| Date: | 09/01/2000 |
|---|---|
| Organization: | Massachusetts Department of Revenue |
| Referenced Sources: | Massachusetts General Laws |
Personal Income Tax
September 1, 2000
On behalf of *************** (hereinafter referred to as "RIC-I"), you request a letter ruling regarding the Massachusetts tax treatment of Exempt-Interest Dividends and Capital Gain Dividends received by its shareholders which have, in turn, flowed from RIC-I's ownership of shares in certain lower-tier funds, including *************** and *************** (either of which is referred to as "RIC-II").
I. FACTS
In support of your request, you represent the facts as follows: Both RIC-I and RIC-II are qualified as Regulated Investment Companies under Internal Revenue Code ("IRC" or "Code") § 851. RIC-I and RIC-2 are also qualified to pay Exempt-Interest Dividends under IRC § 852(b)(5).
As a Massachusetts municipal income fund, RIC-I seeks a high level of current income exempt from federal income tax and Massachusetts personal income tax. RIC-l invests predominantly in obligations of Massachusetts Municipal Issuers and U.S. Territories and Possessions whose interest is exempt from federal and Massachusetts personal income tax ("Massachusetts Exempt Obligations"). RIC-I's dollar-weighted average maturity is close to 14 years. However, in order to fund shareholder redemptions, RIC-I also seeks to invest in short-term investments.
Short-term Massachusetts Exempt Obligations can be in short supply. In order to meet its objective of producing a high level of current income exempt from federal and Massachusetts personal income tax, RIC-I is considering buying shares in one or more money market funds that invest in Massachusetts Exempt Obligations ( i.e., RIC-II) in lieu of, or in addition to, investments in short-term securities.
II. ISSUES
1. Exempt-Interest Dividends
Does the Massachusetts gross income of shareholders of RIC-I include Exempt-Interest Dividends that are attributable to the portion of the dividends on RIC-I's shares of RIC-II that is attributable to interest from Massachusetts Exempt Obligations?
2. Capital Gain Dividends
Does the Massachusetts gross income of shareholders of RIC-I include Capital Gain Dividends that are attributable to the portion of the dividends on RIC-I's shares of RIC-II that is attributable to exempt gains from Massachusetts obligations?
III. RULINGS
1. Exempt-Interest Dividends attributable to Massachusetts Exempt Obligations received by shareholders from a RIC which are excluded from federal gross income under IRC § 852, are also excluded from Massachusetts gross income even if they have flowed through two levels of RICs, subject to the satisfaction of the 60 day notice requirement. G.L. c. 62, § 2(a)(2)(I).
2. Dividends received by shareholders from a RIC which are Capital Gain Dividends under IRC § 852, are excluded from Massachusetts gross income, even if they have flowed through two levels of RICs, to the extent attributable to certain Massachusetts obligations (the gain from which is exempt under Massachusetts law), subject to the satisfaction of the 60 day notice requirement. G.L. c. 62, § 2(a)(2)(J).
IV. DISCUSSION
1. Exempt-Interest Dividends - One-Tier RIC
Massachusetts gross income is federal gross income with certain modifications. G.L. c. 62, § 2(a). Federal gross income does not include interest derived from any obligation of a state or its political subdivision (hereinafter "state obligations"). IRC § 103. [1] For Massachusetts income tax purposes, this exclusion is limited to interest derived from obligations issued by Massachusetts, its political subdivisions, or any agency or instrumentality of either (hereinafter "Massachusetts obligations"). G.L. c. 62, § 2(a)(1)(A). Thus, for federal and Massachusetts income tax purposes, interest derived from such Massachusetts obligations is excluded from gross income.
A RIC that has invested in state obligations receives the interest from such obligations, which is exempt under IRC § 103, and at given intervals, remits the exempt interest to its shareholders. Under the IRC, such flow-through exempt interest is defined as "Exempt-Interest Dividends." IRC § 852. For federal tax purposes, a qualified RIC is allowed to issue Exempt-Interest Dividends to its shareholders to the extent such RIC received interest excludable from gross income under IRC § 103. [2] IRC § 852(b). Shareholders are allowed to treat Exempt-Interest Dividends as interest excludable from federal gross income under IRC § 103. IRC § 852(b)(5)(B). For Massachusetts tax purposes, the exclusion for Exempt-Interest Dividends is allowed ". . . only to the extent of the portion of such exempt interest dividends directly attributable to interest from [Massachusetts Exempt Obligations] . . . " G.L. c. 62, § 2(a)(2)(I). Further, such exempt portion must be ". . . identified in a written notice mailed to the shareholders . . . not later than [60] days after the close of its tax year." Id. Therefore, for Federal and Massachusetts tax purposes, interest directly attributable to Massachusetts Exempt Obligations flowing through a RIC is excluded from the gross income of the shareholders, subject to the satisfaction of the 60 day notice requirement.
