TEXAS STATE TAX DEVELOPMENTS

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1 TEXAS STATE TAX DEVELOPMENTS Kirk Lyda JONES DAY 2727 North Harwood St. Dallas, TX (214) Justin Thompson JONES DAY 2727 North Harwood Street Dallas, TX Direct: (214) David Cowling JONES DAY 2727 North Harwood Street Dallas, TX Direct: (214) Note: COST participants may request a detailed Texas Margin Tax outline from the authors. Lawyerly Caveat: The views set forth herein are the personal views of the authors and do not necessarily reflect those of the law firm with which they are associated. I. REVISED FRANCHISE TAX - MARGIN TAX A. Overview The margin tax applies to all entities that enjoy the privilege of liability protection, meaning that in addition to applying to corporations and LLCs, limited partnerships, limited liability partnerships, professional associations and business trusts are also taxable entities. However, general partnerships that are solely owned by individuals and sole proprietorships are not subject to the new tax. Under the old Franchise Tax, taxable entities paid the tax based on the higher of.25 percent of the entity s capital (net worth) or 4.5 percent of the entity s earned surplus (net income plus officer compensation). These tax bases are replaced in the revised franchise tax with a margin tax base and the tax rate is set at one percent except for entities that qualify as retailers or wholesalers which are subject to a half percent rate. A business tax liability under the margin tax is calculated as the lesser of 70 percent of total revenue OR total revenue less cost of goods sold OR total revenue less compensation; the lesser amount is multiplied by the apportionment factor (Texas sales or receipts/sales divided by receipts from everywhere) and then multiplied by the appropriate tax rate. Alternatively, a business with $10 million or less in total revenue may choose to calculate its tax liability using the E-Z computation and a.575 percent tax rate. The Texas margin tax requires combined reporting for all taxable entities that are: (1) part of an affiliated group; (2) engaged in a unitary business; and (3) not excluded under the Water s Edge provision. A combined group includes all taxable entities without regard to whether the particular entity has nexus with Texas (although Texas follows the Joyce apportionment methodology). The combined group files reports on a combined basis as a single economic unit. Texas Tax Code (eff. 1/1/08). For purposes of defining the members of the combined group, the affiliated group includes one or more entities in which a controlling interest is owned by a common owner or owners, either corporate or noncorporate, or by one or more of the member entities. A controlling interest is defined as follows: DLI v1-1-

2 (1) for a corporation: more than 50 percent of the direct or indirect ownership of the total combined voting power of all classes of stock of the corporation, or of the beneficial ownership interest in the voting stock of the corporation; and (2) for a partnership, association, trust, or other entity: more than 50 percent of the direct or indirect ownership of the capital, profits, or beneficial interest in the partnership, association, trust, or other entity. Texas Tax Code (1) and (8) (eff. 1/1/08). B. Legislative Developments 1. General During a special session during 2011, Texas passed Senate Bill 1, which made the following changes to the margin tax (references to Articles are to the Article in SB1). 2. Small Business Franchise Tax Exemption (Article 37) Extends the $1 million small business franchise tax exemption through Eff. 9/28/ Franchise Tax Exclusions (Article 45) Excludes payments made to artists by a qualified live event promotion company from the total revenue of the promotion company for franchise tax purposes; excludes unincorporated entities organized as a political committee under the Election Code of the Federal Election Campaign Act from the franchise tax; and excludes passthrough charges paid by a courier and logistics company to nonemployee agents from the franchise tax. Eff. 1/1/ Apparel Rental Activities (Article 51) Classifies apparel rental activities as retail trade for purposes of the franchise tax rate (1/2%). Eff. 1/1/ Research & Development Incentives Study The Texas Legislative Budget Board is required to study the costs and benefits of reenacting the credit for research and development activities. The LBB is also required to study similar incentives offered by other states. HB $1 Million No-Tax-Due Threshold Extended Through Dec. 31, 2013 The $1 million no-tax-due threshold was to expire on Dec. 31, The 2011 legislation extends the $1 million threshold through Dec. 31, A $600,000 no-tax-due threshold takes effect Jan. 1, SB 1. C. Judicial Developments 1. TGS-NOPEC Geophysical Co. v. Combs, 340 S.W.3d 432 (Tex. 2011). Receipts from licensing the use of data apportioned to the location of the payor, not to the location of use. The issue in this case is the proper method for apportioning receipts from the licensing of geological and seismic data. The Texas statute includes as Texas receipts the use a patent, copyright, trademark, franchise, or license in [Texas]. The Court of Appeals held that the receipts in question were from the use a license within the meaning the statute, and the DLI v1-2-

3 Comptroller s methodology for determining location of use was reasonable. The Texas Supreme Court reversed, holding that receipts for licensing an intangible (here the data) are not receipts for a license but instead are receipts from licensing the use of an intangible. Because the data was not specifically listed in the statute, the location of use sourcing rule did not apply. Instead, the Court applied the default rule for sourcing intangibles other than those specifically listed in the statute. Under the default location of payor rule, such receipts were properly sourced to the legal domicile of the payor (which in this case was not Texas). 2. AllCat Claims Service, L.P. v. Combs, No (pending before Texas Supreme Court). Asserting that the Texas margin tax is an unconstitutional tax on the income of natural persons, as applied to individual partners of a limited partnership. In this case, the taxpayer claims the Texas margin tax is a tax on the income of natural persons, which if true would violate the Texas Constitution absent voter approval. 1 The prohibition does include a tax on a person s share of partnership and unincorporated association income. An individual limited partner of the partnership/taxpayer reasons that the tax applies to the net income of natural persons because it: (1) reduces the distributive share paid to the individual partners and (2) reduces the value of the partnership interest itself. The Comptroller claims the tax is imposed on the partnership itself, not on the individual partners, and that the Texas Constitution does not prohibit an income tax on legal entities merely because the entities happen to be owned by individuals. In enacting the margin tax, the Legislation specified that such challenges shall be heard by the Supreme Court of Texas, and that the Court must issue a decision within 120 days of the filing of the challenge. The parties have engaged in a series of briefing before the Court. Oral argument is expected to take place during October Taylor & Hill, Inc. v. Combs, No. D-1-GN (Tex. Dist. Ct. 2011, no pet hist.). Registered professional engineering firm temporarily assigning its employees to its clients to supplement its clients' workforce in special situations was a staff leasing company qualifying for the revenue exclusion. 4. Galland Henning Nopak, Inc. v. Combs, 317 S.W.3d 841 (Tex. App. Amarillo 2010, no pet. hist.). Employee s promoting or inducing sales in Texas is sufficient to create nexus and subject an out-of-state company to the Texas franchise tax. The Amarillo Court of Appeals recently held in Galland Henning Nopak, Inc. v. Combs that an employee s promoting or inducing sales in Texas is sufficient to create nexus and subject an out-of-state company to the Texas franchise tax (both the earned-surplus component and 1 Texas Constitution Article VIII, Section 24 provides: A general law enacted by the legislature that imposes a tax on the net incomes of natural persons, including a person's share of partnership and unincorporated association income, must provide that the portion of the law imposing the tax not take effect until approved by a majority of the registered voters voting in a statewide referendum held on the question of imposing the tax. The referendum must specify the rate of the tax that will apply to taxable income as defined by law. DLI v1-3-

4 the taxable capital component in effect during the audit period). 2 Following a franchise tax assessment, Galland Henning Nopak, Inc. (Nopak) filed suit, claiming it lacked substantial nexus with Texas such that imposition of the tax would violate the Commerce Clause. 3 Nopak s only connection to Texas other than common carrier and the United States mail was a regional manager employed to service the needs of distributors in several states, including Texas. 4 Nopak s regional managers were not authorized to directly solicit or take orders. 5 Rather, the regional manager did little beyond extolling the virtues of Nopak s products to distributors and attempting to resolve customer complaints. 6 The Court of Appeals held that the employee s activities were aimed at promoting or inducing sales and were significantly associated with Nopak s ability to establish and maintain a market in Texas; thus, the assessment did not violate the Commerce Clause. 7 The court rejected Nopak s argument that any Texas activities were de minimis, finding that the regional manager s handling of customer complaints served an independent business function and was conducted on a regular basis. The decision highlights a number of issues, including some unique to Texas with which Taxpayers may not be familiar. D. Administrative Developments 1. Comptroller Hearing Nos. 103,786 (2011); 104,092 (2011) For purposes of qualifying for the ½% tax rate, if a company provides services and sells tangible personal property, only the stand alone sales of tangible personal property qualify as retail or wholesale trade. For example, if the company sells tangible personal property and provides related services, those receipts are not from a retail or wholesale trade. 2. Comptroller Letter No L (Sept. 30, 2011). An insurance company may be excluded from the Texas unitary group if it pays gross premiums taxes in Texas. An insurance company paying gross premiums taxes to other states is not (by that fact alone) excluded from the Texas unitary group of its affiliates. 3. Reclaiming Credit Carryover Credit The Texas Comptroller recently reported that it plans to send out letters requiring companies that originally claimed credit for the margin tax business loss carryforward to affirm, by October 31, 2011, continued qualification for the credit. Under the Comptroller s Rules, certain changes in the composition of the combined group will result in a loss of the credit. 8 Failure to respond by the deadline will cause the credit to be lost. Affected companies 2 The court s decision does not specify which component of the tax was at issue; but in light of the discussion of Public Law and the underlying Comptroller hearing, both components appear to have been considered. See Comptroller Hearing No. 43,503, STAR No H (2006). 3 Nopak, 317 S.W.3d at Id. at Id. at Id. at Id. at See Comptroller Rule 3.594(c)(3). If a member changes combined groups, the credit is lost to the member and to the group. DLI v1-4-

