Testimony on HB 1661 from former Senior DRA Official Val Berghaus

Testimony in Support of House Bill 1661 Reversing the Recent Changes to the Interest & Dividends Tax, RSA 77

The intent of the recent changes to the Interest and Dividends (I&D) tax (the so-called “LLC tax”), so says the Department of Revenue Administration, is “to bring fairness and parity” to the tax. ” In the view of the Commissioner, the new law “closes the loophole” in the tax’s treatment of LLC’s. Following the DRA’s lead both the governor and the legislative leadership have defended the changes as necessary to achieve “fairness in our tax system.” By asserting this viewpoint, those holding it strongly imply a constitutional infirmity in the existing tax that requires radical change. Not so. There was no constitutional problem with the old tax. In order to illustrate this one must understand how the old tax actually worked; an explanation that has notably been absent from the presentations heretofore put on by the DRA.

The old I&D tax, enacted in 1923, set about changing the way investment property was to be taxed in New Hampshire. Instead of selecting “money in hand” as the measure of taxable property, it proposed taxing “money received.” That is, instead of taxing the value of shares of stock or “credits,” i.e., the right to receive money from a debtor, the tax would be levied on the actual dividends or interest paid to the owner or creditor. The taxable parties would be individuals, partnerships and fiduciaries receiving such income. But not corporations, corporations would be exempt. The rationale was: if the interest and dividend income received by a corporation were taxed and dividends paid by the corporation also taxed when received by its owner(s), the result would be an unequal burden. Corporations, therefore, ought in fairness to be exempt from the tax. This disparate treatment passed constitutional muster under the sharp scrutiny of the N.H. Supreme Court in Connor v. State, 82 N.H. 126, 132 (1925).

The distinction between taxable and nontaxable parties was elaborated in the former I&D tax by incorporation of the concept of “transferable” versus “not transferable” shares. This concept formed the demarcation between who was a taxable person and who not. It was recognized that corporations almost always had shares that could readily be transferred without substantial impediment. However, other forms of organization such as partnerships, associations and trusts might also have interests that were freely alienable like corporations and therefore ought to be treated similarly. On the other hand, non-corporate organizations which had beneficial interests not represented by transferable shares would be subject to the I&D tax on their receipt of interest and dividend income the same as individuals and fiduciaries.


This distinction makes sense. Since non-transferrable shares have no intrinsic value, they are incapable of alienation. Of course the underlying assets represented by the shares may have value and may be sold or transferred, but that is not the same thing. Contrast this with transferable shares of stock which may be sold on the market and thereby acquire value independent of the assets they represent. This distinction is perfectly consistent with the historical purpose of the old I&D tax’s change of the measure of taxable value from “money in hand” to “money received.”

In 1993, about the time that LLC’s were established in New Hampshire law, the I&D tax was amended to include them along with partnerships, associations and trusts. As a result the same dividing line was applied to LLC’s as to these non-corporate entities. Thus, if an LLC had transferable shares it was exempt from tax on its receipt of interest and dividend income. Its owners, however, would be taxable on dividends they received from their LLC the same as if it were a corporation. On the other hand if the LLC’s shares were not transferable, then it paid tax on interest and dividend income received by it just as did partnerships, associations, trusts, fiduciaries and individuals..

A fundamental touchstone of taxation in New Hampshire is the “rule of equality,” given powerful and long lasting voice by Chief Justice Doe in State v.Express Company, 60 N.H. 219 (1880). For 86 years the I&D tax existed without successful challenge that its treatment of taxpayers violated this rule. Yet the DRA this past year – substituting its own wisdom – seems to have concluded that it did and therefore the tax was unfair to some taxpayers. Either the DRA grossly misunderstood the core precept or some other definition of tax “fairness” – not readily apparent on its face or adequately explained – was intended.


The DRA must have recognized that its radical proposal to change the I&D taxed fundamentally altered the original impost’s limitation to the taxation of only passive investment income. It was never intended in 1923, or for any year thereafter until 2009, to tax earned income or income from capital gains. The law as passed in House Bill 2 last June does exactly that. However, the DRA, with respect to at least earned income, has attempted by rule to limit the scope of the new tax. The proposed DRA rule borrows the “compensation deduction” concept from the Business Profits Tax. However, the compensation deduction is the singularly most problematic feature of the BPT. The difficulties in interpretation and enforcement are legion. It has provoked more discussion, litigation and wringing of hands than practically any other facet of the BPT. More than one attempt has been made to legislatively alter or “clarify” the provision, including HB 1607 introduced this session. The incorporation of the reasonable compensation provision into the I&D tax exponentially expands the complexity of the law and by extension the burden of compliance on taxpayers. Even if ultimately no tax is found to be due, the administrative expense in time and anxiety on the part of the business person and the costs to acquire expert accounting and legal help will amount to a significant economic burden, make no mistake. Furthermore, the burden on the agency relative to administration and audit is also greatly increased. It beggars reason to understand why anyone would want to move from a simple impost like the old I&D to one that is guaranteed to generate such headaches.

The new I&D tax, therefore, cannot be defended on the basis of “fairness.” Furthermore, there was a blatant lack of transparency in the way it was enacted: introduction and passage at the eleventh hour of the 2009 session. Contrast this with the way the Business Enterprise Tax was handled. The initial concepts of the BET were formulated and language drafted within the DRA with the assistance and counsel of an expert outside tax practitioner. The first draft was then introduced to the public by the governor himself in a well publicized hearing, accompanied by a very long and thorough explanation of the technical aspects of the proposed new tax. Following this were months of committee working sessions with much input from the public, with revision upon revision, until finally a consensus was reached and the bill enacted July 1, 1993. It was immediately followed by work on comprehensive rules -- rules actually begun before the bill became law -- so that taxpayers would have early guidance to effectively plan for the day the first returns were due. These rules were promulgated initially as interim rules in September, 1993, and then as permanent rules in January, 1994. All in all, there was a thorough vetting of the proposal in the public arena, a feature almost entirely lacking from the recent I&D tax changes.

Now that the public is fully aware of what transpired last June, many problems with the new law, and in particular the rules being promulgated to administer it, are coming to the fore. Certainly the recently filed lawsuit illustrates this. It is time to take a big step back and reconsider this ill-considered law in an open and transparent way within the tradition of New Hampshire. Furthermore, taxpayers need to be put at ease for the present while the process works itself out. For this and the other reasons cited above, HB 1661 ought to be passed into law as soon as possible.