FRANK E. DALEY & another [Note 1] vs. STATE TAX COMMISSION.

KAPLAN, J. When G. L. c. 62, our State income tax law, was rewritten in 1971 to impose a tax "in conformity with the Federal model" (Ingraham v. State Tax Comm'n, 368 Mass. 242, 247 [1975]), the possibility was created that at some fringe point the new law might collide with art. 44 of the Amendments to the Constitution of the Commonwealth,

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the provision, having no counterpart in the Constitution of the United States, which commands a single rate of tax on income from any given "class" of property. [Note 2] The present case involves such a collision.

Frank E. Daley, upon terminating his employment with the Cabot Corporation in 1972, received in that year a lump sum payment of $55,156.45 from an employees' trust established by the company pursuant to its pension plan. [Note 3] In their joint Federal income tax return for 1972, Daley and his wife [Note 4] treated $2,853.04 of the total as a nontaxable return of the employee's contributions under the plan; $6,720 as ordinary income; and the balance of $45,583.41 as long-term capital gain. The taxpayers about the same time filed a joint Massachusetts return for 1972 in which the two latter portions of the payment were treated as income taxable at a rate of 5%. The Commissioner of Corporations and Taxation assessed an additional income tax of $1,815.13, on the theory that the $45,583.41 considered federally as a long-term capital gain was subject to Massachusetts tax at the rate of 9%. [Note 5] The taxpayers paid the additional assessment, then filed an application for abatement, contending that by force of art. 44 the $45,583.41 as well as the $6,720 must be taxed at the rate of 5%. Upon denial of their application by the State Tax Commission, the taxpayers appealed to the Appellate Tax Board. On stipulated facts (in large part summarized above), the Board found for the taxpayers. In an opinion rendered in February, 1978, the Board construed the relevant provisions of G. L. c. 62 as subjecting

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the $45,583.41 to a 5% rate of tax. This interpretation was plainly impelled by the Board's fears of offending otherwise against art. 44.

The taxpayers do not attempt to support the Board's interpretation of the statute, and we, too, think the interpretation is unsupportable (see note 8, infra.) But we also agree with the taxpayers that if the statute were applied according to its terms to impose the 9% tax, as the State Tax Commission proposed, it would to that extent violate art. 44. [Note 6]

In adapting to the Federal Internal Revenue Code, G. L. c. 62, as appearing in St. 1971, c. 555, Section 5, divided income into two categories: the first, taxable at 9%, included interest, dividends, and "net capital gain," defined as "the excess of the recognized gains over the recognized losses during the taxable year from sales or exchanges of capital assets or from other transactions deemed to be sales or exchanges of capital assets or granted gains treatment under the provisions of the [Federal] Code." Section 4 (a) (3). The second category, taxable at 5%, included all other income (Section 4 [b]: "income subject to taxation, other than the income taxable under subsection [a]"). Here was an effort to conform to art. 44 by relating the rates of tax to income from different classes of property, and at the same time to promote uniformity between State and Federal taxation. Cf. First Interim Report of the Special Commission to Develop a Master Tax Plan, 1971 Senate Doc. No. 1298, at 23. But a vagary of the Federal scheme created a particular difficulty.

The Federal Code in the 1971 text, with effect for 1972, as a general rule taxed distributions from qualified employee benefit plans as ordinary income. Section 402(a)(1). But there was an exception for lump sum retirement or death benefits under qualified plans: in certain circumstances

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these were taxed in part as capital gains and in part as ordinary income. Thus ordinary income treatment was accorded such part of a lump sum retirement benefit as derived from post-1969 employer contributions (apparently represented in the $6,720 in the present case), whereas capital gains treatment was given to the benefits traced to pre-1970 employer contributions or traced to appreciation, dividends, or interest on any contributions whether by employer or employee (the $45,583.41 herein). Section 402 (a) (2), (5). We indicate in the margin how the Federal law attained to these distinctions in the taxation of lump sum retirement distributions. [Note 7] Such as they were, the distinctions were imported into the Massachusetts system by G. L. c. 62, Section 4 (a) (3)--in particular by the language "transactions ... granted gains treatment under the provisions of the [Federal] Code." The additional assessment was faithful to this text of Section 4 (a) (3). [Note 8]

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The collision with art. 44 occurs in the attempt to tax so much of the lump sum payment as comes from the post-1969 employer contributions at a 5% rate, while taxing the part deriving from the corresponding earlier employer contributions at 9%. Giving the legislation the benefit of any constitutional doubt, and placing the burden of proving invalidity on the taxpayers, see Barnes v. State Tax Comm'n, 363 Mass. 589, 594 (1973), we are still unable to say that the fact that the contributions were made at different times can set them apart as different classes of property for art. 44 purposes. [Note 9]

Article 44 [Note 10] affords the General Court broad power to levy a tax on incomes, short of a tax with different rates on income derived from the same class of property. The tax may be "at different rates upon income derived from different classes of property," but it must be at "a uniform rate throughout the commonwealth upon incomes derived from the same class of property." [Note 11] The Legislature

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surely has a considerable range of discretion within the bounds of reason in defining or designating what are different classes, see Opinion of the Justices, 266 Mass. 583, 586 (1929); Tax Comm'r v. Putnam, 227 Mass. 522, 531 (1917), and it has similar liberty in establishing exemptions from the tax, see Opinion of the Justices, 270 Mass. 593 (1930); cf. Opinion of the Justices, 354 Mass. 792 (1968). Although differences in the rates set must reflect "actual underlying differences in the property" [Note 12] giving rise to the income, the "nature of the business and incidents" may characterize a property and distinguish it from another. Barnes v. State Tax Comm'n, supra at 594. So also habitual practice or custom or history or other considerations may play their part in the delineation of classes. Id.; cf. First Fed. Sav. & Loan Ass'n of Boston v. State Tax Comm'n, 372 Mass. 478, 491 (1977), aff'd 437 U.S. 255 (1978). Quite clearly, as the taxpayers concede, the General Court could have drawn a line in the statute between increments on the contributions and the contributions themselves, with different rates applied to the portions of the lump sum payments to taxpayers deriving from the respective sources. The statute, however, went beyond the verge and took an impermissible line in its imitation or absorption of the particular feature of the then current Federal law. Thus we have no choice but to affirm the result reached by the Appellate Tax Board, although not on the ground taken by it. [Note 13]

Decision of the Appellate Tax Board affirmed.