830 CMR, § 63.38B.1

Current through Register 1533, October 25, 2024

Section 63.38B.1 - Massachusetts Taxation of Security Corporations

(1)General.

(a)Purpose of Regulation. 830 CMR 63.38B.1 sets forth the rules for the Massachusetts tax treatment of security corporations under M.G.L. c. 63, § 38B.

(b)Organization. 830 CMR 63.38B.1 is organized as follows:

1. General.

2. Definitions.

3. Qualification for Security Corporation Classification.

4. Definition of Securities.

5. Requirement that Securities be Held Exclusively for Investment Purposes.

6. Procedure for Security Corporation Classification.

7. Continuing Status of Application and Classification; Change in Activities.

8. Election for Voluntary Withdrawal.

9. Revocation.

10. Submissions to the Security Corporations Unit.

11. Effective Date.

(2)Definitions.

Affiliate, for purposes of 830 CMR 63.38B.1, means a member of an affiliated group as defined under section 1504 of the Code.

Arm's Length Secondary Market, a venue for purchasing previously issued and outstanding securities that is not related to the seller, the purchaser, or the issuer of the securities being acquired. An arm's length secondary market may include a private investment firm that makes a market in securities or that otherwise brokers or acts as an intermediary in facilitating a purchase and sale of securities.

Bank Holding Company, a bank holding company as defined under the Code in effect for the tax year.

Code, the federal Internal Revenue Code in effect for the tax year.

Commissioner, the Commissioner of Revenue or the Commissioner's representative authorized to perform the duties of the Commissioner.

Debt Instruments, shall be deemed to include, without limitation, in addition to corporate bonds, debt obligations of the United States, its agencies or instrumentalities and of any state or political subdivision thereof, their agencies or instrumentalities.

Financial Institution, a financial institution as defined in M.G.L. c. 63, § 1.

Open Tax Year, any tax year for which additional assessments may be made by the Commissioner under the applicable statute of limitations.

REIT, a real estate investment trust as defined in the Code.

Related Member, as defined in M.G.L. c. 63, § 31I.

Regulated Investment Company, or RIC, an entity that is treated as a regulated investment company for the tax year under the Code.

Real Estate Mortgage Investment Conduit, or REMIC, an entity that is treated as a real estate mortgage investment conduit for the tax year under the Code.

Securities, securities as defined at 830 CMR 63.38B.1(4).

Security Corporation, every financial institution or business corporation that is engaged exclusively in buying, selling, dealing in, or holding securities on its own behalf and not as a broker, and either applies to the Commissioner to be classified as a security corporation before the end of the tax year and is so classified, or has been so classified by the Commissioner and that classification has not been revoked. A security corporation is subject to tax under the provisions of M.G.L. c. 63, § 38B, and is not subject to an excise imposed by M.G.L. c. 63, §§ 2, 32, 32D, or 39.

(3)Qualification for Security Corporation Classification.

(a)In General. In order to qualify for security corporation classification, the entity must satisfy a two-pronged test:

1. the instruments held by the entity must be securities; and

2. the securities must be acquired and held for investment purposes.

(b) Requirement that a security corporation be engaged exclusively in securities investment activities, namely buying, selling, dealing in, or holding securities on their own behalf and not as a broker. A corporation that is engaged in any business activity other than securities investment activity during any portion of its tax year is not entitled to classification as a security corporation.

Example (3)(b). ManufacturingCo is a corporation engaged in manufacturing with a tax year end of June 30^th. On June 15, 2007 ManufacturingCo enters into a purchase and sale agreement to transfer its manufacturing assets on July 7, 2007. From July 1 through July 7, 2007, the first seven days of its tax year, ManufacturingCo derives income from the last of its manufacturing activities. On July 7, 2007 ManufacturingCo sells all if its manufacturing assets, investing the proceeds in various securities. From July 7, 2007 through June 30, 2008 ManufacturingCo engages exclusively in the buying, selling, holding and dealing in securities. ManufacturingCo is not entitled to classification as a security corporation for its tax year ending June 30, 2008, because it has engaged in a business other than a securities business for a portion of that tax year.

