Presented By: David E. Colmenero, CPA, J.D., LL.M.

Transcription

1 Convergence 2014 May 8, 2014 The Year of the Taxpayer: A Growing Divide Between Texas Comptroller Policies and Texas Courts is Reflected in Recent Decisions Presented By: David E. Colmenero, CPA, J.D., LL.M. 901 Main Street, Suite 3700 Dallas, TX fax dcolmenero@meadowscollier.com Copyright Meadows, Collier, Reed, Cousins, Crouch & Ungerman, L.L.P. All rights reserved.

2 Sales Tax Combs v. Health Care Service Corp., 401 S.W.3d 623 (Tex. June 7, 2013): Sale for Resale Exemption. Taxpayer purchased equipment for use in providing non-taxable administrative services under a contract with the federal government. Title to the equipment but not possession passed immediately to the federal government. The Texas Comptroller argued that the equipment did not qualify for the resale exemption because the primary purpose for the purchase was not to resell it but to use it in providing a service and also because care, custody and control of the equipment did not pass to the federal government. Citing the plain language of the statute, the Texas Supreme Court held that the equipment qualified for the resale exemption because those items were purchased for the purpose of being resold to the federal government in the form or condition in which they were acquired. The Court noted that the definition of sale includes the transfer of title even if care, custody or control is not transferred. The statute does not say (or even intimate) that the primary purpose of the sale must be for a particular kind of sale. 2

3 Sales Tax Combs v. Roark Amusement & Venting, LP., 2013 WL (Tex. App. Austin, March 8, 2013). Taxpayer was in the business of operating coin operated cranes that dispensed toys to successful participants who played the machines. Taxpayer argued that purchase of the toys qualified for the resale exemption citing in part Section which defines a sale for resale to include a sale of tangible personal property to a purchaser who acquires the property for the purpose of transferring it as an integral part of a taxable service. The Texas Comptroller argued that the sale for resale exemption did not apply because coin operated amusement services are exempt from tax under Section (a) and therefore do not constitute a taxable service. The Court held that the toys qualified for the resale exemption as argued by the Taxpayer. Under the plain meaning of the statute, amusement services fall within the definition of taxable services. The fact that the Tax Code sets out an exemption for amusement services provided by coin-operated machines does not alter the fact that they are considered taxable services under the Tax Code. 3

4 Sales Tax DTWC Corporation v. Combs, 400 S.W.2d 149 (Tex. April 11, 2013): Sale for Resale Exemption. The Taxpayer was a hotel operator that purchased several consumable items which were transferred to hotel customers as part of their hotel stay or at least made available to them to take or consume (e.g., soaps, shampoos, conditioners, notepads, mouthwash, etc.). Taxpayer argued that the purchases qualified for the resale exemption citing in part the definition of a sale, which includes a transfer of title or possession of tangible personal property when done or performed for consideration. The Texas Comptroller argued in part that the resale exemption did not apply because (i) the items purchased were not transferred as part of a taxable transaction; (ii) the transfer to customers lacked consideration; and (iii) the hotel was not in the business of selling hotel consumables. The Court agreed with the Taxpayer holding that under the plain language of the statute, purchases of the hotel consumables qualified for the resale exemption. The consumables were TPP that the hotel acquired to put, in the form or condition in which the hotel acquired them, in the hotel rooms for guests to use, not use or take. Guests paid a fee (i.e., consideration) to use the rooms and its amenities, including the hotel consumables. The items were also acquired and transferred in the normal course of business. 4

5 Sales Tax The definition of a sale for resale was amended in 2011 to state: A sale for resale does not include the sale of tangible personal property or a taxable service to a purchaser who acquires the property or service for the purpose of performing a service that is not taxed under this chapter, regardless of whether title transfers to the service provider s customer, unless the tangible personal property or taxable service is purchased for the purpose of reselling it to the United States in a contract, or a subcontract of a contract, with any branch of the Department of Defense, Department of Homeland Security, Department of Energy, National Aeronautics and Space Administration, Central Intelligence Agency, National Security Agency, National Oceanic and Atmospheric Administration, or National Reconnaissance Office to the extent allocated and billed to the contract with the federal government. Note: This amendment appears intended to overrule Health Care Services and possibly DTWC Corporation prospectively, but does it have any effect on the outcome of Roarke? 5

