Tax News Update    Email this document    Print this document  

December 14, 2020

Texas Comptroller proposes sweeping amendments to its franchise tax sourcing rule

On November 2, 2020, the Texas Comptroller of Public Accounts (Comptroller) filed with the Office of the Secretary of State proposed revisions that would make substantial changes to its sourcing rule under 34 Tex. Admin. Code Section 3.591 (Section 3.591) for franchise tax receipts. The proposed revisions are expansive; according to the Comptroller, they (1) incorporate legislative changes enacted in 2013 and 2015;1 (2) update select definitions and define new terms; (3) supersede certain guidance; and (4) make significant changes to the sourcing rules for receipts from advertising services, capital assets and investments, computer hardware and digital property, internet hosting and other services.

Once finalized, the proposed revisions will generally be effective January 1, 2008, except as otherwise noted in the net gain/loss provisions and certain changes stemming from legislation.

The proposed revisions may be adopted at any time, as the public comment period has now ended.

Updated and new definitions

The proposed revisions would define new terms that had not previously been defined in the Texas franchise tax code or rules and would modify existing definitions.2 All but one of the existing definitions set forth in Section 3.591 would be modified to some extent.3 The proposed revisions would define the following terms as follows:

  • Inventory — "Property held primarily for sale to customers in the ordinary course of a trade or business." As proposed, the definition of "inventory" would specifically exclude securities and loans held for investment, hedging or risk management purposes. This change incorporates the Comptroller's guidance in its opinion memo at STAR 201311792L Re: Apportionment of proceeds from the sale of futures contracts and securities (November 21, 2013).
  • Principal Place of Business — "The place where an entity's management directs, controls, and coordinates the entity's activities."
  • Regulated Investment Company (RIC) — "Any domestic corporation defined under IRC [Section] 851(a) (Definition of regulated investment company), including a taxable entity that includes trustees or sponsors of employee benefit plans that have accounts in a regulated investment company."
  • Texas gross receipts — "The portion of a taxable entity's gross receipts that is from business done in Texas."

The proposed revisions to the definition of "gross receipts" are particularly notable in that certain items would be excluded from total revenue but not gross receipts. As revised, "gross receipts" would be defined as total revenue (as determined under 34 Tex. Admin. Code Section 3.587) except for certain capital assets and investments (as provided in Sections 3.591(e)(2)) and loans and securities (as provided in Section 3.591(e)(17)). Further, non-receipt items excluded from the calculation of total revenue under Section 3.587 would not be deductible in computing gross receipts. Such non-receipt items would include the exclusion for uncompensated care, the $500 exclusion per pro bono service case, exclusions for the direct cost of providing waterway transportation or agricultural aircraft services and the exclusion for the cost of a vaccine.

Changes to sourcing provisions

The proposed revisions would significantly change the sourcing rules for receipts under Section 3.591(e), modifying provisions on the sourcing of receipts from services, internet hosting, computer hardware and digital property, advertising services, and capital assets and investments.

Services: Subsection 3.591(e)(26), which provides rules for the sourcing of receipts from the provision of services, would be revised to provide additional guidance as to where a service is performed. In Texas, gross receipts from services are generally sourced to the location where the service is performed. Over the years, numerous rulings and Comptroller decisions have been issued by the Comptroller addressing the location to which receipts from various services are assigned. The proposed revisions to Section 3.591(e)(26)(A) would specify that a service is performed at the location of the receipts-producing, end-product act or acts. If there is a receipts-producing, end-product act, the location of other acts, even acts that are essential to the performance of the receipts-producing act, would not be considered. If the service is performed inside and outside Texas for a single charge, then the receipts from the service would be Texas gross receipts based on the fair value of the services performed in Texas. The proposed revisions expressly state that "[t]he cost of performing a service does not necessarily represent value"; if costs are considered, the revisions state, they should be limited to costs directly related to the service and not overhead costs. The Comptroller has included specific examples with the rule to assist in determining where to assign costs related to work performed by a law firm or landscaper. See subsection 3.591(e)(26)(B).

