In 2016, the Comptroller’s Tax Policy Division authored a memorandum announcing a policy interpretation change based upon the decision in Titan Transportation, L.P. v. Combs. [1] The memorandum was issued on the heels of the Texas Supreme Court’s denial of the Comptroller’s Petition for Review. [2]

Titan Transportation hauled and deposited aggregate (a construction material made of rock, gravel, dirt, sand, or fines) at construction sites using independent haulers. [3] Titan did not have written contracts with its customers, but Titan did have written contracts with the independent haulers. These contracts split the revenue earned from customer jobs between Titan and the subcontractor. [4] Titan sought to exclude its payments to the independent haulers from its Texas franchise revenue based on the following provision:

(g) A taxable entity shall exclude from its total revenue . . . only the following flow-through funds that are mandated by contract to be distributed to other entities: . . .

(3) subcontracting payments handled by the taxable entity to provide services, labor, or materials in connection with the actual or proposed design, construction, remodeling, or repair of improvements on real property or the location of the boundaries of real property. [5]

The Comptroller originally denied Titan’s claim because (1) Titan was not a construction company, (2) Titan did not have customer contracts that referenced its written agreements with the independent haulers, and (3) Titan did not pay its independent haulers with the same dollars that Titan received from its customers. [6] The Third Court of Appeals rejected each of these arguments. [7]

First, the court explained that the real property revenue exclusion under Texas Tax Code § 171.1011(g)(3) is not limited to construction companies. [8] A taxpayer must simply show some reasonable connection between the real property services delineated in the statute and the service, labor, or materials for which the subcontractors receive payment. [9] Titan had the required connection because its services were logically and reasonably connected with the construction of real property improvements. [10]

Second, the court held that Titan’s independent hauler agreements satisfied the statute’s “mandated by contract” language. [11] In doing so, the court rejected the Comptroller’s argument that Titan needed contracts with its customers referring the work done by the independent haulers.

Third, the court rejected the Comptroller’s “segregate, wait, and trace” payment requirement as overly-formalistic and inconsistent with the statute’s plain text. [12] The statute’s “flow-through” language did not require Titan to pay its independent haulers with the same dollars that Titan received from its customers. [13]

Having failed to convince the Texas Supreme Court to overturn Titan Transportation, the Comptroller now appears fixed on limiting the case’s application to its specific facts. In his recent memorandum, the Comptroller states that the contractual mandate requirement in Texas Tax Code § 171.1011(g) will be satisfied:

[I]f the taxable entity has a contract with its customer providing that a subcontractor may be used and requiring payment to the subcontractor, or by a written contract between the taxable entity and the subcontractor where the payment is based on the funds paid to the taxable entity by the taxable entity’s customers. For example, the contract between the taxable entity and the subcontractor require payment based on a percentage of the funds the taxable entity receives from its customer. [14]

The Comptroller’s new policy interpretation appears to defy the Titan Transportation decision’s rationale, which is to exclude from taxation gross receipts that do not constitute actual gain or income to the taxpayer and to prevent double-taxing the same income. [15]

The Third Court of Appeals will soon have the opportunity to weigh-in, as the Comptroller’s interpretation is at issue in Hegar v. Gulf Copper and Manufacturing Corporation. [16] There, the Comptroller argued that Gulf Copper was not entitled to the revenue exclusion under Texas Tax Code § 171.1011(g)(3) where Gulf Copper contracted for certain subcontractor work at an hourly labor rate. According to the Comptroller, such a “fixed-rate” contractual arrangement can never be flow-through funds that are mandated by contract to be distributed to other entities.

[1] STAR System Document No. 201606856L; Titan Transportation, L.P. v. Combs, 433 S.W.3d 625 (Tex. App.—Austin 2014, pet. denied).

[2] After full briefing on the merits, the Texas Supreme Court denied the Comptroller’s Petition for Review on May 1, 2015.

[3] See Titan Transportation¸433 S.W.3d at 629.

[4] See generally id. at 633-34.

[5] Tex. Tax Code § 171.1011(g)(3) (subsequently amended in 2013 to expressly address contracts and subcontracts).

[6] See Titan Transportation¸433 S.W.3d at 630.

[7] Id. at 627.

[8] See id. at 637-40.

[9] Id.

[10] Id.

[11] Id. at 641.

[12] Id. at 641-42.

[13] Id.

[14] STAR System Document No. 201606856L.

[15] Titan Transportation, 433 S.W.3d at 628, 641.

[16] Hegar v. Gulf Copper and Manufacturing Corporation, Docket No. 03-16-00250-CV (April 14, 2016, pet. filed).