2. Exempt-Interest Dividends - Two-Tier RICs
Under the facts you have presented to us, RIC-I has purchased shares in RIC-II, in the same manner and with the same rights to dividends as any individual or institutional investor. RIC-II has invested in state obligations and remits Exempt-Interest Dividends to its shareholders, including RIC-I. For federal tax purposes, RIC-I is allowed to flow these Exempt-Interest Dividends through to its shareholders, where they are received, and excluded from federal gross income, by RIC-I shareholders as Exempt-Interest Dividends from RIC-I. IRC § 852.
For Massachusetts tax purposes, Exempt-Interest Dividends excluded from federal gross income under IRC § 852 are also excluded from Massachusetts gross income to the extent they are directly attributable to Massachusetts Exempt Obligations. G.L. c. 62, § 2(a)(2)(I). Further, such exempt portion must be ". . . identified in a written notice mailed to the shareholders . . . not later than [60] days after the close of its tax year." Id. Therefore, for Massachusetts tax purposes, Exempt-Interest Dividends flowing through two levels of RICs which are excluded from the federal gross income of shareholders under IRC § 852, are also excluded from the shareholders' Massachusetts gross income, subject to the satisfaction of the 60 day notice requirement.
3. Capital Gain Dividends - One-Tier RIC
A RIC that has invested in state obligations derives capital gains from the sale and exchange of such obligations. For federal tax purposes, the RIC calculates the net capital gain from these transactions and remits such net capital gain to the shareholders as a "Capital Gain Dividend." IRC § 852(b)(3)(C).
For Massachusetts income tax purposes, gain or loss derived from state obligations is included in Massachusetts gross income unless specifically excluded by statute. [3] There are numerous state obligations that qualify for a Massachusetts gain exclusion. For Massachusetts income tax purposes, dividends received from a RIC which are Capital Gain Dividends under IRC § 852, are excluded from Massachusetts gross income ". . . to the extent the portion of such capital gain dividends attributable to gain from [Massachusetts obligations] . . . is exempt from taxation under any provision of law . . .." G.L. c. 62, § 2(a)(2)(J). Further, such exempt portion must be ". . . identified in a written notice to the shareholders . . . not later than [60] days after the close of [the RIC's] tax year." Id. Therefore, for Massachusetts tax purposes, gains which are Capital Gain Dividends under IRC § 852, are excluded from Massachusetts gross income to the extent they are attributable to Massachusetts obligations, the gain from which is exempt under Massachusetts law, subject to the satisfaction of the 60 day notice requirement.
4. Capital Gain Dividends - Two-Tier RICs
As noted above, RIC-I has purchased shares in RIC-II, which in turn has invested in state obligations. RIC-II remits Capital Gain Dividends to RIC-I, which in turn for federal tax purposes, treats the Capital Gain Dividend as a gain from the sale or exchange of a capital asset. The RIC-II Capital Gain Dividend increases RIC-I's net capital gain for the taxable year, which in turn for federal income tax purposes, increases the amount of Capital Gain Dividends RIC-I may issue to its shareholders.
For Massachusetts income tax purposes, the RIC-I Capital Gain Dividends are excluded from the shareholder's Massachusetts gross income if they are qualified under IRC § 852 and to the extent attributable to Massachusetts obligations, the gain from which is exempt under Massachusetts law, subject to the satisfaction of the 60 day notice requirement.
Very truly yours,
/s/Frederick A. Laskey
Frederick A. Laskey
Commissioner of Revenue
FAL:DMS:jmw
LR 00-12
[1] The exceptions, such as certain private activity bonds, are not relevant to this inquiry. IRC § 103(b).
[2] There are other federal qualifications regarding Exempt-Interest Dividends that must be satisfied before such dividends are excluded under the Code. These qualifications are under the authority of the Internal Revenue Service and must be satisfied as a condition precedent to any Massachusetts income tax exclusion.
[3] Such exclusions are usually found in the enabling legislation creating the government's authority to issue the obligations.