The Preamble to the proposed revisions (Preamble) states that the Comptroller's amendments are intended to assist in formalizing a Comptroller Decision issued in 1980, which distinguished between receipts-producing activities and non-receipts producing activities.4 It is likely that these provisions are being amended to reconcile two opinions of the Texas Court of Appeals on the sourcing of services — Westcott Communications5 and SiriusXM,6 and support the Comptroller's interpretation of the sourcing rules as argued in those cases. In the Preamble, the Comptroller acknowledges that the proposed revisions "may be inconsistent with some prior rulings," and notes that the purpose of the proposed revisions "is to provide a consistent application of the statute in conformity with the concepts of Comptroller's Decision No. 10,028, even if not consistent with every individual ruling." The Comptroller indicated that inconsistent rulings that have previously been issued would be superseded.

Internet hosting: Renumbered subsection 3.591(e)(13) would replace the rule for sourcing internet access fees with a new rule for sourcing "internet hosting receipts." According to the Preamble, this change implements the Comptroller's policy of sourcing internet hosting receipts to the location of the customer as provided in HB 500 (Tex. Laws 2013), effective for reports originally due on or after January 1, 2014. This new subsection is virtually identical to the definition of "internet hosting service" in the Texas sales tax law, which is rather broad.7 The Preamble expressly notes that the definition of internet hosting receipts is broad and extends beyond the ordinary meaning.

The proposed revisions include non-exhaustive examples of what are and are not internet hosting services. Internet hosting services would include access to data, data processing, database search services, marketplace provider services, video gaming and streaming services. Telecommunications services, cable television services, internet connectivity or advertising services, or internet access solely to download digital content for storage on the customer's computer or other electronic device would be expressly excluded from the definition of internet hosting services.

The proposed revisions would include factors for distinguishing between access to computer services over the internet from the purchase or lease of digital property over the internet. Further, the proposed revisions would provide that the physical location of the "customer" (which is interpreted as the purchaser or the purchaser's designee) is determined by where the service is consumed by the customer. Under this method, receipts from some internet hosting services may be sourced to multiple customer locations or to multiple customers.

Computer hardware and digital property: Subsection 3.591(e)(3) would be amended by replacing the current rule for sourcing receipts from sales of computer software services and programs with sourcing rules for gross receipts from sales, leases, delivery and use of computer hardware and digital property. Prior to these amendments, the method or medium of how the software was transferred was not relevant for Texas receipts-sourcing purposes. Under the proposed revisions, gross receipts from such activities would be sourced as follows:

  • Sales of software installed on computer hardware or digital property transferred by fixed physical media would be sourced as the sale of tangible personal property (TPP) under subsection 3.591(e)(29)
  • Leases of software installed on computer hardware or digital property transferred by fixed physical media would be sourced as the lease of TPP under subsection 3.591(e)(14)(B)
  • Sales or leases of digital property transferred by means other than by fixed physical media would be sourced as the sale of intangible property (i.e., the location of the payor)
  • Delivery of digital property as a service would be sourced as receipts from providing services (sourcing rules described in subsection 3.591(e)(26))
  • Delivery of digital property as part of internet hosting services would be sourced as internet hosting receipts (i.e., the location of the customer) as provided in subsection 3.591(e)(13)
  • Use of digital property would be sourced under the rule for sourcing gross receipts from the use of intangible assets (subsection 3.591(e)(21)(A))

Advertising services: The proposed revisions would consolidate rules for sourcing advertising services for newspapers and magazines, radio and television, and advertising services in other media8 into one subsection under new subsection 3.591(e)(1).9 Gross receipts from the dissemination of advertising would be sourced to the audience location, which would be determined using the "most reasonable method under the circumstances, considering the information reasonably available." If, however, the location cannot be reasonably determined, 8.7% of the gross receipts would be sourced to Texas.

Capital assets and investments: The proposed revisions would amend the treatment of net gains and net losses from the sale of "capital assets and investments" in subsection 3.591(e)(2), which the Comptroller contends is intended to reflect the Texas Supreme Court's decision in Hallmark Marketing Co.10 that net losses from such sales are not included in the determination of gross receipts. Thus, only net gains from the sale of a capital asset or investment would be included in gross receipts. The proposed revision would take this analysis one step further; for reports due after January 1, 2021, the net gain or net loss for each sale of a capital asset or investment would be determined on an asset-by-asset basis, only including the net gain for each individual asset. Specifically, in the proposed revision, the Comptroller gives an example describing the result if two investment properties were sold in Texas, one of which resulted in a gain and one of which resulted in a loss. In such a case, according to the example, only the gain would be included in total gross receipts and Texas gross receipts. The loss could no longer be netted against gross receipts for purposes of determining the taxable entity's Texas apportionment factor.

