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Texas Comptroller Proposes Rule Amendments for Sourcing Service Receipts in Light of Sirius XM

The Texas Comptroller has proposed further amendments to the agency’s recently-amended Texas franchise tax rule on sourcing receipts from the performance of services. The proposed amendments reflect the Texas Supreme Court’s ruling in Sirius XM. The proposed amendments have been published in the January 20, 2023 issue of the Texas Register and the comment period will close on February 19, 2023.

Authors

Rich Moore

Background

In March 2022, the Texas Supreme Court held that, for purposes of the Texas franchise tax, receipts from the provision of a service are sourced to the location of performance, i.e., the location of the taxpayer’s personnel or equipment that performs the service for which the customer pays.1 As discussed in our March 2022 Client Alert, the Texas Supreme Court did not provide an answer, however, on how to make a fair value allocation of service receipts if the taxpayer performs the service both within and outside of Texas. Instead, the high court remanded the case to the Third Court of Appeals for further consideration of that issue.

In November 2022, the Third Court of Appeals held that sourcing service receipts using cost of performance is an appropriate method for making a fair value allocation, although perhaps not the exclusive method.2 As discussed in our November 2022 Client Alert, the court concluded that “nothing 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.” Following the Third Court of Appeals’ opinion, the Comptroller chose to not petition the Texas Supreme Court for review.

2023 Proposed Amendments

The Comptroller’s proposed amendments modify the definition of “location of performance” in Section 3.591(e)(26)(A) by removing the “receipt-producing, end-product act” standard and corresponding examples, and providing that “a service is performed at the location or locations where the taxable entity’s personnel or property are doing the work that the customer hired the taxable entity to perform.”3 The proposed rule further provides that activities not directly used in the performance of the service would not be relevant in determining the location of where the service was performed.

Provisions for sourcing services performed both inside and outside of Texas under Section 3.591(e)(26)(B) also would be amended to make clear that, when costs are considered in determining the service's fair value, only the direct costs of doing work the entity was hired by the customer to perform would be considered.4 Costs would not include those which are not directly used to provide a service to the customer.

Comments due February 19, 2023

Comments on the proposed rule must be received by the Comptroller by February 19, 2023. The earliest date the proposed amendments could take effect is February 19, 2023. Please contact us if you would like to discuss the Comptroller’s proposed amendments.

About Reed Smith State Tax

Reed Smith’s state and local tax practice is composed of more than 30 lawyers across seven offices nationwide. The practice focuses on state and local audit defense and refund appeals (from the administrative level through the appellate courts), as well as planning and transactional matters involving income, franchise, unclaimed property, sales and use, and property tax issues.

  1. Sirius XM Radio, Inc. v. Hegar, 643 S.W.3d 402 (Tex. 2022).
  2. Hegar v. Sirius SM Radio, Inc., No. 03-18-00572-CV (Tex. App.—Austin 2022, no pet.).
  3. Proposed 34 Tex. Admin. Code § 3.591 (Texas Register, published January 20, 2023).
  4. Id.

Client Alert 2023-023

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