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April 2010 TAX POLICY NEWS
a monthly newsletter about Texas tax policy

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FRANCHISE TAX

Determining if an Entity is Eligible for the 0.5 Percent Rate

Specific instructions for determining if an entity is eligible for the 0.5 percent tax rate are provided in Texas Tax Code Section 171.002. Subsection (b) of this section allows a rate of 0.5 percent of taxable margin for those taxable entities primarily engaged in wholesale and retail trade as described in Division F and G of the 1987 Standard Industrial Classification (SIC) Manual. Subsection (c) provides three steps to determine if an entity is primarily engaged in retail or wholesale trade.

The first step, Tax Code Section 171.002(c)(1), involves analyzing and separating total revenue by SIC classification to determine if total revenue from activities in retail or wholesale trade is greater than the total revenue from activities in trades other than retail or wholesale trade.

Example:

A taxable entity sells Swiss watches and offers repair services for these watches. This entity must compare its total revenue from the sale of watches (retail - under SIC Industry No. 5944) to its total revenue from the repair of watches (service - under SIC Industry No. 7631). If the total revenue from its activities in retail trade (the sale of watches) is greater than the total revenue from its activities in service trade (the repair of watches), the entity has passed the first of three tests for being primarily engaged in retail or wholesale trade. If the total revenue from its activities in service trade (the repair of watches) is greater than the total revenue from its activities in retail trade (the sale of watches), then the entity is not primarily engaged in retail or wholesale trade and is not eligible for the 0.5 percent tax rate.

For the second step, Tax Code Section 171.002(c)(2), an entity must determine if less than 50 percent of the total revenue from its 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 also belongs (this does not apply to total revenue from activities described by Major Group 58: Eating and Drinking Places). If 50 percent or more of its total revenue is from the sale of products it produces or from products produced by an affiliate, the entity is not primarily engaged in retail or wholesale trade.

Continuing with the above example:

Assume the entity's total revenue from the sale of watches is greater than its total revenue from the repair of watches. More than 90 percent of the store's total revenue from the sale of watches comes from the sale of watches produced by its affiliate, as defined in Tax Code Section 171.0001(1), a manufacturer based in Switzerland.

Because 50 percent or more of the store's total revenue from retail comes from the sale of products manufactured by an affiliate (the affiliate does not have to be a member of the combined group to disqualify the group for the 0.5 percent rate), the entity is not primarily engaged in retail trade and is not eligible for the 0.5 percent tax rate.

The third step, Tax Code Section 171.002(c)(3), does not allow taxable entities that provide retail and wholesale utilities (including telecommunications services, electricity, or gas) to be considered primarily engaged in retail or wholesale trade. As a result, these entities are not eligible for the 0.5 percent tax rate.

To summarize, a taxable entity will qualify for the 0.5 percent tax rate if the entity 1) has total revenue from activities in retail or wholesale trade that is greater than the total revenue from activities in other trades; 2) does not produce, and does not have an affiliate that produces, products that account for 50 percent or more of the entity's total revenue from retail or wholesale trade; and 3) does not provide retail or wholesale utilities.

INSURANCE TAX

Federal Excise Tax on Certain Insurance Premiums

The U.S. government imposes a federal excise tax (FET) on insurance premiums paid to alien (non-U.S.) insurers for policies issued to U.S. insureds covering risks located in this country. The FET tax rate is 4 percent on property, casualty and marine insurance risks and 1 percent for reinsurance. The FET is in addition to state premium taxes.

Most non-U.S. insurers are exempt from this tax. Exemptions from the FET can be secured if the insurer is a qualified resident of a country that has an FET treaty with the U.S. Currently, in order to obtain a "qualified exemption" from the FET, each insurer must either enter into a "closing agreement" with the IRS or pay U.S. income taxes.

Many eligible surplus lines insurers and captive insurers, most of which are domiciled in the Caribbean, are subject to the FET. This is a complex and widely misunderstood tax, and legal counsel should be sought if questions arise.

MIXED BEVERAGE GROSS RECEIPTS TAX

Audit Liability Dismissed — Business Was Not Acquired Through Fraudulent Transfer or Sham Transaction

Texas tax law, in Tax Code Section 111.024, provides that a person who acquires a business, or the assets of a business, from a taxpayer through a fraudulent transfer or a sham transaction is liable for any tax, penalty and interest owed by the taxpayer. A transfer is considered "fraudulent or sham" if the transfer was made with the intent to evade, hinder, delay or prevent the collection of a state tax, or without receiving reasonably equivalent value in exchange for the transfer. See Tax Code Section 111.024(b).

In Hearing No. 47,683, the Texas Comptroller of Public Accounts assessed a taxpayer (Petitioner) for the mixed beverage gross receipts tax liability of a company that operated a lounge. The Comptroller claimed the Petitioner was a transferee of the other company pursuant to a fraudulent transfer.

The company had operated a lounge at the same location as the Petitioner's club. The company was audited for mixed beverage gross receipts tax compliance and assessed tax, penalty and interest. When incorporated in 1987, the company's original officers, directors and shareholders were a father and his two sons. The father resigned from the company in 1990 and, by 2002, had transferred all of his shares of the company's stock to his two sons. In late 2003, one of the sons resigned and transferred his shares of the company to his brother, leaving the remaining brother as the company's only officer, director and shareholder.

