Fort Worth Chapter/TSCPA August 19, 2015 Dallas, TX

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1 Fort Worth Chapter/TSCPA August 19, 2015 Dallas, TX On the Front Lines of Texas Tax: Significant Recent Developments in Texas Franchise Tax David E. Colmenero, CPA, J.D., LL.M. 901 Main Street, Suite 3700 Dallas, TX fax Copyright Meadows, Collier, Reed, Cousins, Crouch & Ungerman, L.L.P. All rights reserved.

2 2015 Legislative Developments: Property Tax SB 1: Property Tax Relief Temporarily increases the homestead exemption from $15,000 to $25,000. Special provisions apply to over-65 and disabled homeowners. Requires approval of a constitutional amendment: SJR 1 which will be voted on in November The constitutional amendment takes effect on January 1, 2015 and expires January 1,

3 2015 Legislative Developments: Franchise Tax HB 32: Franchise Tax Rate Reduction Reduces the 1% tax rate to.75%. Reduces the.5% for retailers and wholesalers to.375% Reduces the EZ computation tax rate to.331% from.575% and makes it available to taxpayers with $20 million in revenue (up from $10 million). Effective: Applies to reports originally due on or after January 1,

4 2015 Legislative Developments: Franchise Tax HB 2896: Apportionment For Broadcasters States that a broadcaster shall include in the numerator of the broadcaster s apportionment factor receipts arising from licensing income from broadcasting or otherwise distributing film programming by any means only if the legal domicile of the broadcaster s customer is in Texas. The terms customer film programming and programming are all defined terms. A broadcaster is defined as a taxable entity, not including a cable service provider or a direct broadcast satellite service, that is a (i) television station licensed by the FCC; (ii) television network; (iii) cable television network; or (iv) television distribution company. 4

5 2015 Legislative Developments: Franchise Tax SB 1049: Temporary Veteran-Owned Business Exemption Amends Section the Tax Code to state that the Texas franchise tax is not imposed on a taxable entity that qualifies as a new veteran-owned business until the earlier of (i) the fifth anniversary of the date on which the taxable entity begins doing business in Texas; or (ii) the date the taxable entity ceases to qualify as a new veteran-owned business. Adds Section to define a new veteran-owned business as a taxable entity (i) that is chartered or organized or otherwise formed in this state and first begins doing business in Texas on or after January 1, 2016; and (ii) in which each owner is a natural person who served in and was honorably discharged from a branch of the United States armed forces and provides verification of service and discharge. Effective Date: January 1, Automatic Repeal: These provisions are also repealed effective January 1,

6 2015 Legislative Developments: Franchise Tax HB 3230: Rehabilitation Credit For purposes of determining eligible costs and expenses eligible for the Rehabilitation of Certified Historic Structures credit, HB 3230 amends the Tax Code to state that the depreciation and tax exempt use provisions in IRC Sec. 47(c)(2) do not apply to costs and expenses incurred by an entity exempt from Texas franchise tax under Section and states further that those costs and expenses are eligible costs and expenses if the other provision of Section 47(c)(2) are satisfied. Effective Date: Applies to reports originally due on or after January 1,

7 2015 Legislative Developments: Sales Tax HB 1905: Food Products The definition of non-taxable snack food items is revised to exclude pine nuts but expanded to include (i) pork rinds; (ii) corn nuts, (iii) sunflower or pumpkin seeds; (iv) ice cream, sherbet, or frozen yogurt; (v) ice pops, juice pops, sorbet or other frozen fruit items containing not more than 50 percent fruit juice by volume. The prepared food exception that makes the sale of food products taxable when sold for ready consumption at restaurants, lunch counters, cafeteria, vending machines, hotels, or like places of business is expanded to include delis. In addition, a like place of business for these purposes includes a grocery stores or convenience stores that contain any of these types of locations but only in relation to items sold at that location. Effective: September 1,

