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On September 27, 2019, the Texas Comptroller of Public Accounts (Comptroller) proposed amendments to its franchise "margin" tax nexus rule (34 TAC Section 3.586) that would adopt an economic nexus threshold of $500,000 in annual Texas receipts for foreign taxable entities that do not have a physical presence in the state.

This change would apply to franchise tax reports due on or after January 1, 2020.

Under Texas law (Tex. Tax Code Section 171.001(b)), the state's ability to impose franchise tax extends to the limits of the U.S. Constitution and corresponding federal laws. In response to the U.S. Supreme Court's ruling in South Dakota v. Wayfair, Inc. (Wayfair),¹ which held that the Court's long-standing physical presence nexus standard "is an unsound and incorrect" interpretation of the Commerce Clause, the Comptroller has proposed amendments to 34 TAC Section 3.586 that would adopt an economic nexus provision for Texas franchise tax purposes.

Under the proposed rule, for federal income tax accounting periods ending in 2019 or later, a foreign taxable entity (a taxable entity not chartered or organized in Texas) with no physical presence in Texas would have nexus with Texas if, during its federal income tax accounting period, it had gross receipts from business done in the state of $500,000 or more, as determined using the state's apportionment sourcing rules in 34 TAC Section 3.591.

In addition, the proposed rule would presume nexus for a foreign taxable entity that has a Texas use tax permit. In the rule's Preamble, the Comptroller noted that this change (i.e., expressly tying nexus under the use tax to that under the franchise tax) would codify the Comptroller's existing practice.

Under the proposed rule, a foreign taxable entity would be doing business in Texas on the earliest of:

1. The date it has physical presence in the state (the proposed rule sets forth a list of activities that constitute a physical presence nexus)
2. The date it obtains a Texas use tax permit, or
3. The first day of the federal accounting period it has Texas gross receipts from business that is done in Texas and exceeds $500,000.

Interested parties have 30 days from September 27, 2019 — the date the proposal was published in the Texas Register — to submit comments.

Implications

If the proposed rule amendments establishing an economic nexus standard are adopted, Texas would be the fourth jurisdiction that has changed its corporate income/franchise tax law or interpretation of its law in response Wayfair. The other three jurisdictions are: Hawaii (by enacted law), Pennsylvania (by administrative guidance), and City of Philadelphia (amended regulation).

If the proposed nexus threshold is adopted, Texas would have a $500,000 economic nexus threshold for both franchise tax and sales/use tax (see 34 TAC Section 3.286) purposes. Taxpayers are reminded that the Texas margins tax has a "no tax due" threshold of $1.18 million of gross receipts for tax years 2020 and 2021.²

EY will continue to monitor these developments, and issue additional Tax Alerts as needed.

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ENDNOTES

¹ South Dakota v. Wayfair, Inc., 138 S.Ct. 2080 (2018).

² See Tex. Tax Law §171.002(d)(2) ("no tax due" exception from franchise tax) and §171.006(b) (adjustment to "no tax due" threshold based on changes to consumer price index). See also Tex. Comp. Pub. Accts., Franchise Tax - Tax Rates, Thresholds and Deduction Limits (available on the internet here (last accessed Oct. 4, 2019)).