Thus, the Texas Third Court of Appeals was tasked with determining whether Sirius XM’s cost of performance (COP) methodology was a permissible apportionment method. The court held that COP is an appropriate method for making a fair value allocation, although perhaps not the exclusive method. Per the court: “[N]othing in the plain language of the Rule dictates a specific method for calculating fair value or excludes cost of performance as a reasonable means of assessing fair value for purposes of apportionment.” This language from the court, coupled with the Comptroller’s 2021 rule amendments offering COP-alternatives because “the costs of performing a service does not necessarily represent its value,” may allow taxpayers or the Comptroller to argue for non-COP methods of identifying the fair value of services performed in and outside of Texas. For example, the Comptroller’s rule suggests using the relative value of each service provided on a stand-alone basis or units of service (e.g., hours worked). See 34 Tex. Admin. Code § 3.591(e)(26)(B). However, the court’s opinion did not evaluate these methods.

Having determined that Sirius XM was allowed to determine its Texas receipts using a COP methodology (Texas costs / total costs), the court turned to the Comptroller’s complaints that Sirius XM’s COP methodology was flawed because it over- and under-included certain costs. The court held that the Comptroller waived any challenge to Sirius XM’s COP methodology because the Comptroller failed to object to the taxpayer’s expert report outlining its methodology. As a result, the Comptroller’s audit assessment of additional tax against Sirius XM was incorrect.

Taxpayers and practitioners now wait to see if the Comptroller appeals the decision in Sirius XM Phase II to the Texas Supreme Court and whether the Comptroller may further revise his 2021 rule amendments concerning the apportionment of service receipts in the wake of this decision. Regardless, taxpayers should evaluate their Texas sourcing methodology for service receipts and determine whether the flexibility in sourcing methods allowed by the court’s opinion and the Comptroller’s apportionment rule presents refund opportunities.

1. Hegar v. Sirius SM Radio, Inc., No. 03-18-00572-CV (Tex. App.—Austin 2022, no pet. h.).

Client Alert 2022-373