I. Background

Recently, the U.S. Congress changed the qualification rules for regulated investment companies (RICs). Specifically, the Taxpayer Relief Act of 1997 changed the federal treatment of RICs by eliminating a requirement that limited the amount of income a RIC could receive from the sale or disposition of certain short term assets. P.L. 105-34, § 1271, repealing I.R.C. § 851(b)(3), and redesignating § 851(b)(4) as § 851(b)(3). As discussed below, it is not clear how this federal tax law change affects the treatment of RICs for Massachusetts tax purposes. However, it appears that the federal tax law change, if not adopted by Massachusetts, would have a disruptive effect on the Massachusetts taxation of RICs and their shareholders. This Technical Information Release announces that, pending legislation clarifying the Massachusetts law governing the taxation of RICs and their shareholders, the Department will treat a corporate trust or corporation as a RIC for Massachusetts purposes, provided that the corporate trust or corporation qualifies as a RIC for federal income tax purposes.

II. Federal Law

Under § 851 of the Internal Revenue Code (Code) a corporation or corporate trust (1) registered with the Securities and Exchange Commission as an investment company under the provisions of the Investment Company Act of 1940 may elect to be a RIC for a taxable year if it satisfies certain requirements relating to the source of its income and the diversification of its assets. Effective for tax years beginning after August 5, 1997, Congress repealed the 30% gross income test or "short-short" rule, under which a RIC had to derive less than 30 percent of its gross income from the sale or disposition of certain short-term assets held for less than three months. The repeal of the short-short rule eases restrictions on investments made by RICs and eliminates significant recordkeeping and compliance requirements.

III. Massachusetts Treatment of RICs

For Massachusetts purposes, RIC status confers two important benefits on a corporate trust or a corporation. First, the corporate trust or corporation is not subject to tax at the entity level. Second, the corporate trust or corporation may distribute income from federal and Massachusetts obligations through to its shareholders free of Massachusetts taxation. The personal income tax statute governs taxation of RICs organized as corporate trusts as well as the taxation of RIC shareholders, regardless of whether the RIC is organized as a corporate trust or as a corporation.
The new federal law has raised the issue of whether RICs will jeopardize these tax benefits by taking advantage of the new federal eligibility rules. The crux of the problem is whether references to § 851 of the Code in the Massachusetts personal income tax statute include (1) all RICs which qualify for federal income tax purposes, or (2) only those RICs which would qualify under the Code as amended and in effect on January 1, 1988.

For personal income tax purposes, references to the Code are, unless the context indicates otherwise, to the Code as amended and in effect on January 1, 1988. G.L. c. 62, § 1(c). A RIC organized as a corporate trust is exempt from the Massachusetts personal income tax at the entity level, provided it qualifies under § 851 of the Code as defined in chapter 62. G.L. c. 62, § 8(b)(i). A literal reading of the statute may require that RICs organized as corporate trusts must continue to comply with RIC requirements in effect as of January 1, 1988, in order to continue to qualify for an exemption from Massachusetts taxation under § 8(b)(i). Thus, under this literal interpretation, corporate trusts could not take advantage of the new federal rules if they wish to retain their status as RICs for Massachusetts purposes. (2)
A similar Code update issue arises with respect to RIC shareholders. Specifically, the question is how the new qualification rules may affect the pass through of tax-exempt income to such shareholders.

Massachusetts generally adopts the federal treatment of income from RICs as provided in the Code as of January 1, 1988. Dividends from a RIC are taxable under G.L. c. 62 unless they are excludable from Massachusetts gross income under G.L. c. 62, § 2. Certain dividends received from a RIC qualified under § 851 of the Code that are attributable to tax-exempt government obligations are deducted from federal gross income in determining Massachusetts gross income. Dividends received from RICs may be deducted to the extent they are attributable to (1) interest on tax-exempt obligations of the United States; or (2) interest on or gain from tax-exempt obligations of Massachusetts or its subdivisions, or any of their agencies or instrumentalities. Such dividends may be excluded only if identified as exempt dividends in a written notice to shareholders by the RIC no later than 60 days after the close of its tax year. See G.L. c. 62, § 2(a)(2)(A),(I) and (J). In the case of a RIC organized as a corporation, a literal reading of the statute may require that these exclusions from Massachusetts gross income are allowed only if the RIC qualifies under federal requirements in effect on January 1, 1988. This restriction would apply regardless of whether a RIC is subject to the jurisdiction of Massachusetts.

The above interpretations notwithstanding, it could be argued that the Massachusetts personal income tax provides for an automatic Code update with respect to RIC qualification. This argument is based on the theory that the context in which the term RIC is used indicates that a departure from the 1988 Code definitions may be allowed. Therefore, the term RIC may be construed as referring to a corporation's or corporate trust's federal tax status as in effect for the current taxable year. This Technical Information Release is not intended to resolve these conflicting interpretations.

IV. Conclusion

In order to provide the legislature the opportunity to consider the appropriate Massachusetts tax treatment of RICs and their shareholders in light of the recent federal tax law change, pending further notification, the Department of Revenue will treat a corporate trust or corporation as a RIC for Massachusetts purposes, provided that the corporate trust or corporation qualifies as a RIC for federal income tax purposes under the current Code. At the shareholder level, distributions from any RIC qualified for federal income tax purposes will be treated as a distribution from a RIC for Massachusetts personal income tax purposes.

In addition, the Department will take a similar position with respect to any changes in the federal definition of real estate investment trusts (REITs) under IRC § 856 and real estate mortgage investment conduits (REMICs) under IRC § 860D, as those terms are used in G.L. c. 62, § 8(b). Specifically, pending further notification, the Department will treat any entity that qualifies as a REIT or REMIC for federal income tax purposes under the current Code as a REIT or REMIC for Massachusetts personal income tax purposes. Distributions from such entities will be treated as distributions from REITs or REMICs as the case may be.

Any change in the position announced by this Technical Information Release will have prospective effect only.

Mitchell Adams
Commissioner of Revenue

December 30, 1997




1. A corporate trust is any partnership, association or trust, the beneficial interest of which is represented by transferable shares. G.L. c. 62, § 1(j). For Massachusetts income tax purposes, a Massachusetts business trust is a corporate trust. (return to text)

2. Because of the annual Code update provisions of Chapter 63, the new federal rules will not affect the entity level tax treatment of RICs organized as corporations. For corporate excise purposes, a RIC that qualifies under § 851 of the Code as amended and in effect for the taxable year is excluded from the definition of "domestic corporation" and "foreign corporation" and is not subject to the corporate excise. G.L. c. 63, § 30. Thus, the recent federal tax law change does not create a conformity problem at the entity level with respect to RICs organized as corporations. (return to text)