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Comptroller Issues Guidance on Cost of Goods Sold

On September 23, 2022, the Texas Comptroller proposed amendments to Rule 3.334, which deals with local sales and use taxes. This is the latest development in a years-long effort by the Comptroller to change local tax sourcing for many online and shopping app sales.

In 2020, the Comptroller adopted amendments to Rule 3.334’s subsection (b)(5) which shifted the local tax sourcing for many internet and shopping app sales to the customer’s location instead of the seller’s location (i.e., “origin” sourcing). Texas law provides that a sale occurs where it is “consummated” and provides that sales are typically consummated at the seller’s place of business. See, e.g., Tex. Tax Code § 321.203(b) (“If a retailer has only one place of business in this state, all of the retailer's retail sales of taxable items are consummated at that place of business . . .”).

As a result of this origin sourcing, cities in Texas have been successful in attracting out-of-state businesses to build large facilities by offering incentives in the form of a partial share of the local...

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In Hegar v. Sirius XM Radio, Inc., the Texas Supreme Court reversed the Third Court of Appeals, rejecting the Comptroller’s argument that receipts from services should be apportioned based on the “receipt-producing, end-product act” test. Instead, the court found that Sirius’ services should be apportioned based upon the locations of the employees and equipment providing the service.

Sirius XM Radio performs its satellite radio subscription services through an extensive network of equipment located around the globe. While roughly 8–9% of Sirius’ customers are in Texas, virtually none of its equipment, employees, or operations are located in Texas. Sirius broadcasts over 150 satellite channels, produced primarily from studios in New York City and Washington, D.C. Only one Sirius radio channel has ever been produced in Texas. Sirius transmits signals to satellites using uplink facilities in New Jersey, Washington D.C., and Georgia. These satellites are launched from Kazakhstan and orbit 22,000 miles above the earth. They transmit signals back to Earth, where...

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On February 4, 2022, the Texas Comptroller recently provided guidance clarifying several Texas franchise tax Cost of Goods Sold (“COGS”) issues for Texas taxpayers. The Comptroller issued the guidance as responses to Frequently Asked Questions (“FAQs”). The FAQs touch on several important topics, including the proper calculation of COGS and whether labor and other expenses across certain industries qualify for subtraction, which components of mixed transactions qualify for a COGS subtraction, how to determine Internal Revenue Code (“IRC”) Section 179 expense limitations and federal bonus depreciation for Texas COGS purposes, and information on capitalizing versus expensing costs.

Texas COGS is calculated separately from federal reporting and industry calculations.

Subtractable costs must be expressly listed in Texas Tax Code § 171.1012. Several industry-specific COGS subtractions covered by the FAQS include:

Is the Expense Included in COGS Calculation?

Contractor’s payments to...

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A Texas appellate court sitting en banc recently made it easier for taxpayers to preserve refund claims for judicial review by quoting the relevant subsection(s) of the manufacturing exemption statute and including supporting documentation identifying the equipment and transactions at issue.

El Paso Electric Company (“El Paso”) seeks refund of sales tax paid in error on exempt manufacturing equipment.

El Paso is a fully integrated public utility in the business of manufacturing, generating, transmitting, and distributing electricity in west Texas and southern New Mexico. Hegar v. El Paso Electric Company, No. 03-18-00790-CV (Tex. App.—Austin Aug. 13, 2020, no pet. h.) (majority opinion). El Paso filed an administrative sales tax refund claim for different types of equipment under a variety of sales tax exemptions. Of the $5.1 million total refund El Paso sought, the Comptroller agreed to refund over $2.5 million.

The Comptroller would not agree to refund sales tax El Paso allegedly paid in error on the purchase of meters and disconnect collars that El Paso...

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A Texas appellate court recently allowed the manufacturing exemption for equipment used to process real property into products.

Lignite begins as real property and ends as tangible personal property.

Texas Westmoreland Coal Company (“Westmoreland”) owned and operated a lignite coal mine in Texas. Lignite, also called brown coal, is the lowest grade of coal, but like other forms of coal, is found in large veins underground. Hegar v. Texas Westmoreland Coal Co., No. 03-20-00406-CV (Tex. App.—Austin Oct. 7, 2021, no pet. h.).

