May 16, 2011

I. Facts

The facts as you state them are as follows. ***************************** *********** ("Security Corporation") is a corporation organized under the laws of the Commonwealth of Massachusetts with its principal place of business in Massachusetts. It is a wholly-owned subsidiary of ****************************** ("Bank"), which is in turn a wholly-owned subsidiary of ***************** ("Parent"). Security Corporation is subject to the jurisdiction of the Massachusetts Commissioner of Banks.

The Commissioner of Revenue classified Security Corporation under G.L. c. 63, § 38B(a), for the tax year ending December 31, 1991, and its classification has not been revoked. Security Corporation's activities are limited to buying, selling, dealing in and holding securities, as defined in G.L. c. 63, § 38B.

Security Corporation seeks to acquire, in the manner described below, certain transferable Massachusetts tax credits for the purpose of reducing its security corporation excise liability under G.L. c. 63, § 38B. Specifically, Security Corporation proposes to acquire and use film incentive credits, historic rehabilitation credits and Brownfields credits (together the "tax credits").

II. Rulings requested

Security Corporation requests a ruling on the following issues:

1. Whether the acquisition of the proposed tax credits by Security Corporation is an ancillary activity within the meaning of 830 CMR 63.38B.1(3)(c), participation in which will not cause a security corporation to lose its security corporation classification under G.L. c. 63, § 38B.

2. Whether Security Corporation may purchase the proposed tax credits from a third party and use them to reduce its security corporation excise liability without losing its security corporation classification.

3. Whether Security Corporation may acquire the proposed tax credits from an affiliate by purchase at an arm's length price or as a transfer or contribution of capital from the affiliate to Security Corporation and use the tax credits to reduce its security corporation excise liability without losing its security corporation classification.

III. Rulings

1. Security Corporation may acquire transferable tax credits without losing its security corporation classification under G.L. c. 63, § 38B as an allowable ancillary activity under 830 CMR 63.38B.1(3)(c), provided security corporation pays full face value for the credit. A security corporation may not use a tax credit against its tax liability if it has not purchased the credit at full face value. A tax credit is not a security within the meaning of G.L. c. 63, § 38B(b ½). Because a tax credit is not a security, a security corporation is not permitted to sell or exchange a tax credit.

2. Security Corporation may purchase a transferable tax credit from an unrelated party and use it to reduce its security corporation excise liability without losing its security corporation classification under G.L. c. 63, § 38B, provided security corporation pays full face value for the credit. The transferor is subject to tax on the income incurred on the sale or transfer of the credit.

3. Security Corporation may acquire the proposed tax credit from an affiliate, and use it to reduce its security corporation excise liability without losing its security corporation classification under G.L. c. 63, § 38B, provided security corporation pays the affiliate full face value for the credit. The transferor is subject to tax on income incurred on the sale or transfer of the credit. Even if federal law may permit an affiliate to contribute as capital a tax credit to a security corporation, such a contribution contradicts the Massachusetts security corporation statute at G.L. c. 63, § 38B, and thus a security corporation that receives a credit as a contribution to capital is ineligible for security corporation classification.

IV. Discussion

An entity that is classified as a security corporation in Massachusetts is subject to an excise based on its gross income. This excise is levied at a lower tax rate than the general excise on business corporations. See G.L. c. 63, §§ 38B (the security corporation excise) and 39 (the general business corporation excise). Because of this tax-advantaged treatment, the category of businesses that qualify for classification under G.L. c. 63, § 38B is carefully circumscribed. A security corporation is an entity whose activities are limited by statute to being engaged in "buying, selling, dealing in, or holding securities on its own behalf and not as a broker . . . ." G.L. c. 63, § 38B (a), (b). Regulations promulgated by the Commissioner further explain G.L. c. 63, § 38B. See 830 CMR 63.38B.1. One of the regulatory sections sets forth the security corporation classification process, which requires an entity to apply to the Commissioner of Revenue and demonstrate its compliance with the statute and regulations. See 830 CMR 63.38B.1(6).

The term "securities" is well defined in the statute. G.L. c. 63, § 38B(b ½). In its most general terms, it includes "equity or debt instruments and options, futures and other derivatives, that are traded on and were acquired through a public exchange or another arms length secondary market . . . ." Taxpayer does not advance a theory that the credits it proposes to purchase are securities within the meaning of G.L. c. 63, § 38(b ½). The Department rules that a tax credit cannot be considered a security within the meaning of G.L. c. 63, § 38B. Specifically, the purchase of a tax credit is not the engagement in buying, selling, dealing in, or holding securities on its own behalf. See G.L. c. 63, § 38B(a), (b).

Generally when a tax credit is transferred, the purchaser pays something less than the face value of the credit. This arrangement benefits both seller and buyer: the seller receives some cash or other consideration for a credit item that it is not able to use, often because the credit value exceeds the taxpayer's total state tax liability. The buyer benefits because it reduces its tax liability by the face value of the credit, having only paid a portion of the face value for this reduction. Thus the spread between the buyer's purchase price and the credit face value is the equivalent of monetary enrichment to the buyer. It is the potential for this enrichment, not sanctioned by the security corporation statute, which causes concern in the case of security corporations.