6 Sales Tax Cirrus Exploration Co. v. Combs, No CV, 2014 WL (Tex. App. Austin, Feb. 14, 2014). Taxpayer was in the business of hiring out helicopters and pilots to the public for use in a variety of activities, including aerial tours, photography, surveys and inspections. Taxpayer operated in compliance with FAA regulations and held a Letter of Authorization that authorized it to conduct commercial air tours. Taxpayer argued that the helicopter purchased for its business qualified as an exempt purchase of an aircraft for use as a certified or licensed carrier of persons or property, citing the Comptroller Regulations which define a licensed or certificated seller as a person authorized by the appropriate United States agency to operate an aircraft as a common or contract carrier for hire in the regular course of business. Citing Texas Comptroller policy, the Texas Comptroller argued that the exemption should only apply to an air carrier certificated under a provision that specifically qualifies it to be used to carry persons or property for hire as opposed to being merely authorized or permitted by law to do so. The Court agreed with Taxpayer based on the plain language of the Comptroller s regulations which only required a taxpayer to be authorized to carry persons or property to qualify for the exemption. 6

7 Sales Tax Tracfone Wireless, Inc. v. State Emergency Comm n, 397 S.W.3d 173, 183 (Tex. 2013). The issue was whether two statutes imposing emergency fees on wireless telecommunications providers applied to prepaid wireless providers. A 1997 statute imposed a $.50/month emergency service fee on wireless subscribers. A later statute enacted in 2010 imposed a flat 2% fee on prepaid wireless subscribers. The issue was whether the 1997 tax also applied to prepaid wireless subscribers. The Court held in favor of Taxpayer noting that, in this case, it does not matter whether the statute was deemed ambiguous or not. If the statute was unambiguous, it would result in double taxation which violates the Equal and Uniform guarantee of the Texas Constitution. If it was ambiguous, it must be construed in favor of the Taxpayer: We acknowledge that deference to the regulations or interpretations of an agency charged with enforcing a tax has its place -- for example, when a tax unarguably apples and the Court is weighing competing interpretations of the amount owed. However, agency deference does not displace strict construction when the dispute is not over how much tax is due but, more fundamentally, whether the tax applies at all. Under either standard, the Taxpayer prevailed in this case. 7

8 Sales Tax Combs v. Newpark Resources, Inc., (Tex. App. Austin, Dec. 31, 2013): Cost of Goods Sold/Combined Reporting. Taxpayer was a combined group involved in the manufacture, sale, injection, and removal of drilling mud used in oil and gas production. One of the subsidiary entities removed the drilling mud from the well and transported it to waste disposal sites. Taxpayer argued that the subsidiary furnish[ed] labor or materials to a project for the construction improvement, remodeling, repair or industrial maintenance of real property and its costs were therefore includible in the combined group s cost of goods sold deduction. The court held that, under the plain language of the statute, the subsidiary entity s eligibility to take a cost of goods sold deduction must be viewed within the context of the combined group s overall business rather than in isolation. The court also held that the costs of the entity in question were attributable to labor provided for the construction and improvement of real property and were thus includible in the combined group s cost of goods sold deduction. 8

9 Franchise Tax Titan Transportation, LP v. Texas Comptroller, (Tex. App. Austin, March 14, 2014): Exclusion from Total Revenue. Titan is in the business of transporting aggregate to construction sites where it is used in construction projects. Titan claimed that it was entitled to exclude from Total Revenue payments made to independent contractors under Section (g)(3). Prior to 2013, Section (g)(3) permits an exclusion from total revenue for flowthrough funds that are mandated by contact to be distributed to other entities including 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. The Comptroller argued that (g)(3) requires that the taxable entity: (i) must provide design construction, remodeling or repair services which Titan did not do; (ii) must have a written contract with its customers that essentially requires the subcontract; and (iii) can only meet the flow-through requirement if third-party payments are segregated and paid to the subcontractor only when the Taxpayer has received the money. Titan did not meet any of these requirements. 9

