Can a Connecticut corporation deduct dividends it receives from a regulated investment company that aren't deductible on its federal return?

Note: DRS marks this Ruling "not current … provided for reference purposes only" and states it "has been revoked by Ruling 93-24." Do not rely on it as current guidance. The plain-English summary below describes what the ruling said when issued, for historical reference only.

Plain-English summary

A corporation (the "Company") owned shares of a regulated investment company ("RIC") — a mutual-fund-type entity under 26 U.S.C. § 851. This RIC's income came solely from interest on U.S. Government obligations plus any capital gain on selling them, and it paid dividends to its shareholders, including the Company. DRS was asked a corporation business tax question: can the Company deduct those RIC dividends under Conn. Gen. Stat. § 12-217(a) even though they are not deductible on its federal return under 26 U.S.C. § 243?

The holding (now revoked): no deduction. DRS ruled that the dividends are not deductible under either subparagraph of Connecticut's dividends-received deduction — § 12-217(a)(A) or (D) — if no portion of them is deductible federally under 26 U.S.C. § 243.

Why. Connecticut's corporate dividends-received deduction has two parts:

• § 12-217(a)(A) piggybacks on federal law: it lets a corporation deduct what is deductible under the federal corporate income tax. Because the special RIC rules of 26 U.S.C. § 854(b) made these dividends not deductible under § 243, they were not deductible under § 12-217(a)(A) either.
• § 12-217(a)(D) (added by 1981 Conn. Pub. Acts 411) lets a corporation deduct "all dividends" not otherwise deducted. Read literally that might cover any distribution of earnings — but DRS found the phrase ambiguous (the Internal Revenue Code has both general and special definitions of "dividend") and turned to legislative history. The legislature's aim was to eliminate "double taxation" by letting corporations deduct the remaining slice of dividends that would have been deductible under § 243 but for its percentage limitation in § 243(a)(1) — not to deduct every amount that might be called a dividend. Because a RIC generally pays no tax on its distributed income, the RIC's income is taxed only once (at the shareholder level), so there is no "double taxation" to relieve — and therefore no § 12-217(a)(D) deduction.

How the pieces normally fit together (as the ruling described them, after the 1991 amendment):

• A corporate shareholder owning at least 20% but less than 100% of the payor deducts 80% of the dividends under 26 U.S.C. § 243(c) and § 12-217(a)(A), and the remaining 20% under § 12-217(a)(D).
• A shareholder owning less than 20% deducts 70% under § 243(a) and § 12-217(a)(A); the remaining 30% may not be deducted under § 12-217(a)(D) (1991 Conn. Pub. Acts 3, § 100).
• A shareholder owning 100% deducts 100% under § 243(a) and § 12-217(a)(A).

Applying the principle that deductions are a matter of legislative grace, strictly construed against the taxpayer (Bolt Technology Corp. v. Dubno), DRS concluded the Company's right to a deduction for the RIC dividends was neither clear nor unambiguous, so it was denied. This ruling was later revoked by Ruling 93-24.

What this means for you

Treat this ruling as history, not guidance

DRS has flagged this ruling as not current and revoked by Ruling 93-24. If you're a corporate shareholder of a RIC or similar entity, do not rely on the specific conclusion here — the Department itself withdrew it. Use the current statute, regulations, and later rulings, and get professional advice.

The idea behind Connecticut's dividends-received deduction

The durable concept the ruling explains is that Connecticut's dividends-received deduction was designed to prevent the same corporate earnings from being taxed twice as they pass up a chain of corporations — not to create a deduction where the income was only taxed once. That "no double tax to relieve" logic is why RIC dividends (whose underlying income isn't taxed at the RIC level) were treated differently. Later guidance (Ruling 93-24) revisited the outcome.

Federal characterization drives the Connecticut result

Because § 12-217(a)(A) follows federal law, whether a dividend is deductible under 26 U.S.C. § 243 on the federal side largely determines the Connecticut treatment. Special federal rules for RICs (§§ 854–855) can change that characterization — a reminder to work the federal analysis first.

Common questions

Q: Can I still rely on Ruling 93-2?
A: No. DRS marks it "not current … for reference purposes only" and says it "has been revoked by Ruling 93-24." It's kept here for historical reference only.

Q: What did it originally hold?
A: That a Connecticut corporation could not deduct dividends received from a regulated investment company under Conn. Gen. Stat. § 12-217(a)(A) or (D) if none of those dividends were deductible federally under 26 U.S.C. § 243.

