• Texas research exemption/credit
o 2013 Texas legislature provided for a sales tax exemption or a franchise tax credit (not both) for qualified research and development activities
o Texas Comptroller will allow taxpayers to switch between taking the exemption and credit; however need to amend the applicable returns and pay interest/penalties
Taxpayers may need to consider the cost/benefit of doing so
o Sales tax exemption applies to depreciable TPP used in qualified research if sold/leased/rented/stored by person engaged in qualified research
Taxpayers must register with Comptroller and receive a registration number before claiming the exemption
Annual information reports are due on or before March 31st
o Franchise tax credit can’t reduce franchise tax by more than 50% and must be taken before any other applicable tax credits
Qualified research expenses include:
• Wages directly related to the research activities
• Supplies directly consumed by the research activity
• Computer use (i.e., costs incurred to pay for right) to conduct qualified research
• Contract research expenses (outside consultants) to perform qualified research
• Revenue exclusion for real estate activities
o Two recent opinions (Titan Transportation and Newpark Resources) from 3rd Cir. App. in Texas that may affect reporting positions previously taken by taxable entities on 2008 – 2013 Texas franchise tax reports. Texas businesses may be eligible for refunds (unclaimed revenue exclusions or COGS deductions) for previously paid franchise tax in the following areas:
Construction, improvement and remodeling
Real property repairs & maintenance
Trucking & transportation
Highway repairs & construction
Oil well drilling contractors
Exploration & production
o Subcontractor payments are excluded from revenue when taxable entity has an agreement with subcontractor to provide materials, services, or labor in connection with real estate activities
Titan Transportation v. Combs – Taxpayer win. Titan Transportation engaged in hauling and transporting aggregate. Court concluded that revenue exclusions allowed if there is a reasonable nexus between materials, service or labor provided and the actual/proposed design, construction, remodel, repair or location of boundaries of real property. No requirement/limitation for taxable entities to be “construction companies,” make a physical change to real property, tracing of payments, or written agreement referencing subcontractor will provide materials, labor, services to customer.
2013 Texas legislature also made clarifying amendment on this issue (so likely can claim refund for prior periods) and specifically provided exclusion for aggregate haulers so they get exclusion for 2014 forward
o Overlapping provisions with COGS
• COGS deduction for real estate activities
o Taxable entity may claim COGS deduction when it doesn’t own/sell goods when it furnishes labor/materials to a project for construction, improvement, remodel, repair or industrial maintenance of real property.
o Texas Comptroller position – look at member basis to determine if eligible for COGS deduction, however:
Combs v. Newpark Resources (2013) – Taxpayer win. NewPark and its subsidiaries (combined group) provided integrated oilfield services. One sub sold and injected drilling mud. One sub transported waste mud from drilling site and disposed. Court held that waste sub was component of larger group providing integrated services and eligible to claim COGS deduction because waste removal was necessary and essential to the continued construction and drilling of oil & gas well sites. Court rejected Comptroller’s position that taxable entity must be construction company or oil & gas well driller, making physical change to real property site in order to claim COGS deduction.
Newpark – Court decision also implies 4% cap on overhead is calculated on a combined basis.
• Combined reporting and P.L. 86-272
o Texas combined reporting – requires taxable entities to be a part of an affiliated group engaged in a unitary business instead of reporting as separate taxable entities.
o Combined group chooses to either deduct COGS, compensation or 30% of total revenues; apportions its margin to Texas; computes and pays franchise tax as a single entity.
Requirements for combination
Taxable entity requirements
Affiliated group requirements
Unitary business factors
• Same general line
• Vertically integrated
• Functionally integrated
• Other unitary factors
o TX Supreme Court
o Non arm’s length prices
o Benefits from common activity
o PL 86-272 – uncertain as to whether franchise tax is limited by P.L. 86-272
Supremacy doctrine – federal law supersede those of conflicting provisions found in state law, including Texas state law that expressly states that it is not an income tax and that P.L. 86-272 does not apply.
Many commentators (including former Comptroller Strayhorn) believe the revised franchise tax is a net income tax.
