Background
By way of background, the Comptroller and several Texas cities have been litigating for several years how internet sales by in-state retailers to Texas residents (i.e., intrastate online sales) should be sourced for local sales and use tax purposes. Until 2020, these sales were generally sourced to the seller’s in-state place of business where the online purchase was “consummated” — that is, where the order was received or fulfilled by the seller. As a result, the city that hosts an online retailer’s order-processing facility or fulfillment center has traditionally received the local tax on 100 percent of the intrastate online orders processed and fulfilled at the location in the city. In many cases, local governments made deals with retailers to site facilities within their jurisdictions to capture the local sales tax revenue on intrastate online sale, often providing sales tax rebates to retailers in return.
In 2020, to address these perceived abuses, the Comptroller adopted changes to the state’s local tax sourcing rule — Comptroller Rule § 3.334 — including a provision that would change the sourcing of online sales for local sales and use tax purposes to the location where the goods are delivered or taken possession of, unless the sale is fulfilled at a location that constitutes a “place of business”. In response, the cities of Round Rock, Coppell, DeSoto, Humble, Carrollton, and Farmers Branch — many of which host fulfillment centers for online retailers — filed suit in 2021 to overturn those changes in City of Round Rock v. Hegar.2 The cities raised procedural and substantive arguments, including that the Comptroller was creating a destination-sourcing local tax regime without legislative authorization.
In August 2022, the district court upheld the cities’ procedural complaints. In January 2023, the Comptroller readopted the rule to correct the procedural defects, but also included new language providing that online orders forwarded to a fulfillment center are not considered to be received at the fulfillment center. The Comptroller also included language providing that facilities like fulfillment centers are not places of business per the state’s sales tax law unless they meet certain criteria, like having sales personnel working at the facility and receiving orders from customers. The Comptroller’s amended sourcing rule effectively results in the local tax on many intrastate internet sales going to the location of the buyer.
On January 5, 2024, the Comptroller adopted another change to the local tax rule: the addition of a single paragraph that borrows language from a portion of the Streamlined Sales and Use Tax Agreement (“SSUTA”). This amendment provided that an order is deemed to be received when all the information necessary to determine if it can be accepted is received by the seller, and that the location where an order is received by or on behalf of the seller is the first physical location of the seller that initially receives it, including an outlet, office, or “automated order receipt system.” The amendment also asserted that the location “from which a product is shipped shall not be used in determining the location where the order is received by the seller.” It is noteworthy that Texas is not a participating member in the SSUTA. In response to the January 2023 and January 2024 amendments, the cities again raised procedural arguments, including that the Comptroller did not comply with the rulemaking procedures in the Administrative Procedures Act.
On April 4, 2024, the district court ordered — and the parties’ agreed — that the Comptroller failed to comply with certain procedural requirements in enacting the January 2024 amendments.3 In response to the district court’s order, the Comptroller proposed the readoption of Comptroller Rule § 3.334, with the amendments discussed below, and a more complete statement of the elements required by Government Code § 2001.024 and Government Code, Chapter 2006.
Proposed amendments to local tax rule
On April 19, 2024, the Comptroller proposed amendments to Comptroller Rule § 3.334, including the addition of the following definitions:
“Independently owned and operated business – a self-controlling entity that is not a subsidiary of another entity or otherwise subject to control by another entity, and that is not publicly traded.”4
“Micro-business – a legal entity, including a corporation, partnership, or sole proprietorship, that:
a. is formed for the purpose of making a profit;
b. is independently owned and operated; and
c. has not more than 20 employees.”5
“Small business – a legal entity, including a corporation, partnership, or sole proprietorship, that:
a. is formed for the purpose of making a profit;
b. is independently owned and operated; and
c. has fewer than 100 employees or less than $6 million in annual gross receipts.”6
Additionally, the Comptroller has proposed the addition of Comptroller Rule § 3.334(b)(6), which states “[i]f a small business seller or a micro-business seller operates a single location out of which it conducts all of its business activities, the comptroller will presume that the location is a place of business of the seller.”
The Comptroller states that he “cannot make a location a ‘place of business’ by rule if the statute does not allow it.” Nevertheless, the Comptroller posits he “can presume that a location is a ‘place of business’ based on indicative facts, such as a small, independent business that conducts all of its business operations out of a single location.”
Prior to proposing these amendments, the Comptroller considered other alternatives to reduce the adverse impact on small businesses and micro-businesses. These alternatives included allowing small or micro-businesses to source local sales tax to their principal place of business, or establishing a single local sales tax rate for small or micro-businesses that would be distributed like the distribution of the single local use tax collected by remote sellers. However, as stated above, because these proposals would require amendments to the local sales tax statute, the Comptroller claims that it does not currently have the regulatory authority to implement these proposed methods.
Public hearing and comment period
The Comptroller will hold a hearing to take public comments, on May 9, 2024, at 9:00 a.m. in Room 2.034 of the Barbara Jordan Building, 1601 Congress Avenue, Austin, Texas 78701. Additionally, the Comptroller must receive written comments no later than 30 days from the date of publication of the proposal in the Texas Register. Therefore, the 30-day comment period concludes on May 19, 2024.
Please let us know if you would like to discuss the impact of the proposed amendments to Comptroller Rule § 3.334 or provide oral or written comments.
- Proposed Comptroller Rule § 3.334, Texas Register (April 19, 2024).
- Travis County District Court Consolidated Case No. D-1-GN-21-003203.
- The merits of the case have yet to be addressed and the temporary injunction, which is preventing the Comptroller from enforcing the amendments to Comptroller Rule § 3.334, remains in effect.
- The definition of “independently owned and operated business” is taken from the Attorney General of Texas’ Government Code Chapter 2006 Small Businesses and Rural Communities Impact Guidelines updated in December 2017.
- The definition of “micro-business” is taken from Government Code, Chapter 2006.
- The definition of “small business” is taken from Government Code, Chapter 2006.
Client Alert 2024-084