5 should note the deadline and determine whether any changes in the composition of their combined groups run afoul of the credit disallowance rules. 4. Comptroller Letter No L (Aug. 30, 2011). For purposes of COGS, direct labor only includes the labor of those that physically produce a good or that acquire a good. Supervisory labor does not qualify as a direct cost. 5. Comptroller Letter No L (May 5, 2010). A series of an LLC as a whole is a taxable entity and must file a single margin tax report. One series of a series LLC cannot file a margin tax report separate from the LLC. 6. Comptroller Taxability Memo No L (Aug. 1, 2011). For purposes of COGS, a company selling software will be considered to be selling TPP even though the company is only providing a license to use software. 7. Comptroller Taxability Memo No L (Aug. 9, 2011). If, upon audit, two or more entities or groups of entities are found to be unitary (required to file a single combined group), the resulting combined group may elect to compute margin using any method (COGS or Compensation) used by any member on the returns as originally filed. 8. Comptroller Letter No L (Jan. 2011). While lending institutions are allowed to deduct interest as COGS, a lending institution only making loans to customers purchasing products does not qualify because it does not offer loans to the public. 9. Comptroller Hearing No. 103,083, STAR No H (July 28, 2010). Taxpayer may not amend its franchise tax report to change the method used to calculate taxable margin from the 70 percent of revenue method to cost of goods sold. Taxpayer filed an amended franchise tax report for 2008 in which it sought to change the method it used to calculate taxable margin from the 70 percent of revenue method to instead deducting COGS. The Comptroller denied the refund citing Rule 3.584, which the Comptroller claimed precludes a taxable entity from amending its report to change its election to the COGS or compensation deduction after the due date of the report. Taxpayer requested a refund hearing on the grounds that the original report was prepared using the best information available and that a later review of its business and a redesign of its accounting system produced an accurate COGS calculation. The administrative law judge s decision turned on the construction of Texas Tax Code (a) and (d) and Rule 3.584(f), which control the election for computing margin. The Tax Code provides that, as an alternative to the 70 percent of revenue margin calculation, taxable margin may be calculated by subtracting COGS or compensation from total revenue. The election to use the COGS or compensation deduction must be made by the due date of the report. Rule explicitly prohibits an entity from amending its report to change to a COGS or compensation deduction after the due date of the report. DLI v1-5-

6 The ALJ agreed with the Comptroller and affirmed the denial of the refund claim. The ALJ stated that the 70 percent of total revenue method of computing margin is not an election, but rather operates as a baseline or default for computing margin and that, for this reason, it is not inconsistent for the Comptroller to allow amendments to change from COGS or compensation to the 70 percent method but not allow the reverse change. The ALJ also found that the Comptroller s position was supported by the legislative history of Texas Tax Code (d). 10. Comptroller Hearing No. 104,076, SOAH , STAR K (Feb. 2011); Comptroller Hearing No. 103,083, SOAH , STAR H (July 2010) Taxpayer not entitled to change from 70% deduction to COGS on amended report. 11. Comptroller Hearing No. 103,807, SOAH , STAR H (Nov. 2010) -- Taxpayer not entitled to change from 70% deduction to Compensation on amended report. 12. Comptroller Hearing No. 103,450, SOAH , STAR H (Aug. 2010) -- Taxpayer not entitled to change from E-Z Computation to COGS on amended report. 13. Comptroller Hearing No. 103,340, SOAH , STAR H (Jan. 2011) Taxpayer did not qualify for ½% where more than 50% of revenue was attributable to products produced by Taxpayer s 100% parent, even though parent was in turn owned by 10 individuals whose ownership interests ranged from 42.6 percent to 0.65 percent. Parent and Taxpayer were still members of the same affiliated group. 14. Service Industry Entities Use of the COGS Deduction Explained Tax Policy News, Texas Comptroller of Public Accounts, July Section of the Texas Tax Code specifically provides that, in determining the COGS, the term goods means real or tangible personal property sold in the ordinary course of business and does not include services. The Texas Tax Code does not allow a COGS deduction for entities that provide services such as (per the Comptroller) dry cleaners, law firms, parking facilities, rental services, towing companies, etc. Rule 3.588(c)(8) allows a COGS deduction for transactions that contain elements of both a sale of tangible personal property and a service; however, an entity may only subtract as cost of goods sold the costs otherwise allowed in relation to the tangible personal property sold. For example, an auto body shop offers the service of car repair and in the process of the repair, replaces some of the car s parts. If the auto body shop elects to use the cost of goods, the shop may only deduct the cost of the car parts. The labor related to the repair of the car is not allowed as cost of goods sold. If an entity that is not eligible for the COGS deduction elected to use COGS for prior years reports, the entity must amend the reports. The compensation deduction, however, is not available for the prior years reports. The election language in Tax Code Section (d) does not allow a change in the method of computing margin to a cost of goods sold or compensation deduction after the due date of the report. DLI v1-6-

7 Entities that originally elected to use the COGS method must amend and use the 70 percent method to determine margin or, if total revenue is not more than $10 million, may use the E- Z Computation to determine tax due. The E-Z Computation does not allow a COGS or compensation deduction in computing margin but instead applies a lower tax rate of percent directly to apportioned total revenue. In future years, entities that do not sell real or tangible personal property in the ordinary course of business may choose the compensation deduction over the 70 percent method or the E-Z computation. The compensation deduction, detailed in Rule 3.589, includes W-2 wages and cash compensation paid, net distributive income reported to natural persons and employee benefits provided. (Note: IRS Form 1099 wages cannot be included in the compensation deduction.) 15. The Multistate Tax Compact (MTC) Apportionment Formula is Prohibited for Texas Franchise Tax Tax Policy News, Texas Comptroller of Public Accounts, July The Comptroller s Office announced its position that the MTC provisions in Chapter 141 of the Texas Tax Code do not apply to the revised Texas franchise tax. Specifically, the Comptroller has stated that the apportionment provision in Texas Tax Code Chapter 141 does not apply to the revised Texas franchise tax and entities may not elect to use the MTC s three-factor apportionment formula in lieu of the formula specified in Texas Tax Code Chapter Application of the ½% Tax Rate to Entities with Foreign Manufacturing Affiliates Clarified Tax Policy News, Texas Comptroller of Public Accounts, March 2010 The Comptroller provided an explanation of the application of the ½% rate to foreign manufacturing affiliates. The Comptroller s explanation is in the form of an example, the facts of which are generally as follows: o An affiliated group consists of one or more entities domiciled in the United States and a foreign entity. An affiliated group is defined in Rule 3.590(b)(1) as entities in which an interest of more than 50 percent is owned by a common owner. o The foreign entity is a manufacturer that conducts business outside of the US (80 percent or more of the taxable entity s property and payroll are assigned to locations outside the US). o The US entities are primarily engaged in wholesale or retail trade, as defined in Texas Tax Code (c), and 50 percent or more of items they sell are items that the foreign entity manufactures. o The foreign manufacturing entity, although part of the affiliated group, is not included in the combined group because the foreign entity conducts business outside of the US, as provided in Texas Tax Code (a). Under these circumstances, the taxable entity would not be eligible for the ½% tax rate. Under the provision in Texas Tax Code (c)(2), A taxable entity is primarily engaged in retail or wholesale trade only if less than 50 percent of the total revenue from activities in retail or wholesale trade comes from the sale of products it produces or products DLI v1-7-

8 produced by an entity that is part of an affiliated group to which the taxable entity also belongs. Although the foreign manufacturing entity is not included in the combined group, the statute specifically provides that it need only be part of the affiliated group to make the taxable entity ineligible for the ½% tax rate. 17. Eligibility Requirements for the ½% Tax Rate Explained For Entities That Modify Goods Acquired for Resale Tax Policy News, Texas Comptroller of Public Accounts, January Texas Tax Code (c)(2) does not allow the ½% percent tax rate to taxable entities engaged in retail or wholesale trade if 50 percent or more of the entity s 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 belongs. Rule 3.584(d)(3) was amended recently to clarify that, in determining if an entity is eligible for the retail/wholesale (½%) tax rate, a product is not considered to be produced if the Taxpayer s modifications to the acquired product do not increase the sales price of the product by more than 10 percent. Example 1: A taxable entity is a retailer in the business of selling baseball caps that are embroidered at the shop to a customer s specifications. The entity purchases the baseball caps from a manufacturer and sells them, without embroidery, for $10 each. An embroidered cap sells for $18. The entity is considered to be the producer of the embroidered caps since the modifications made to them increases the sales price by 80 percent. If the sale of the embroidered caps accounts for 50 percent or more of the entity s total revenue, the entity would not be eligible for the ½% tax rate because 50 percent or more of the entity s total revenue comes from the sale of products it produces. Example 2: A taxable entity is a retailer in the business of selling men s dress shirts. The dress shirts sell for $60 each. A customer may purchase a dress shirt that is personalized with a monogram for $65. Monogramming the shirt is not considered production because the modifications made to the shirt increase its sales price by less than 8.5 percent. This retailer will not lose its eligibility for the ½% tax rate because of its shirt monogramming activities. The loss of an entity s eligibility for the ½% tax rate does not affect the entity s eligibility to deduct the cost of goods sold to determine margin. Retailers, wholesalers and producers (and any entity that sells real or tangible personal property in the ordinary course of business) may elect to deduct the cost of goods sold to determine margin. 18. No Exclusion For 1099 Labor For Non-COGS Companies Comptroller Taxability Memo No L (April 19, 2011) In this taxability memo, Comptroller franchise tax policy explained to Comptroller audit that a transportation company that contracts with independent owner/operators to perform transportation services on its behalf, could not deduct the 1099 payments from its total revenue. The Taxpayer elected COGS on its returns but that was disallowed on audit. The Taxpayer then amended its federal income tax returns by netting the 1099 payments from its total revenue. Franchise tax policy explained that if the Taxpayer was responsible for the transportation (as opposed to finding someone else to transport the goods), then the Taxpayer cannot net the 1099 payments from its total revenue, even if the Taxpayer files DLI v1-8-