10 Franchise Tax Titan Transportation, LP v. Texas Comptroller continued Court overruled Texas Comptroller: On the first issue, all that is required is a reasonable nexus between the service, labor and materials provided by the subcontractor and the real property work. The Court also rejected a related Texas Comptroller argument that a subcontractor must be involved in activities that make a physical change to property to qualify for the exclusion. On the second issue, the Court overruled Comptroller policy relating to the applicability of the exclusion in Section (g) only if a contract with a client state that the taxable entity will subcontract out a specified portion of the work. A tripartite contractual relationship is not required. On the third issue, the Court held that the evidence showed that Titan earned and retained only 16% of its customers gross customer receipts and that the remainder was passed through to the subcontractors, which satisfied the flow-through requirements. Failure to treat these payments as flow-through would ignore the economic realities of the transactions and could result in double taxation. Note: Section (g)(3) was amended in 2013 to include the word subcontract thus presumably resolving this issue prospectively. 10

11 Overview Broader Implications of Recent Cases: The plain language of a statute controls if unambiguous; The plain language of a Comptroller rule controls if unambiguous; The unambiguous language of either may not be altered by reading into the language limitations, qualifications or restrictions; Ambiguity regarding whether a tax applies at all to a transaction should be resolved in favor of the Taxpayer; On the other hand, when a tax unarguably applies and the court is weighing competing interpretations of the amount owed, Comptroller rules or interpretations may be entitled to deference. 11

12 Potential Implications Contractors: Physical Presence Requirement for Cost of Goods Sold: Construction Projects. Section (i): A taxable entity furnishing labor or materials to a project for the construction, improvement, remodeling, repair, or industrial maintenance of real property may include the costs, as allowed by this section, in the computation of cost of goods sold. Tax Policy News (Aug. 2010): The caveat is that, to be eligible under this provision, the entity furnishing the labor or materials for a construction project must be physically working on the real property and effecting a change to that property. Query: Is this physical change requirement appropriate under the plain language of the statute? 12

13 Potential Implications Owner versus Owners Scenario: Section (1): Affiliated group means a group of one or more entities in which a controlling interest is owned by a common owner or owners, either corporate or non-corporate, or by one or more of the member entities. Comptroller Rule 3.590(a)(1): Affiliated group Entities in which a controlling interest is owned by a common owner, either corporate or non-corporate, or by one or more of the member entities. Query: Should entities with common owners that collectively meet the controlling interest test be treated as an affiliated group for combined reporting purposes? 13

14 Combined Reporting Affiliated Group? Individual A Individual B Individual A Individual B 50% 50% 50% 50% Corporation A Corporation B 14

15 Potential Implications Definition of Production: Section (a)(2): Production includes construction, installation, manufacture, development, mining, extraction, improvement, creation, raising, or growth. Comptroller Rule 3.588(a)(7): Production Construction, manufacture, installation occurring during the manufacturing or construction, process, development, mining, extraction, improvement, creation, raising, or growth. Query: Should installation labor be included in cost of goods sold regardless of whether related to manufacturing or construction? Ewing Buick, LP v. Combs, Cause No. D-1-GN

16 Potential Implications Flow-Through Funds: Section (f): A taxable entity shall exclude from its total revenue flow-through funds that are mandated by law or fiduciary duty to be distributed to other entities, including taxes collected from a third party by the taxable entity and remitted by the taxable entity to a taxing authority. To date, the Texas Comptroller has only applied this exclusion to sales and use tax collected from a customer. See: Texas Comptroller Franchise tax FAQ, Total Revenue, No