Q: Why did the RIC dividends fail the test?
A: Federal special rules (26 U.S.C. § 854(b)) made them non-deductible under § 243, and DRS read § 12-217(a)(D) as aimed only at eliminating "double taxation." A RIC generally pays no tax on distributed income, so there was no double taxation to relieve.

Q: What should a corporate RIC shareholder do now?
A: Look to the current statute and later guidance (including Ruling 93-24), run the federal dividends-received analysis, and consult a Connecticut tax professional.

Citations and references

Statutes:

• Conn. Gen. Stat. § 12-217(a) (dividends-received deduction, subparagraphs (A) and (D)), as amended by 1991 Conn. Pub. Acts 3, § 100 (June Spec. Sess.), originally added by 1981 Conn. Pub. Acts 411, § 1; § 12-213 (net income)
• 26 U.S.C. § 243 and § 243(a)(1) (federal dividends-received deduction and percentage limitation); § 316(a) (definition of "dividend"); §§ 851, 854, 855 (regulated investment companies); § 561 (dividends-paid deduction)

Case law (as cited by the ruling):

• Bolt Technology Corp. v. Dubno, 213 Conn. 220 (1989); Circuits, Inc. v. Dubno, 213 Conn. 442 (1990); Skaarup Shipping Corp. v. Commissioner of Revenue Services, 199 Conn. 346 (1986); Golf Digest/Tennis, Inc. v. Dubno, 203 Conn. 455 (1987); Waterbury Motor Lease, Inc. v. Tax Commissioner, 174 Conn. 51 (1977)

Related guidance (described in prose, not linked):

• Ruling 93-24 (revokes this Ruling)

Source

• Landing page: Connecticut DRS Rulings
• Ruling: Ruling 93-2

Original ruling text

Ruling 93-2, Corporation Business Tax

This information is not current and is being provided for reference purposes only

This Ruling has been revoked by Ruling 93-24

FACTS:

A corporation (hereinafter "the Company") owns shares of a company (hereinafter "the Regulated Investment Company") that is a regulated investment company, as defined in 26 U.S.C. § 851(a), and is "considered a regulated investment company", under 26 U.S.C. § 851(b). The Regulated Investment Company's income consists solely of interest income from U.S. Government obligations and capital gain, if any, on sales of such obligations. The Regulated Investment Company pays dividends, as defined generally in 26 U.S.C. § 316(a), to its shareholders, including the Company.

ISSUE:

Whether dividends paid by the Regulated Investment Company to the Company are deductible under Conn. Gen. Stat. §12-217(a) if they are not deductible under 26 U.S.C. § 243.

DISCUSSION:

A cardinal rule of statutory construction is that statutes are to be construed to give effect to the apparent intention of the lawmaking body. Farms Country Club, Inc. v. Carini, 172 Conn. 439, 444, 374 A.2d 1094 (1977); Plasticrete Block & Supply Corporation v. Commission , 216 Conn. 17, 25, 579 A.2d 20 (1990); Jarvis Acres, Inc. v. Zoning Commission , 163 Conn. 41, 46, 301 A.2d 244 (1972); McAdams v. Barbieri , 143 Conn. 405, 416, 123 A.2d 182 (1956); 2A Sutherland, Statutory Construction (4th Ed.) § 45.05. If the language of the statute is clear, it is assumed that the intention is expressed by the words themselves and therefore there is no need to construe the statute; Anderson v. Ludgin, 175 Conn. 545, 552, 400 A.2d 712 (1978).

Conn. Gen. Stat. §12-217(a), as amended by 1991 Conn. Pub. Acts 3, §100 (June Spec. Sess.), provides in pertinent part:

In arriving at net income as defined in section 12-213 ...there shall be deducted from gross income ... (A) all items deductible under the federal corporation net income tax law effective and in force on the last day of the income year ... and (D) additionally ... all dividends as defined in the federal income tax law effective and in force on the last day of the income year not otherwise deducted from gross income ... other than thirty per cent of dividends received from a domestic corporation in which the taxpayer owns less than twenty per cent of the total voting power and value of the stock of such corporation ....

The dividends in question are not deductible under Conn. Gen. Stat. § 12-217(a)(A). Because of the special rules of 26 U.S.C. § 854(b), the dividends received from the Regulated Investment Company are not deductible under 26 U.S.C. § 243. Thus, those dividends are not deductible under the plain language of Conn. Gen. Stat. §12-217(a)(A). Circuits, Inc. v. Dubno , 213 Conn. 442, 568 A.2d 457 (1990); Skaarup Shipping Corp. v. Commissioner of Revenue Services, 199 Conn. 346, 507 A.2d 988 (1986).

