Technical Advice Memorandum
Subject: Subsidiary Dividends and Other Dividend Income
Schedule: Corporate Income Tax - Article 4, Schedule D
Statute: G.S. 105-130.4(c) and (f); G.S. 105-130.5(c)(3); G.S. 105-130.7(4)
Issued By: Corporate, Excise, and Insurance Tax Division
Date: September 15, 1997
Reference: CTAM 97-14
Subsidiary Dividend Deduction
Under G.S. 105-130.7(4), a corporation whose commercial domicile is within North Carolina can deduct all dividends received from corporations in which it owns more than 50% of the outstanding voting stock. Foreign corporations, which are those whose commercial domicile is outside North Carolina, cannot take the deduction. Therefore, this deduction treats domestic and foreign corporations differently.
In light of the United States Supreme Court's decision in Fulton Corp. v. Faulkner and an Advisory Opinion of the Attorney General dated July 14, 1997, the Department believes that G.S. 105-130.7(4) would be found unconstitutional if challenged in our courts. Therefore, the Department is extending to foreign corporations the deduction in G.S. 105-130.7(4) for dividends received from corporations in which they own more than 50% of the outstanding voting stock.
Expenses Related to Subsidiary Dividend Deduction
Under general principles of income taxation, expenses are deductible if they are incurred to produce taxable income and are not deductible if they are incurred to produce income that is exempt from tax. The reason for this is obvious; it prevents a double tax benefit that would result if a taxpayer both exempted income from tax and deducted the expenses incurred to produce the exempt income. This disallowance of a deduction for expenses related to the production of exempt income is commonly referred to as attribution of expenses.
Despite the principle of attribution of expenses, expenses that are related to exempt subsidiary dividends can be deducted along with the dividend income. The reason for this is G.S. 105-130.5(c)(3). That subdivision sets out the general rule that no deduction is allowed for any direct or indirect expenses related to income not subject to tax, but then forbids an adjustment under that subdivision for adjustments addressed in G.S. 105-130.5(a) and (b). One of the items addressed in G.S. 105-130.5(b) is (b)(3), which allows corporations to deduct from federal taxable income the amount of subsidiary dividends excluded under G.S. 105-130.7(4).
The Department has interpreted the combination of G.S. 105-130.7(4) and 105-130.5 to override the general policy on attribution of expenses. The effect of this is that expenses related to subsidiary dividends excluded under G.S. 105-130.7(4) are deductible. The same result applies to subsidiary dividends of foreign corporations that are deductible under G.S. 105-130.7(4) by application of the policy announced in this memorandum. The expenses incurred by a foreign corporation to produce subsidiary dividends deductible under G.S. 105-130.7(4) are deductible and no attribution of expenses is required for these dividends. Prior to this memorandum, subsidiary dividends earned by a foreign corporation were allocated as non-business income to the corporation's state of commercial domicile, and the corporation was required to attribute expenses to that nonbusiness dividend income.
The changes described in this memorandum concerning the taxation of subsidiary dividends and their related expenses are effective September 15, 1997. Taxpayers filing original returns on or after September 15, 1997, may follow this treatment in computing their North Carolina taxable income. Refunds of taxes paid for prior years are governed by G.S. 105-267. Taxpayers seeking a refund should contact the Corporate, Excise, and Insurance Tax Division at (919) 733-8510 regarding their claims.
Distinction Between Business Dividends and Non-business Dividends
In reviewing the issue of subsidiary dividends and related expenses, the Department has reconsidered its position on the treatment of dividend income earned by a corporation. This memorandum announces a new policy on dividend income.
Effective for taxable years beginning on or after January 1, 1998, dividend income may be either business income or non-business income depending on its nature. Business income is apportioned among the states based on apportionment factors; whereas, nonbusiness income is allocated to the corporation's state of commercial domicile. A dividend will be considered business income if any of the following circumstances apply:
- The dividend arises out of or is acquired in the regular course of the corporation's trade or business.
- The purpose of the corporation in acquiring or holding the stock that gives rise to the dividend is related to the corporation's trade or business.
- The dividend is paid by a unitary subsidiary.
If a dividend is not business income, it is non-business income.
The attribution of expenses is required for dividends that are non-business income. This applies to domestic as well as foreign corporations but does not apply to dividends deducted as subsidiary dividends under G.S. 105-130.7(4). Non-business dividends, less related expenses, are allocated under G.S. 105-130.4(c) and (f) to the corporation's state of commercial domicile.