Recognizing that the proposed revision makes a change to existing policy, subsection 3.591(e)(29) would be effective beginning January 1, 2021. For Texas franchise tax reports originally due before January 1, 2021, a taxable entity determining total gross receipts from the sales of capital assets and investments could add the net gains and losses from these sales; the net gain from the sale of the capital asset or investment would be sourced based on the type of asset or investment sold (e.g., net gain from the sale of an intangible asset would be sourced to the location of the payor, real property would be sourced to the location of the property, and TPP would be sourced as described in subsection 3.591(e)(29)).

Financial derivatives: New subsection 3.591(e)(10) would source gross receipts from the settlement of financial derivatives contracts (e.g., hedges, options, swaps, futures, forward contracts, other risk management transactions) to the location of the payor.

Loans and securities treated as inventory of the seller: Renumbered and renamed subsection 3.591(e)(17) would be amended to make clear the Comptroller's position that this subsection applies only to loans and securities treated as inventory of the seller and that securities and loans held for investment or risk management purposes are not inventory. Gross receipts from the sale of loans and securities treated as inventory of the seller would be sourced to the location of the payor.

Texas population percentage updated for securities sold through an exchange: Subsection 3.591(e)(25) would be amended to update the percentage that applies to securities sold through an exchange when a buyer is not known from 7.9% to 8.7%. In the Preamble, the Comptroller said the change was made to reflect a more current ratio comparing the population of Texas to the United States.

Sale of membership interest in a single member limited liability company (SMLLC): New subsection 3.591(e)(27) would source the sale of a membership interest in an SMLLC by its sole owner to the location of payor.

Television broadcaster licensing income: New subsection 3.591(e)(31) would implement HB 2896 (Tex. Laws 2015) and would follow the statutory language in Tex. Tax Code Section 171.106(h). Generally, a broadcaster's gross receipts from licensing income from broadcasting or distributing film programming would be sourced to Texas if the legal domicile of the broadcaster's customer is in the state. This sourcing rule would apply to reports originally due on or after January 1, 2018.

New examples: The proposed revisions include new illustrative examples of the application of select sourcing provisions.


Once finalized, the proposed revisions will bring about sweeping changes to Texas apportionment provisions, changes that some may argue are contrary to the language and intent of the underlying statutes. Taxpayers should review these proposed changes and determine their impact, if any, on franchise tax reports. Texas taxpayers must keep in mind that some of the changes may apply retroactively and that these amendments are intended to supersede prior inconsistent rulings.


Contact Information
For additional information concerning this Alert, please contact:
State and Local Taxation Group
   • Jamie Bowden (
   • Karen Currie (
   • Donna Rutter (
   • Davila Niesen (
   • Haley Smith (
   • Keith Anderson (
   • Chinh Nguyen (
   • Morgan McVicker (


1 The proposed revisions incorporate legislative changes brought about by HB 500 (Tex. Laws 2013), which affected the sourcing of internet hosting receipts and HB 2896 (Tex. Laws 2015), which affected the sourcing of licensing income for broadcasters (based upon the legal domicile of the customer).

2 See Section 3.591(b).

3 The definition of "location of payor" would not be changed.

4 Comptroller Decision No. 10,028 (1980) (available through the Texas STAR system as Document 8011H0320C09).

5 Westcott Communications, Inc. v. Strayhorn, 104 S.W.3d 141 (Tex. App. — Austin 2003).

6 Hegar v. Sirius XM Radio, Inc., No. 03-18-00573-CV (Tex. App. — Austin May 1, 2020).

7 Compare Tex. Tax Law Section 151.108 (defining "internet hosting" as "providing to an unrelated user access over the Internet to computer services using property that is owned or leased and managed by the provider and on which the user may store or process the user's own data or use software that is owned, licensed, or leased by the user or provider") with Subsection 3.591(e)(13)(A) ("Internet hosting service means providing to an unrelated user access over the Internet to computer services using property that is owned or leased and managed by the provider and on which the user may store or process the user's own data or use software that is owned, licensed, or leased by the user or provider.").

8 Currently in subsections 3.591(e)(20), (e)(22) and (e)(26), respectively.

9 Current subsection 3.591(e)(1) regarding bad debt recoveries would be deleted, as the Comptroller has determined the "guidance is unnecessary."

10 Hallmark Marketing Co. v. Hegar, 488 S.W.3d 795 (Tex. 2016).