82-38 | Virginia Tax

Tax Type

Corporation Income Tax

Description

Tax Exempt Interest and Regulated Investment Companies

Topic

Computation of Income

Date Issued

04-01-1982

DATE: April 1982 82-38

SUBJECT: Virginia Income Tax Exempt Interest and Regulated Investment Companies

§ 58-151.013 of the Code of Virginia, 1950 as amended, provides for a subtraction from federal adjusted gross income for interest on obligations of the United States and of Virginia. The purpose of this bulletin is to point out certain types of interest which do and do not qualify for the subtraction.

(1) Specific Statutory Exemptions: Various §s of federal and Virginia law exempt from state taxation the interest on specific securities of particular U. S. or Virginia agencies, commissions, etc. All interest received on these specific securities qualify for the subtraction even though the obligation might not come within the definition of an exempt obligation under § 58 - 151.013.

(2) General definitions (a) If an obligation is not one of those mentioned in (1) above the interest on such obligation may still qualify for the subtraction if the obligation is either:

- (i) An obligation of the United States, its authorities, commissions or instrumentalities, or
  
  (ii) An obligation of Virginia, its political subdivisions or instrumentalities.
  
  (b) The term "obligation" as used in § 58-151.013 means a debt obligation or security issued by the United States or Virginia in the exercise of their borrowing power, which obligation is backed by the full faith and credit of the United States or Virginia.

(3) Guarantees: Obligations of private individuals or corporations may be guaranteed by the United States or Virginia. The guarantee may be backed by the full faith and credit of the United States or Virginia. The guarantee is merely a contingent obligation. Interest is paid by the private party to the owner of the obligation. Such interest does not qualify for the subtraction unless the obligation is specifically exempted by statute under (1) above.

(4) Repurchase agreements (a) Under the usual form of repurchase agreement, financial Institutions will issue their own obligations secured by obligations which are exempt from Virginia income taxation under (1) or (2) above. In such cases, the interest paid by the financial institution to purchasers of repurchase agreements does not qualify for subtraction.

(b) However, if the purchaser is regarded as the true owner of the underlying exempt obligation the interest will qualify for the subtraction even though paid to the seller and then distributed to the purchaser.

(c) Repurchase agreements issued following current commercial practice will invariably be subject to paragraph 4(a), Transactions in which the purchaser is regarded as true owner will be the exception.

(5) Expenses: The subtraction for interest on exempt obligations must be reduced by the expenses attributable to such interest and by interest paid on indebtedness incurred or continued to purchase or carry exempt obligations. See § 265 I.R.C and the regulations thereunder,

(6) Regulated Investment Companies. (a) Regulated Investment Company is subject to Virginia income tax if it is doing business in Virginia, but only to the extent of its federal investment company taxable income" modified by Virginia statutory additions and subtractions. Since its "investment company taxable income" excludes income passed through to shareholders in qualifying distributions (as defined in § 852 I.R.C.) and since statutory additions and subtractions are only applicable to undistributed income, a Regulated Investment Company will have no Virginia taxable income if it distributes all of its income to its shareholders as dividends.

(b) Interest on exempt obligations received by a Regulate& Investment Company and passed through to the stockholders in qualifying distributions (as defined in § 852 I.R.C.) will retain its exempt status in the hands of the shareholders,

(c) However, exemptions from taxation are required to be strictly construed and if a Regulated Investment Company receives interest from both exempt and nonexempt obligations, all distributions from the Regulated Investment Company will be presumed taxable unless the shareholder can substantiate the exempt portion of distributions.

(d) For example, many popular money market funds which qualify as Regulated Investment Companies under federal law invest not only in U.S. Government Obligations, but also in obligations of various U.S. Government agencies and in securities backed by U.S. Government Obligations (i.e. Guarantees or Repurchase Agreements). The portion of shareholder's distributions representing interest from U.S. Obligations will be exempt from Virginia income tax. However, the portion representing interest from various U.S. Government agencies may not be exempt and the portion representing interest from securities backed by U.S. Government Obligations generally will not be exempt. Furthermore; the portion of interest, if any, from obligations of states other than Virginia will not be exempt. any portion claimed as a subtraction must he substantiated.

(7) The Department of Taxation will attempt to answer taxpayer's questions as to the taxable status of specific securities if supplied with sufficient information. Due to the turnover in investments held by a Regulated Investment Company and the commingling of interest from exempt and nonexempt obligations the Department cannot advise anyone as to the taxable status of distributions from any Regulated Investment Company.

Rulings of the Tax Commissioner