8 2015 Legislative Developments: Sales Tax HB 1905: Liquefied Gas Section (39) is revised to state that liquefied gas is considered a special fuel for purposes of Section , which exempts special fuels from Texas sales tax. Effective: September 2,

9 2015 Legislative Developments: Sales Tax HB 2313 Makes the sale of tangible personal property through a vending machine exempt from sales tax if (i) the sale is made by a Section 501(c)(3) organization; (ii) the machine is owned by the nonprofit organization; and (iii) the machine is stocked and maintained by individuals with special needs as part of an independent life skills and education program operated by the non-profit organization. Effective: September 1,

10 2015 Legislative Developments: Sales Tax HB 2507: Exemption for Certain Broadcast Equipment Creates an exemption for tangible personal property that is sold to an entity to which 47CFR sec (a) applies if the property is necessary to provide the broadcast services described by 47 CFR or Effective: September 1,

11 HB 2712: Large Data Center (i.e., Facebook s New Fort Worth Development) Exemption Complex bill that generally creates an exemption for tangible personal property that is necessary and essential to the operation of a qualifying large data center project if the tangible personal property is purchased for installation at, incorporated into or in the case of electricity, used in a qualifying large data center project by a qualifying owner, qualifying operator, or qualifying occupant. The tangible personal property must be of a particular nature as provided for in the statute. The qualifying owner, operator or occupant must create at least 40 qualifying jobs and agree to make a capital investment of at least $500 million. 11

12 2015 Legislative Developments: Sales Tax SB 140: Agricultural Exemption Extends the agricultural exemption to telecommunications services exclusively provided or used for the navigation of machinery and equipment exclusively used or employed on a farm or ranch in the building or maintaining of roads or water facilities or in the production of (i) food for human consumption; (ii) grass; (iii) feed for animal life; or (iv) other agricultural products to be sold in the regular course of business. Effective Date: The amendment takes effect September 1,

13 2015 Legislative Developments: Sales Tax SB 755: Software Resold as Part of Internet Hosting Expands the resale exemption to include the sale of a computer program to a provider of Internet hosting who acquires the computer program from an unrelated vendor for the purpose of selling the right to use the computer program to an unrelated user of the provider s Internet hosting services in the normal course of business and in the form or condition in which the provider acquired the computer program. Various limitations apply. Effective Date: Immediately as it received more than two-thirds vote by both Houses. 13

14 2015 Legislative Developments: Sales Tax SB 904: Exemption for Emergency Preparation Items Creates new exemption for sales/use tax purposes for emergency preparation items if the sale takes place during a period beginning at 12:01 a.m. on the Saturday before the last Monday in April and ending at 12 midnight on the last Monday in April. Emergency preparation items is a defined term that includes several different items including the following subject to various conditions and price limitations: (i) portable generators; (ii) certain storm protection devices; (iii) an emergency or rescue ladder; (iv) a reusable or artificial ice product; (v) a portable, self-powered light source; (vi) a gasoline or diesel fuel container; (vii) various batteries other than automobile or boat batteries; (viii) a nonelectric cooler or ice chest for food storage; (ix) a tarpaulin or other flexible waterproof sheeting; (x) a ground anchor system or tie-down kit; (xi) a mobile telephone battery or battery charger; (xii) a portable self-powered radio, including a two-way radio or weatherband radio; (xiii) a fire extinguisher, smoke detector, or carbon monoxide detector; (xiv) a hatchet or axe; (xv) a self-contained first aid kit; or (xvi) a nonelectric can opener. Effective Date: September 1,

15 2015 Legislative Developments: Sales Tax SB 853: Sales Tax Application Signature Amends Section to state that a sales tax application that is filed electronically complies with the signature requirement under subsection (b) of that section. Effective Date: Immediately as it was unanimously approved. 15

