dissenting.
I respectfully dissent from Part I of the Court’s opinion and from the resulting partial affirmance of the order for refund. The Court has compromised, severely and gratuitously, the separate entity theory, one of the foundations of an income tax system.
The Trust for Short-Term U.S. Government Securities (the Trust), whose distributions to shareholders are involved here, is a Massachusetts business trust and a regulated investment company (RIC) under subchapter M of the Internal Revenue Code (IRC).1 Associations doing business in the form of Massachusetts business trusts are taxable as corporations. See IRC § 7701(a)(3); Morrissey v. Commissioner, 296 U.S. 344, 56 S.Ct. 289, 80 L.Ed. 263 (1935); Hecht v. Malley, 265 U.S. 144, 44 S.Ct. 462, 68 L.Ed. 949 (1924); 10 J. Mertens, The Law of Federal Income Taxa*376tion § 38A.36, at 90 (1989). The “definition of ‘corporation’ for the State income tax laws [is] similar to the definition used in the federal income tax laws.” Revisor’s Note to Md.Code (1988), § 10-101(b) of the Tax-General Article.
A corporation and its shareholders are separate entities. Income received by the corporation is taxed to it. Dividends paid out of that same income are also taxed to the shareholders. The separate taxation of corporation and shareholder is not affected, absent statute, by the fact that the corporation regularly distributes all, or nearly all, of its net income to shareholders. See National Carbide Corp. v. Commissioner, 336 U.S. 422, 69 S.Ct. 726, 93 L.Ed. 779 (1949).
Here the Trust derives income from two sources, interest paid to it by the United States on federal obligations owned by the Trust, and income from the repo transactions. From its total income the Trust pays all of the salaries, fees, commissions, perquisites and other business expenses and capital expenditures required in operating a mutual fund. It then pays the net income to shareholders. By computing the ratio which total federal obligation interest paid to the Trust bears to the Trust’s gross income from all .sources, and then by applying that ratio (53.55%) to its distribution of net income to shareholders, the Trust derives an amount which it contends is still interest on federal obligations and exempt from taxation.
For the shareholders to escape state taxation it is not sufficient that the income from federal obligations received by the Trust is exempt from state taxation of the Trust’s income. See Md.Code (1957, 1980 Repl.Vol., 1984 Cum. Supp.), Art. 81, § 280(c)(1). In order for the dividend paid by the corporation to the shareholder to be immune under principles of intergovernmental immunity, it is necessary (1) for the law to consider that a dividend is apportionable according to the various types of income received by the dividend payor and (2) for that portion of the dividend prorated on the basis of total federal obligation interest to total corporate income to continue to carry that same char*377acter as federal obligation interest after distribution by the corporation to the shareholder.
Nothing in IRC subchapter M, relating to RICs, achieves that result. Highlighting that conclusion is a comparison of the provisions dealing with partnerships and with “S” corporations to the provisions relating to RICs. IRC § 1366(b) deals with the tax treatment of shareholders of an “S” corporation. It provides that “[t]he character of any item included in a shareholder’s pro rata share [of corporate income] shall be determined as if such item were realized directly from the source from which realized by the corporation, or incurred in the same manner as incurred by the corporation.”
IRC § 701 provides that “[a] partnership as such shall not be subject to the income tax imposed by this chapter.” Section 702(b) provides that, in determining the income tax of each partner, “[t]he character of any item of income ... included in a partner’s distributive share ... shall be determined as if such item were realized directly from the source from which realized by the partnership[.]”
Congress knows how to express clearly an intent that income, distributed from one entity to another, retain, after distribution, the same character which the income had when received by the distributing entity. Congress has not done so with respect to federal obligation interest income of RICs.
With respect to RICs there are provisions which allow an RIC to avoid taxation at the corporate level. The provisions of the IRC under which a RIC may avoid federal taxation are described in Hervey, T.M. Port. No. 10, Taxation of Regulated Investment Companies, at A-l (1987) (Hervey).
“Under the RIC provisions ([IRC] §§ 851-55, § 860), a domestic corporation or business trust registered with the Securities and Exchange Commission as an investment company under the provisions of the Investment Company Act of 1940 may elect to be a RIC for a taxable year if it satisfies certain requirements relating to the source of *378its income and the diversification of its assets. If a RIC satisfies certain additional requirements relating to the distribution of its net income, the RIC will generally be taxed as a pass-through entity which acts as a partial ‘conduit’ of income to its shareholders. Such conduit treatment is achieved by allowing a qualifying RIC to deduct the amount of dividends paid to its shareholders in computing the RIC’s taxable income, with the result that the RIC’s distributed net income can be passed through to its shareholders free of tax at the corporate level.”
(Emphasis added). The availability of the above-described deduction to the RIC does nothing to assist the shareholder in attributing to a dividend received the character of the income received by the RIC.
A RIC, however, may pay a capital gain dividend, as defined in IRC § 852(b)(3)(C) which “shall be treated by the shareholders as a gain from the sale or exchange of a capital asset held for more than 6 months.” § 852(b)(3)(B).