9 amended federal income tax returns. Citing the IRC 61 definition of gross income, policy concluded that there is no federal basis for removing 1099 payments to independent contractors from revenue on a federal tax return. Note: Companies that qualify for COGS can generally deduct 1099 labor. 19. Access Fees For Social-Networking Site Sourced To Location Of Payor Comptroller Letter Ruling No L (Feb. 2, 2011). Comptroller franchise tax policy held that a social-networking website s revenues from website access fees should be sourced to the location of the payor. 20. Explanation Of Margin Tax For Cattle Feedlot Industry Comptroller Tax Policy Newsletter March 2011 The Comptroller explained the margin tax implications for members of the cattle feedlot industry. Because members of the cattle industry may not be described in Standard Industrial Classification Code G or F (that is, in Retail or Wholesale trades), the Comptroller explained that the tax rate is 1%. To the extent industry members own the cattle they are raising for sale, those members qualify for the COGS deduction on direct and certain indirect costs of acquiring or producing the cattle/goods. To the extent industry members do not own the cattle they are raising for sale, those members are generally performing a service and thus generally do not qualify for the COGS deduction. In that case, since the cattle feeder is selling feed and medicine in providing its service, the cost of the tangible personal property would qualify for the COGS deduction. If an entity raises both cattle it owns and cattle owned by others, the entity must determine the percentage of cattle owned by the entity for the period upon which the tax is based. This percentage is then applied to all costs (direct and indirect) incurred by the company to determine the amount of COGS that will be allowed for company-owned cattle. 21. Explanation Of Margin Tax Rate For Contractors/Retailers -- Comptroller Tax Policy Newsletter February 2011 The Comptroller explained the margin tax rate issues for retailers/contractors, meaning entities that have both retail operations (selling goods) and contracting operations (improving realty). Based on the Comptroller s interpretation of the SIC Manual, a company should compare its receipts from selling materials without installation with its receipts from selling materials with installation (receipts for the labor AND the materials). If the first category is 50% or more of the total, the company qualifies for the ½% rate. Notably, the Comptroller takes the position that a retail sale of materials is not a retail sale if the sale takes place as part of construction installation services. The Comptroller applied this rationale in Hearing No. 104,092, SOAH , STAR H (Feb. 2011). 22. Explanation Of COGS Deduction Related To Sales Tax Costs Comptroller Tax Policy Newsletter January 2011 The Comptroller explained how the COGS deduction applies in a couple of examples to illustrate the agency s policies on various types of selling and distribution expenses: Example 1 A department store chain that sells clothing for men, women and children has several retail stores throughout Texas. The department DLI v1-9-

10 store chain owns a centrally located distribution center that supplies the retail stores with the acquired apparel. The following costs are allowed as COGS: the cost of acquiring the apparel; compensation and other expenses (travel, etc.) related to purchasing agents; the cost of transporting apparel to the distribution center; depreciation of the distribution center; depreciation on equipment used in the distribution center; distribution center utility costs; the cost of transporting apparel from the distribution center to the retail stores; and the cost of utilities for the storage area only at the retail stores. The following costs are not allowed as COGS: rent paid to shopping centers for retail store space; utility costs for the retail store display areas; display racks and display shelving; compensation paid to sales managers and sales personnel; the cost of cash registers; credit card company fees; shopping bags; and tissue. Example 2 A grocery store chain has stores located throughout central Texas and rents a distribution center located in San Antonio. The following costs are allowed as COGS: the cost of acquiring the groceries; compensation and other expenses (travel, etc.) related to purchasing agents; DLI v1-10-

11 the cost of transporting the groceries to the distribution center; depreciation on equipment used in the distribution center; distribution center utility costs; the cost of transporting groceries from the distribution center to the grocery stores; and compensation paid to employees that stock the shelves. The following costs are not allowed as COGS: rent paid for the distribution center; rent paid for the grocery store space; refrigerated display cases; shelving for grocery display; compensation paid to cashiers and baggers; the cost of cash registers; credit card company fees; and grocery bags. 23. Change in Reporting Policy for Certain Passive Entities Comptroller Tax Policy Newsletter December 2010 Under existing policy, an entity that filed as passive on a prior report is not required to file a subsequent franchise tax report as long as the entity continues to qualify as passive. This policy is changing beginning with reports originally due on or after Jan. 1, A passive entity that is registered, or required to be registered, with the Comptroller's office or the Secretary of State's office is now required to file a No Tax Due Information Report (Form ) to affirm that the entity qualifies as passive for the period upon which the tax is based. An entity that qualifies as passive is not required to file an Ownership Information Report (Form ). The policy will not change for a partnership or trust that qualifies as passive and is not registered, and not required to be registered, with the Comptroller's office or the Secretary of State's office. These entities are not required to register with, or file a franchise tax report with, the Comptroller's office as long as they continue to qualify as passive. 24. Pass-Through Entities Allowed Oil and Gas Depletion As COGS Comptroller Tax Policy Newsletter November 2010 The Comptroller explained many have questioned about the eligibility of pass-through entities, such as partnerships and S corporations, to include oil and gas depletion costs as COGS. Depletion, as reported on the federal income tax return, is allowed as COGS to the extent associated with, and necessary for, the production of goods under Texas Tax Code Section (c)(6). A pass-through entity may include as COGS the depletion costs DLI v1-11-

12 incurred and reported to its owners for federal tax purposes. The owners of a pass-through entity, however, may not include the depletion reported to them as COGS. The Comptroller announced that Rule 3.588(d)(6) will be amended to reflect this policy. 25. Margin Tax And The Automotive Repair Industry Comptroller Tax Policy Newsletter November 2010 The Comptroller explained the margin tax rate issues for the automotive repair industry. An entity that sells auto parts from a retail establishment that also provides automotive repair services must compare the total revenue received from retail sales to the total revenue received from the automotive repair business (both parts and labor) in order to determine the tax rate. If the former is 50% or more of the total, the company qualifies for the ½% rate. The Comptroller provided the following examples of how the COGS deduction is calculated: Example 1 An entity provides general automotive repair services as described in Industry Number 7538, General Automotive Repair Shops, of the SIC Manual. This entity is not eligible for the ½% tax rate because its activities are described in Division I, Services, (and not in Division F or G) of the SIC Manual. If this entity chooses to deduct COGS in determining its margin, only the allowable costs related to tangible personal property sold can be included in the deduction. The labor costs for the repair services cannot be included in the COGS deduction. Example 2 An entity sells auto parts from a retail establishment and also provides automotive repair services such as oil changes, tire rotations, wheel alignments, etc. To determine if this entity is eligible for the ½% tax rate, the total revenue received from retail sales must be compared to the total revenue received from automotive repair services (which includes revenue from both the sale of parts and labor). If the total revenue from retail sales is greater than the total revenue from automotive repair services, the entity is eligible for the ½% rate. The COGS deduction for this entity includes the allowable costs as specified in Texas Tax Code Section for the retail sales and also for the sale of any parts (tangible personal property) included in the automotive repair services. The labor costs for the automotive repair services, however, cannot be included in the COGS deduction. Example 3 A car dealership sells new automobiles and also provides automotive repair services. To determine if this entity is eligible for the ½% tax rate, the total revenue received from the retail sale of automobiles must be compared to the total revenue received from automotive repair services (revenue from the sale of parts and labor). If total revenue from retail sales is greater than the total revenue from DLI v1-12-

13 automotive repair services, the entity is eligible for the ½% rate, if it meets the requirements of Texas Tax Code Section (c). The COGS deduction for this entity includes the allowable costs as specified in Texas Tax Code Section for the retail sale of automobiles and also for the sale of any parts (tangible personal property) included in the automotive repair services. The labor costs for the automotive repair services, however, cannot be included in the COGS deduction. See Comptroller Letter Ruling No L (Oct. 2010) for more information. 26. Margin Tax And The Restaurant Industry Comptroller Tax Policy Newsletter October 2011 The Comptroller explained how the margin tax applies to the restaurant industry. Restaurants and bars are generally allowed a tax rate of ½%. The Comptroller provided the follow examples of how the COGS deduction applies: Examples of direct costs allowed by Texas Tax Code Section (c) are: acquisition of food; equipment (such as refrigerators, ovens, stoves, pots, pans, etc.) used to store and prepare the food or the depreciation of such equipment (see Cost of Goods Sold FAQ #24 for Section 179 computation limits); production labor (payments made to food preparers, including IRS Form W-2 wages, IRS Form 1099 wages, temporary labor wages, payroll taxes and employee benefits); rent allocable to the production area (kitchen) only; cleaning and janitorial costs allocated to the production area and food storage area. Examples of costs related to the goods allowed by Texas Tax Code Section (d) are: insurance allocable to the production area; utilities allocable to the production area and food storage area; franchise fees directly associated with the goods produced. Examples of indirect or administrative overhead costs that are allocable to the acquisition or production of goods and are, therefore, allowed by Texas Tax Code Section (f) but limited to 4 percent of all indirect and administrative overhead costs are: supervision of production labor; DLI v1-13-

14 property taxes allocable to the production area. Examples of costs that are not allowed as COGS because they are not related to the acquisition or production of the goods or they are specifically disallowed under Texas Tax Code Section (e) are: rent allocable to the dining area and other non-production areas; dining area furniture; dishware, silverware, linens; utilities allocable to the dining area; cleaning and janitorial costs allocated to the dining area; payments made for hosts, wait staff and busboys (including any uniforms provided); credit card commissions/fees; mixed beverage gross receipts tax; advertising; officers' compensation. 27. Margin Tax And The Transportation Industry Comptroller Tax Policy Newsletter September 2011 The Comptroller explained how the margin tax applies to the transportation industry. Per the Comptroller, the tax rate is 1 percent for entities in the transportation industry. Total Revenue Total revenue, as defined in Texas Tax Code Section , is tied to the amounts entered on specific lines from the federal return, to the extent the amount entered complies with federal income tax law, minus specific statutory exclusions. The exclusions from revenue for flow-through funds are specific and do not expressly include subcontracting payments such as those paid to independent truckers. Additionally, according to the Comptroller, netting the subcontracting payments made to independent truckers from gross receipts is not appropriate under federal tax law. Entities engaged in the transportation business are not eligible to subtract COGS for their transportation services to determine margin. A deduction for COGS is generally only allowed on sales of tangible personal property or real property in the ordinary course of business. As defined in Texas Tax Code Section (a)(3), tangible personal property does not include services. Allowable costs for the compensation deduction include W-2 wages paid to officers, directors, owners, partners and employees and net distributive income reported to natural DLI v1-14-

