January 7, 2021
Texas adopts sweeping amendments to sourcing rule for franchise tax
On January 4, 2021, final/adopted revisions to the Texas Comptroller of Public Accounts' sourcing rule under 34 Tex. Admin. Code Section 3.591 (Section 3.591) for franchise tax receipts, were filed with the Texas Secretary of State (hereafter, final rule). The revisions made by the final rule are expansive; according to the Comptroller, they:
The final rule was adopted with changes to the proposed revision to Section 3.591, as published in the November 13, 2020 issue of the Texas Register (proposed revision). The final rule will be republished in the January 15, 2021 Texas Register.1
The revisions made by the final rule generally are effective January 1, 2008, except as otherwise noted in the net gain/loss provisions and certain changes stemming from legislation. The final rule also allows, in certain instances, the option of applying sourcing procedures under the former rule to former periods.
Modifications to the proposed revision made by the final rule
The proposed revisions to Section 3.591, which were based on the text published in the November 13 Texas Register, were discussed in Tax Alert 2020-2863. While the proposed revision is mostly similar to the final rule, the final rule's Preamble describes the changes made from the proposed revision.
Notable changes from the proposed revision include the following:
Advertising services: The final rule retains the following changes in the proposed revision — (1) consolidating the rules for sourcing advertising services for newspapers, magazines, radio, television and other media into one subsection (new subsection 3.591(e)(1)) and (2) sourcing gross receipts from the dissemination of advertising based upon the audience location. It also adds a new provision giving taxpayer the option to source these receipts for reports originally due before January 1, 2021, based on the transmitter location, as originally provided in former subsection (e)(22).
Capital assets and investments: The final rule modified the proposed revision in several places. According to the Preamble to the final rule, the treatment of net gains and net losses from the sale of "capital assets and investments" in subsection 3.591(e)(2) was amended to reflect the Texas Supreme Court's decision in Hallmark Marketing Co.,2 which held 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 are included in gross receipts.
While revising the rule to comply with Hallmark, the Preamble explains, the final rule "also evaluated its rule regarding the calculation of net gains and losses … [and] concluded that the only reasonable interpretation of the statute is that 'net gain' refers to the net amount resulting from proceeds of an asset sale reduced by the adjusted basis in the asset. Because the statute only permits the inclusion of net gains, the net loss from the sale of one asset cannot be used to offset the net gain from another asset." Thus, for reports due on or after January 1, 2021, the net gains or net loss for each sale of a capital asset or investment is determined on an asset-by-asset basis, only including the net gain for each individual asset.
The proposed revision provided that "net gain or net loss is determined separately for each sale of a capital asset or investment." The Comptroller, however, modified this language in the final rule, providing that "net gain or net loss from the sale of a capital asset or investment is the amount realized from the sale less the adjusted basis for federal income tax purposes." Further, in the final rule, 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 that 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.
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 may add the net gains and losses from these sales. The net gain from the sale of the capital asset or investment is sourced based on the type of asset or investment sold (e.g., net gain from the sale of an intangible asset is sourced to the location of the payor, real property is sourced to the location of the property, and tangible personal property is sourced as described in subsection 3.591(e)(29)).
Texas population percentage updated for securities sold through an exchange: The final rule retains the change from the proposed revision amending subsection 3.591(e)(25) 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 response to comments submitted by interested parties, the Comptroller will allow taxpayers to continue to use 7.9% for reports originally due before January 1, 2021. The Comptroller declined a request for an alternative method of sourcing that would have used similar, comparable securities instead of 8.7%.
Services: Regarding subsection 3.591(e)(26), which provides rules for sourcing receipts from the provision of services, the Preamble of the final rule on services omits language from the proposed revision's Preamble acknowledging that the proposed revision "may be inconsistent with some prior rulings," and that inconsistent rulings would be superseded. The Preamble of the final rule, however, addresses the Comptroller's authority to supersede selected rulings that are inconsistent with its current interpretation and contends that such action does not constitute retroactive rulemaking, as obsolete or inconsistent rulings are commonly superseded without rulemaking.
Transportation services: The proposed revision would have limited the option to source receipts from transportation services under subsection 3.591(e)(33) using a ratio of total mileage in Texas to total mileage everywhere for reports originally due before January 1, 2021. Based on comments from interested parties, the Comptroller retained the option, but modified it to base the ratio on total compensated mileage in the transportation of goods and passengers in Texas to total compensated mileage.
Implications The final rule modifying the proposed revisions will bring about sweeping changes to the apportionment provisions for Texas franchise tax purposes. Some may argue that some of these changes are contrary to the statutory language and the intent of those underlying statutes. Taxpayers should review these changes and determine the impact, if any, of these changes on the preparation of their Texas franchise tax reports. Texas taxpayers must keep in mind that some of the changes may apply retroactively and that these amendments in some cases are intended to supersede prior inconsistent rulings.
1 The final rule is effective January 24, 2021.
2 Hallmark Marketing Co. v. Hegar, 488 S.W.3d 795 (Tex. 2016).