In a hearing decision issued in May 2017, the Comptroller held that an auditor’s COGS allocations for labor costs incurred by a grocery store in its deli and pharmacy department were understated.

Taxable entities are entitled to include all direct costs of acquiring or producing goods in their Texas franchise tax COGS subtraction. An entity may include in its COGS calculation labor costs (other than service costs) that are properly allocable to the acquisition or production of goods.

During a refund-verification audit of a grocery store, an auditor allocated a small percentage of the taxpayer’s costs related to deli clerks, deli and meat market managers, and pharmacy employees. The auditor contended that certain costs were related to selling goods, rather than acquiring or producing goods, so these costs should be excluded. The taxpayer disagreed, arguing that the auditor’s production allocations for labor costs in the deli, meat market, and pharmacy departments were far too low.

The taxpayer presented detailed evidence during the hearing to support its argument that the allocation percentages for labor costs should be increased, including witness testimony, a labor study, and detailed job descriptions for the employees. The Comptroller found the taxpayer’s evidence persuasive, and increased the allocation percentages for labor from 20-25% for the various departments to 70-83.67%.

This hearing serves as a good example of the detailed evidence that a taxpayer is often required to present at an administrative hearing in order to meet its burden of proof.