88-7 | Virginia Tax

Tax Type

Individual Income Tax

Description

Investment company dividends

Topic

Taxable Income

Date Issued

01-04-1988

January 4, 1988

Re: Request for Ruling/Individual Income Tax
Exempt Interest and Dividends

Dear****************

This is in reply to your letter of November 2, 1987 in which you request a ruling regarding the deductibility of interest and dividends received from *************** ( Trust ).

FACTS

Based on the prospectus enclosed with your letter, Trust is a regulated investment company which seeks a high current return by investing in U.S. Government securities, including GNMA Certificates, and related options and by writing covered options. Trust invests in U.S. Government securities which include: (1) U.S. Treasury obligations - U.S. Treasury bills, U.S. Treasury notes and U.S. Treasury bonds; and (2) obligations issued or guaranteed by U.S. Government agencies and instrumentalities. Trust: may also purchase U.S. Government securities and enter into "repurchase agreements" with the seller. According to the dividend procedure in the prospectus, Trust will pay dividends on a monthly basis.

RULING

An individual's Virginia taxable income is his federal adjusted gross income (FAGI), with the modifications set forth in §58.1-322 of the Code of. Virginia. §58.1-322(B)(2) provides that to the extend excluded from FAGI, there shall be added "interest or dividends, less related expenses to the extent not deducted in determining federal taxable income, on obligations or securities of any authority commission or instrumentality of the United States which the laws of the United States exempt from federal income tax but not from state income taxes". §58.1-322(C)(1) provides for the subtraction from FAGI of "interest or dividends on obligations of the United States and on obligations or securities of any authority commission or instrumentality of the United States to the extent exempt from state income taxes under the laws of the United States including but not limited to stocks bonds treasury bills and treasury notes" to the extent the income is included in FAGI.

Virginia Regulation 630.2-322(3)(B) defines an "obligation" as "[a] debt obligation or security issued by the United States or any authority commission or instrumentality of the United States...issued in the exercise of the borrowing power of the United States...and is backed by the full faith and credit of the United States." The regulation further states:

- Guarantees by the United States or Virginia of obligations of private individuals or corporations are merely contingent obligations of the United States or Virginia even though the guarantees may be backed by the full faith and credit of the United States and Virginia. The obligation does not become an obligation of the United States or Virginia because of the guarantee and interest and dividends paid on such guaranteed obligations do not qualify for the subtraction unless specifically exempted by statute.

VR 630-2-322(3)(B)(4) also addresses the Virginia tax consequences of repurchase agreements. The regulation provides that under the usual form of repurchase agreements, financial institutions will issue their own obligations secured by obligations which are exempt from Virginia income taxation. In such cases the interest paid by the financial institution to purchasers of repurchase agreements does not qualify for the subtraction.

The department recognizes that interest on exempt government obligations received by a regulated investment company and passed through to the shareholders in qualifying distributions will retain its exempt status in the hands of shareholders. However based upon the information in the prospectus some of the investments by the Trust are merely contingent obligations of the United States and as such the interest and dividends derived from these obligations are subject to Virginia income tax under VR 630-2-322(3)(B). In addition the Trust's repurchase agreements are subject to Virginia income tax under VR 630-2-322(3)(B)(4).

VR 630-2-322(3)(C)(2) provides that "[w]hen taxable income is commingled with exempt income all income is presumed taxable unless the portion of income which is exempt from Virginia income tax can be determined with reasonable certainty and substantiated". (Emphasis added)

Therefore based on the foregoing dividends paid by the Trust will be nontaxable for Virginia purposes only to the extent that the Trust can substantiate the portion of each distribution to each shareholder relating to investments in exempt securities. As noted in VR 630-2-322(3)(C)(2):

- [I]f distributions are made monthly then the determination must be made monthly. As a practical matter only pass-through entities which invest exclusively in U.S. or Virginia obligations or which have extremely stable investment portfolios will be likely to make such determinations.

Consequently in order for you to have sufficient evidence to substantiate the subtraction of exempt income Trust will need to provide you with a breakdown of exempt and nonexempt dividends on a monthly basis since dividends are paid monthly. otherwise all income from Trust must be included in Virginia taxable income.

I hope this information is helpful. If you have any further questions please do not hesitate to contact me.

Sincerely,

W. H. Forst
Tax Commissioner

Rulings of the Tax Commissioner