United States

Maryland: Tax Court Holds That Comptroller’s Policy Regarding Federal Obligation Interest is Discriminatory

Aug 29, 2016
From KPMG TaxWatch

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Recently, the Maryland Tax Court granted a taxpayer’s corporate income tax refunds after holding that the Comptroller’s policy on federal obligation interest was unconstitutional. The taxpayer, a North Carolina based bank, received interest from federal and state obligations. Both types of interest are excluded from federal taxable income. Maryland, however, requires taxpayers to add back federal obligation interest in computing state taxable income. There is no requirement to add back interest from Maryland obligations. Federal obligation interest is then subtracted in computing Maryland taxable income, but the Comptroller allows the subtraction only to the point that it does not create or increase a net operating loss (NOL)).  The taxpayer filed refund claims on which it deducted the federal obligation interest that it was precluded from subtracting in earlier years to avoid creating an NOL. After the Comptroller denied the refunds, the taxpayer took the matter to the tax court.

The tax court first addressed whether the Comptroller’s policy violated the Supremacy Clause of the U.S. Constitution because it placed heavier burdens on holders of federal obligations than holders of state obligations. As support for its position the taxpayer cited to a case, Kraft, in which the court held that Maryland’s policy on the subtraction of foreign sourced dividends discriminated against foreign commerce. Specifically, taxpayers that received domestic dividends were not required to add them back and therefore, to the extent the taxpayer had a loss, it could be carried forward to future years. Taxpayers that received foreign-sourced dividends, however, were required to add them back. The foreign dividends could then be subtracted in the year received unless the subtraction created a loss. The tax court, relying on the Kraft decision, likewise held that the Comptroller’s policy of not allowing carryforwards of unsubtracted exempt federal obligation interest discriminated against the holders of federal obligations in favor of those who held Maryland obligations. Thus, to not violate the Supremacy Clause, a full subtraction of exempt federal obligation interest must be allowed. Please contact Mike Riscili at 703-286-8307 with questions on Branch Banking and Trust Co. v. Comptroller.

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The following information is not intended to be "written advice concerning one or more federal tax matters" subject to the requirements of section 10.37(a)(2) of Treasury Department Circular 230.

The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.