16 2015 Legislative Developments: Sales Tax SB 1356: Water Conservation Equipment Amends the Tax Code by adding Section to provide an exemption for (i) certain water conservation equipment and (ii) products that have been designated as WaterSense certified products under the WaterSense program operated by the United States Environmental Protection Agency or similar successor program. The exemption applies if the sale takes place during a period beginning at 12:01 a.m. on the Saturday preceding the last Monday in May (Memorial Day) and ending at 11:59 p.m. on the last Monday in May. 16

17 2015 Legislative Developments: Sales Tax HB 1841: Insurance Services Amend the Tax Code to exclude a service performed on behalf of an insured by a person licensed under Chapter 4102, Insurance Code, from the definition of taxable insurance services. Effective Date: October 1,

18 2015 Legislative Developments: Sales Tax SB 1396: Sales and Use Taxation of Aircraft Amends the Tax Code to include some provisions favorable to taxpayers as it relates to certain aircraft transactions. It states, in part, that the purchase of an aircraft qualifies for the resale exemption even if the purchaser makes limited use of the aircraft. It also states that a sale, lease, rental or other transaction between a person and a member, owner, or affiliate (or owner or member of an affiliate) of the purchaser involving an aircraft that would not be subject to tax or would qualify for an exemption from tax if the transaction were between unrelated persons, remains not subject to tax or exempt from tax to the same extent as if the transaction were between unrelated persons. In addition, no tax is due by a member, owner or affiliate of the purchaser with respect to the use of an aircraft if (i) the purchaser paid tax on the purchase of the aircraft; (ii) the purchase was exempt other than under Section (sale for resale) or (occasional sale) unless the owner, member, affiliate, etc, would have qualified for the occasional sale directly. Effective Date: September 1,

19 Recent Developments Affecting 2015 Texas Franchise Tax Reports and possibly requiring protective refund claims: Total Revenue Reimbursements Excluded from Total Revenue Subcontracted Real Estate Work Cost of Goods Sold Deduction Real Estate Work Installation Activities Telecommunication Companies Movie Theaters and Others? Farming Operations Research & Development Combined Reporting Common Owners v. Common Owner Eliminate Intercompany Transactions 19

20 Hearing No. 107,916 (May 7, 2013): 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 the 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). 20

21 Hearing No. 107,457 (Dec. 4, 2014): Reimbursements Facts: Taxpayer transports freight on a contract basis. It charged its customers a fuel surcharge to account for fluctuations in fuel prices. The surcharge was essentially an estimate based on industry standards that sought to recover excess fuel costs on a dollar-for-dollar basis and was billed separately on customer invoices. Taxpayer initially included its fuel surcharge amounts in its gross receipts amount for federal purposes. Subsequently, TP amended its FIT returns to exclude the surcharge from gross receipts and sought a corresponding refund of Texas franchise tax. Issue: Whether Taxpayer could exclude the fuel surcharge amounts from Total Revenue for franchise tax purposes. The auditor argued that the charges were for the provision of transportation services rather than reimbursements.. 21

22 Hearing No. 107,457 (Dec. 4, 2014): Reimbursements Held: The judge held that the fuel surcharge amounts could be excluded from total revenue. Citing to federal tax authority, the judge concluded that the fuel surcharges were excludable from federal income tax gross receipts because they would otherwise be deductible under IRC Section 162 and there was a right or expectation of reimbursement at the time the expenditure occurred. The right of reimbursement does not have to be absolute under Fifth Circuit authority. The judge noted that (i) Taxpayer paid for fuel upfront with the expectation that it would be substantially repaid by client; (ii) clients were routinely invoiced for the fuel and were required to pay within 15 days; and (iii) less than 1% of fuel surcharges billed were written off. 22

23 Titan Transportation, LP v. Texas Comptroller, (Tex. App. Austin, March 14, 2014): Subcontracted Work Facts: Titan is in the business of transporting aggregate to construction sites where it is used in construction projects. Issue: 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 flow-through funds that are mandated by contract 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. (emphasis added). 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. 23