15 persons, limited to $320,000 per person per 12-month period for tax reports due in 2010 and The compensation deduction also includes certain benefits provided to all personnel to the extent deductible for federal income tax purposes. Per the Comptroller, amounts reportable to independent contractors on Internal Revenue Service Form 1099 cannot be included in the compensation deduction. A hugely beneficial, sometimes key rule for transportation companies is that only receipts from transportation services in intrastate commerce are apportioned to Texas. "Intrastate commerce" means the transportation of passengers or freight from one point in Texas to another point in Texas if both pickup and delivery occur in Texas. Receipts from interstate commerce, where either pickup or delivery occurs outside of Texas, are not Texas receipts and no proration of these receipts is required for the portion of the transportation that occurred in Texas. Tip: Transportation companies are taxed disproportionally under the margin tax. Affected companies should consider this apportionment rule. 28. Margin Tax And The Construction Industry Comptroller Tax Policy Newsletter August 2010 The Comptroller explained how the margin tax applies to the construction industry. According to the Comptroller, the construction industry must use a 1% tax rate, based on the applicable SIC classification. Revenue reportable for franchise tax purposes equals the amounts entered on an entity's federal income tax return, to the extent the amounts entered comply with federal income tax law. Texas Tax Code Section (g)(3) allows an exclusion from revenue for certain flow-through funds that are mandated by contract to be distributed to other entities. The specified exclusions include subcontracting payments handled by the taxable entity to provide services, labor or materials for the actual or proposed design, construction, remodeling or repair of improvements on real property or the location of the boundaries of real property. Notably, the Comptroller stresses that this exclusion is allowed only when the taxable entity has a contract with its client that states that the taxable entity will subcontract out a specified portion of the work. A general statement saying only that some of the work may be subcontracted out is not sufficient. As provided in Tax Code Section (j), any amount excluded from revenue cannot be included in the determination of cost of goods sold or the determination of compensation. Tip: Contractors should review contracts with property owners to make sure payments to third parties are mandated by contract to be distributed to other entities. Generally, the COGS provisions apply only to entities that sell real or tangible personal property in the ordinary course of business. If not for an exception to the general COGS provisions, most contractors would only be allowed a cost of goods sold for construction materials provided and not for labor. This exception, found in Tax Code Section (i), states that "...A taxable entity furnishing labor or materials to a project for the construction, improvement, remodeling, repair, or industrial maintenance of real property is considered an owner of that labor or materials and may include the costs, as allowed by this section, in the computation of cost of goods sold." The caveat is that, to be eligible under DLI v1-15-

16 this provision, the entity furnishing the labor or materials for a construction project must be physically working on the real property and effecting a change to that property. The Comptroller listed a few examples to illustrate the last point: Example 1 A general contractor is hired to construct a private residence. The general contractor's contract with his client states that he will subcontract out all electric, plumbing and HVAC work on the project. The general contractor, therefore, may exclude from revenue the subcontracting payments made to the electrician, plumber and HVAC technician. Once these particular subcontracting payments have been excluded from revenue, they may not be included in the determination of cost of goods sold. Payments made to subcontractors for work not specified in the contract and the costs of direct labor and materials may be included in the cost of goods sold deduction. Example 2 An architecture firm is hired to provide all of the design work for a construction project. The architecture firm's contract with the customer says that it will subcontract out the engineering work on this project. Based on this contractual provision, the architecture firm is allowed to exclude from revenue the amounts paid to an engineering firm for work on this project. The architecture firm, however, only produces the plans for the construction project. The architecture firm does not construct, improve, remodel or repair the property (physically work on the real property and effect a change to that property). As a result, the architecture firm is not eligible to take a cost of goods sold deduction for its services. Example 3 A general contractor is hired to construct a commercial building. The general contractor hires a transportation company to bring materials to the construction site and haul debris away from the site. The general contractor, who physically works on the real property and effects a change to that property, can include these trucking costs in the cost of goods sold deduction. The transportation company, however, is not allowed a cost of goods sold deduction. A transportation company is a service provider and does not sell tangible personal property in the ordinary course of business. Transporting materials to or from a construction site is not effecting a change to the real property and does not qualify for the COGS deduction. Also, the transportation company cannot subtract from revenue any subcontracting payments made to independent truckers. The exclusion from revenue for subcontracting payments is allowed only for entities that provide services, labor, or materials for the actual or proposed design, construction, remodeling or repair of improvements on real property or the location of the boundaries of real property. DLI v1-16-

17 29. Comptroller Hearing No. 100,085, SOAH , STAR H (Feb. 2011) Warranty repair work in Texas established nexus for purposes of the franchise tax. The warranty repair costs constituted 3.7 percent of the receipts apportioned to Texas, which the ALJ held falls well within the parameters set in Wisconsin v. William Wrigley Jr. Co., 505 U.S. 214, 229 (1992), where the activities deemed not to constitute protected sales solicitation represented percent of Wrigley's annual Wisconsin sales and in absolute terms amounted to only several hundred dollars a year. The Supreme Court nevertheless had little difficulty concluding that they constituted a nontrivial additional connection with the State. Similarly, the ALJ had no difficulty in concluding the warranty repair works constituted a nontrivial connection with Texas and there was nexus in Texas for earned surplus purposes during the report years 2003 through Significant Amount Of Margin Tax Guidance Incorporated Into Comptroller s STAR System During 2010, the Comptroller continued their practice of incorporating informal rulings related to key margin tax issues into the Comptroller s STAR System (which can be accessed at ). Rulings covering a variety of topics have now been posted. An example is reproduced below for reference: DATE: July 21, 2010 TO: William Hamner FROM: Jerry Oxford SUBJECT: FAQ; Compensation; Wage Limitation for W-2 Wages and K-1 How does the wage limitation for the wages and cash compensation component apply when W-2 wages and a K-1 are paid to the same person? If an entity issues a W-2 and a K-1 to an individual, the wage limitation, per 12-month period on which margin is based, applies to the sum of the individual's W-2 and K-1. The wage limitation is: $300,000 for reports originally due in 2008 and 2009, or $320,000 for reports originally due in 2010 and E. New and Amended Comptroller Rules 9 1. As of the date of publication, the Comptroller has not adopted any amendments to the Franchise Tax Rules in In Texas, administrative regulations in 34 TEX. ADMIN. CODE are traditionally referred to as a Comptroller Rule. DLI v1-17-

18 F. Trends/Outlook for 2011/ State Of The State Texas went into the 2011 legislative session facing a 2 year budget deficit estimated at $27B. While the economy has left many states with budget deficits, the economic downturn caused only a third of the revenue shortfall in Texas. When consumer spending slowed, state revenue from sales tax receipts also decreased, creating a $4 billion deficit in this year's budget. Most of the shortfall was created when the state overhauled the business tax structure and the school finance system in The new tax structure (like the margin tax) did not generate enough money to offset decreases in school property tax rates, creating a recurring $10 billion budget hole. In the current budget, most of the hole was filled with some state savings and federal stimulus dollars that are no longer available. In reaction, during the 2011 legislative session the Texas Legislature made significant cuts in spending, most notably in funding for public education. No significant changes were made to the Texas margin tax. Local school districts throughout the state have been forced to retire or fire school employees. A group of local school districts recently filed a lawsuit against the state challenging the cuts and the reliance on local property taxes that led to the cuts. The Texas Comptroller is trying to increase tax revenue through collections and audits. Audit and collection deadlines are being rigorously enforced and contested issues are being pursued zealously. 2. Margin Tax Underperforming The Texas margin tax has raised about $1.5 billion a year less than anticipated when it was enacted in One reason believed to be behind the less than stellar results is that more businesses are claiming the COGS deduction than previously anticipated and the dollar value of the COGS deduction is greater than expected. Council on State Taxation, COST Legislative Alert, Issue 10-29; September 1, The COGS deduction is averaging 82% of total revenue of companies who claim it, whereas the compensation deduction is averaging 55% of total revenue of companies who claim it. Id. 3. Unitary The number of margin tax audits by the Comptroller will continue to increase and substantive scrutiny of combined reporting will occur. Accordingly, Taxpayers should ensure that contemporaneous documentation and analysis is prepared to explain the combined reporting positions. 4. Margin Tax Desk Audits The Comptroller s Office will continue its desk audits of margin tax reports that were filed in 2008, 2009 and The reviews thus far have identified several areas of concern for the Comptroller: A number of Taxpayers have reported a Standard Industrial Classification (SIC) Code in the service industry and computed margin using the cost of goods sold computation or inappropriately claimed the ½% rate; DLI v1-18-

19 A significant number of Taxpayers in service industries have improperly taken the cost of goods sold deduction (key industries have been transportation, professional services, warehouses, and information services); A significant number of Taxpayers reported No Tax Due for margin tax, but reported and paid tax under the prior franchise tax report; and A significant number of Taxpayers have taken excessive revenue deductions under the EZ filing option, reporting deductions greater than 30% of total revenue. So far the audits have focused mainly on single-entity returns. The Comptroller s Office is expected to increase its focus on combined reports with particular attention being paid to taxpayers that used the ½% tax rate and taxpayers that took the COGS deduction. II. SALES AND USE TAX A. Legislative Developments 1. In General As stated, the Texas Legislature meets bi-annually. The 82 nd Regular Session of the Legislature began on January 11, 2011 and concluded on May 30, Many tax bills were filed and some fairly significant changes were enacted. 2. Restricted Sale For Resale Exemption Effective October 1, 2011, the sale for resale exemption is restricted to items that will be resold as or with a taxable item. The intent is that items purchased for use in performing a nontaxable service will not qualify for the exemption. In reaction to the Blue Cross case, the exemption is further amended to clarify when purchases of items for use in performing contracts with the federal government qualify for the exemption. SB Definition Of Retailer Amended The sales tax was amended to provide that the terms seller and retailer include a person who, by agreement with an owner of tangible personal property, has been entrusted with possession of and authority to sell, lease or rent the property without additional action on the part of the owner. The term retailer engaged in business in this state was also amended to include a retailer who: (1) holds a substantial ownership in, or is owned in whole or substantial part by, a person who maintains a business location in this state if the retailer sells substantially the same product line and does so under substantially the same business name as the related retailer or if the facilities or employees of the related person in this state are used to advertise, promote, or facilitate sales by the retailer or are used to maintain a marketplace in this state for the retailer, exchanging returned merchandise; or (2) holds a substantial ownership in, or is owned in whole or substantial part by, a person that maintains a distribution center, warehouse or similar location in this state that delivers property sold by the retailer. DLI v1-19-

