Texas Margin Tax. Steven Moore Attorney Jackson Walker LLP. Texas Aggregates and Concrete Association 58 th Annual Meeting June 27, 2012

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1 Texas Margin Tax Steven Moore Attorney Jackson Walker LLP Texas Aggregates and Concrete Association 58 th Annual Meeting June 27, 2012

2 Franchise Tax 2

3 Franchise Tax: Cost of Goods Sold Historical Background 1) Franchise (a/k/a Margin ) tax adopted in ) First returns due May 15, ) Tax did not raise as much tax revenue as fiscal note projected (short $1.5 billion per year) 4) Comptroller began a broad audit program and announced that lack of compliance on COGS is one culprit for revenue shortfall 5) Several TACA members are under audit 3

4 Franchise Tax: Basic Calculation Gross Revenue (-) Cost of Goods Sold or Compensation or 30% of Gross Revenue X Texas Gross Receipts 1% X All US Gross Receipts 4

5 Franchise Tax: Cost of Goods Sold Includes (Comptroller Rule Edited) All direct costs of acquiring or producing goods, including: 1) labor 2) materials purchased or consumed 3) handling costs, processing, assembling, repackaging, and inbound transportation 4) storage- including carrying, storing, or warehousing 5) depreciation, depletion, and amortization necessary for production 6) leasing equipment or facilities for production 7) repairing and maintaining equipment or facilities for production 5

6 Franchise Tax: Cost of Goods Sold Includes (Comptroller Rule Edited) 8) research costs, directly related to production 9) deterioration of goods 10) obsolescence of goods 11) spoilage and abandonment, including reclamation 12) preproduction direct costs 13) postproduction direct costs including storage and handling 14) insurance on plant and equipment directly used in production 6

7 Franchise Tax: Cost of Goods Sold Includes (Comptroller Rule Edited) 15) insurance on produced goods 16) utilities directly used in production 17) quality control 18) licensing fees for franchise, trademark, corporate plan, procedure, or recipe for goods 19) 4% of indirect or administrative overhead costs 20) taxes paid in relation to acquiring or producing any material 21) taxes paid in relation to services that are direct cost of production 7

8 Franchise Tax: Costs Not Included (Edited) 1) leasing equipment or facilities not used for production of the goods 2) selling 3) distribution, including outbound transportation costs 4) advertising 5) idle facility expenses 6) interest, including interest on debt incurred or continued during production period to finance production of goods 7) any compensation paid to undocumented worker used for production of goods 8

9 Sample Texas Comptroller FAQs/ Responses on Cost of Goods Sold 3. Is the calculation for COGS like federal reporting and industry calculations? No, allowable costs to be included in COGS are specifically defined for franchise tax reporting purposes in TTC What costs are included in computation of COGS? Allowable costs for COGS generally include costs related to acquisition and production of tangible personal property or real property. See Rule for detailed listing of costs that may be included in COGS. 9

10 Sample Texas Comptroller FAQs/ Responses on Cost of Goods Sold 5. What costs are not allowed in computation of COGS? COGS does not include selling costs, distribution costs, advertising costs, officer compensation and payments made to undocumented workers. See Rule for detailed listing of costs that are not included in COGS. 23. Can the labor to install tangible personal property be included in COGS? Labor to install tangible personal property outside of manufacturing process, unless part of construction, improvement, remodeling, repair or industrial maintenance of real property, is not allowed as part of cost of goods sold deduction. See Rule 3.588(b)(7). (Updated 06/19/08) 10

11 Texas Franchise Tax: Cost of Goods Sold / Property Taxes Comptroller Policy Letter with Accession No L You ask if real estate taxes can be deducted as cost of good sold (COGS) when real estate taxes relate to manufacturing building. Franchise tax rule Margin: Cost of Goods Sold (COGS) addresses question. Property taxes on manufacturing facilities are not specifically allowed under either rule 3.588(d) or (e). However, they are also not specifically excluded under rule 3.588(g). Therefore, they may be included in indirect and administrative costs that entity can demonstrate are allocable to acquisition or production of goods. See franchise tax rule 3.588(f). This limits deduction to 4% of indirect or administrative overhead costs per year. 11

12 Franchise Tax: COGS Audit Issues (1) Salaried individuals providing direct labor? (2) What is scope of direct labor? (3) Does worker have to touch manufacturing equipment? 12

13 Franchise Tax: COGS Audit Issues (4) Mixer, cab and chassis (5) PTO fuel (6) Drive train fuel a. Fuel to jobsite b. Fuel to return 13

14 Franchise Tax: COGS Audit Issues (7) Driver pay a. While in cab b. While at job site (8) Repair and maintenance for (i) mixer (ii) cab and chassis 14

15 Franchise Tax: COGS Audit Issues Compare Texas sales tax ruling on mixers: mobile transit mixer unit purchased separately from cab/chassis qualifies for the [manufacturing] exemption. Comptroller Accession L 15

16 Franchise Tax: COGS Audit Issues Industry Manufacturing Standards: ASTM C94 TxDOT 421 ACI 301 All of these support fact that manufacturing occurs during transit. 16

17 TACA Working DRAFT Position 1. Salaried or hourly labor should be analyzed on substantive basis to determine compensation that meets reasonable definition of direct labor costs. 2. Mixer trucks and powering cab/chassis should be allowed direct manufacturing cost because manufacturing occurs during delivery and normally during back haul, either to continue to process product or prevent damage to mixer. 17

18 TACA Working DRAFT Position 3. Driver pay should be allocated on some reasonable basis with???% allocated to direct manufacturing labor and???% allocated to nondeductible outbound transportation cost. 4. Fuel cost should be allocated on some reasonable basis with???% allocated to direct manufacturing cost and???% allocated to nondeductible outbound transportation cost. 18

19 TACA Working DRAFT Position 5. Dump trucks would not be deductible. 6. Repair and maintenance for mixer trucks would be deductible at???%. 7. Other support? 19

20 2013 Texas Legislature 28

21 2013: State Tax Issues What is a tax increase? (a) provisions that raise tax rates or impose a new tax vs. (b) provisions that effectively raise tax rates or expand tax bases by eliminating exemptions or deductions 29

22 2013: Technical Corrections Legislators might take the position that 2013 changes to the franchise tax to cause it to raise the money they thought it would have raised when originally passed are not tax increases. 30

23 2013: Franchise Tax Esoteric But Important Franchise Tax Issues 1. Texas Supreme Court holding in Allcat opens the door for traditional income based tax on business entities in Texas. 2. The Bullock amendment does not ban entity level income tax on partnerships. 31

24 Texas Margin Tax Steven Moore Attorney Jackson Walker LLP Questions?