CONNECTICUT ENACTS TECHNICAL CORRECTIONS BILL WHICH CLARIFIES STATE TAX TREATMENT OF TERRITORIAL OBLIGATIONS

June 23, 1992 TO: TAX MEMBERS NO. 40-92 MONEY MARKET MEMBERS - ONE PER COMPLEX NO. 9-92 RE: CONNECTICUT ENACTS TECHNICAL CORRECTIONS BILL WHICH CLARIFIES STATE TAX TREATMENT OF TERRITORIAL OBLIGATIONS __________________________________________________________ As you know, prior to its adoption last year of a broad- based income tax, Connecticut imposed a dividend and interest income tax which taxed dividends of regulated investment companies ("RICs") derived from interest on federal obligations, in violation of federal law. (See Institute Memorandum to Members - One Per Complex No. 37-90, dated September 12, 1990, announcing Connecticut denial of petition for declaratory ruling on pass-through treatment of federal obligation interest.) However, Connecticut Department of Revenue Ruling No. 91-14 excluded from the dividend and interest income tax exempt- interest dividends of RICs, as defined in Internal Revenue Code section 852(b)(5), derived from interest on obligations of Puerto Rico. (See Institute Memorandum to Tax Members No. 17-91 and Money Market Members - One Per Complex No. 11-91, dated May 24, 1991.) Under the ruling, RIC ordinary income dividends (those other than exempt-interest or capital gain dividends), derived from interest on Puerto Rican and other U.S. territorial obligations remained subject to tax. The general income tax enacted by Connecticut last year excluded from state taxable income the portion of RIC ordinary income dividends derived from interest on obligations which are exempt from state tax by federal law, provided that at least 50 percent of the RIC's assets at the end of each calendar quarter consist of such obligations. (See Institute Memorandum to Tax Members No. 36-91 and Money Market Members - One Per Complex No. 23-91, dated August 30, 1991.) Because federal law exempts interest on Puerto Rican and other territorial obligations from state tax, Connecticut, therefore, does not tax RIC dividends derived from interest on Puerto Rican obligations when those Puerto Rican obligations are held in RICs which meet the above restrictions. However, the income tax bill altered the manner in which exempt-interest dividends were taxed from that which had existed under the prior-law dividend and interest income tax, calling - 1 - into serious doubt the rationale and validity of Ruling No. 91- 14, the exemption from tax for RIC exempt-interest dividends derived from interest on Puerto Rican obligations. (See Institute Memorandum to Tax Members No. 33-91 and Money Market Members - One Per Complex No. 24-91, dated September 23, 1991.) Senate Bill No. 2014, (attached) which became Public Act No. 92-5 of the May, 1992 Special Session of the Connecticut General Assembly, was signed by the Governor on Friday, June 19, 1992. The Act consists mainly of technical corrections to the earlier income tax bill, including a technical correction dealing with the inadvertent overruling of Ruling No. 91-14. Effective for taxable years of taxpayers beginning after 1991, RIC exempt- interest dividends derived from obligations, the interest on which the states are prohibited from taxing by federal law, would be exempt from the state income tax on individuals, trusts and estates. We will keep you informed of further developments. David J. Mangefrida Jr. Assistant Counsel - Tax Attachment