Texas revises regulations on apportionment for purposes of franchise tax

| 2/11/2021
Texas revises regulations on apportionment for purposes of franchise tax

The Texas comptroller of public accounts issued final regulations on apportioning income to Texas under Texas Administrative Code Section 3.591. The regulations generally are effective Jan. 1, 2008. Among other items, the regulations make significant changes to the treatment of receipts from services, to net gains on the sale of assets and investments, and to sales of digital property.

Sourcing of receipts from services based on “receipt-producing end-product act”

For apportionment purposes, Texas Tax Code 171.103(a)(2) provides that a receipt from services is considered a Texas receipt if the service is performed in Texas. The revised regulations define the location of performance as the place where the receipt-producing end-product act occurs. This concept is consistent with past positions of the comptroller but is not without controversy as it resembles a market-based approach that uses the location of the customer and is inconsistent with the statute. The revised rule is consistent with the court’s decision in Hegar v. Sirius XM Radio Inc. in which the Texas 3rd Court of Appeals ruled that the relevant activity for determining where service is performed was the location of the audience. Sirius XM Radio Inc. has appealed this ruling to the Texas Supreme Court.

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Net gains on sales of assets and investments

Texas Administrative Code Section 3.591(e)(2) is revised to include in the apportionment calculation only net gains on the sale of assets and investments. Prior to the Texas Supreme Court decision in Hallmark Marketing Co. LLC v. Hegar, net gains and losses were offset to determine a net amount. Furthermore, effective for reports due on or after Jan. 1, 2021, determining the net gain or loss is made on a sale-by-sale basis. The new rule benefits companies with significant losses on sales of assets or investments that would be sourced outside of Texas, since the gains in the denominator will not be offset with losses and thus will result in a lower sales percentage.

Sourcing of receipts from the sale of computer and digital property

The comptroller has clarified the rules for sourcing various types of digital property. Most notably:

  • Gross receipts from the sale or lease of digital property that is transferred by means other than by fixed physical media are sourced based on the location-of-payer rules. Sales to corporations and limited liability companies are sourced to the state of legal domicile of the payer.
  • Gross receipts from the delivery of digital property as a service are sourced based on the sourcing rules for services.
  • Gross receipts from the delivery of digital property as part of an internet hosting service are sourced based on the location of the customer.

The new sourcing rules clarify the comptroller’s position that, “Receipts from the sale or license of a computer program … are receipts from the sale of an intangible asset and are apportioned to the legal domicile of the payor.”1

Looking ahead

The new regulations might provide some taxpayers an opportunity to reduce their Texas franchise tax. Companies that derive revenue from the sale of services provided within Texas and those that derive receipts from the sale or lease of digital property should consider whether an opportunity exists to reduce their Texas franchise tax burden. Companies that under the previous regulations would include significant losses on the sale of assets or investments in their sales factor should consider whether the new regulations affect their expected tax burden for tax years ended in 2020.

1 Texas Policy Letter Ruling No. 201006004L, June 1, 2010.

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