The Texas Comptroller of Public Accounts (Comptroller) recently released guidance¹ on the treatment of vendor funded incentives (VFI) (e.g., volume-based purchase price adjustments, sales-based incentives, product placement incentives, new store allowances, depletion allowances) in computing the cost of goods sold (COGS) under the Texas revised franchise (Margin) tax.

Historical treatment

Previously, Texas has not addressed the treatment of VFI in the COGS and had relied on the broader exclusion of selling and advertising costs in Tex. Tax Code Section 171.1012(e)(2),(4) and 34 Tex. Admin. Code Section 3.588(g)(2),(4), when determining whether taxpayers must include VFIs in their COGS calculation. Traditionally, VFIs are contra-expenses that, if included, reduce COGS. Some retailers argued that VFIs should not be reported as contra-expenses because VFIs relate to the sale of goods and not the purchase of goods for resale.

New tax policy guidance

Under the new guidance, the Comptroller split VFIs into two categories: (1) excluded VFIs that primarily relate to advertising and selling activities and (2) included VFIs that are considered incentives and may be based on the sales volume.

Contra-expense accounts of the following VFIs are excluded from the COGS calculation:

— Advertising — Vendor payments for costs incurred in publishing an advertisement

— Coupon program handling fee — Vendor payments for handling costs incurred in producing a coupon

— Product demos — Vendor payments for costs incurred in putting on a demo

— Product placement — Vendor payments for strategic placement of goods

— Shows/seminars — Vendor payments for costs incurred in putting on a product show/seminar

Contra-expense of the following VFIs are included in the COGS calculation if not already reported as revenue:

— Coupon program-face value — Vendor payments for the face value of coupons used to reduce selling price

— Depletion allowance/volume incentives — Vendor payments received once a sales goal is reached

— Mark down funding — Vendor payments received as part of an exit strategy (i.e., phase out) of a product and used to reduce the selling price to the customer

— New item allowance — Vendor payments for costs incurred in getting a new item on the shelf

— Sales based incentives — Vendor payments received based on a reduction in the selling price to the customer

— Temporary price reductions — Vendor payments received as part of a short-term promotion and used to reduce the selling price to the customer

Implications

This is just one more example of the significant changes that have occurred in recent months to the Texas franchise tax COGS calculation. Now is the time to review the appropriate direct costs that should be included in the calculation of this important Texas margins tax deduction. Retailers that use VFIs should be aware of this important policy change by the Comptroller and determine the proper treatment of contra-expenses in COGS.

———————————————

———————————————
ENDNOTES

¹ Tex. Comp. of Pub. Accts., No. 201608950L (Aug. 11, 2016).