Rent-A-Center is a leading provider of furniture and electronics to consumers through rent-to-own agreements in which customers become the owners of property if they do not terminate or breach the agreement during the lease term. Federal income tax law required Rent-A-Center to capitalize the costs it in incurred to purchase furniture and electronics that it leased to customers. Rent-A-Center claimed depreciation on its federal income tax return on the items while they were being leased.

On its 2008 franchise tax report, Rent-A-Center elected to subtract COGS related to “rental-purchase sales” when computing its taxable margin. Rent-A-Center calculated its COGS subtraction based upon the costs it had incurred to purchase the leased items, but did not reduce the costs by the amounts claimed for federal depreciation. Effectively, Rent-A-Center subtracted the full, original cost of the leased items. Rent-A-Center then calculated its margin tax using the lower tax rate available to retailers and wholesalers.

The Comptroller audited Rent-A-Center and rejected Rent-A-Center’s use of its original cost of the leased items as well as the lower tax rate. It reduced Rent-A-Center’s COGS subtraction by the depreciation deducted on the federal returns in prior years which caused Rent-A-Center’s taxable margin to increase. It then applied the higher tax rate to the increased taxable margin to calculate additional franchise taxes due. Rent-A-Center paid the additional taxes under protest and brought suit.

The court held that the Comptroller correctly reduced Rent-A-Center’s COGS subtraction by the prior depreciation but allowed Rent-A-Center to calculate its margin tax using the lower rate available to retailers and wholesalers.

In addressing the depreciation issue, the court noted that Texas Tax Code § 171.1012(g) allows some taxpayers to calculate their COGS subtraction by either expensing or capitalizing their costs, at the taxpayer’s election. Rent-A-Center had elected to capitalize its costs for purposes of the COGS subtraction.

Texas Tax Code § 171.1012(g) also requires, for taxpayers electing to capitalize costs, to capitalize them “in the same manner and to the same extent” they were capitalized on the taxpayers’ federal income tax returns. The court found that this language “dictates that Rent-A-Center’s COGS deduction be reduced by the amount of depreciation it claimed on its federal taxes.”[1]

However, the court reasoned that Rent-A-Center was entitled to use the lower franchise tax rate allowed for retailers, because its business was “more like selling than leasing.”[2] Neither party has yet filed an appeal of this decision with the Texas Supreme Court. If the parties do not appeal this decision, or the Texas Supreme Court affirms it, similarly situated taxpayers who claim depreciation on federal returns may find that they may lower their Texas franchise tax liabilities by electing to calculate their COGS by expensing these costs instead of capitalizing them.

[1] Rent-A-Center, Inc. v. Hegar, 03-18-00247-CV, 2019 WL 1925389, at *4 (Tex. App.—Austin Apr. 30, 2019, no pet. h.).

[2] Rent-A-Center, Inc. v. Hegar, 468 S.W.3d 220, 225 (Tex. App.—Austin 2015, no pet.).