In an effort to render the application of the security corporation statute practicable, the Department of Revenue, through its regulatory authority, permits a security corporation to engage in "ancillary activity that is necessary or typical in the context of its securities investment business." 830 CMR 63.38B.1(3)(c). The regulation offers examples of permissible ancillary activities: the owning of office furniture used in operating the business; engaging a payroll services company for payment of its staff; or sponsoring employee benefits programs on behalf of its staff. 830 CMR 63.38B.1(3)(c). An ancillary activity does not include enrichment to a security corporation in a manner not specifically allowed in G.L. c. 63, § 38B.

The Department rules that the purchase of a credit from a third party or an affiliate may be deemed a valid ancillary activity provided that Security Corporation pays the full face value of the credit. This proviso ensures that there is no issue of built-in gain; built-in gain is this case would be the difference between a purchase price that is below the credit's face value and the amount of credit the security corporation would actually use against its tax liability.

The Department rules that although a transfer of tax credits to Security Corporation will not, in itself, disqualify the entity from security corporation classification under 830 CMR 63.38B.1(3), (5), and (6), Security Corporation may not retain its security corporation classification if the credit passes as a transfer without consideration, or for consideration less than full face value of the credit.

While Security Corporation is permitted to reduce its corporate excise liability by the use of credits as an allowable ancillary activity under the conditions of this ruling, Security Corporation is not permitted to sell the credit. The statute at G.L. c. 63, § 38B permits a security corporation to sell only securities; we have ruled that credits are not securities, and thus the security corporation has no statutory right to sell them.

You also ask whether Parent or Bank can transfer a credit to Security Corporation as a contribution to capital, which means that there would be no sales price. We note first that the determination of whether such a transfer is considered a contribution to capital is a matter of federal law, see, for example, IRC § 118(a), and as such, the Department expresses no opinion on whether such a transfer would be considered a contribution to capital. See G.L. c. 63, § 30.3 (basing the Massachusetts definition of gross income on the federal definition).

While the statute permits an affiliate to contribute qualifying securities to a security corporation, as further set forth in 830 CMR 63.38B.1, we have determined that a tax credit is not a security. Permitting a parent to contribute a credit to a subsidiary security corporation would have the same problematic result that the purchase at below face value would have; built in to the credit is a tax reduction, in this case for the entire amount. The tax reduction would be, if allowed, a source of enrichment to Security Corporation. Since a security corporation may not profit by actions other than the buying, selling, dealing in, or holding securities, enrichment derived from the contribution of something other than a security violates G.L. c. 63, § 38B.

We also rule that a transferor of a credit is subject to tax on the income incurred on the sale or transfer of the credit. See TIR 07-15, footnote 13, citing IRS Chief Counsel Advice 200211042 (February 5, 2002). As a general matter, the receipt of a tax credit generated by a taxpayer is not considered the receipt of income to the extent the credit is used to actually offset a tax owed by that original recipient. The credit is in such a case considered a tax remediation that extends to the original recipient. In granting a transferable tax credit, however, the Commonwealth is conferring more than a right of tax remediation; it is granting a property right, namely the right of transfer. Once that right is exercised, by virtue of the transfer, the original recipient receives income that derives from this property right, and such income is properly subject to tax.

There is no basis in a tax credit to an original recipient, because there is no cost. See generally IRC § 1012. Thus, when an originator of a tax credit in Massachusetts sells the credit to a security corporation, the full sales price of the credit is part of the seller's gross income, and is thus fully taxable to the transferor. In the facts of this ruling, Bank, Parent, or an unrelated party may be selling a transferable tax credit to Security Corporation. In such a case, Bank, Parent, or the unrelated party will include in gross income the full price received from Security Corporation, since basis in the credit in the case of an original recipient is zero. This income is not subject to deferral or elimination in calculating the Bank or Parent's excise in a combined return under G.L. c. 63.

Where Parent, Bank, or an unrelated third party has purchased the tax credit, Parent, Bank, or the unrelated third party has basis in the credit, namely the price it paid for the credit. If Parent, Bank, or the unrelated party then sells the credit to Security Corporation, the amount included in Parent, Bank, or the unrelated third party's gross income is the difference between the sales price of the credit (which has to be the full face value of the credit in the case of a purchase by a security corporation) and Parent, Bank, or the unrelated third party's basis in the credit. This income is not subject to deferral or elimination in calculating the Parent or Bank's excise in a combined return under G.L. c. 63.

V. Conclusion

A security corporation is allowed to use certain tax credits to offset its corporate excise. While these tax credits do not qualify as securities, the purchase by a security corporation at full face value of a transferable credit is properly deemed a permissible ancillary activity within the meaning of the security corporation regulation. The transfer or sale of a credit by one party to another, including to a security corporation, is generally a transfer that will result in the recognition of income by the transferor.

Very truly yours,

/s/Navjeet K. Bal

Navjeet K. Bal
Commissioner of Revenue

NKB:MTF:dt

LR 11-6