(c) A security corporation may engage in ancillary activity that is necessary or typical in the context of its securities investment business. Examples of this type of ancillary activity include: owning office furniture or supplies used in operating its business; engaging a payroll services company for payment of its staff; sponsoring employee benefits programs on behalf of its staff. Ancillary activities may include activities that are necessary to protect a corporation's assets from liabilities, or to meet obligations that may arise from a prior, discontinued business.

Example (3)(c). SecurityCo currently invests only in securities, but prior to 2002 it sold parts for heavy construction equipment. SecurityCo continues to maintain products liability insurance for potential liabilities arising from the continuing existence of the equipment. Generally, a security corporation does not purchase products liability insurance, but in this case, because the corporation maintains the insurance to insulate its assets from liabilities that could arise from its prior, discontinued business activities, the ownership of the insurance will not of itself preclude SecurityCo from obtaining security corporation classification.

(4)Definition of Securities.

(a) The definition of securities that applies to bank holding companies. As applied to bank holding companies, the term security means a security that is recognized as such under the general rules of Massachusetts case and statutory law. The scope of qualifying securities for these purposes will generally encompass any instrument qualifying as a security under the rules found at M.G.L. c. 63 § 38B(b1/2), and more fully explained in 830 CMR 63.38B.1(4)(b).

(b) The definition of securities that applies to entities that are not bank holding companies. As applied to entities that are not bank holding companies, for tax years that end on or after October 1, 2004, securities are defined under M.G.L. c. 63, § 38B(b1/2) to include:

1. Equity or debt instruments and options, futures and other derivatives, that are traded on and were acquired through a public exchange or another arm's length secondary market. These options, futures, and other derivatives may have as their underlying property either tangible goods, such as petroleum, grain, or livestock, or intangible items, such as securities.

Example (4)(b)(1.1). SubsidiaryCo is an investment subsidiary of ParentCo, a real estate developer. OtherCo is an unrelated company. SubsidiaryCo lends money to OtherCo and takes back a promissory note. Even though this security may in some circumstances be saleable on a secondary market, it does not qualify as a security in this case because it was not in fact purchased on an arm's length secondary market. SubsidiaryCo will not qualify as a security corporation.

Example (4)(b)(1.2). InvestCo invests in and holds securities. It approaches EquityCo, a major investment firm that pairs interested investors with sellers of suitable privately-held business interests to encourage private investment. EquityCo recommends that InvestCo purchase ten percent of the stock of CloseCo from a third party, which holds previously issued and outstanding stock of CloseCo. Neither EquityCo nor InvestCo are affiliates of CloseCo. Provided it meets all other requirements of this regulation, InvestCo's investment in CloseCo stock is an investment in a security acquired on an arm's length secondary market.

2. Bonds as defined in and issued pursuant to M.G.L. c. 23G, which includes bonds issued by the Massachusetts Development Finance Agency.

3. Cash and cash equivalents, including savings and checking accounts and certificates of deposit, and foreign currencies.

4. Interests in a REIT under section 856 of the Code or a RIC under section 851 of the Code, or a real estate mortgage investment conduit under section 860D of the Code, so long as none of the mortgages owned by the conduit were originated by the holder of the instrument or by an affiliate of the holder.

5. Mortgage-backed securities that are guaranteed by the Federal National Mortgage Association, the Government National Mortgage Association, the Federal Home Loan Bank or the Federal Home Loan Mortgage Corporation.

6. Collateralized mortgage obligations, so long as none of the mortgages that underlie the obligation were originated by the holder or by an affiliate of the holder.

7. Any other passive investment vehicles that, in the judgment of the Commissioner, should be considered to constitute "securities." Taxpayers may request guidance on specific questions about what qualifies as a security under this paragraph, by seeking a letter ruling under 830 CMR 62C.3.2.