To extract the coal, Westmoreland first removes the top layer of soil using a dragline (which was not at issue in the case) to expose the lignite formation. Then it uses a variety of excavators with large, toothed buckets to crack, break, or rip apart the lignite into smaller pieces to meet its customer’s size requirements. Once the buckets are full, the excavators drop the lignite into dump trucks from approximately 12 feet high, further breaking the lignite apart. At the end of the process, the lignite...

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Businesses that finance sales using leases should consider filing Texas franchise tax refund claims based upon a recent Texas court case.

A Texas appellate court recently held that Xerox Corporation (“Xerox”) was entitled to compute its franchise tax based upon the lower Texas franchise tax rate, which resulted in a refund of half of the Texas franchise tax Xerox had paid during the relevant periods.

Xerox leases printers long-term to businesses under financing lease agreements. Xerox’s finance lessees:

  • Receive possession, but not title, to the equipment;
  • Were responsible for insuring the equipment against loss;
  • Were required to make all payments under the lease, even if the contract was terminated; and
  • Could purchase the equipment at the end of the lease but typically did not because the lease was designed to last for the useful life of the equipment.

Wholesale sales qualify for lower Texas franchise tax rate, but rentals do not.

Generally, taxpayers pay Texas franchise tax at the...

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Texas Taxpayers have reached a deal with the Comptroller to delay implementation of the Comptroller’s new local sales tax sourcing rules for internet and shopping app sales until a trial expected to occur the week of June 13, 2022.

On Monday, August 30, 2021, Travis County District Judge Karin Crump presided over hearings over whether to issue an injunction blocking an effort by Comptroller Glenn Hegar to unilaterally upend the local sales tax sourcing rules established under Texas law. The next morning, as the hearing reconvened, the parties announced an agreement to delay implementation of these new rules and the Comptroller acquiesced in the injunction.

The Comptroller’s rule amendments would switch online sales to being sourced to the customer’s location, instead of the business location of the seller. This would apply to many sellers who have only one place of business in Texas. Sourcing online sales to these sellers’ business locations enhanced local taxing authorities’ ability to incentivize taxpayers to locate large facilities within their boundaries,...

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On June 7, 2021, the Texas Governor signed both HB 2080 and SB 903 into law. The bills substantially lower the practical hurdles that taxpayers must meet to challenge the Comptroller in state court.

New Option to Challenge Audit Assessments

Generally, to bring a protest suit in state court, a taxpayer must pay the audit assessment under protest and submit a written protest letter raising the arguments that it will raise in its protest suit. Under the current “pay-to-play” provision of the Texas Tax Code, a taxpayer must pay the entire amount of the audit assessment to challenge it in court.

A newly-enacted law, HB 2080, eases that burden by allowing the taxpayer to pay only the undisputed portion of its audit assessment. Importantly, however, any portion of a disputed amount that is not initially paid but...

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Texas taxpayers can breathe a collective sigh of relief since House Bill 1195 was signed into law on May 8, 2021. The bill provides that forgiveness on Paycheck Protection Program (PPP) loans will not be considered revenue for Texas franchise tax purposes. Additionally, HB 1195 clarifies that taxpayers may include qualifying expenses paid with PPP loans into their Texas franchise tax compensation or cost of goods sold calculations (if they otherwise qualify).

Prior to the passage of this bill, the Comptroller’s position was that taxpayers must include the proceeds from the forgiven PPP loans in total revenue on their franchise tax reports for the year in which the loan was forgiven. For a significant number of taxpayers, this would have resulted in the taxpayers being hit with an increased tax bill stemming from PPP loan forgiveness.

The 2020 CARES Act stipulated that PPP loan forgiveness would not be classified as taxable income for federal tax purposes even though loan forgiveness is usually taxed under federal income tax law as cancellation-of-debt (COD) income....

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Texas Franchise Tax Update: Congressman Fires Back with Proposed Bill After Texas Comptroller Threatens to Tax PPP Loan Forgiveness

A Texas lawmaker has introduced a bill in the current legislative session reversing the Comptroller’s policy of treating federal Paycheck Protection Program (PPP) loan forgiveness as revenue for Texas franchise tax. The proposed bill also allows taxpayers to include the corresponding costs when calculating their compensation or cost of goods sold subtraction.

During the 2021 Texas Comptroller’s Tax Policy Update, an official at the Comptroller’s office stated that the Comptroller plans to require taxpayers to add any forgiven portion of a PPP loan they received to their total revenue, which is the starting point for the Texas franchise tax margin calculation. Although cancellation-of-debt (COD) income is typically taxed under federal income tax law, the U.S....

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