Declaratory Ruling No. 1990-1
Dividends, Interest and Capital Gains Tax
This publication has been obsoleted by AN 94(2)
The Trust for Government Cash Reserves (the "Trust") is a mutual fund which invests exclusively in short-term obligations of the <st1:country-region>
The Trust qualifies as a regulated investment company for the special tax treatment under the Internal Revenue Code of 1986, 26 U.S.C. §§851 through 855, and so incurs no federal income tax liability on its undistributed income. In order to receive the special tax treatment provided by the Code, the Trust must, among other requirements, distribute at least 90% of its taxable income during the tax year. Distributions from the Trust are taxable to shareholders for federal tax purposes.
The Trust has requested a ruling to the effect that distributions from it to its investors which represent interest from federal obligations are not taxable under the Connecticut Dividends, Interest and Capital Gains Tax, Conn. Gen. Stat. §12-505 – 522.
Connecticut Gen. Stat. §12-505(a) defines "interest income" as "… any interest income from obligations issued by or on behalf of any state, political subdivision thereof, or public instrumentality, state or local authority, district, or similar public entity, exclusive of such income from obligations issued by or on behalf of the state of Connecticut, any political subdivision thereof, or public instrumentality…"
Connecticut Agencies Regs. §12-518-9a(d) defines "interest income" to mean any interest income which, for federal tax purposes, is subject to tax; any interest income which is derived from obligations issued by or on behalf of any state, any political subdivision thereof, or any agency, instrumentality, authority or district thereof; and any exempt-interest dividends, as defined in §852(b)(5) of the Internal Revenue Code.
Connecticut Gen. Stat. §12-506 imposes a tax on all dividends and interest income earned, received in fact or constructively, accrued or credited to the taxpayer during his taxable year where the taxpayer’s adjusted gross income in such year equals or exceeds $54,000.
Connecticut Agencies Regs. §12-518-6a provides that a taxpayer may exclude from interest income any interest income the taxation of which by any state is prohibited by federal law; any interest income derived from obligations issued by or on behalf of the state of Connecticut, any Connecticut political subdivision, or any agency, instrumentality, authority or district of the state of Connecticut; plus any exempt interest dividends, as defined in §852(b)(5) of the Internal Revenue Code, to the extent that such dividends are derived from obligations issued by or on behalf of the state of Connecticut, any Connecticut political subdivision, or any agency, instrumentality, authority or district of the state of Connecticut.
Title 26, section 852(b)(5) of the United States Code provides that an exempt interest dividend shall be treated by the shareholders of a regulated investment company as an item of interest excludable from gross income under §103(a). Section 103(a) excludes from gross income interest on any "state or local bond", which means an obligation of a state or political subdivision thereof.
Title 31, section 3124 of the United States Code provides that obligations of the federal government are exempt from taxation by a state or political subdivision of a state. The exemption applies, with two exceptions, to each form of taxation which requires the obligation, the interest on the obligation, or both, to be considered in computing the tax.
The Connecticut Dividends, Interest and Capital Gains Tax applies to dividend distributions arising from mutual funds whose portfolio of investment securities contains, in whole or in part, federal obligations.
The imposition of the Connecticut Dividends, Interest and Capital Gains Tax on dividend distributions from mutual funds derived from interest on federal obligations does not require the obligation, the interest on the obligation, or both, to be considered in computing the tax, and thus does not violate 31 U.S.C. §3124. The tax is imposed on the distributions from a mutual fund to its shareholders, not on the interest paid by the federal government on its transactions to the fund. It is the latter transaction to which 31 U.S.C §3124(a) pertains, not the distributions from fund assets in which interest payments and dividends from the fund’s various investments are mingled.
While interest received by a mutual fund retains its identity as interest when taxed at the corporate level, distributions from a mutual fund are not passed through as tax exempt interest. Instead, the interest received by a mutual fund is regarded as dividend income for federal income tax purposes upon distribution to the fund’s shareholders. The Connecticut Supreme Court in Alling Woodruff v. Comm’r, 185 Conn. 186 (1981) addressed the issue presented herein. The taxpayer in that case contended that a regulated investment company should properly be regarded as a conduit of nontaxable interest. (At that time, interest was not subject to
In 1976 Congress amended 26 U.S.C. §852(b)(5) to provide flow-through tax exempt treatment for distributions from mutual funds. Congress therefore enacted the amendment to allow, for federal tax purposes, such flow-through treatment of interest income of a mutual fund as exempt interest dividends.
When Congress amended 26 U.S.C. §852 in 1976, it did not prohibit the states from taxing exempt interest dividends distributed by mutual funds, but only exempted such distributions from federal taxation. See the legislative history at 1976 U.S. Code. Cong. & Admin. News 4240. Furthermore, the exemption of §852 does not apply to distributions arising from obligations issued by the federal government, but only to interest arising from state and local obligations.
American Bank and Trust Co. v. Dallas County, 463 <st1:country-region>
It is hereby ruled that dividend distributions of the Trust for Governmental Cash Reserves are subject to the
James F. Meehan