a. Further explanation of the term "other passive investment vehicles." The Department will not treat a corporation as failing to qualify for classification as a security corporation solely because it holds on or after October 1, 2004 an equity interest in a business organized as a corporation that it purchased at arm's length but which is otherwise not described in section 38B(b 1/2)(1), for example, stock purchased from the original issuer. In order to meet this requirement, the taxpayer must be able to demonstrate to the satisfaction of the Commissioner, based on all the facts and circumstances, that the instrument was purchased and is held for passive investment purposes only; and neither the taxpayer nor any of its shareholders, officers, directors, or related members:

i. has either legal or effective control, directly or indirectly, of the business (whether through stock ownership, board representation, contract, or otherwise), either with respect to operations or with respect to any fundamental business matters, such as corporate governance, dividend policy, mergers and acquisitions, and financings, etc.;

ii. participates actively in management of the business, whether or not serving in a formal capacity such as an officer;

iii. is a related member of the business;

iv. holds a debt security, not otherwise named in 830 CMR 63.38B.1(4)(b), in the business, or is otherwise a creditor of the business.

Any decision on qualification as a security pursuant to 830 CMR 63.38B.1(4)(b)7. shall be in the Commissioner's discretion, and the taxpayer shall have the burden of satisfying the Commissioner with respect to both the applicable facts and circumstances and the application of the standards set out above. The Department in the future may issue further guidance to change, refine, or add to the requirements for qualification under section 38B(b 1/2)(7), and it is possible that such guidance will, on a prospective basis, further restrict or eliminate the potential for qualification.

(c)Transition Rule. A corporation shall not lose its status as a security corporation for a tax year that begins before October 1, 2004 if:

1. the instruments that it holds for the portion of the tax year ending on September 30, 2004 qualify as securities under M.G.L. c. 63, § 38B as it read prior to the effective date of the definition of "securities" set forth in M.G.L. c. 63, § 38B(b1/2) and 830 CMR 63.38B.1(4)(b), namely October 1, 2004; and

2. the instruments that it holds for the portion of the tax year beginning on October 1, 2004 qualify as securities as defined in 830 CMR 63.38B.1(4)(b).

(d) The new definition of "securities" will not be construed to preclude a security corporation from acquiring certain qualifying securities from an affiliate. The Department will not treat a corporation that owns securities that otherwise meet the definition set forth in 830 CMR 63.38B.1(4)(b)1. as failing to qualify as a security corporation solely because it acquires securities from an affiliate, provided the securities were initially acquired by the affiliate through a public exchange or other arm's length secondary market as part of the affiliate's securities investment activities.

(e)Ownership of REITs by Security Corporations. A security corporation may own an interest in a REIT. However, an ownership interest in a REIT that is a related member shall not be considered a qualifying security. This rule applies to bank holding companies and non-bank holding companies.

(f)Limitation on Scope of the Definition of Securities in 830 CMR 63.38B.1(4)(b). The definition of "securities" in 830 CMR 63.38B.1(4)(b) shall not be construed to limit the instruments that may be held by an investment partnership for purposes of the safe harbor set forth in M.G.L. c. 62, § 17(b).

(5)The Securities must be Acquired and Held Exclusively for Investment Purposes.

(a)

1.Analysis of Investment Intent. To qualify for security corporation classification, the corporation must engage in its activities for an investment purpose. This purpose includes the intent to conserve and augment capital and to provide income through judicious acquisition and retention of securities. Holding an instrument, even one that in another context may qualify as a security, for any purpose other than investment will disqualify an entity from security corporation classification. A corporation that holds securities, such as cash equivalent instruments, in circumstances where the funds invested in an instrument are used directly or by an affiliate for operational purposes, or are used as part of a cash management system, does not qualify as a security corporation.

2.Special Rule for Security Corporation Subsidiaries of Financial Institutions. Security corporations that are subsidiaries of financial institutions are permitted to deposit cash in an account of a related financial institution (the "related financial account") under certain conditions, notwithstanding the provisions in 830 CMR 63.38B.1(5)(a)1. This permission is limited to a security corporation that has generated cash from interest, dividends, or other qualifying income earned from its investments, or from the sale, redemption, or maturity of a security, and that deposits the cash in the related financial account solely on a temporary, short-term basis pending reinvestment of the cash by the security corporation in qualifying securities issued by unrelated issuers. To be eligible for this exception, the following additional conditions must be met:

a. The related financial account must be established, and deposits made therein, on terms and conditions generally available to similarly-situated customers.

