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December 2009 TAX POLICY NEWS
a monthly newsletter about Texas tax policy

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A Special Note to Readers
Sales Tax Update — So Long, Farewell…

Sales Tax Update, our quarterly online newsletter with tips about Texas sales and use tax, is being merged with Tax Policy News beginning with this issue. We will continue to publish Tax Policy News once a month. With this change, the latest information you need about Texas sales and use tax will be available sooner, and Tax Policy News will continue to have all the latest news about Texas taxes.

If you currently subscribe to Sales Tax Update, you don't have to do a thing — you will automatically receive future issues of Tax Policy News.

If you aren't a subscriber, you can use our online subscription service to be notified by e-mail when the latest issue of Tax Policy News is available. You can also use our subscription service to receive updates to other Comptroller's office publications and news of interest to you.

COIN-OPERATED AMUSEMENT MACHINES TAX

Renewal Application Due Dates, Fees and Penalties

Renewal applications for coin-operated amusement machine General Business License, Import License, Repair License and Registration Certificates were due December 1, as announced in the September 2009 issue of Tax Policy News.

Applicants who filed and paid all fees and taxes by the due date, but have not received a license or registration certificate, may continue to operate their machines after December 31, unless notified by our office of a problem with the renewal.

A renewal application filed after the due date may result in the license or registration certificate being issued after December 31, when the 2009 license or registration certificate expires. Taxpayers who filed their renewal applications late cannot operate amusement machines until the 2010 license or registration certificate is issued. A person who operates amusement machines without a license or registration certificate, or with an expired license or registration certificate, is guilty of a Class A misdemeanor, as provided in Occupations Code Section 2153.356 and Rule 3.602(b)(1).

Fees applied to late filers, as provided in Occupation Code Section 2153.162, include: $50 on renewal applications filed after the due date but before the license or registration certificate expires on December 31; one-and-a-half times the annual license or registration fee when filed January 1 through March 31; and twice the annual license or registration fee when filed April 1 or after.

In addition to the renewal fee, the law requires payment of a $60 occupation tax for each coin-operated amusement machine that is “exhibited or displayed on location.” An occupation tax permit sticker (decal) must be affixed to each machine in use. See Occupations Code Sections 2153.401 and 2153.406.

Coin-operated amusement machine operators who did not receive their renewal packets should contact our office at (800) 252-1385, or in Austin at 463-4600 to request another renewal packet.

For more information on tax permits and license and registration fees, including a fee schedule, see the Coin-Operated Machines Tax section of our Web site and our publication Coin-Operated Amusement Machine Regulation and Taxation (Pub.96-256).

FRANCHISE TAX

The Taxability of Grantor Trusts

A grantor trust, as defined by Sections 671 and 7701(a)(30)(E), Internal Revenue Code, is nontaxable only if all of the grantors and beneficiaries are natural persons or charitable entities as described in Section 501(c)(3), Internal Revenue Code. If the grantor or beneficiaries are other than natural persons or charitable entities, or the grantor trust is taxable as a business entity under Treasury Regulation Section 301.7701-4(b), the grantor trust is taxable unless it qualifies as a passive entity.

INSURANCE TAX

Electronic Reporting and Paying of Maintenance Taxes

The October 2009 Tax Policy News article “Insurance Tax Electronic Reporting Update” provided information on the electronic reporting and paying of insurance premium taxes using the Comptroller's online WebFile system.

We are pleased to announce that the Comptroller's office now provides an additional Web-based tax reporting option for taxpayers to file and pay maintenance taxes. While the electronic filing of premium tax is mandatory for taxpayers who paid $50,000 during the preceding fiscal year, at this time, the electronic filing of maintenance taxes is voluntary for all taxpayers. We hope this option will make it easier for taxpayers to file their reports at one time. You may register once and file reports for multiple taxpayer numbers.