24 Titan Transportation, LP v. Texas Comptroller continued Court overruled Texas Comptroller On the first issue, the Court agreed with Taxpayer arguing that 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 states 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. Notes: Section (g)(3) was amended in 2013 to include the word subcontract thus presumably resolving this issue prospectively. On May 1, 2015, the Texas Supreme Court denied the State s petition for review. 24

25 Combs v. Newpark Resources, Inc., (Tex. App. Austin, Dec. 31, 2013): Cost of Goods Sold/Combined Reporting Facts: 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. Issue: 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. Held: 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. 25

26 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? 26

27 Contractors: Comptroller Internal Memorandum Following Newpark and Titan (June 18, 2014) Issued revised policies as to (g)(3) and (i) (g)(3): Subcontracting payments that are mandated by contract to be distributed to others and have a reasonable nexus to the actual or proposed design, construction, remodeling, or repair of improvements to real property or the location of boundaries of real property may be excluded (i): No longer required to actually physically touch the property or make a change to the property to qualify for the COGS deduction. 27

28 Autohaus LP, LLP v. Combs (Tex. Dist. Ct. April 29, 2015): Cost of Goods Sold/Installation Activities Facts: Taxpayer is an automobile dealer in the business of selling and repairing automobiles. At issue were labor costs associated with the installation of automobile parts in the repair business. Issue: Taxpayer claimed these labor costs were includable in cost of goods sold under the plain language of Tex. Tax. Code as the definition of production in (a)(2) included installation. Comptroller argued that production was defined by Texas Admin. Code (b)(7) and thus only included installation during the manufacturing or construction process. Held: The Court granted Plaintiff s Motion for Summary Judgment in its entirety, granting the deduction and associated refund, along with declaring that Tex. Admin. Code 3.588(b)(7) is invalid because it conflicts with Tex. Tax. Code (a)(2). Final Judgment entered April 29, State will appeal. 28

29 Definition of Production: Section (c): Cost of goods sold includes all direct costs of acquiring or producing goods. 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? 29

30 American Multi-Cinema, Inc. v. Combs (Tex. App. Austin, Texas April 30, 2015): Cost of Goods Sold/Movie Theaters Facts: Taxpayer is engaged in the movie theater business. It claims that it is entitled to include the cost of exhibiting movies and other content to its customers. Taxpayer also claims that it is engaged in producing TPP and therefore costs of the entire auditorium are costs that may be included in cost of goods sold. Held: On April 30, 2015, the Third Court of Appeals agreed with Taxpayer. The court held that the exhibition of movies by Taxpayer constitutes the production of personal property for which a cost of goods sold deduction could be claimed. The cost of exhibiting movies and other content to paying customers could be included in cost of goods sold. In addition, costs associated with the square footage of its auditoriums were also direct costs of production. 30

31 NTS Communications v. Combs: Do telephone, cable and Internet access services qualify for the cost of goods sold deduction? "Goods" means real or tangible personal property sold in the ordinary course of business of a taxable entity. "Tangible personal property includes personal property that can be seen, weighed, measured, felt, or touched or that is perceptible to the senses in any other manner. Mixed Transaction Rule: If a transaction contains elements of both a sale of tangible personal property and a service, a taxable entity may only subtract as cost of goods sold the costs otherwise allowed by this section in relation to the tangible personal property sold. 31

32 Hearings 11, ,869 (pending): Prepaid Telephone Cards Taxpayer is a seller of prepaid telephone cards. Taxpayer seeks a refund of Texas franchise tax on the basis that (i) calls made with the prepaid calling cards are international in nature and cannot, therefore, be sourced to Texas; (ii) Taxpayer is entitled to a cost of goods sold deduction for the cost of the prepaid calling cards; and (iii) Taxpayer is entitled to use the reduced rate available to retailers and wholesaler. The Comptroller claims that Taxpayer is engaged in selling intangibles and does not, therefore, qualify to use the apportionment sourcing rules applicable to telephone service providers, the cost of goods sold deduction or the.5% rate. Position Letter filed; Reply to Position Letter due in May. 32