b. The security corporation must regularly (e.g. quarterly) declare and pay dividends or otherwise make distributions of all amounts of cash or other property on hand, except to the extent that such cash or other property is either held in cash or invested in qualifying securities issued by unrelated issuers or is deposited in the related financial account on terms meeting the standards set out in 830 CMR 63.38B.1.

c. Deposits by the security corporation in the related financial account must be limited in amount and time on deposit so as to reasonably reflect, and be commensurate with, a demonstrated need for holding cash in an interest-bearing account on a short-term, temporary basis pending reinvestment in qualifying securities issued by unrelated issuers (taking into account the availability to the security corporation of any other cash or property for purposes of investing in qualifying securities, including cash or other property contributed by its parent or other shareholders). Any amounts so deposited that are not promptly reinvested in such qualifying securities must be dividended or otherwise distributed by the security corporation to its parent or other shareholders.

d. In computing its net income, the related financial institution paying interest on the related financial account in which the security corporation is permitted to make temporary, short-term deposits of cash pursuant to 830 CMR 63.38B.1(5)(a)2. must add back otherwise deductible interest paid, accrued, or incurred to the security corporation, subject to the exceptional cases where such deductions are allowable, according to the provisions of M.G.L. c. 63, § 31J. The Department will closely examine requests for such add back exceptions, and the taxpayer must establish to the Department's satisfaction the reasonableness of the security corporation deposits in light of the standards set out in 830 CMR 63.38B.1.

e. The security corporation must maintain books and records establishing that it has met the standards set out in 830 CMR 63.38B.1, and be prepared to demonstrate to the satisfaction of the Department that it has met such standards.

Example (5)(a.1). LendCo is in the business of lending money for business and personal reasons, which it secures through promissory notes. The business of lending money is not the acquisition of securities for an investment purpose; thus LendCo is ineligible for security corporation classification.

Example (5)(a.2). InvestCo owns a variety of securities, including stock of BigCo that it purchased through a secondary market. InvestCo has negotiated loans with BigCo and has taken back promissory notes as a means of financing BigCo's operations. InvestCo is ineligible for security corporation classification, for two reasons: Because InvestCo is negotiating loans with BigCo, it is engaged in activities with respect to its holdings that go beyond an investment related purpose; and the notes themselves are not securities within the meaning of 830 CMR 63.38B.1(3)(b)1., because the notes were not acquired through a public exchange or other arm's length secondary market.

Example (5)(a.3). CloseCo is a closely held corporation. CloseCo holds, in addition to various securities, promissory notes received from its president and a principal stockholder of CloseCo as security for loans made for the accommodation of CloseCo's principals. The notes are unsecured and provide for a favorable rate of interest. CloseCo may not be classified as a security corporation for two reasons. First, the notes were not taken for investment purposes, but as security for loans made for the accommodation of CloseCo's principals. Second, the notes were not purchased on an arm's length secondary market.

Example (5)(a.4). ManufacturingCo is a corporation engaged in manufacturing. In 2007, ManufacturingCo sells its plant, equipment and other assets and ceases its manufacturing business, taking back from Buyer a promissory note that Buyer will repay over a fifteen-year period. After 2008, ManufacturingCo continues to hold the note, and engages in investing in a variety of securities. ManufacturingCo may not be classified as a security corporation for any year during which it holds the original note, because the note was not acquired for investment purposes.

(b)

1. In order to qualify as a security corporation, the taxpayer generally must exercise no management or control over the issuer of the instrument. The taxpayer can have no more than the ordinary rights typically possessed by a corporate shareholder, which include:

a. the right to elect directors;

b. the right to vote on the amendment of a corporate charter;

c. the right to agree to dissolution of the corporation; and

d. the right to agree to the sale of substantially all of the corporation's assets.