The Comptroller's electronic reporting and payment options are available 24 hours a day, seven days a week. Use these services to save time, money and paper.

To log in, you will need the taxpayer ID number(s) and WebFile or RT number. Your RT numbers are different for each type of tax — you will have one number for premium tax and another for maintenance. For additional information, see the WebFile section of our Web site.

Taxpayers who paid $100,000 or more in the preceding state fiscal year must electronically transmit payments via the TEXNET system. You must enroll in the TEXNET system prior to use, so contact us early to ensure you don't miss your deadline.

Electronic reporting for the Automobile Burglary and Theft Prevention Authority Assessment is on the way. Stay tuned!

INSURANCE TAX

Mailing Premium Tax Reports

Taxpayers for whom electronic reporting of premium tax data was mandatory for the 2008 tax year will not receive a paper report for the 2009 tax year. Instead, they will receive a reminder e-mail that the filing deadline is approaching.

Taxpayers for whom electronic reporting of premium tax data was not mandatory, but who voluntarily chose to file their taxes using the electronic reporting system last year, will receive a paper tax report this year, but not in the future.

SALES TAX

Data Processing v. Manufacturing

In Hearing 46,333, the taxpayer claimed that certain equipment (such as scanners) used in its business of scanning and imaging documents for its customers was exempt manufacturing equipment. The taxpayer claimed the exemption based on Section 151.318(a)(2) of the Tax Code. The provision exempts equipment that is directly used or consumed in the manufacture of tangible personal property for ultimate sale provided the equipment is both necessary and essential to the manufacturing process and directly makes or causes a chemical or physical change to the product being manufactured for sale. The hearing found that the equipment did not qualify for exemption because the taxpayer's sales of scanning and imaging were data processing services and not sales of tangible personal property. A service provider is not eligible for the manufacturing exemption.

The taxpayer scanned and imaged various items including bound materials, engineering and large format documents, microfiche, microfilm and magnetic tape, and placed the data in electronic format, such as JPG files and TIFF files, on optical disks such as CD-ROMs. JPG and TIFF files cannot be word (text)-searched, nor can the data in the files be manipulated by the user. But, the taxpayer typically used directory file names that contained a numbered indexing system (for example, 0001.JPG, 0002.JPG, 0003.JPG) which allowed the user to view a particular file by searching for its identifying number in the directory.

The taxpayer claimed that it was a manufacturer selling tangible personal property as opposed to a provider of data processing services. This claim was based on the “essence of the transaction” test. That is, customers paid for, and were primarily interested in receiving, tangible personal property (such as a CD-ROM) produced by the taxpayer.

The taxpayer compared its business to that of a professional photographer selling photographic images, in that the taxpayer imaged documents on a disk or other medium, and charged clients on a per-image basis. Photographers are considered manufacturers of the images they sell. In addition, the taxpayer observed that photocopying machines are viewed as exempt manufacturing equipment, and the copies produced by them and sold are tangible personal property.

The Comptroller turned to the plain meaning and common usage of the term “data” to determine that the taxpayer's transactions were data processing service transactions, not manufacturing. A standard dictionary definition of “data” is “information in numerical form that can be digitally transmitted or processed.”

The result is that charges for entry of even a small amount of data are taxed as data processing services. Moreover, the source of the data is critical. By definition, data processing is a service performed using the customer's data. With data processing, the services performed in connection with the data are primarily valued by the customer, not the medium (tangible personal property) in which the data is received by the customer.

Activities performed by the taxpayer, such as indexing, scanning, data storing and providing data retrieval have long been determined to be taxable data processing services. See Rule 3.330 and STAR 9401L1282B08 for more information.

