You represent the Fund (the "Fund"), [an out-of-state] corporation that qualifies as a regulated investment company ("RIC") for federal tax purposes. You ask whether distributions from the Fund to its Massachusetts shareholders are subject to the personal income tax where the distributions are derived from interest on U.S. obligations held by the Fund. We rule that such distributions are subject to the personal income tax.
The Fund is a corporation organized under the laws of [another state]. The Fund qualifies as a RIC under Section 851 of the Internal Revenue Code (the "Code"). The Fund invests exclusively in short-term United States Treasury securities. The Fund receives interest on those securities and distributes it to its shareholders. You have asked us to rule that such distributions received by Massachusetts shareholders constitute "[i]nterest on obligations of the United States," which is exempt from the Massachusetts personal income tax under G.L. c. 62, § 2(a)(2)(A). For the following reasons we rule to the contrary.
Massachusetts gross income is federal gross income determined under the Code as amended and in effect on January 1, 1988, with certain modifications. G.L. c. 62, §§ 1(c), 2(a). Amounts received as dividends are includable in Massachusetts gross income to the same extent they are includable in federal gross income, unless such amounts are specifically required to be subtracted under G.L. c. 62, § 2(a)(2). Dividend is defined as "any item of income which is treated as a dividend under the Code." G.L. c. 62, § 1(e).
Under the Code, any distribution of earnings and profits by a corporation, including a corporate RIC, is generally characterized as a dividend. See I.R.C. § 316(a). This is so even where the source of those earnings and profits is interest on United States obligations held by the RIC. See generally I.R.C. § 852(b). Thus, for federal income tax purposes, the Fund's distributions are includable in the shareholders' gross income as dividends. Under the definition of dividend employed by Chapter 62, and because the Fund is a corporation, the Fund's distributions have the same characteristics for Massachusetts personal income tax purposes as they do under the Code. Because the distributions are treated as dividends under the Code, the distributions are includable in Massachusetts gross income as dividends.
Distributions treated as dividends may not be excluded from Massachusetts gross income under the provisions of G.L. c. 62, § 2(a)(2)(A). That exclusion, by its terms, applies only to "[i]nterest" on exempt obligations of the United States. Interest has the same meaning for Massachusetts personal income tax purposes as it does for federal purposes. G.L. c. 62, § 1(i). Distributions treated as dividends for federal purposes are, by definition, dividends and not interest for Massachusetts purposes. Therefore the distributions do not fall within the scope of the exclusion under G.L. c. 62, § 2(a)(2)(A). Moreover, no other provision of Chapter 62 excludes distributions by a RIC organized as a corporation from Massachusetts gross income. Thus, distributions by the Fund that are treated as dividends for federal purposes are taxable as dividends for Massachusetts personal income tax purposes.
In your ruling request, you ask us to construct a characterization-of-income rule allowing flow-through of exempt interest on federal obligations, where no such rule exists for RIC's organized as corporations. Your position is that, where the Fund receives income that would be exempt from the personal income tax under G.L. c. 62, § 2(a)(2)(A), if received directly by a Chapter 62 taxpayer, such income should retain its character as exempt income when distributed to the shareholders. You base this contention on the Fund's status as a RIC, which for federal tax purposes would allow the Fund to distribute income derived from capital gain and federally exempt securities to its shareholders as capital gain dividends and exempt income dividends. See I.R.C. § 852(b)(3), (5). 1
Under the Code, capital gain dividends and exempt interest dividends fall under the general definition of dividends, but are treated as capital gain and exempt income respectively when received by the shareholders. Thus, as you correctly point out, RIC's are, in effect, treated as flow-through entities under the Code for purposes of distributing capital gain and federally exempt interest. Because Massachusetts adopts the federal definitions of dividends and capital gain, capital gain dividends and exempt interest dividends are treated as capital gain and interest on state obligations respectively for Massachusetts personal income tax purposes. See Letter Ruling 83-59 and 82-23 for a discussion of exempt interest dividends. However, there is no corresponding federal treatment of interest from obligations of the United States to which a Massachusetts statutory provision can attach.
The treatment of RIC's formed as corporations, in this regard, is in contrast to the treatment of RIC's formed as corporate trusts. G.L. c. 62, § 8(b) specifically recognizes and affords special treatment to RIC's organized as corporate trusts, exempting them from the personal income tax and imposing the tax on their shareholders. In Commissioner v. Plymouth Home National Bank, 394 Mass. 66 (1985), the Supreme Judicial Court ruled that interest on federal obligations received by a RIC organized as a corporate trust and distributed to shareholders was exempt from the income tax. See also Technical Information Release 85-4. No provision of the General Laws or the Plymouth Home National Bank decision, however, requires or allows us to extend the same treatment to RIC's organized as corporations. If the Legislature wished to adopt a characterization-of-income rule applicable to RIC's organized as corporations, it knew how to do so. See G.L. c. 62, § 11, which allows the flow-through of income characteristics for distributions by trustees not subject to the Massachusetts income tax. We cannot adopt a similar rule for RIC's organized as corporations without explicit statutory authorization.
Based on the foregoing analysis, we rule the distributions by the Fund are includable in its resident shareholders' Massachusetts gross income as dividends. Such distributions are therefore subject to the personal income tax. The exclusion from Massachusetts gross income for "[i]nterest on obligations of the United States" afforded by G.L. c. 62, § 2(a)(2)(A), does not apply to the Fund's distributions.
Very truly yours,
Commissioner of Revenue
January 28, 1992
1 You also contend that such treatment is required by the United States Constitution because the federal government's constitutional tax immunity, established in McCulloch v. Maryland, 4 Wheat. 316 (1819), and codified by 31 U.S.C. § 3124(a), prohibits the Commonwealth from taxing the Fund's distributions of interest derived from federal obligations. We do not address this issue because we do not issue rulings on the constitutionality of the statutes we are charged with enforcing.