17 Potential Implications FAQ No. 9: If you reduce your property taxes and insurance expense for IRS reporting purposes for the amount of reimbursements received from tenants, can you also exclude these reimbursements from total revenue for Texas margin tax purposes? CFR (c) states, As a general rule, if a lessee pays any of the expenses of his lessor such payments are additional rental income of the lessor Total revenue for franchise tax reporting is specifically defined in Texas Tax Code and is tied to the amounts entered on specific lines from the federal return, to the extent the amount entered complies with federal income tax law, minus statutory exclusions. Based on the above IRS regulation, the reimbursement of expenses should be reported for federal tax purposes in gross rental income and not offset with the expenses. Therefore, for franchise tax reporting purposes the expense reimbursements are included in total revenue. (Updated 4/10/08) 17

18 Potential Implications Apportionment: Does the 3-Factor apportionment formula of the MTC apply to the Texas franchise tax? Section : [A] taxable entity s margin is apportioned to this state by multiplying the margin by a fraction, the numerator of which is the entity s gross receipts from business done in this state and the denominator of which is the entity s gross receipts from its entire business 18

19 Potential Implications Apportionment: Section : The Multistate Tax Compact is adopted and entered into with all jurisdictions Article III, Section 1: Any taxpayer subject to an income tax whose income is subject to apportionment and allocation for tax purposes pursuant to the laws of the party state may elect to apportion and allocate in accordance with Article IV. Article IV, Section 8: All business income shall be apportioned to this state by multiplying the income by a faction, the numerator of which is the property factor plus the payroll factor plus the sales factor, and the denominator of which is three. Article IV, Section 1(a): Business income means income arising from transactions and activity in the regular course of the taxpayer s trade or business and includes income from tangible and intangible property if the acquisition, management, and disposition of the property constitute integral parts of the taxpayer regular trade or business operations. Graphic Packaging Corp. v. Combs: MSJ granted in favor of the State on January 15,

20 Potential Implications Cost of Goods Sold: Does a sale or lease qualify as a sale for cost of goods sold purposes? The term sale is not defined for franchise tax purposes. For sales tax purposes, the term is defined to include, in part, the exchange, barter, lease or rental of tangible personal property. Tex. Tax Code Sec Should the term sale for franchise tax purposes follow the same definition as it does for sales tax purposes? 20

21 Potential Implications Economic Substance/Economic Presence: Comptroller s office seeks to disregard or re-characterize some transactions on the basis of economic substance/business purpose. Mostly applied to aircraft and large dollar transactions. Issue: Does the Comptroller have authority to disregard or re-characterize transactions? If so, is it properly applying this doctrine? Will this doctrine be applied to other taxes? 21

22 Sales Tax Aircraft: 2006 Ruling/Disregard of Transitory Entities. Co. A Co. B Aircraft purchases out of State. Co. A contributes money to Co. B for purchase of aircraft out of State. Co. B dissolves; Co. A brings aircraft to Texas; Comptroller will ignore Co. B if Co. B does not have business purpose other than tax avoidance. 22

23 Sales Tax Aircraft: 2009 Ruling/Disregard of Non-Transitory Entities. Individual Aircraft purchases out of State. Contributes aircraft out of State ABC Corp. ABC issues no additional stock to Individual; ABC brings aircraft into Texas; Individual may use aircraft under Operating Agreement for no consideration; Comptroller will disregard ABC Corp. and hold Individual liable for use tax. 23

24 Sales Tax Aircraft: 2009 Ruling / Re-characterization of Transactions. Broker Individual Sales aircraft out of State Individual A Sales aircraft Individual B Individual A holds no sales tax permit; has made no other sales of TPP in previous 12 months. Comptroller may view transactions as a sale from Broker to B if there is no business purpose or economic substance to the series of related transactions. 24

25 Sales Tax 2009 Ruling / Re-characterization of Transactions: Relevant Factors according to Texas Comptroller: Did purchase and sale of aircraft by A have substantial economic effect (i.e., did A make a profit in excess of the tax savings?) Was the sale to B arranged before the sale to A? Was A a mere straw-man? Did A incur any economic risk? Did A have any business purpose or personal reasons to acquire the aircraft? Did A use the aircraft? Was A related to either the Broker to Y? 25