SALES TAX

Lump-Sum v. Separated Contract

In Hearing 49,560 (2009), the taxpayer provided heating, ventilating and air conditioning (HVAC) contracting services for new construction. The taxpayer entered into a subcontract with a contractor who, in turn, had entered into a contract with a prime contractor performing commercial new construction for the owner of a hotel. The taxpayer did not pay sales tax to suppliers for materials it incorporated into the job. The taxpayer claimed that its contract qualified as a separated contract for sales and use tax purposes, and therefore, it qualified for the sale for resale exemption. The contract, however, stated a lump-sum price.

The taxpayer based its claim on three arguments. First, the taxpayer argued that the contract was a separated contract by its terms, based on precedent established in Comptroller Decision No. 40,445 (2002). In that decision, the disputed contract was held to be a separated contract because the incorporated materials and labor were separately stated in a schedule of values included in a revised bid proposal, which was specifically incorporated by the contract.

In this hearing, however, even though the contract required a statement of values on which to base applications for payment, the contract did not require the statement of values to break out the charges for incorporated materials and labor. Additionally, the taxpayer neglected to provide a copy of the statement of values as evidence. The Comptroller determined that the testimony regarding the statement of values was insufficient to compensate for the absence of the evidence.

Second, the taxpayer argued that the contract was separated because the parties intended it to be separated and treated it as such. The taxpayer initially billed the contractor for sales tax on the incorporated materials. The contractor directed the taxpayer to cease charging tax on the incorporated materials, and provided the taxpayer with a resale certificate for them.

Subsequently, the contractor submitted two change orders, one directing the taxpayer to deduct an amount of sales tax from the original contract amount, another directing the taxpayer to apply a credit in sales tax against the contract amount. Per taxpayer testimony, the taxpayer had charged sales tax on materials only, and the change orders were triggered by the issuance of the resale certificate. Regarding whether these documents served to establish intent, the Comptroller held that intent could not be given any weight under established Comptroller precedent. See Comptroller Decisions 35,473 (1996) and 24,368 (1990).The Comptroller stated, “The parties' intent cannot override the clear language of the contract providing for a lump-sum contract price.”

Third, the taxpayer argued that the contract was separated because it incorporated the contract between the prime contractor and the owner, which, it claimed, was separated. The Comptroller did not address the argument because the taxpayer neither produced a copy of that contract nor described its provisions.

RECENTLY ADOPTED RULES

The following rule adoptions were filed with the Texas Secretary of State on Dec. 11, 2009, and were published in the Dec. 25, 2009, issue of the Texas Register. The effective date is 20 days after filing.

Franchise Tax

Section 3.582 Margin: Passive Entities*
Section 3.583 Margin: Exemptions*
Section 3.584 Margin: Reports and Payments
Section 3.587 Margin: Total Revenue
Section 3.589 Margin: Compensation
Section 3.590 Margin: Combined Reporting
Section 3.591 Margin: Apportionment
Section 3.593 Margin: Franchise Tax Credits

* Adopted with changes to the proposed text as published in the Oct. 30, 2009, issue of the Texas Register

RECENTLY PROPOSED RULES

The Comptroller's office filed the following rule with the Texas Secretary of State for publication in the Dec. 18, 2009, issue of the Texas Register. The comment period is 30 days from publication.

State Sales and Use Tax

Section 3.333 Security Services

ABOUT THE NEWSLETTER

The Comptroller's office publishes this newsletter to keep you informed about state taxes. Tax questions can be complicated, so please use these summaries as guidelines only.

For a Copy of a Proposed Rule

For a copy of a proposed rule or information about a proposed rule, write to Bryant Lomax, Tax Policy Division, 1700 North Congress Avenue, Austin, Texas, 78701-1436, or submit a request via Texas Tax Help.

For Publications, Rules or Other Tax Information

For a wealth of tax information sorted by tax type or by subject matter, please visit the Texas Taxes section of our Web site.

Contributors to This Month's Issue

Teresa Bostick, Robin Corrigan, Don Dillard, Jody Frierson, Gary Johnson, Carol McAnnally, Jerry Oxford, Viki Smith, Karen Snyder and Jennifer Specchio

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