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.