While the phrase "all dividends as defined in the federal income tax law"; Conn. Gen. Stat. §12-217(a)(D); might appear to be unambiguous, the Internal Revenue Code includes both general and special definitions of the term "dividend". For example, the general definition of "dividend" provides that a "dividend" is a distribution made out of current earnings and profits or earnings and profits accumulated since February 28, 1913. 26 U.S.C. § 316(a). If this definition were used, Conn. Gen. Stat. §12-217(a)(D) would permit the deduction of any amount received that was a distribution of current or accumulated earnings and profits, even if not deductible under 26 U.S.C. § 243 (and therefore not deductible under Conn. Gen. Stat. §12-217(a)(A)).

However, special rules applying to the definition of "dividend" appear in the same section of the Internal Revenue Code as the general definition of "dividend"; 26 U.S.C. § 316(b) narrows the general definition of "dividend" with respect to certain insurance company dividends; 26 U.S.C. § 316(b)(2) modifies the general definition of "dividend" with respect to distributions by personal holding companies; 26 U.S.C. § 316(b)(3) modifies the general definition of "dividend" with respect to deficiency dividend distributions by a regulated investment company or real estate investment trust. The term "dividend" is also defined specially for purposes of the dividends-paid deduction in 26 U.S.C. § 561.

Special rules in 26 U.S.C. § § 854 and 855 modify the general definition of "dividend" for purposes of regulated investment company distributions and the dividends received deduction therefore. If this definition were used, Conn. Gen. Stat. §12-217(a)(D) would permit the deduction of the portion of dividends that exceeds the percentage limitation of 26 U.S.C. § 243(a)(1), while Conn. Gen. Stat. §12-217(a)(A) would permit the deduction of the portion of dividends that equals such percentage limitation.

"[Where the wording is plain, courts will not speculate as to any supposed intention because the question before a court then is not what the legislature actually intended but what intention it expressed by the words that it used. Doe v. Institute of Living, Inc ., 175 Conn. 49, 68, 392 A.2d 491; Lee v. Lee , 145 Conn. 355, 358, 143 A.2d 154." Robinson v. Unemployment Security Board, 181 Conn. 1, 6, 434 A.2d 293 (1980). On the other hand, where the wording is ambiguous, as is the case here, resort to the legislative history is necessary. An examination of 1981 Conn. Pub. Acts 411, §1, which added what is now Conn. Gen. Stat. §12-217(a)(D), indicates that the General Assembly intended to permit corporations to deduct only the remainder of dividends that would have been deductible under 26 U.S.C. § 243 but for the percentage limitation of 26 U.S.C. § 243(a)(1).

The chief proponent in the House of Substitute Senate Bill No. 523, which was enacted as 1981 Conn. Pub. Acts 411, noted that Conn. Gen. Stat. §12-217, as amended by the bill, "would . . . actually have a minimal effect [on state revenue], because 85% of corporate dividends were already excluded from income." 24 H.R. Proc., Pt. 24, 1981 Sess., p. 8146 (Remarks of Rep. Markham). (Until 1986, 26 U.S.C. § 243(a)(1) generally allowed corporate shareholders to deduct 85% of the dividends they received. The deductible percentage was decreased to 80% in 1986 (Pub. L. No. 99-514, § 611(a)(1), 100 Stat. 2085, 2249), and to 70% in 1987 (Pub. L. No. 100-203, §10221(a)(1), 101 Stat. 1330, 1330-408).)

These remarks illustrate that the General Assembly did not intend Conn. Gen. Stat. §12-217(a)(D) to allow all amounts that might be defined as "dividends" to be deductible. Instead, the General Assembly intended that Conn. Gen. Stat. §12-217(a)(D) function to completely eliminate the "double tax" on dividends that are deductible in part under 26 U.S.C. § 243. (This colloquial usage of the term "double taxation" is not one with which either the Department or the Connecticut Supreme Court concurs. See Waterbury Motor Lease, Inc. v. Tax Commissioner, 174 Conn. 51, 62-63, 381 A.2d 552 (1977).) Thus, while Conn. Gen. Stat. §12-217(a)(A) eliminates most of the "double tax" because it follows federal law, and federal law now permits the deduction of either 70, 80, or 100 percent of dividends received, as the case may be; 26 U.S.C. § 243(a); Conn. Gen. Stat. §12-217(a)(D) eliminates the "double tax" on the amounts received by corporate payees that are not 20 percent shareholders of the dividend payor.

