By Liz Cha and Open Weaver Banks

The North Carolina Supreme Court affirmed the North Carolina Business Court’s decision that Fidelity Bank was precluded from deducting “market discount income” from US bonds for North Carolina corporate income tax purposes. Fidelity Bank acquired US government bonds at a discount, held these bonds until maturity, and earned “market discount income.” Market discount income is the difference between (1) the amount a corporation initially paid for discounted bonds and (2) the amount it received from those discounted bonds at maturity. To determine its taxable corporate income, Fidelity Bank treated the market discount income as taxable income and then deducted this income as interest earned on US government obligations. Fidelity Bank argued that this income should be treated as interest because it is treated that way for federal income tax purposes.

However, the court determined that, while North Carolina law does not define the term “interest,” it should be interpreted in accordance with its plain meaning as involving “periodic payments received by the holder of a bond.” The fact that market discount income is treated as interest for purposes of determining federal taxable income did not mean that it should be treated as “interest” for all purposes under North Carolina tax law. The court also noted that the state legislature has selectively incorporated certain definitions from the Internal Revenue Code into the North Carolina Revenue Act and that if the legislature intended for “interest” to take on the same meaning it would require “specific support in relevant statutory language.” The Fidelity Bank v. North Carolina Department of Revenue, No. 392A16, 393PA16 (N.C. Aug. 18, 2017).