20 The term substantial ownership generally means 50%. SB New $50 Late Filing Penalty Beginning with reports originally due on or after October 1, 2011, the Comptroller will assess a penalty of $50 when certain tax reports are filed late. The penalty applies to latefiled sales tax, margin tax, hotel occupancy tax, mixed beverage gross receipts tax, and certain other taxes. Previously, penalty did not attach until the third late-filed report. SB1. 5. Record Keeping / Contemporaneous Documents Senate Bill 1 requires require taxpayers to keep records open for inspection for at least four years (which is the normal statute of limitations), and with respect to records related to a taxpayer s claim, longer than four years during any period when tax, penalty or interest may be assessed, collected or refunded by the Comptroller or while an administrative hearing or judicial proceeding is pending. The Bill also requires taxpayers to produce contemporaneous records and supporting documentation for transactions in question, to enable verification of claims related to the amounts of tax, penalty or interest to be assessed, collected or refunded in an administrative hearing or judicial proceeding. 6. Tax Exemption Number For Agricultural Exemption Beginning January 1, 2012, a person claiming an exemption from sales tax on the purchase of certain items used in the production of agricultural and timber products must provide a registration number issued by the Comptroller on the exemption certificate issued to the seller. The Comptroller s Office has developed a new system for use in obtaining an agriculture exemption number. HB Internet Hosting Does Not Create Nexus Effective 2011, contracting with an Internet web host in Texas does not create nexus with Texas. HB Exemption For Certain Dairy Structures Effective September 1, 2011, tangible personal property incorporated into or attached to a free-stall dairy barn or a dairy structure used solely for maternity purposes that is located on a commercial dairy farm and is used or employed exclusively for the production of milk is exempt from sales tax. HB Oilfield Portable Units Subject To Sales Tax, Not Hotel Tax Or Motor Vehicle Tax The 2011 legislation provides that oilfield portable units are subject to sales tax, rather than hotel occupancy tax or motor vehicle sales tax. An oil field portable unit is a bunkhouse, manufactured home, trailer or semi-trailer (other than a travel trailer) designed to be used for temporary lodging or as temporary office space that is used exclusively at any oil, gas, water disposal or injection well site to provide to well site employees, contractors or other workers sleeping accommodations or temporary work space, including office space; which does not require attachment to a foundation or to real property to be functional. Similar items used at DLI v1-20-

21 locations other than the well site continue to be subject to hotel tax or motor vehicle sales tax. HB B. Judicial Developments 1. Combs v. Health Care Services Corp. (a/k/a Blue Cross), No. D-1-GN (Travis Co. Tex. Dist. Ct. July 2009), affirmed, No CV (Tex. App. Austin March 16, 2011, no pet. hist.) (slip op. at 044). Items purchased for use in performing service contracts for the federal government qualify for sale for resale exemption. In Combs v. Health Care Services Corp. (a/k/a Blue Cross), the Taxpayer obtained a $4.8 million judgment 10 against the State of Texas for Texas sales tax paid on items purchased for use in performing cost-plus service contracts for the federal government. Blue Cross originally paid Texas sales tax when it purchased the items. 11 Blue Cross claimed, and the District Court and Austin Court of Appeals held, that the purchase of the items was exempt from the Texas sales tax because the items were resold to the federal government by virtue of the title passage provisions in the Federal Acquisition Regulations (48 C.F.R and ). The Courts held that Blue Cross was entitled to a refund of the Texas sales tax paid when it purchased the items. The Legislature subsequently amended the sale for resale exemption statute in an effort to overturn this decision. 2. Kahn v. Texas, No CV (Tex. App. Austin Aug. 31, 2011, no pet. hist). Owner of convenience stores held personally liable for Comptroller s estimated sales tax assessment issued against the convenience stores. 3. Austin Engineering Co., Inc. v. Combs, No CV (Tex. App. Austin Aug. 5, 2011, no pet. hist). Taxpayer liable for sales tax on construction related erosion control measures and services. Essence of the transaction was not performing erosion control services, but sale of tangible personal property used to prevent erosion. Case remanded back to trial for consideration of taxpayer s alternative exemption claims. 4. Roark Amusement & Vending, L.P. v. Combs, No CV (Tex. App. Austin January 26, 2011). Tangible personal property purchased for use in performing a taxable albeit exempt amusement service qualified for the sale for resale exemption. In Roark Amusement & Vending, L.P. v. Combs, the Austin Court of Appeals held that toys purchased for use in performing a taxable albeit exempt amusement service qualified for the sale for resale exemption. Roark owned and leased coin-operated amusement crane machines, which it placed at various grocery stores, restaurants, and shopping malls in Texas and other states. Roark held a license issued by the Comptroller's office for 10 The issue has been touted as the billion dollar refund when applied to other similarly situated companies. 11 The items include things like office supplies, furniture, telephone equipment, utilities, capitalized assets, services (telephone, laundry, printing, landscaping, and janitorial services), leased assets, and software and maintenance on software. DLI v1-21-

22 amusement machines. It paid Texas sales tax on its lease payments for the machines and an annual occupation tax for each machine it owned in Texas. Roark sought a refund of the sales tax it paid on the plush toys used to stock the machines, arguing that the toys are subject to the sale-for-resale exemption because they are transferred as an integral part of Roark's taxable amusement services. See Tex. Tax Code Ann (a)(3) (defining sale for resale to include sale of tangible personal property to a purchaser who acquires the property for the purpose of transferring it... as an integral part of a taxable service ); Id (a)(1) (including amusement services within definition of taxable services ). The Comptroller countered that the integral-transfer exemption does not apply, arguing that Roark's services are not taxable for purposes of the sale-for-resale exemption because the tax code specifically exempts coin-operated amusement services from sales and use tax. See Id ( Amusement and personal services provided through coin-operated machines that are operated by the consumer are exempt from the taxes imposed by this chapter. ). Thus, in the State's view, Roark is the ultimate consumer of any tangible personal property including the plush toys used to perform its nontaxable amusement services. The Austin Court of Appeals ruled in favor of Roark. The Court held that the purchase of the toys qualified for the sale for resale exemption notwithstanding the fact that the toys were used in performing an exempt service. In so holding, the Court distinguished between nontaxable services and services, like the amusement services in question, that are taxable but qualify for an exemption. 5. Combs v. Home & Garden Party, Ltd., No CV, 2010 Tex. App. LEXIS 8875 (Tex. App. Austin Nov. 3, 2010, no pet. hist.). Manufacturing process does not include packaging of finished items received from another manufacturer when the physical properties of those items are not changed in some way. The Austin Court of Appeals ruled that the manufacturing process does not include packaging of finished items received from another manufacturer when the physical properties of those items are not changed in some way, even if the purchase is by a manufacturer. The court held that the manufacturing exemption does not apply to the purchase of materials used to package items that the Taxpayer does not fabricate, process, alter, or assemble. In essence, the court held that the manufacturing process ended when Home & Garden Party, Ltd. (HGP), purchased the items from the initial manufacturer and that it was not revived or continued by the activities of HGP. The decision illustrates how the courts sometimes resolve tension between the statutes and the Comptroller rules where the statute favors the Taxpayer but the rule may not. In addition to manufacturing some items itself, HGP purchased bulk-packaged items that it then repackaged prior to shipping but did not alter or assemble in any way. HGP claimed this packaging operation was integrated with the packaging of the items manufactured internally and asserted that the packaging materials were exempt property used in manufacturing. The Comptroller argued that HGP merely repackages the majority of the items it sells, an activity that does not qualify for the manufacturing exemption because it does not make or cause a physical change in the items themselves. Acknowledging that manufacturing in some cases includes packaging, the Comptroller suggested that once an item has the physical properties, including packaging, it possesses when transferred from the DLI v1-22-

23 manufacturer to another, the manufacturing process has ended and subsequent repackaging by another does not qualify for the manufacturing exemption. The court agreed that a distinction exists between manufacturers that package items for transfer and wholesalers that repackage them for sale, ruling that materials used by the latter in repackaging are taxable, even if the wholesaler engages in manufacturing other items. C. Administrative Developments 1. Pending Change In Comptroller Letter Ruling Procedure The Texas Comptroller recently announced a possible change in the procedure for issuing letter rulings to taxpayers. Traditionally, a Comptroller letter ruling issued to a particular taxpayer was binding on the Comptroller, at least in terms of abating penalty. In order to better allocate Comptroller resources, the Comptroller plans to begin issuing two types of rulings: General information letters, which will apply the law to a general set of facts; and Declaratory rulings, which will apply the law to a complete set of specific facts for a specific taxpayer not currently under audit or in litigation. Under the new procedures, a declaratory ruling will be binding on the Comptroller for the specific facts and issues addressed in that ruling. The Comptroller plans to update the administrative rules to reflect the specific guidelines. 2. Comptroller Hearing No. 47,782, SOAH , STAR H (Aug. 2009) Taxpayer liable for use tax on aircraft because aircraft was hangared in Texas. An aircraft not hangared in Texas is subject to Texas use tax only if the Texas use is 50% or greater. Once it is shown that an aircraft was hangared in this state, use tax is due on that basis, and taxability does not depend upon the percentage of Texas use. 3. Comptroller Letter Ruling No L (April 2011) Title company may not purchase survey services for resale. Purchase of survey services by a title company does not qualify for exemption afforded to contractors. 4. Comptroller Hearing No. 101,650, SOAH , STAR H (March 2011) -- Refund denied for tax paid on purchases of cryogenic plants that are a part of its gas manufacturing plant. While Tax Code Section does not state explicit rules for determining what constitutes an item of manufacturing equipment, it is clear that the exemption does not apply broadly to plants or segments of plants, but rather to specific items within the plant that directly make or cause a chemical or physical change to the product being manufactured or processed. 5. Comptroller Letter Ruling No L (March 2011) Servers in Texas do/do not create nexus. The Comptroller explained that the recently adopted language in Rule 3.286(a)(2)(E) regarding derives receipts from a rental or lease of tangible personal property that is located DLI v1-23-

