gross income; the word "affiliate" means a member of an affiliated group as defined under...[Internal Revenue Code § 1504]; and the word "securities" means transferable shares of beneficial interest in any corporation on other entity, bonds or debentures of any issuer or notes and other evidences of indebtedness of affiliates.
Under these provisions, the Bonds of the Target Company are clearly "securities." When held by the Business Trust, the Bonds will qualify as "securities...issued by affiliates" if, at the end of the taxable year of the Business Trust, both the Business Trust and the Target Company are members of the same affiliated group under IRC § 1504. Assuming that it is a corporate trust, the Business Trust may qualify as a "holding company" under G.L. c. 62, § 8(b), if it meets the various percentage tests set out in that section at the end of its taxable year.
Security Corporation 1 and Security Corporation 2 may hold beneficial interests in the Business Trust without jeopardizing their classification under G.L. c. 63, § 38B, provided that they restrict their activities with respect to the Business Trust in the manner described in this ruling. The Bonds of the Target Company, when held by the Business Trust, will be securities of an affiliate under G.L. c. 62, § 8(b), if both the Business Trust and the Target Company are members of the same affiliated group at the end of the taxable year of the Business Trust.
Very truly yours,
Commissioner of Revenue
October 21, 1991
1 We distinguish the facts of this ruling, which involve the acquisition, in an arms' length transaction, of outstanding publicly traded debt instruments of a security corporation's prospective affiliate, from the lending of money to an affiliated corporation, however structured. Notes or other instruments evidencing a loan of money will not qualify as securities under G.L. c. 63, § 38B. Industrial Finance Corp. v. State Tax Commission, 367 Mass. 360 (1975). Edgerson, Inc. v. Commissioner of Revenue, A.T.B. No. 141859 (October 6, 1989). (1)