Moreover, it is doubtful that the General Assembly contemplated that Conn. Gen. Stat. §12-217(a)(D) would apply to dividends paid by regulated investment companies to corporate shareholders. The chief proponent of Substitute Senate Bill No. 523 in the Senate remarked that Conn. Gen. Stat. §12-217, as amended, would "eliminate the corporate profits tax on dividends at that level, thus eliminating a double form of taxation. .." 24 S.R. Proc., Pt. 10, 1981 Sess., pp. 3683-4 (emphasis added) (Remarks of Sen. Beck). Because regulated investment companies generally do not pay tax on their distributed income, there is no element of "double taxation" as between the Company and the Regulated Investment Company. Under the facts presented here, the Regulated Investment Company's distributed income is taxed at only one level: the shareholder level. If the legislative intent of eliminating "double taxation" of dividends is to be given effect, Conn. Gen. Stat. §12-217(a)(D) should not be interpreted as permitting the deduction by a corporate shareholder of amounts received from a corporation that was not taxed on the distributed income.

This policy against "double taxation" was reversed to some extent, however, with the passage of 1991 Conn. Pub. Acts 3, §100, which amended Conn. Gen. Stat. §12-217(a)(D) to provide for the nondeductibility of 30% of dividends received from a domestic corporation in which the taxpayer owns less than 20% of the total voting power and value of the stock of such corporation.

This conclusion that part of Conn. Gen. Stat. §12-217(a)(D) is ambiguous is not at variance with Bolt Technology Corp. v. Dubno, 213 Conn. 220, 567 A.2d 371 (1989). There the Court determined that Conn. Gen. Stat. §12-217(a)(D)(1), which disallows the deduction of expenses "related to dividends" to the extent of the dividends received, was unambiguous. That phrase is not at issue here.

After the passage of 1991 Conn. Pub. Acts 3, §100, the application of Conn. Gen. Stat. §12-217(a)(A) and (D) is as follows: Where the corporate shareholder owns at least 20% but less than 100% of the total voting power and value of the stock of the payor corporation, the corporate shareholder may deduct 80% of the dividends that it receives from such payor under 26 U.S.C. § 243(c) and Conn. Gen. Stat. § 12-217(a)(A), and the remaining 20% under Conn. Gen. Stat. §12-217(a)(D). Where the corporate shareholder owns less than 20% of the total voting power and value of the stock of the payor corporation, the corporate shareholder may deduct 70% of the dividends that it receives from such payor under 26 U.S.C. § 243(a) and Conn. Gen. Stat. §12-217(a)(A). The remaining 30% may not be deducted under Conn. Gen. Stat. §12-217(a)(D), as amended by 1991 Conn. Pub. Acts 3, §100. Where the corporate shareholder owns 100% of the total voting power and value of the stock of the payor corporation, the corporate shareholder may deduct 100% of the dividends that it receives from such payor under 26 U.S.C. § 243(a) and Conn. Gen. Stat. § 12-217(a)(A).

The Connecticut Supreme Court "has 'uniformly adhered to the view that deductions from otherwise taxable income are a matter of legislative grace and hence are strictly construed against the taxpayer.[']" Bolt Technology , supra, at 227 (citations omitted). In accordance with that principle, the right to claim a deduction under Conn. Gen. Stat. §12-217(a)(D) for dividends received from the Regulated Investment Company must be clear and unambiguous. Id., at 228 ( citing Golf Digest/Tennis, Inc. v. Dubno , 203 Conn. 455, 465, 525 A.2d 106 (1987)). The Company's right to such a deduction is neither clear nor unambiguous, and permitting a deduction to the Company would be in contravention of the legislative intent.

RULING:

Dividends paid by the Regulated Investment Company to the Company are not deductible under Conn. Gen. Stat. §12-217(a)(A) or (D) if no portion thereof is deductible under 26 U.S.C. § 243. The legislature intended Conn. Gen. Stat. §12-217(a)(D), as added by 1981 Conn. Pub. Acts 411, to allow the deduction only of that portion of dividends received by the Company that was in excess of the amount deductible by the Company under 26 U.S.C. § 243 and thus under Conn. Gen. Stat. (§12-217(a)(A). With respect to dividends received from the Regulated Investment Company, the Company may deduct under Conn. Gen. Stat. §12-217(a)(D) only that portion, if any, of the dividends that the Company would have been entitled to deduct under 26 U.S.C. §243 and Conn. Gen. Stat. §12-217(a)(A) but for the percentage limitations of 26 U.S.C. § 243(a)(1).

LEGAL DIVISION

May 7, 1993