Texas - Franchise tax relief, R&D incentives, sales and use tax exemptions for telecommunication, internet providers

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1 No June 17, 2013 Texas - Franchise tax relief, R&D incentives, sales and use tax exemptions for telecommunication, internet providers June 17: Texas Governor Rick Perry on June 14 signed three business friendly tax bills into law. House Bill 500 implements an estimated $700 million in franchise tax relief generally effective for reports due on or after January 1, House Bill 800 adopts tax incentives for research and development (R&D) activities. House Bill 1133 adopts a new sales and use tax exemption for property purchased and used by certain cable television, telecommunications, and internet service providers (ISPs) Additional details on these bills are discussed below. House Bill 500 Permanent extension of the $1 million franchise tax exemption - Under this exemption, which had been scheduled to drop to $600,000 for the 2014 tax year, a taxable entity is not required to pay any franchise tax and is not considered to owe any tax for a period if the taxable entity s total revenue from its entire business is less than or equal to $1 million. Temporary permissive alternative rates - House Bill 500 adopts elective (although it is unclear why an entity would not elect to use lower rates) temporary permissive alternative rates of 0.975% (general taxable entities) and % (retailers and wholesalers) for reports due on or after January 1, The rates are further reduced to 0.95% and 0.475% for reports due on or after January 1, 2015, and before January 1, 2016, but only if the Comptroller certifies that 2015 state revenues amounts are anticipated to meet expectations. Entities qualifying as retailers subject to tax under lower retailer rate - The definition of retail trade is amended to include the following: Activities classified as Industry Group 753 of the 1987 SIC manual

2 (automotive repair shops) Rental purchase activities regulated by Chapter 92 of the Texas Business and Commerce Code (rent-to-own businesses) Activities involving the rental or leasing of tools, party and event supplies, and furniture that are classified as Industry 7359 of the 1987 SIC manual Heavy construction equipment rental or leasing activities classified as Industry 7353 of the 1987 SIC manual New exemptions - House Bill 500 adopts franchise tax exemptions for (1) political subdivision corporations, and (2) certain non-admitted insurance organizations subject to occupation taxes or certain business privilege taxes in other states or foreign countries. Alternative option for computing margin - The legislation amends the calculation of margin by providing a taxable entity the additional option of computing margin as total revenue less $1 million. Exclusions from total revenue - Under the new law, revenue from certain industry-specific activities is excluded from the calculation of total revenue, including entities (1) operating pharmacy networks, (2) primarily engaged in the business of transporting aggregate or barite, or performing landman services (as defined), (3) transporting goods by waterways, and (4) registered as motor carriers under the Texas Transportation Code. Taxable entities also will be able to exclude from total revenue the cost paid by the taxable entity for a vaccine. Pipeline companies and movie theater COGS deductions - Certain pipeline entities providing services for others related to products they do not own are allowed to subtract depreciation, operations, and maintenance costs as costs of goods sold (COGS). Likewise, movie theaters that elect to deduct COGS can deduct certain costs associated with the acquisition, production, exhibition, or use of a film or motion picture, including expenses for the right to use the film or motion picture. Combined group exclusion for certain taxable entities providing retail or wholesale electric utilities - Under prior law, a taxable entity was primarily engaged in retail or wholesale trade (and therefore qualified to use the lower rate) only if: (1) the total revenue from its activities in retail or wholesale trade is greater than the total revenue from its activities in trades other than the retail and wholesale trades; (2) less than 50% of the total revenue from activities in retail or wholesale trade comes from the sale of products it produces or products produced by an entity that is part of an affiliated group to which the taxable entity

3 also belongs; and (3) the taxable entity does not provide retail or wholesale utilities, including telecommunications services, electricity, or gas. An additional law change in House Bill 500 essentially removes an electric utility provider from the unitary combined group, thus allowing the rest of the group to qualify for the lower rate. Specifically, a taxable entity that provides wholesale or retail electric utilities will be excluded as a member of a combined group that includes other taxable entities that do not provide wholesale or retail electric utilities if the following conditions are met: (1) the entity is not considered engaged in retail or wholesale activities because it provides wholesale or retail utilities; and (2) less than 5% of the combined group s total revenue is derived from providing retail or wholesale electric utilities. Sourcing rules for Internet hosting receipts - Receipts from internet hosting are attributed to Texas only if the customer to whom the service is provided is located in Texas. House Bill 800 Texas research & development (R&D) credit - House Bill 800 adopts an R&D credit to be applied against franchise tax liability. In general, taxpayers are eligible for the Texas R&D credit if they have qualified research expenses (QREs) as defined by IRC section 41 conducted in Texas, including wages, supplies, and contract research expenses. Similar to the methodology used to calculate the federal Alternative Simplified Credit, the Texas R&D credit will generally be 5% of the difference between the QREs incurred during the tax period (current period QREs) and 50% of the average QREs incurred during the prior three tax periods (base amount). If the taxpayer contracts with a public or private institution of higher education for the performance of qualified research in Texas, the tax credit increases to 6.5% of the difference between the current period QREs and the base amount. If a taxpayer has no base amount, the credit will be equal to 2.5% (3.125% if contracted with an institution of higher education) of the current period QREs. The allowable credit in any one tax period, including any carryforward amount, may not exceed 50% of the taxpayer s franchise tax due for the period. The amount in excess of the credit ceiling may be carried forward for a maximum of 20

4 consecutive tax periods. An eligible taxpayer is to apply for a credit by including the necessary information on or with the tax report for the tax period for which the credit is claimed. Sales and use tax exemption - In lieu of the R&D franchise tax credit, taxpayers may claim an exemption from Texas sales and use tax for depreciable tangible personal property directly used in qualified research as defined in IRC section 41. Taxpayers may claim either the sales and use tax exemption or the franchise tax credit, but not both. House Bill 1133 Effective September 1, 2013, House Bill 1133 allows providers of cable television services, internet access services, or telecommunications services a refund of sales and use taxes paid on certain purchases of tangible personal property. Specifically, a provider of such services will be entitled to a sales and use refund on the sale, lease, or rental, or storage, use, or other consumption of tangible personal property if: The property is sold, leased, or rented to or stored, used, or consumed by a provider or the provider s subsidiary; and The property is directly used or consumed by the provider or its subsidiary in (1) distributing cable television services, (2) providing internet access, or (3) transmitting, conveying, or routing telecommunications. Refunds of sales and use taxes are not available for tangible personal property used or consumed in providing data processing or information services. The total amount of sales and use taxes that can be refunded to all providers and subsidiaries each calendar year is $50 million. If total refunds requested exceed this amount, eligible providers will be entitled to a pro-rata portion of the $50 million. For more information, contact a tax professional with KPMG s State and Local Tax practice: Doug Maziur Chris Bajec

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