24 in this state OR OWNS OR USES TANGIBLE PERSONAL PROPERTY THAT IS LOCATED IN THIS STATE, INCLUDING A COMPUTER SERVER OR SOFTWARE has been interpreted more broadly than the Comptroller intended. Comptroller Policy said they are working to amend the rule again. In the interim, the Comptroller advised as follows: If the entirety of your presence and business activity in Texas is limited to: 1) having ONLY a website on a third-party server in Texas (upon which the third-party provides all the functionality) and 2) delivering physical products into the state via third-party common carrier, you are not considered to be engaged in business in Texas. 6. Comptroller Hearing No. 46,579, SOAH , STAR H (2010) Essence of the direct mail transactions was a nontaxable referral service. Automobile dealers hire Taxpayer to solicit referrals of potential automobile purchasers meeting certain credit criteria using internet, television, and direct mail advertising packages. At issue in the hearing was Taxpayer s use of targeted direct mail advertising to solicit leads. Based on credit criteria, location and number of direct mail letters selected by automobile dealers, Taxpayer acquires a targeted mailing list from a credit reporting agency and contracts with a direct mail vendor to print and mail letters to Taxpayer s designated recipients. Dealers do not take possession of the letters and do not know the names of the letter recipients. In most, if not all, instances the dealers are not mentioned in the letters. The letters direct recipients to call Taxpayer if they are interested in purchasing a vehicle. If a potential automobile purchaser meets a dealer's criteria, Taxpayer refers the recipient to the respective dealer. Taxpayer charges dealers for the referral service based on the number of direct mail letters selected the number of referrals are not guaranteed. The Comptroller Tax Division maintained that Taxpayer provides a taxable direct mailing/printing service to dealers, and assessed Taxpayer for uncollected Texas sales tax. The ALJ rejected the Tax Division s position and agreed with Taxpayer's contention that the essence of the transaction was a nontaxable customer referral service. The ALJ reached his decision in part because the direct mail letters were never in the possession or control of dealers and the letters directed potential automobile customers to call Taxpayer (not the dealers). The ALJ held that our case was compelling. 7. Comptroller Hearing No. 102,623, SOAH , STAR H (Aug. 2010) Sales tax applies to purchase of packaging items by other than manufacturer. The Taxpayer sold collectible coins. The Taxpayer purchased coin cases and holders to package its coins for sale and shipment to its customers, without paying sales tax. The Comptroller assessed tax on the purchases of the cases and holders as taxable packaging supplies. In the ensuing redetermination hearing, the Taxpayer claimed the coin cases and holders become an integral part of the coins and that the cases and holders are necessary to preserve the value of the coins. The Tax Division argued the Taxpayer was a retailer and its purchases of coin holders and cases were taxable packaging supplies under Texas Tax Code Section (c). This section does not allow a resale exemption for packing and wrapping supplies purchased in the furtherance of a sale of tangible personal property. Additionally, Tax Code Section (c) provides that packaging supplies used in wrapping or packing tangible personal property for the purpose of furthering the sale of tangible personal property may not be purchased for resale. The Administrative Law Judge DLI v1-24-

25 determined that the Taxpayer was a retailer, not a manufacturer, and that as such, the Taxpayer was not eligible to claim an exemption for packaging and wrapping supplies. D. Amended Comptroller Rules 1. Offsets and Credits; Unjust Enrichment 34 TAC 3.2 (eff. July 20, 2011) The Comptroller amended Rule 3.2 on offsets, credits, and unjust enrichment, largely to incorporate existing policy into the formal Rule. 2. Refunds & Statutes of Limitations 34 TAC & (eff. July 19, 2011) The Texas Comptroller recently amended the administrative rules governing refund claims. These proposed rules reflect a number of changes in the refund procedures in Texas during the last several years. These rules illustrate a number of traps of which to be mindful in considering refund claims in Texas, such as procedural remedies, pleading requirements, exclusive remedy (jurisdictional) issues, statute of limitation issues, and the prior collection rule, to name a few. 3. Exempt Organizations 34 TAC (eff. Aug. 2011) The Comptroller amended Rule regarding exempt organizations in part in reaction to legislation, but also to express agency policy concerning who is responsible for remitting sales tax when an exempt organization contracts with a private entity to sell taxable items belonging to the private entity during fundraising events. The latter change was prompted by the Austin Court of Appeal s decision in Combs v. Entertainment Publications, Inc., 292 S.W.3d 712 (Tex. App. Austin 2009, no pet.). 4. Use Tax - 34 TAC (eff. Feb. 2011) The Comptroller amended Rule regarding use tax to implement prior changes in the law. 5. Security Services 34 TAC (eff. 2/24/10) The Comptroller modified the regulation concerning security services to conform with legislation changing the definition of a security service to mean a service for which a license is required. The amended regulation changes the licensing authority to Occupations Code chapter 1702, adds a new license required under section , and adds electronic access control device companies, locksmith companies, and private security consultant companies to those requiring a license. Certain persons who provide telematics services, certain persons who provide personal emergency response systems, accountants, and persons selling alarm systems through e-commerce are now excepted from the licensing requirements. Finally, services involving the use of a slim-jim or similar device to unlock a vehicle are now exempt from sales tax. 6. Telecommunication Services 34 TAC (eff. Oct. 2010) The Comptroller amended Rule telecommunication services to implement prior changes in the law. DLI v1-25-

26 7. Sales Tax Holiday: Certain Energy Star Products 34 TAC (eff. 9/9/10) The Comptroller adopted new Rule 3.369, concerning the sales tax holiday for certain energy star products. The new Rule implements 2007 legislation which added Texas Tax Code regarding exemption for certain Energy Star qualified products sold during a three day period in May. 8. Seller s and Purchaser s Responsibilities 34 TAC (eff. 7/11/10) The Comptroller modified the regulation regarding sales and use tax permit and collection requirements for entities that engage in business in the state. In addition to entities previously listed, the amendments indicate that the following are engaged in business in the state and are required to obtain a tax permit for each place of business operated in the state: (1) promoters of an arts and crafts show or festival, (2) kiosk operators, (3) itinerant vendors, and (4) sellers that own or use computer servers or software or other tangible personal property in the state. The amendments also provide that a tax exempt entity that runs a fund-raiser and sells taxable items, other than amusement services, provided by a for-profit entity is considered the for-profit entity s representative and the for-profit entity is considered the seller. As a result, the for-profit entity must obtain a permit and is responsible for proper tax collection and remittance. Furthermore, such a fund-raiser would not qualify as a tax-free sale. The amendments also add related definitions, provide due dates for electronic payments, and make additional clarifications. E. Trends/Outlook for 2011/ State Of The State See prior discussion. 2. Aggressive Stance on Remote Retailer Nexus The Comptroller is taking an aggressive stance on remote retailer nexus. According to BNA s 2010 Survey of State Tax Departments, Texas has indicated that a click-through-type arrangement with an in-state affiliate would trigger nexus. III. PROPERTY TAXES A. Legislative Developments As stated, the Texas Legislature meets bi-annually. The 82 nd Regular Session of the Legislature began on January 11, 2011 and concluded on May 30, The Texas Legislature made an unusually large number of changes to the Texas property tax. These changes generally fall into the following categories: Restrictions on the interaction between an appraisal review board and an appraisal district and similar changes to improve and appraisal review board process; Expanded exemptions for veterans and surviving spouses of veterans; DLI v1-26-

27 Renditions to rental personal property (personal property located in a rental house); Appraisal methods for selected industries and equipment; Technical changes to assessments and collections; and Judicial review. The Texas Comptroller published a very good, comprehensive summary of the 2011 property tax legislation, which can be accessed at: B. Judicial and AG Developments 1. Texas Taxpayer & Student Fairness Coalition v. Texas, No. D-1-GN (filed in Travis Cty. Dist. Ct. Oct. 2011). Lawsuit brought by more than 100 school districts against the State of Texas for alleged unconstitutional cuts in school funding. Suit claims reliance on local property taxes to fund public education violates the Texas Constitution. 2. Midland Central Appraisal District v. BP America Production Co., 282 S.W.3d 215 (Tex. App. Eastland 2009, pet. denied), cert. denied, 79 U.S.L.W (U.S. Apr. 18, 2011) (No ); Harrison Central Appraisal District v. The Peoples Gas, Light, and Coke Co., 270 S.W.3d 208 (Tex. App. Texarkana 2008, pet. denied), cert. denied, 79 U.S.L.W (U.S. Apr. 18, 2011) (No ). Commerce Clause bars ad valorem tax on oil and gas located in tank farms and underground storage facilities in Texas that are part of interstate common carrier pipelines. Ad valorem tax could not be imposed on crude oil or natural gas located in a tank farm or underground storage facility that was an integral part of an interstate, common carrier pipeline system since the tax was not valid under either the Commerce Clause or Texas Tax Code 21.02(a)(1). The trial courts correctly determined that the oil and gas at issue were in the stream of interstate commerce: the oil and gas had been injected into common carrier pipeline systems and remained in the interstate systems at the time of the tax assessment, any delay at the tank farm or underground storage facility was not attributable to the oil and gas companies but was incidental to the transportation of the oil and gas by the common carriers and was necessary for the safe and efficient operation of the pipeline systems. Additionally, the trial courts did not err in concluding that the oil and gas had no taxable situs in the applicable counties. The tank farm and underground storage facility were not used for storage. Although much of the oil and gas had a nexus with Texas in that it was produced in Texas, it had no such nexus with the counties assessing the tax. The oil and gas were merely transported through the counties and were only temporarily located in the counties. The Texas Supreme Court denied the appellant counties petitions for review on March 12, The United States Supreme Court likewise denied the appellant counties petitions for writ of certiorari on April 18, DLI v1-27-