• Management company issues
o Under Texas tax code, management company may exclude from its total revenue the reimbursement of specified costs in its active trade/business of a managed entity (including wages and cash compensation)
o Comptroller policy/rule imposes conditions beyond plain language of statute – to qualify as a management company, an entity must perform active and substantial management and operational functions; control and direct daily operations; provide services such as accounting, general admin, legal, finance and other similar services.
• Three-factor election issues (MTC)
o Texas is a signatory state to MTC
o Litigation/Comptroller position – Comptroller consistently rejected taxpayers’ request to use three-factor formula under premise that franchise tax is not a an income tax.
Lead Texas case Graphic Packaging Corp v. Combs (case presently pending appeal before the 3rd Cir. App) Taxpayer lost at trial level.
• Oil and gas producing partnership
o Revenue exclusion for funds that taxpayer must distribute to others as a result of a fiduciary or statutory duty.
o Texas natural resources code requires operators to distribute to non-operating interest holds their respective shares from oil & gas leases
o Comptroller position – exclusion applies only to taxes
o Two cases pending in Texas courts may help resolve scope of this exclusion.
Seltex v. Combs – addresses whether this provision allows a freight broker that serves as a limited agent for its customers to exclude the customer payments it flows through to haulers.
BASA Resources v. Combs – addresses whether this provision allows a taxpayer that owns working interests in oil & gas leases and sells a net profits interest to another entity to exclude the net profits distributions it makes. Taxpayer sold 96% net profits interest in leases to another entity and excluded the amounts of its net profits distributions from total revenue and the Comptroller denied the exclusion. Comptroller settled the case before trial.
• Compensation deduction
o Includes wages and cash compensation paid and cost of all benefits paid to certain individuals:
Employees, officers, owners, partners, directors but NOT independent contractors
Also included is net distributive income: allowance for service businesses – (e.g., law and accounting firms) that compensate partner-employees in whole or in part through partnership distributions. Net distributive losses, taxable entity may be forced to reduce compensation by the loss (i.e., anti-abuse rules for net distributive income).
Compensation cap 2014 and 2015 – $350,000
o Benefits – in addition to wages/cash compensation, Texas tax code allows an entity to deduct benefits as compensation. However, benefits not defined in statute or Comptroller rules.
Winstead (March 2013) – district court case ruled that the working condition disallowance provision in Comptroller rule 3.589(e)(2)(D) is invalid to the extent it disallows deductions that are allowed for federal income tax purposes.
• Retail tax rate and installation labor
o Two common issues: 1) retailers and wholesalers subject to lower rate vs. other taxable entities pay higher rate and 2) whether installation labor should be included in COGS
o 2013 Legislature amended definition of retailer to include auto repair shops
o Arise with businesses that sells parts and mixed goods and services
o Autohaus v. Combs (2014) Taxpayer win. Court ruled that an auto dealer could include labor costs to install new and replacement auto parts in its cost of goods sold for Texas franchise tax purposes. This case is a big win for taxpayers that, if it becomes final, could allow many taxpayers to include labor costs in cost of goods sold that the Texas Comptroller previously denied.
• Medical exclusion issues in computing taxable margin
o Providers (e.g., physicians, clinics, physician assistants)
100% revenue earned from qualified government programs such as Medicare/Medicaid excluded
o Institutions (e.g., hospitals, nursing homes, retirement homes)
50% revenue earned from qualified government programs excluded
o Co-pays and deductibles under government programs and actual cost of uncompensated care may also be excluded
• Procedural issues
o Richmond Aviation v. Combs (2013) Taxpayer able to bring case to court without paying in Texas. Appellate court ruled that Texas Constitution imposed unreasonable financial barriers to court access even though the statute excused prepayment for indigent taxpayers.
o Could have implications in other states
We got a bounded book that outlines these topics but no slides. I asked for slides and will forward on if I can get a copy.
Tram Le, CPA, J.D., LL.M.
State and Local Tax Consultant
Eide Bailly LLP
440 Indiana St., Ste. 200
Golden, CO 80401-5021
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