Example (5)(b)(1.1). ConsultCo owns a variety of securities. Recently, ConsultCo acquired an 8% limited partnership interest in a limited partnership (LP) that it purchased through a secondary market. The limited partnership is not in the business of dealing in securities. There are ten other limited partners invested in LP, each of which holds an 8% interest. ConsultCo's interest in LP gives it a variety of powers. ConsultCo has the right to vote on amendments to the underlying partnership agreement. It also has rights that exceed those granted to all limited partners under M.G.L. c. 109, which governs limited partnerships. For example, ConsultCo has the right to veto decisions concerning the business activities of the limited partnership; and it has the right to veto borrowing and investment activities of the limited partnership. While an interest in a limited partnership may be a security provided it meets all the requirements of 830 CMR 63.38B.1(4)(a), in this case the rights granted the limited partner exceed those allowed under 830 CMR 63.38B.1. The right to vote on amendments to the underlying partnership agreement is similar to rights given an ordinary corporate shareholder, and does not disqualify the corporation from security corporation classification. The right to veto business or investment decisions of the partnership, however, is not a right held by an ordinary investor, and will prevent the corporation from having security corporation classification.

Example (5)(b)(1.2). VentureCo generates capital through equity investments in high-risk ventures, such as in early-stage development companies. VentureCo introduces other investors to potential investments in companies in which Venture Co invests; VentureCo both extends lines of credit to the developing companies and arranges the extension of credit from lenders to them. It also advises management of the emerging businesses on best practices and strategies. Because VentureCo's activities include both investment activities and non-qualifying business activities, it does not qualify for security corporation classification.

Example (5)(b)(1.3). Parent Corporation owns several subsidiaries, including ManageCo, which contracts to manage publicly traded mutual funds, and InvestCo, which purchased shares in several funds managed by ManageCo through an arm's length secondary market. Provided InvestCo engages in no other disqualifying activity, it is eligible to be classified as a security corporation, notwithstanding ManageCo's contractual relationship with the purchased funds to provide management services.

Example (5)(b)(1.4). InvestCo purchases investments through stock exchanges and arm's length secondary markets. It purchases a 40% interest in NewCo, which gives it the right to vote to hire and fire managers. InvestCo has rights that exceed those ordinarily held by a corporate shareholder, and is ineligible for security corporation classification.

2. In order to qualify as a security corporation, a non-bank holding company must not own a controlling interest in a business entity. In addition to satisfying other requirements for qualification as a security corporation, a non-bank holding company security corporation's investment (whether direct or indirect) in the equity of a business entity (or options or interests exercisable or convertible into equity) must in any event not exceed 50% of the outstanding equity interests in that entity (determined as if options and instruments exercisable or convertible into equity are in fact exercised or converted), whether measured by vote or value. For example, a corporation will not be eligible for security corporation classification if it owns more than 50% of the stock of a subsidiary, or is a related member of the subsidiary.

Example (5)(b)(2). ParentCo owns 51% of HoldingCo, a holding company that it purchased through an arm's length secondary market. HoldingCo owns the stock of two corporations that perform business functions. ParentCo has no explicit rights to manage or control the business of HoldingCo. Because its interest in HoldingCo exceeds 50% of HoldingCo's outstanding equity interests, ParentCo is ineligible for security corporation classification.

(6)Procedure for Security Corporation Classification.

(a)Timing of the Application. A corporation seeking to be classified as a security corporation must submit an application to the Commissioner prior to the end of the tax year for which classification is sought.

(b)Information Required in the Application. A corporation that seeks security corporation classification must include in its application the following information:

1. the name, address, and federal identification number of the corporation;

2. the tax year for which classification is sought;

3. a balance sheet as of the first day of the tax year;

4. a balance sheet as of the date of the application ( or as near as is reasonably possible);

5. an income statement for the period from the first day of the tax year to the date of the application;

6. a statement that the corporation will be in compliance with M.G.L. c. 63, § 38B for the remaining portion of the tax year, and specifically that the corporation will be engaged exclusively in buying, selling, dealing in and holding securities on its own behalf and not as a broker, and engage in its activities exclusively for investment purposes;

7. a statement that the corporation is or is not a regulated investment company or a bank holding company; and

8. the name and telephone number of the officer or representative who is to be contacted in case additional information is needed. If a representative, the application must include a duly executed power of attorney authorizing the Commissioner to discuss the application with that representative.

(c)Requirements for Statements Accompanying the Application. Any general balance sheet entries, such as "Investments," "Accounts Receivable," or "Marketable Securities" must be accompanied by a detailed schedule listing the applicable assets.