26 Potential Implications Application of the Deference Tracfone Standard: In applying sales tax principles, applicability of the Tracfone deference standard where there is ambiguity should be clear in most cases: With respect to franchise tax, applicability of Tracfone remains to be determined: In determining federal income tax gross income, which is the starting point in arriving at total revenue, should any ambiguity be resolved in favor of Taxpayer? In construing the statutory exclusions that apply in arriving at total revenue and resolving related issues, should any ambiguity be resolved in favor of the Taxpayer? In determining allowable deductions and computational issues should ambiguities be resolved in favor of the State? In cases where the Comptroller seeks deference, should her litigating position receive the same deference as her rules and other interpretations? 26

27 Other Developments Hearing No. 107,916 (May 7, 2013): Total Revenue Exclusion for Certain Reimbursements: Taxpayer was a forwarding agent. On its 2008 and 2009 franchise tax reports, TP deducted out-of-pocket costs from total revenue and later sought to amend federal tax returns to exclude the reimbursements from gross receipts. Comptroller agreed that federal income tax returns could be amended to report gross receipts by excluding reimbursed expenses. If amended, total revenue could also be reduced. Petitioner amended two returns but stated that he could not amend the third because of federal statute of limitations. It is not clear why Petitioner believed federal law precluded amending federal returns: 3-year statute of limitations for federal tax purposes applies to refund claims. See IRC Sec. 6511(a). 27

28 Other Developments Internal Memorandum (Nov. 21, 2013): Apportionment of Proceeds From Sale of Securities: The gross proceeds from the sale of securities that are treated as inventory of the seller for federal income tax purposes are considered gross receipts for franchise tax apportionment purposes, regardless of whether the gross proceeds are included in the calculation of the seller s taxable margin. Consequently, gross proceeds may be included in the apportionment factor even if total revenue includes only net gain from the sale of those securities. Note: Under Comptroller Rule 3.591(e)(25), receipts from the sale of securities are apportioned based on the location of the Payor. If securities are sold through an exchange and the buyer cannot be identified, only 7.9% of the revenue is considered a Texas receipt. 28

29 David E. Colmenero Partner Mr. Colmenero practices in the areas of Federal Tax Litigation, State Tax Litigation and Wealth Transfer Tax Litigation. He represents individuals, closely held businesses, and large corporations in IRS audits, appeals, and litigation in the United States Tax Court, Federal District Courts and the United States Court of Federal Claims. He also represents taxpayers in disputes with the Texas Comptroller of Public Accounts and has helped taxpayers resolve tax related controversies with several other states as well. Mr. Colmenero has represented taxpayers in complex and contentious federal tax matters through various stages of examination, appeals and litigation, some of which have involved high profile taxpayers and high profile legal issues. In the recent past, Mr. Colmenero has helped taxpayers either settle or litigate dozens of cases involving complex transactions alleged by the IRS to be abusive tax shelter transactions as well as other matters involving complex transactions and technical provisions of the Internal Revenue Code. He has also been asked to advise taxpayers regarding the federal tax consequences in divorce proceedings, litigation between private parties and significant business transactions. phone (214) toll-free (800) fax (214) Mr. Colmenero, in addition, brings considerable state tax experience to the table. He was previously a tax auditor for the State of Texas and, as a lawyer, has successfully represented many taxpayers in contested proceedings involving sales and use tax, franchise tax, motor fuels tax, mixed beverage tax, and others. Mr. Colmenero has in the recent past been actively involved in working with taxpayers, professional organizations, the Texas Comptroller of Public Accounts and various legislators in addressing key issues pertaining to the recently revised Texas franchise tax. Mr. Colmenero is a Certified Public Accountant and maintains active involvement in various professional legal and accounting organizations. He frequently speaks on substantive and procedural tax issues involving both federal and state tax matters and has published several articles relating to tax developments. Mr. Colmenero was admitted to practice in Texas in

30 Disclaimer The information included in these slides is for discussion purposes only and should not be relied on without seeking individual legal advice. IRS Circular 230 Disclosure Information included in these slides is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding any penalties under U.S. federal tax law, or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. 30