A Massachusetts security corporation is an entity that receives beneficial Massachusetts tax treatment but is required to restrict its activities in two ways: (1) it may engage exclusively in buying, selling, dealing in, or holding securities on its own behalf and not as a broker; and (2) the securities must be acquired and held for investment purposes. On September 30, 2011, the Massachusetts Department of Revenue (the “DOR”) issued a working draft of a Directive on the Scope of Certain Permissible Activities and Use of a Security Corporation (the “Original Draft Directive”) that restricted the ability of a security corporation shareholder to pledge its stock in the security corporation as collateral for a loan to the shareholder. Security corporation classification would be denied or revoked if: (1) the stock pledged represented more than fifty percent of the value or total combined voting power of the corporation; or (2) there were negative covenants or restrictions in connection with the pledge that related to the scope of permitted assets, liabilities, or activities of the corporation. Under certain circumstances, those restrictions were to go into effect the day after the Original Draft Directive was issued.
On April 6, 2012, the DOR issued a revised working draft Directive (the “Revised Draft Directive”) that removed the above restrictions imposed by the Original Draft Directive. The Revised Draft Directive does observe, however, that certain activities would result in denial or revocation of security corporation classification. Many of these prohibited activities were understood by practitioners to exceed activities permitted to a security corporation. The Revised Draft Directive includes a nonexclusive list of prohibited activities; for example, a security corporation may not act as guarantor of a loan to a shareholder, and a security corporation’s assets (as opposed to its stock) may not be pledged as security for a loan to a shareholder. It also includes a nonexclusive list of restrictive covenants that are impermissible as part of the pledge of a security corporation stock to a lender; namely, a covenant that allows the pledgee to become a direct creditor of a security corporation or that requires the pledgor to withdraw securities from the security corporation through a distribution and pledge those securities to the lender, or a covenant that directs the security corporation’s investments to securities of the shareholder or the pledgee.
Both the Original and Revised Draft Directives address in similar ways the circumstances in which a security corporation could acquire appreciated securities from an affiliate and subsequently sell those securities to a third party without resulting in revocation of security corporation classification. For example, a security corporation may not be used as a conduit for the sale of appreciated securities for the purpose of sheltering the gain on the sale from the general corporate excise tax rate.