(d)Additional Information. In addition to the application described in 830 CMR 63.38B.1(6), the Commissioner may require a corporation seeking security corporation classification to submit additional information supporting its application.

(e)Application Submission Instructions. Applications for security corporation classification should be submitted to the Security Corporations Unit, as set forth in 830 CMR 63.38B.1(10).

(7)Continuing Status of Application; Change in Activities.

(a)Classification in Successive Years. Once a corporation has been classified as a security corporation, it may continue to file as a security corporation for successive years unless it is notified by the Commissioner that its classification has been revoked, provided that the corporation must in good faith believe that it continues to qualify as a security corporation.

(b)Required Notification to Commissioner of a Change in Corporate Activities or Other Facts that Might Affect Security Corporation Status. A corporation that has been classified as a security corporation must notify the Commissioner of any change in its activities or other facts that might impact its classification. Such notice should be submitted to the Security Corporations Unit, as set forth in 830 CMR 63.38B.1(10) before the end of the tax year in which such change occurs.

(8)Election for Voluntary Withdrawal.

(a)General. A corporation that has been classified as a security corporation may elect to withdraw from the classification.

(b)Time for Election. To be effective for a given tax year, a corporation's election to withdraw as a security corporation must be submitted to the Commissioner by the end of the tax year.

(c)Information Required. A notice to withdraw as a security corporation must include the corporation's federal identification number and a brief statement of the reason for the request.

(d)Effect of Election. A notice to withdraw as a security corporation is effective for the tax year during which the security corporation submits the notice and for all succeeding tax years of the corporation.

(e)Notice Submission Instructions. A notice to withdraw from security corporation classification should be submitted to the Security Corporations Unit, as set forth in 830 CMR 63.38B.1(10).

(f)Retroactive Voluntary Withdrawal Not Allowed. After the end of a tax year, a security corporation may not seek to withdraw as a security corporation for a prior tax year.

Example (8)(f). SecurityCo elects to be classified as a security corporation and duly files its returns for tax years 2004 - 2007 as a security corporation. After filing, SecurityCo reviews its 2005 return and realizes that if it had been a business corporation it would have been entitled to a dividends received deduction for some of its income, which would have yielded a more favorable tax result. SecurityCo seeks to file an amended return as a business corporation for the year in question. SecurityCo is not permitted to change its status as a security corporation because the tax year is concluded.

(9)Revocation of Security Corporation Classification.

(a)Assessment. A corporation that has been classified as a security corporation is entitled to taxation under M.G.L. c. 63, § 38B for a given tax year only if it meets the requirements of that section for that year. Accordingly, if during any tax year a corporation that is classified under M.G.L. c. 63, § 38B fails to meet this section's requirements, the Commissioner may revoke the corporation's classification and assess the corporation for any amounts due under the corporate excise.

(b)Retroactive Revocation. Where the Commissioner finds that a corporation classified under M.G.L. c. 63, § 38B has failed to meet the requirements of that section for a prior tax year, the Commissioner may retroactively revoke the security corporation classification for that year and all subsequent years that the corporation failed to meet the classification requirements under M.G.L. c. 63, § 38B. Where the Commissioner has retroactively revoked a corporation's security corporation classification for a prior tax year, the Commissioner may assess that corporation under the applicable statute for all open tax years. The Commissioner has the discretion to treat a corporation that met the requirements of M.G.L. c. 63, § 38B in other open tax years as a security corporation for any such year.

(10)Submissions to the Security Corporations Unit.

(a) Taxpayers shall submit all required written applications and notices to the Security Corporations Unit at the following address:

Massachusetts Department of Revenue

Attn: Security Corporations Unit

200 Arlington Street, Room 4300

Chelsea, MA 02150

(b)Electronic Filing. Security corporations are subject to the general rules for electronic filing that apply to other corporations. Taxpayers are advised to review current electronic filing requirements on the Department of Revenue Web site, www.dor.state.ma.us.

(11)Effective Date. 830 CMR 63.38B.1 shall take effect for tax years beginning on or after January 1, 2006.

830 CMR, § 63.38B.1

Amended by Mass Register Issue 1493, eff. 4/14/2023.