33 CGGVeritas Services (USA), Inc. v. Combs (Travis County District Court 2014): Cost of Goods Sold Taxpayer sells audio and visual representations of the earth s subsurface to oil and gas well drillers and producers. The oil and gas well drillers and producers use Taxpayer s product to construct oil and gas wells. Taxpayer stores the audio and visual recordings in a library and makes them available to customers for purchase. Issue: Taxpayer claims that it is entitled to claim a cost of goods sold deduction. District Court agreed with the taxpayer. Comptroller is appealing to Third Court of Appeals. 33

34 Letter Ruling L (June 5, 2015): Farming Operations A farmer that owns and sells the crops he grows is considered the producer of those crops and is allowed to subtract as cost of goods sold all costs that are allowed under Section Includible costs include but are not limited to labor, seed, fertilizer, irrigation, insecticides/fungicides, rental or depreciation of production equipment, repair and maintenance of production equipment, fuel for production equipment, and storage of crops. 34

35 Internal Memo L (April 23, 2015) Revises existing tax policy to permit a taxable entity that is eligible for a COGS deduction to claim as COGS all research, experimental, engineering, and design activity costs, including all research or experimental expenditures described in Section 174 of the IRC, regardless of whether the taxable entity is the producer of the good. Under prior Comptroller policy, these deductions were available only to those entities that produced the goods at issue. 35

36 Hearing No. 108,066 (May 12, 2015) Facts: Taxpayer was engaged in the publication of a guidebook that listed residential properties for sale. The guidebook was distributed at no cost to the general public. Advertisers paid a fee for advertising space. Ruling: The ALJ ruled that Taxpayer was not entitled to a cost of goods sold deduction because the guidebook was not, sold in the normal course of business. Taxpayer s customers purchased a service not a product or good. 36

37 Temporary Credit: Combined Reporting Amended Policy for Temporary Credit for Business Loss Carryforward STAR L (Nov. 14, 2014) Amended STAR L (April 9, 2014) Clarified Comptroller Policy for claiming credit where new entity is formed to acquire a combined group. Change of combined group if: Existing entity is used to acquire a combined group; or If other entities affiliated with newly formed acquiring entity join combined group. 37

38 Fig. 1 Fig. 2 Shareholders Investor Investor Newco Newco Parent Co. Parent Co. Entity X Entity Y Entity X Entity Y 38

39 Temporary Credit: Hearing No. 110,191 (June 24, 2015): Late Report Facts: Taxpayer filed its 2010 Texas franchise tax report late. It filed its report on October 20, 2010 but the due date had only been extended to August 15, On that report, Taxpayer claimed a large Temporary Credit carryover that had previously been preserved in The Texas Comptroller disallowed the credit on the basis that the report was not timely filed. Under the Texas Comptroller s regulations, a late report resulted in loss of the credit for that year and could not be carried over. Ruling: Citing to the plain language of the statute, the ALJ ruled that a Temporary Credit was preserved in 2008 when the taxpayer properly elected to claim the carryover in that year. It was not necessary for taxpayer to make a separate election each subsequent year to claim the Temporary Credit for each later year. In addition, Taxpayer did not revoke the Temporary Credit and took the credit on its original 2010 report. This was sufficient. 39

40 Combined Reporting: 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? 40

41 Combined Reporting Affiliated Group? Individual A Individual B Individual A Individual B 50% 50% 50% 50% Corporation A Corporation B 41

42 Combined Reporting: Owner versus Owners Scenario: A SOAH Proposal for Decision in Hearing No. 109, ,673 was issued on June 2, 2014 ruling that two entities with multiple owners who collectively owned more than 50% of both entities were an affiliated group. On August 12, 2014, the ALJ rejected exceptions filed by the State upholding PFD as originally issued. No final decision issued by Comptroller yet. 42