The federal income tax treatment of interest on state obligations received by RICs is also instructive on the problem in this case. With exceptions not relevant here federal gross income does not include interest on the obligations of a state. IRC § 103(a). “Interest on such tax-exempt obligations is also not included in the gross income of a RIC for purposes of computing the RIC’s investment company taxable income.” Hervey, at A-54. Under IRC § 852(b)(5) a RIC, under certain conditions, “is permitted to pass through to its shareholders the tax-exempt character of the RIC’s net income from tax-exempt [state] obligations ... through the payment of ‘exempt-interest dividends.’ ” Hervey, at A-54 (footnote omitted). This retention in the dividend paid by the RIC of the character of exempt state interest received by the RIC is effected by the language of § 852(b)(5)(B). It states that “[a]n exempt [state] interest dividend shall be treated by the shareholders for all purposes of this subtitle as an item of interest excludable from gross income under section 103(a)____” The quoted language is, of course, a statutory modification of the separate *379entity principle. There is no comparable provision retaining in the hands of shareholders the character of federal obligation interest received by a RIC.
The majority opinion says that the absence of a character retention provision for federal obligation interest is irrelevant because federal obligation interest is federally taxable. But the point relevant to the instant problem is that the Trust’s distribution to a shareholder comes onto a shareholder’s federal return, and hence, onto the Maryland return, as a dividend because nothing in federal law preserved the character of the federal interest as federal interest after distribution.
Thus, the result reached by the majority rests solely on 31 U.S.C. § 3124(a). As a result the holding in this case cannot be limited on any principled basis to mutual funds. Whether mutual funds which concentrate their investments in federal obligations are good for the economy is not legally germane.2 The issue is whether Maryland’s income tax requires “the interest on the obligation ... to be considered in computing [the] tax” on the shareholder, within the meaning of 31 U.S.C. § 3124(a).
Maryland’s tax on this dividend is not computed by considering interest on a federal obligation. Federal obligation interest is part of the gross income of the Trust. The Maryland tax is computed on the Taxpayer’s taxable income, which in turn includes a dividend from the Trust, which in turn is part of the net income of the Trust, which *380in turn is the gross income of the Trust, less expenses. That gross income of the Trust includes interest on federal obligations. The majority opinion reaches its conclusion by stirring the Trust and its shareholders together in one bowl of indistinguishable, economic mush.
The majority opinion favorably cites cases from other states which, in my view, fall into the same mistaken approach. Thus, the distinction between interest to the Trust and a dividend to its shareholders is denounced as a “ ‘formal but economically meaningless’ distinction.” Maj. opinion at 360 (quoting Brown v. Franchise Tax Bd., 197 Cal.App.3d 300, 304-05, 242 Cal.Rptr. 810, 813 (1987)). The separate entity doctrine “ ‘elevates form over substance.’ ” Maj. opinion at 360 (quoting Matz v. Department of Treasury, 155 Mich.App. 778, 782, 401 N.W.2d 62, 64 (1986)).
The federal constitution does not require this wholesale “trashing” of tax and corporate law principles. Decisions of the Supreme Court “ ‘have treated [§ 3124] as principally a restatement of the constitutional rule.’ ” South Carolina v. Baker, 485 U.S. 505, 526, 108 S.Ct. 1355, 1368, 99 L.Ed.2d 592, 612, reh’g denied, 486 U.S. 1062, 108 S.Ct. 2837, 100 L.Ed.2d 937 (1988) (quoting Memphis Bank & Trust Co. v. Garner, 459 U.S. 392, 397, 103 S.Ct. 692, 695, 74 L.Ed.2d 562, 567 (1983)). Supreme Court decisions dealing with a property tax on intangibles illustrate how the constitutional immunity is violated and how the immunity’s sweep is not nearly so great as the majority opinion would make it here.
American Bank & Trust Co. v. Dallas County, 463 U.S. 855, 103 S.Ct. 3369, 77 L.Ed.2d 1072, reh’g denied, 463 U.S. 1250, 104 S.Ct. 39, 77 L.Ed.2d 1457 (1983), held that a property tax on bank shares valued at the net worth of the issuing bank, without any exclusion for federal obligations held by the bank, infringed federal immunity. The problem presented in American Bank may be demonstrated by an oversimplification. Assume a bank which has 100 stockholders, each of whom owns one share. The bank has no real estate and presents the following balance sheet:
*381$ 2,500 U.S. Obligations $ 7,500 Liabilities
7.500 Other Assets 2,500 Net Worth
$10,000 $10,000.
A tax assessor, proceeding in the same fashion as the assessor in American Bank, would value the bank shares in our example at $25 per share ($2,500 net worth divided by 100 shares). Utilizing all of the federal obligations to determine the bank’s net worth and thereby value the shares, in the words of § 3124(a), “require[d] the obligation ... to be considered in computing [the] tax.”
