Mass

Article XIII, section 26(a) of the California Constitution authorizes the Legislature to impose income taxes on persons, corporations, and other entities. Subdivision (b) of that section ( Section 26 (b)) exempts from state income tax interest on bonds issued by the State or a local government in the State (California government bonds). I write separately to emphasize that Section 26 (b) does not prohibit the Legislature from imposing state income tax on corporate shareholder dividends comprised, in part, of interest on California government bonds.

California Revenue and Taxation Code section 17145 ( Section 17145 ) authorizes a regulated investment company (RIC) to designate a portion of its shareholder dividends as exempt from state income tax if, and to the extent that, at least 50 percent of the RIC's assets consist of tax-exempt California government bonds. Appellants Ronald and Pamela Mass (taxpayers) invested in an RIC with an investment portfolio that contains some California government bonds but does not meet the 50 percent threshold. They claim the 50 percent threshold in Section 17145 is facially unconstitutional because it violates Section 26 (b). Essentially, the…

*281 *962 Ronald D. and Pamela S. Mass (Taxpayers) bought shares in a company that invests in government bonds. They received dividends derived from interest on those bonds. Because the California Constitution exempts interest on government bonds from taxation, Taxpayers contend that their dividends were unconstitutionally taxed. We disagree.

BACKGROUND

The parties stipulated to the following facts. Taxpayers reside in California. They held shares in The Blackrock Insured Municipal Term Trust, Inc. (BMT), a regulated investment company (RIC). ( Int.Rev. Code, § 851.) BMT received 12.41 percent of its interest income from its holdings in California municipal bonds. During the 2010 tax year, Taxpayers received interest dividends 1 from their investments in BMT, but did not report the interest dividends as taxable income. The Franchise Tax Board (the Board) assessed taxes against Taxpayers on the interest income, which they protested.

The amount of tax in controversy is $7,384, which is the tax assessed on the interest dividends Taxpayers received from BMT that were derived from California bonds. Taxpayers filed a claim for refund, which the Board denied. They also filed an appeal…