28 3. Lack s Stores, Inc. v. Gregg County Appraisal District, 2011 WL (Tex. App. Texarkana, September 9, 2011, no pet hist.) (not reported) Appraisal of inventory at cost (unreduced by depreciation) upheld where appraisal district provided evidence that cost was reasonable estimate of market value. 4. Lewisville Independent School District v. CH Townhomes, Inc., -- S.W.3d ---, 2011 WL (Tex. App. Fort Worth Apr. 21, 2011, no pet. h.). Property tax refund suit against school district barred by governmental immunity. A Texas Court of Appeals has dismissed a property tax refund suit for lack of jurisdiction because Taxpayer s suit against the school district was barred by governmental immunity. Taxpayer requested a refund from the county taxing authority, citing Texas Tax Code 31.11, but the request was denied. Taxpayer then filed suit in district court against Lewisville Independent School District for a refund of the overpaid taxes. The trial court denied the school district s plea to the jurisdiction and motion to dismiss. On appeal, the appellate court reversed the trial court s order and rendered judgment dismissing Taxpayer s suit, concluding that does not clearly and unambiguously express a legislative intent to waive governmental immunity from suit. 5. Sturgis Air One, LLC v. Harris County Appraisal District, -- S.W.3d --, 2011 WL (Tex. App. Houston [14th Dist.] Mar. 24, 2011, no pet. h.). Transportation company waived right to claim interstate allocation on aircraft when it failed to report aircraft to county appraisal district by statutory deadline. Taxpayer was a transportation company based in the U.S. Virgin Islands. Taxpayer leased an aircraft to a Texas Corporation, which routinely hangared the aircraft in Texas. Prior to 2006, Taxpayer never rendered the aircraft for property tax purposes to any taxing authority. Harris County Appraisal District assessed back property taxes for 2005 and After receiving the notice, Taxpayer rendered the aircraft for 2005 and 2006 and claimed an interstate apportionment under Texas Tax Code After being denied the apportionment, Taxpayer appealed to district court. The district court granted the taxing authority s motion for summary judgment. On appeal, the appellate court affirmed the district court, holding Taxpayer waived its right to interstate allocation by failing to render the aircraft by the statutory deadline. 6. McLennan County Appraisal District v. American Housing Foundation, -- S.W.3d --, 2011 WL (Tex. App. Waco Mar. 9, 2011, no pet. h.). Nonprofit entities entitled to ad valorem exemption on affordable apartment complexes even if financed by for-profit entities, because complexes were used to provide low- to moderate-income housing. Taxpayers are limited partnerships that engage exclusively in the provision of low-income or moderate-income housing. Taxpayers general partners are the same 501(c)(3) entity, but their limited partners are various for-profit entities that receive federal tax credits and depreciation because of their investment. Taxpayers sought judicial review in district court of the McLennan County Appraisal District s denial of their applications for exemptions from ad valorem taxes for two apartment complexes used to provide low-income and moderate-income housing. The district court ruled that Taxpayers were entitled to the DLI v1-28-

29 exemptions. The Waco Court of Appeals affirmed, concluding that Taxpayers established that they meet the constitutional and statutory requirements for the tax exemptions. 7. Crescent Oaks LP v. Harris County Appraisal District, No CV, 2011 WL (Tex. App. Houston [14 Dist.] Jan. 13, 2011, no pet. h.) (mem. op., not designated for publication). Appraisal agreement reached at protest hearing by Taxpayer and chief appraiser's representative valid. At a protest hearing, the Harris County Appraisal Review Board acting without its chief appraiser present agreed with the owner s opinion of the total value of the property at issue. Nonetheless, Taxpayer filed suit in district court challenging the Board s valuation determination and claimed that a valuation agreement may only by entered into by Taxpayer or Taxpayer s agent and the chief appraiser. The appellate court upheld the trial court s grant of the taxing authority s plea to the jurisdiction. The court stated, The chief appraiser is not prohibited from delegating his authority to reach an agreement with a property owner. 8. Dallas Central Appraisal District v. 717 S. Good Latimer LTD, S.W.3d, Texas Court of Appeals, 5th District, No CV, 2010 WL (Apr. 29, 2010). A property owner who fails to file an oath of inability to pay property taxes before the statutory delinquency date does not forfeit its right to a final determination of its appeal. The Dallas Central Appraisal District ( DCAD ) appealed the trial court s denial of its plea to the jurisdiction arguing that the Taxpayer s failure to pay any taxes before the delinquency date deprived the trial court of jurisdiction to hear the Taxpayer s protest. At issue was the timeliness of the Taxpayer s oath of inability to pay, which was filed three months after the delinquency date. DCAD, thus, argued that the Taxpayer failed to substantially comply with the statute. The court, however, refused to read a deadline for filing the oath into the statue and concluded that "the statute does not provide a deadline for filing an oath of inability to pay and we are not inclined to create one by judicial mandate." The court held that the Taxpayer had substantially complied with the statute (despite its delayed filing of the oath) and had not forfeited its right to a final determination of its appeal. 9. Hotel Corporation International v. Harris County Appraisal District, Texas Court of Appeals, 152nd District, No CV, S.W.3d, 2010 WL , June 3, A property owner that fails to prepay property taxes before the statutory delinquency date forfeits its right to proceed to a final determination of its appeals. The Taxpayer protested the valuations of both its real and business personal property. The Taxpayer failed to pay any portion of the property taxes before the February 1st delinquency date and, instead, requested a correction of both appraisals. The Taxpayer ultimately paid the taxes more than four months late. A correction hearing was held relating to the business personal property and resulted in a roughly 50% reduction in the appraisal. The Taxpayer failed to appear for the correction hearing relating to the real property. The Taxpayer then sued in district court and the district court granted the appraisal district s plea to the jurisdiction and motion to dismiss. The appeals court upheld the district court s dismissal of the suit. The court determined that by paying its property taxes more than four months after the delinquency date the Taxpayer had not substantially complied with the requirements of Texas Tax Code 42.08(b) and, DLI v1-29-

30 thus, forfeited its right to final determination of its appeals. The court also concluded that the Taxpayer s allegation that it was denied a hearing under Texas Tax Code 41.45(f) was inapplicable since the Taxpayer was granted a hearing but failed to appear. The court had previously rejected the Taxpayer s claim that Texas Tax Code 41.45(f) created a new avenue of judicial appeal in tax protest cases. 10. Texas Attorney General Opinion No. GA-0790 (August 23, 2010). The Attorney General has addressed who determines whether land and improvements are combined on one single parcel identification number or Taxpayer account for appraisal district record purposes when the land and improvements are under common ownership. The Attorney General concluded that the decision to combine land and improvements is an administrative determination within the discretion of the chief appraiser. The Attorney General rejected the notion that a real property owner may, at his discretion, render the land and improvements separately such that they would be classified with separate account numbers. The Attorney General concluded that a rendering Taxpayer is not entitled, as a matter of law, to have property appraised in accordance with a rendition. Rather, the chief appraiser must analyze the rendition in light of the facts and determine how to organize the property into taxpayer accounts or parcels. C. Amended Comptroller Rules 1. Charitable Organization Exemptions - 34 TAC (eff. 2/22/10) The Rule was amended to reflect 2009 legislation concerning applications for charitable organization property tax exemptions. The legislation repealed Texas Tax Code (b) to change the exemption for organizations engaged primarily in performing charitable functions from optional to mandatory and also permit exemption for charitable organizations that are exempt from federal income taxation under the Internal Revenue Code. 2. Appraisal District Reviews 34 TAC (eff. 2/22/10) The Rule, which was added to implement 2009 legislation, establishes administrative and procedural guidelines for reviews of appraisal districts governance, Taxpayer assistance, operating standards, appraisal standards, appraisal procedures and appraisal methodology at least once every two years. 3. Property Value Studies - 34 TAC (eff. 3/31/10) The Rule was amended to implement 2009 legislation that changed the property value study from every year to every other year, changed the definition of an eligible school district, established a uniform record system for appraisal districts, and established administrative and procedural guidelines for reviews of appraisal districts governance, Taxpayer assistance, operating standards, appraisal standards, appraisal procedures and appraisal methodology at least once every two years. 4. Appraisal Review Board Records 34 TAC (eff. 5/16/10) The Rule was amended to delete reference to the deadline for appealing a review board s final order to the district court, which changes the deadline for appeal. DLI v1-30-