First Nat’l Bank v. Bartow County Bd. of Tax Assessors, 470 U.S. 583, 105 S.Ct. 1516, 84 L.Ed.2d 535 (1985), also involved a property tax on bank shares which, by state law, were to be valued at the net worth of the issuing bank. The assessor in First Nat’l Bank sought to avoid the constitutional violation found in American Bank by proceeding somewhat differently. The assessor recast the balance sheet by eliminating all federal obligations as assets, but the assessor also reduced liabilities by a percentage equal to the ratio of U.S. obligations to total assets. Using the same oversimplified example set forth above, that balance sheet presented on the First Nat’l Bank model would appear as follows:
$ 0 U.S. Obligations $5,625 Liabilities
7.500 Other Assets 1,875 Net Worth
$7,500 $7,500.
The share tax would then be applied to stock valued at $18.75 per share. The same mathematical result would be obtained if the liabilities were not reduced at all and United States obligations were reduced from $2,500 to $1,875.
$1,875 U.S. Obligations $7,500 Liabilities
7,500 Other Assets 1,875 Net Worth for
Tax Valuation
$9,375 $9,375.
The Court in First Nat’l Bank recognized that a rule which required the elimination from assets of all U.S. obligations, without an adjustment in liabilities, would permit a bank to shelter its shareholders by maintaining U.S. government obligations in an amount equivalent to net *382worth. “The tax exemption required by the Constitution and [§ 3124(a) ] is not a tax shelter.” Id. at 597, 105 S.Ct. at 1524. The connection, which was constitutional, between the federal obligations owned by First National Bank and the tax on the shares held by its stockholders seems to me to be closer than the attempted connection between shareholders and federal obligation interest income paid to a corporation, passed through that entity, reduced by expenses, and then paid out as dividends.
Memphis Bank & Trust Co. v. Garner, 459 U.S. 392, 103 S.Ct. 692, involved subparagraph (1) of § 3124(a) which recognizes that there is no constitutional immunity from a nondiscriminatory, nonproperty tax which is in lieu of a franchise tax imposed on a corporation. Tennessee taxed the net earnings of banks and, in defining net earnings, included income from obligations of the United States but excluded interest earned on the obligations of Tennessee and its political subdivisions. This discriminatory feature excluded the tax from the protection of subparagraph (1) of § 3124(a). In South Carolina v. Baker, 485 U.S. 505, 108 S.Ct. 1355, the Court, referring to Memphis Bank & Trust Co., said that “this Court has in effect acknowledged that a holder of a government bond could constitutionally be taxed on bond interest[.j” Id. at 526, 108 S.Ct. at 1368. The principle applied was that “[w]here ... the economic but not the legal incidence of the tax falls upon the Federal Government, such a tax generally does not violate the constitutional immunity if it does not discriminate____” Id. (quoting Memphis Bank & Trust Co., 459 U.S. at 397, 103 S.Ct. at 695). Maryland’s tax on the Trust’s dividend in the hands of its shareholders places the legal incidence of the tax on the shareholder. Any effect on the federal government is an economic ripple.
The majority opinion characterizes as “unsound” the opinion of the Attorney General of Maryland, 68 Op.Att’y Gen. 410 (1983), which approved the manner in which the Comptroller applies the income tax in situations of the type presented here. Maj. opinion at 366. In a RIC sharehold*383er’s Maryland return, based upon the shareholder’s federal return, the portion of a RIC dividend representing interest on state obligations retains its character as interest on state obligations and is not taxed by Maryland. See IRC § 103; Art. 81, § 280(c)(1). The portion of a RIC dividend proportional to interest on federal obligations, which does not retain its character as interest on the shareholder’s federal return, is taxed as a dividend by Maryland. The majority concludes that this difference in result “would appear to be in violation of federal law.” Id. This dissenting opinion has taken pains to demonstrate that the difference in character of the income received by the shareholder results from differences in treatment by the Internal Revenue Code. I am at loss to understand how Maryland can be discriminating against federal obligations when Maryland simply takes as the starting point for the Maryland return the characterizations of shareholder income effected by federal law and reflected on the federal return. The Trust’s distribution to shareholders is a dividend for federal purposes. The distribution is a dividend for State purposes.
Further, by holding that federal immunity overrides the traditional treatment of corporation and shareholder as separate entities, the majority opinion furnishes a justification for shareholders of ordinary business corporations to consider as immune from state taxation a portion of their dividends representing the pro rata share of gross corporate income derived from corporate investment in federal obligations. When the majority chooses to ride the horse of § 3124(a), nothing restrains the beast to the path of RICs which earn part of their income from interest on federal obligations.
I would entirely deny the claim for refund.
MURPHY, C.J., and ADKINS, J., authorize me to state that they join in the views expressed in this dissenting opinion.
. All citations to the IRC are to provisions applicable to calendar 1985.
. If the national economic policy of prohibiting state taxation is as clear-cut as counsel for the Taxpayer (i.e., the Trust) argues, one wonders why Congress has never legislated that the portion of mutual fund dividends originating in federal obligation interest is itself characterized as federal obligation interest. In fact, thirteen states administratively tax mutual fund distributions regardless of whether federal obligation interest is a component of that distribution on the theory that the exempt interest does not retain its character when distributed by the mutual fund. See State Taxation of Income from Mutual Funds or Money Market Accounts Invested in U.S. Government Securities, Federation of Tax Administrators, Research Report No. 122, at 7-9 (Jan. 1988).