43 Combined Reporting May Be More Beneficial Than Separate Reporting Where: A large number of intercompany transactions exist; One or more entities in the combined group have no nexus with Texas; or One or more entities have a significant out of state presence. 43

44 Tiered Partnership Reporting A lower tier pass-through taxable entity with taxable entity owners may in some cases elect to have its owners include their allocable share of the lower-tier s total revenue in the upper tier entities total revenue. In the past, tiered partnership reporting was not highly beneficial and therefore, was not frequently utilized. Following a 2013 change in the law, tiered partnership reporting may become more popular. 44

45 Graphic Packaging, Inc. v. Combs, Cause No CV (Third Ct. of Appeals, July 28, 2015): Apportionment/MTC Three-Factor Facts: Taxpayer claims that it should be entitled to use the 3-factor apportionment formula provided for under the Multi-State Tax Compact. The trial court denied Graphic s motion for partial summary judgment and granted the Comptroller s cross-motion concluding that Graphic was not entitled to apportion its tax base under the Compact formula. Held: On July 28, 2015, the Third Court of Appeal held there the three-favor apportionment formula does not apply to the Texas franchise tax because the Texas franchise tax is not an income tax. According to the Court, none of the alternative ways of computing the franchise tax results in taxing net income. 45

46 Section of Tax Code: [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 Section of MTC: 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 fraction, 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 s regular trade or business operations. 46

47 Hallmark Marketing Company, LLC v. Combs, 2014 WL (Tex. App. Corpus Christi, Nov. 13, 2014): Apportionment Facts: For 2008, Hallmark generated $4,516,155,458 in gross receipts and $628,243,514 in losses on sales of investments and capital assets. For apportionment purposes, Hallmark excluded the loss amount from the denominator. Following an audit, the Comptroller assessed additional tax claiming that the denominator should be reduced by the loss amount. Issue: At issue was Section (b) which states that, [i]f a taxable entity sells an investment or capital asset, the taxable entity s gross receipts includes only the net gain from the sale. Held: The term net gain is ambiguous. It could refer to the particular gain or loss that results from each individual sale or it may instead refer to the taxpayer s cumulative gain or loss on its various investment and capital asset sales. Under the former, losses resulting from individual sales would not be deducted, but under the latter, they would. Citing to the Third Court of Appeals prior holding in Calver v. Electro-Science Investors, Inc., 509 S.W.3d 700, 702 (Tex. Civ. App. Austin, 1974, no writ), the court found that the Texas Comptroller s interpretation was reasonable. 47

48 Gulf Chemical v. Comptroller (Tex. App. Austin, Tex. 2015): Apportionment Facts: Taxpayer provides environmental disposal land recycling services for oil refineries by processing spend fuel catalysts, recovering precious metals from the catalysts and selling the metals at a profit. Taxpayer charged a fee to each refinery customer and also provided customers with a credit for a portion of profits derived for selling recovered metals. Taxpayer erroneously included the credit in its cost of goods sold for federal tax purposes. For GAAP purposes, Taxpayer was required to treat the credit as a contra-revenue which reduced revenues. Issue: Whether for the years at issue (2005, 2006 and 2007), gross receipts for apportionment purposes should be computed to include sales proceeds with or without netting by credits paid to customers. The Comptroller s former Rule 3.557(e) stated that, sales returns and allowances that a seller allows reduce gross receipts of the seller in the computation of gross receipts. 48

49 Gulf Chemical v. Comptroller (Tex. App. Austin, Tex. 2015): (cont d) Held: Citing to the definition of an allowance in Blacks Law Dictionary, the court held that the credits should be treated as an allowance because it reduced the sales price and could actually result in no payment to Taxpayer. In addition, relying solely on the manner in which the transactions were reported for federal tax purposes improperly elevated form over substance. [T]he legal determination of whether the metal credits constitute allowances under Texas law cannot turn on the labeling of such credits in Gulf s internal books or tax forms but must turn, rather, on the substance of the transactions. This appears to be the first time the Court has mentioned a substance over form analysis in a Texas franchise tax case. Arguably, the Court decided the case on the basis of the plain language of the Texas Comptroller s regulations and did not need to resort to substance over form. Nevertheless, we may see this case cited by the Texas Comptroller in future cases in support of the State s continued push to apply a substance over form approach in construing the Texas Tax Code. 49