31 5. Limitations on Appraised Value and Tax Credits 34 TAC through (eff. 6/22/10) The Rules were repealed and readopted to reflect and implement the amendments to Chapter 313 of the Texas Tax Code included in HB 3676 enacted by the 81st Legislature. House Bill 3676 postponed for three years, to December 31, 2014, the expiration of provisions of the Texas Economic Development Act relating to school district limitations on appraised value and relating to school tax credits. HB 3676 also made numerous changes to the law concerning eligibility for valuation limitation, the procedures and requirements relating to the application and approval process, the ability to appeal the denial of a limitation application to SOAH and the district court, and the prohibition of supplemental payments to a district in excess of $100 per student per year. 6. Comptroller Housekeeping The Comptroller repealed several Rules after determining that the reasons for initially adopting the Rules no longer exist. The repealed Rules include 9.17 (eff. 6/18/10); 9.18 (eff. 6/27/10); (eff. 6/27/10); (eff. 6/27/10); (eff. 7/4/10) D. Trends/Outlook for 2011/ State Of The State See previous discussion. 2. Ad Hoc Committees A number of committees have been named to review various aspects of property tax administration, including commercial appraisal, arbitration, appraisal review boards, etc. 3. House Bill 8 Improving the Appraisal System The Comptroller continues to work to implement HB8 passed by the 81st Legislature which requires the Comptroller to review appraisal district governance, Taxpayer assistance, operating procedures, and appraisal standards and methodologies. Several of the Rule changes adopted in 2010 have been aimed at these mandates. HB 8 also amended Government Code to change the frequency of property value studies for school districts from every year to every other year. Starting in January 2010, the Comptroller s Property Tax Assistance Division began performing Methods and Assistance Program reviews of half of all appraisal districts. School districts located in a county that does not receive a review in a year will be subject to property value studies in that year. A lengthy presentation and discussion of the scope of these MAP reviews is available on the Comptroller s website at IV. OTHER TAXES A. Insurance Tax The Nonadmitted and Reinsurance Reform Act (NRRA) became effective on July 21, The basic tax component of this act is that only the home state of the insured can tax a multistate insurance policy; however, states may join a compact or other agreement to allocate the taxes among the states afforded coverage under such policies. The states are DLI v1-31-

32 generally in the process of conforming their insurance taxes to the requirements of the federal act. The act defines home state as the principal place of business for an entity or the principal residence of an individual, but fails to define principal place of business. In general, there are two predominant, competing approaches in defining a corporation's principal place of business: the nerve center approach and the activities or place of operations approach. The nerve center approach looks at where the executive officers hold meetings and make high-level decisions. The state from which the officers provide direction, control and coordination is deemed to be the principal place of business under this approach. The activities or place of operations approach focuses on the location of a corporation's day-to-day business activities and operations, which is not necessarily the entities' headquarters. The Texas Comptroller has announced the agency will apply the nerve center test to determine the home state of the insured. B. Severance 1. Coll v Abaco Operating LLC, et al, (filed September 11, 2008 in the Eastern District of Texas, Case No. 2:2008CV00345) Recently commenced class action suit related to compliance with severance tax refunds. This is a class action suit, initially naming over 50 defendants and involving severance taxes. Under Texas law, mineral interest owners, including royalty owners, bear their proportionate share of severance taxes. The producers or first purchasers of natural gas and crude oil are required to withhold from any payment due to interested parties their proportionate amount of tax due, and most severance taxes are paid by producers or first purchasers on behalf of other interested parties, including royalty owners. The Texas Comptroller processes refunds of oil and gas severance taxes pursuant to numerous statutory exemptions. (Approximately $1.1 billion in refunds were paid over the past four years.) Plaintiffs sue for a class consisting of all Indirect Taxpayers as to whom severance taxes were paid and deducted from payments that were due to them. A portion of the suit is based on the allegation that refunds awarded by the Comptroller have been held by the producers and that the Indirect Taxpayers have not received their share of such refunds. New Mexico severance tax issues are also involved. C. Sexually Oriented Business Fee 1. Combs v. Texas Entertainment Association, Inc., and Karpod, Inc., 287 S.W.3d 852 (Tex. App. Austin June 5, 2009, pet. filed). The Texas $5 per person sexually oriented business tax violates freedom of speech under the First Amendment of the United States Constitution because the tax is content-based and is not necessary to serve a compelling state interest. The Texas Supreme Court heard oral arguments in this case on March 25, A sexually oriented business and an association representing the interests of sexually oriented businesses in Texas sued the Texas Comptroller seeking declaratory and injunctive relief against the Comptroller, asserting that the Texas sexually oriented business tax violated the state and federal constitutions. The tax at issue is imposed on a sexually DLI v1-32-

33 oriented business in an amount equal to $5 for each entry by each customer admitted to the business. Tex. Bus. & Com. Code Ann (a). A sexually oriented business is defined as a nightclub, bar, restaurant, or similar commercial enterprise that: (A) provides for an audience of two or more individuals live nude entertainment or live nude performances; and (B) authorizes on-premises consumption of alcoholic beverages, regardless of whether the consumption of alcoholic beverages is under a license or permit issued under the Alcoholic Beverage Code. Id (2) After a bench trial, the trial court issued a declaratory judgment that the statute violated the First Amendment to the United States Constitution, permanently enjoined the Comptroller from collecting or assessing the tax, and awarded attorneys fees in favor of the business and the association. The Austin Court of Appeals affirmed, ruling that the tax violated the First Amendment to the United States Constitution and was therefore invalid. Applying a strict scrutiny analysis, the Court held that the tax was a content-based tax and that the Texas Comptroller failed to show the tax was necessary to serve a compelling state interest. The Court ruled that even under an intermediate-scrutiny standard, the tax would fail constitutional muster because it was not narrowly tailored to further a substantial governmental interest. The tax at issue was not imposed in all incidents where live nude entertainment occurred in the presence of alcohol, but only in those situations in which the Comptroller determined that the essence of the performance or transaction was live nude entertainment. For instance, a play or comedy show involving nudity did not trigger the tax. This type of differential taxation based on content warranted strict scrutiny. The Court rejected the Comptroller s characterization of the tax as an alcohol regulation rather than a tax on speech. Although a sexually oriented business owner could avoid the tax by choosing not to allow the consumption of alcohol on the premises, this aspect of the tax was insufficient to transform a content-based tax into a content-neutral alcohol regulation. The Comptroller sought review by the Supreme Court of Texas. The Supreme Court reversed, holding that five dollar fee imposed on businesses that offer live nude entertainment and allow the consumption of alcohol on the premises does not violate Freedom of Speech as fee is not directed to content of dancing but instead seeks to regulate bi-product of dancing and alcohol consumption V. AUTHOR BIOGRAPHIES Kirk Lyda, attorney and CPA, is a partner in the Jones Day Dallas Office. He concentrates his practice on state tax litigation, controversies, and planning. His experience includes representing Taxpayers in cases such as Rylander v. Bandag Licensing Corp., 18 S.W.3d 296 (Tex. App. Austin 2000, pet. denied) (declaring the Texas franchise tax unconstitutional as applied to a foreign corporation without any substantial physical presence in the state and awarding attorney s fees to the Taxpayer) and Rylander v. Fisher Controls Int l, 45 S.W.3d 291 (Tex. App. Austin 2001, no pet.) (holding that the Texas comptroller violated the Texas Tax Code s "throwback rule" for Texas franchise tax apportionment purposes). He assisted in the representation of the Taxpayers in Sharp v. Park N Fly Of Texas, Inc., 969 S.W.2d 572 (Tex. App. Austin 1998, pet. denied) (Texas sales tax lawsuit) and Nabisco, Inc. v. Rylander, 992 S.W.2d 678 (Tex. App. Austin 1999, pet. denied) (Texas franchise tax lawsuit). He has represented Taxpayers in numerous Texas franchise tax and Texas sales tax hearings before the Texas Comptroller of Public Accounts. More recently he has represented Taxpayers with intangible property management company tax cases pending before the courts or administrative agencies of Maryland, Massachusetts, and North Carolina. Kirk has extensive experience in representing major online travel DLI v1-33-

34 service companies in tax controversies and litigation and in related transactional and legislative work. He has advised clients on the state tax implications of restructuring their business operations throughout the United States. Kirk has spoken at seminars and conferences throughout Texas and in other states on a variety of state tax topics. He also co-authored Accounting and Finance for Lawyers, a Harcourt publication, and Business Purpose: What Is It? How Much Is Enough?, a New York University Institute On State And Local Taxation 2004 publication. Kirk was recognized by Chambers USA ( ) in tax. Admitted: Texas Education: The University of Texas at Austin (J.D. 1999; M.P.A. 1996; B.B.A. 1996) David Cowling chairs Jones Day s state and local tax practice and its e-commerce tax practice. His corporate, partnership, and individual tax practice includes extensive federal, state, and local income, gross receipts and franchise, sales and property tax audit planning, tax class action defense, and litigation experience; complex multijurisdictional individual tax and compensation planning; tax planning for the acquisition and disposition of businesses; tax planning for distressed businesses prior to, in, and emerging from bankruptcy proceedings; structuring of real estate, oil and gas, entertainment, and equipment leasing transactions; tax planning in connection with public and private securities offerings; and tax planning for a wide variety of tax-exempt bond offerings. David is listed in the The Best Lawyers in America ( ), Chambers USA ( ), and Texas SuperLawyers (2010) and was selected by D Magazine as one of the "Best Lawyers in Dallas" ( ). He is a member of the BNA Tax Management State Tax Advisory Board, the CCH State Tax Advisory Board, the State Bar of Texas (Tax Section), and the District of Columbia Bar (Taxation Section). David is a frequent speaker at conferences and seminars including: the Council on State Taxation, the Tax Executives Institute, the Institute for Professionals in Taxation and conferences of various industry trade associations. Admitted: Texas, District of Columbia, and New York Education: Texas Tech University (National Merit Scholar; B.A. with honors 1973); The University of Texas at Austin (Order of Barristers; J.D. 1976); New York University (LL.M. 1977) Justin Thompson practices primarily in the area of state and local taxation, with an emphasis on multistate tax planning and controversy. His experience includes income tax, franchise tax, sales and use tax, and hotel occupancy tax audit defense; state-level administrative proceedings and appeals of tax matters; and multistate tax compliance for businesses in numerous industries. Justin has authored numerous articles on state and local tax issues that have appeared in national journals, including Corporate Business Taxation Monthly and the Journal of Tax Practice and Procedure. He is a member of the State Bar of Texas, the Dallas Bar Association, and the Dallas Association of Young Lawyers. DLI v1-34-

35 Admitted: Texas Education: Southern Methodist University (J.D. magna cum laude 2009; Order of the Coif; Executive Editor, SMU Law Review); Washington University in St. Louis (B.A. in Political Science 2006) CAVEAT Please consult your tax advisor on your specific facts. This outline is neither intended to offer nor does it offer legal advice. IRS Circular 230 Disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. DLI v1-35-