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On December 20, 2019, the Texas Comptroller of Public Accounts (Comptroller) adopted amendments to its franchise "margin" tax nexus rule (34 TAC Section 3.586) (Section 3.586 or final rule), establishing an economic nexus standard with a $500,000 threshold.¹ This change takes effect December 29, 2019, and applies 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)² overturning its long-standing physical presence nexus standard (concluding that it "is an unsound and incorrect" interpretation of the Commerce Clause of the U.S. Constitution), the Comptroller amended Section 3.586 to adopt an economic nexus provision for Texas franchise tax purposes.

Under the final rule, for federal income tax accounting periods ending in 2019 or later, a foreign taxable entity (i.e., a taxable entity not chartered or organized in Texas) that does not have a physical presence in Texas will still be deemed to 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 set forth in 34 TAC Section 3.591.

In addition, the final rule includes a provision under which a foreign taxable entity is presumed to have nexus with Texas if it holds a Texas use tax permit. In the final rule's preamble, the Comptroller noted that this change (i.e., by which it expressly ties nexus under Texas's use tax to the nexus provisions of the state's franchise tax) codifies the Comptroller's existing practice. Further, in response to a public comment that the provision could be unconstitutional, the Comptroller concluded this provision "is appropriate because an entity may rebut the presumption."

Under the final rule, a foreign taxable entity will be deemed to be doing business in Texas on the earliest of:

1. The date it has physical presence in the state (the final rule sets forth a list of activities that constitute a physical presence nexus)
2. The date it obtains a Texas use tax permit

or

• The first day of the federal accounting period in which it has over $500,000 in Texas gross receipts from business done in Texas

Implications

With the adoption of an economic nexus standard for franchise tax purposes, Texas becomes the fifth jurisdiction to change its corporate income/franchise tax law or interpretation of its law in response to the U.S. Supreme Court's ruling in Wayfair. The other four jurisdictions are: Hawaii (by enacted law), Massachusetts (amended regulation), Pennsylvania (by administrative guidance), and City of Philadelphia (amended regulation).

It's worth noting that Texas has the same $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; while a taxable entity might be deemed to have a tax filing obligation under the Texas margins tax, it may not have any actual direct tax liability.³

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ENDNOTES

¹ The rule was adopted without changes to the proposed rule. Text of the amended rule is available here.

² South Dakota v. Wayfair, Inc., 585 U.S. ___, 138 S.Ct. 2080 (2018).

³See Tex. Tax Law Section 171.002(d)(2) ("no tax due" exception from franchise tax) and Section 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.