50 Location of Payor Rule Generally, proceeds from the sale of intangibles are sourced to the location of the payor for Texas franchise tax apportionment purposes. This may create an opportunity when selling a business in some cases. Query: Should the sale of an entity that is disregarded for Federal tax purposes be treated as the sale of an intangible for Texas franchise tax apportionment purposes? 50

51 School Finance Texas Taxpayer & Student Fairness Coalition, et al v. Williams (Travis County District Court, Cause No. D-1-GN ) (Aug. 28, 2014) At issue: Art. VII, 1: A general diffusion of knowledge being essential to the preservation of the liberties and rights of the people, it shall be the duty of the Legislature of the State to establish and make suitable provision for the support and maintenance of an efficient system of public free schools. Art. VIII, 1-e: No State ad valorem taxes shall be levied upon any property within this State. Holding/Status: District Court Judge Dietz declared the Texas school finance system unconstitutional claiming that it is inequitable, inadequate and constitutes a statewide property tax. The case is on appeal directly to the Texas Supreme Court. A decision will likely not be issued until later this year. 51

52 Burden of Proof 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 applies 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. 52

53 Injunctive and Declaratory Relief Tax Code Injunctive relief or a restraining order prohibiting the assessment or collection of tax is generally prohibited unless the applicant previously files with the attorney general a statement of the grounds on which the order or injunction is sought and either (i) pays all taxes, fees and penalties due; or (ii) files a bond sufficient to pay twice the amount of taxes, fees and penalties due or that may reasonably be expected to become due during the period the order or injunction is in effect. The Tax Code also prohibits issuance of declaratory relief except where an oath of inability to prepay tax, penalties and interest has been filed with the court and the court finds that prepayment would constitute unreasonable interference with right of access to court. Granting of declaratory relief does not entitle taxpayer to attorney fees. The oath of inability to pay language was added in 1995 in response to the R. Communications case. 53

54 Declaratory Relief Case Law Richmont Aviation, Inc. v. Combs (Tex. App. Austin, 2013) Facts: Taxpayer appealed District Court s dismissal of suit due to noncompliance with jurisdictional requirements of Section Analysis: Court s ruling in Bandag Licensing that Section was unconstitutional has not been overruled, meaning Taxpayer may sue for injunctive relief without meeting the requirements of the statute and also for declaratory relief. Held: The Court reversed the District Court s Order dismissing the suit as to the Taxpayer s injunctive claims and request for declaratory relief. Texas Supreme Court refused to hear. Richmont is now a final decision. 54

55 Declaratory Relief Case Law Sanadco, Inc. v. Hegar (Tex. App. Austin, March 25, 2015) Facts: Taxpayer let sales tax assessment become final and after Comptroller filed suit to recover delinquent taxes, taxpayer asserted counterclaims for declaratory and injunctive relief. Analysis: Court stated that Chapter 112 provided the exclusive remedy for challenging a tax assessment and that Taxpayer may not circumvent Chapter 112 by filing counterclaim to Comptroller s suit to collect taxes. Held: The Court affirmed the District Court s Order dismissing the suit as to the Taxpayer s injunctive claims and request for declaratory relief. Motion for Rehearing and Reconsideration En Banc filed on May 11, 2015 Question: Does this case preclude taxpayers from bringing claim for declaratory relief in addition to claim under Chapter 112? 55

56 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

57 Disclaimer The information included in these slides is for discussion purposes only and should not be relied on without seeking individual legal advice. 57