The lounge the company operated was located in a building owned by the same brother that had resigned from the company. In November 2004, this brother filed notice revoking the right of the company to use the lounge's name and evicted the company from the building. The following month, the Petitioner leased the same space in the building and began operating a Bring Your Own Bottle club under an almost identical name. The Petitioner's sole officer, director and shareholder was the father of the two sons.

Comptroller staff argued at the hearing that the business was transferred to the Petitioner for the purpose of evading state taxes and that no consideration was received for the transfer. The law, in Section 111.024(c), provides factors in determining whether a transfer was made with intent to evade tax. As proof of fraudulent transfer, staff referenced the relationship between the father, the sons and the brothers as owners of the companies involved. The staff asserted that the location of the club remained the same, the original company knew of the audit at the time of the transfer to the Petitioner, and alleged the transfer was concealed from the Comptroller to evade payment of tax.

The Petitioner responded there was no transfer, but the original company was actually evicted for nonpayment of rent. The Petitioner said the tables and chairs and the name of the lounge were owned by the building owner and that those assets were transferred under a lease to Petitioner from the building owner.

The administrative law judge agreed with the Petitioner there was no evidence of a transfer. The judge acknowledged there had been a relationship between the principals of the involved companies and that the original company knew about the audit liability. But, instead of a transfer, the judge ruled that the case concerned a family argument resulting in eviction of the lounge and the new operation of a club with the same name. "Families," the decision stated, "just as any other business associates, can have a falling out, and the fact that one family member steps into a vacuum caused by that falling out is not, without more evidence, sufficient to find that a transfer occurred, much less that it was a fraudulent transfer."

The judge concluded that Comptroller staff had not met the burden of proof to make a prima facie case showing the transfer was made with the intent to evade, hinder, delay or prevent the collection of a state tax. The Comptroller concurred with the judge's recommendation to dismiss the audit assessment.

MOTOR VEHICLE TAX

Tax Due Dates on Seller-Financed Sales

A seller-finance dealer holding a seller-finance permit should collect motor vehicle tax on seller-financed sales as payments are received from purchasers and remit the tax directly to the Comptroller's office on the next monthly or quarterly tax return. Returns and payment are due 20 calendar days from the end of the report period designated on the return. See Texas Tax Code 152.047(e).

Vehicle titling and registration requirements fall under a separate statute and, as a result of legislation passed in 2009, now have different guidelines. Senate Bill 1235, passed by the 81st Texas Legislature, changed the due date for filing the application for title and registration with the local county tax assessor-collector on seller-financed sales.

Effective Sept. 1, 2009, the application for title and registration must be made in the name of the purchaser to the appropriate county tax assessor-collector no later than the 45th calendar day after the date the motor vehicle is delivered to the purchaser.

Previously, the application for title and registration on all sales was due by the 20th county working day from the date of sale. The new provision of SB 1235 does not extend or amend the due date for motor vehicle tax on seller-financed sales. Motor vehicle tax is still due on the 20th day following the reporting period.

If a seller-finance dealer pays the motor vehicle tax at the time of title application and registration to the county tax assessor-collector (rather than reporting and paying the tax to the Comptroller's office as payments are received), the transaction does not meet the definition of a seller-financed sale for tax purposes. In this case, the tax payment is due within 20 county working days after the date the motor vehicle is delivered to the purchaser just as in cash sales or sales financed by a third party.

A penalty equal to 5 percent of the tax will be charged when the tax or surcharge is paid from 1 to 30 calendar days late. When paid more than 30 calendar days late, an additional 5 percent penalty (totaling 10 percent) of the tax will be due. The minimum penalty imposed is $1.

Any direction concerning the titling and registration requirements must come from the Texas Department of Motor Vehicles (TxDMV).

SALES TAX

Energy Star Sales Tax Holiday

In addition to the annual August clothing sales tax holiday, Texas shoppers get a break from state and local sales and use taxes during Memorial Day weekend every year on purchases of certain energy-efficient products.

This year, the Energy Star Sales Tax Holiday begins Memorial Day weekend at 12:01 a.m. on Saturday, May 29 and ends at 11:59 p.m. on Monday, May 31.

Energy Star is a joint program of the U.S. Environmental Protection Agency (EPA) and the U.S. Department of Energy (DOE). Earning the Energy Star means a product meets strict energy efficiency guidelines set by the EPA and the DOE. The products qualifying for the exemption are:

  • air conditioners priced under $6000 (room and central units)
  • clothes washers (but not clothes dryers)
  • ceiling fans
  • dehumidifiers
  • dishwashers
  • light bulbs (incandescent and fluorescent)
  • programmable thermostats
  • refrigerators priced under $2000

Qualifying products display the Energy Star logo on the appliance, the packaging or the Energy Guide label. Clothes dryers are not included in the items qualifying for exemption during the Energy Star holiday because they use similar amounts of energy; therefore, the Energy Star program does not label clothes dryers.

There are no limits on the number of items that may be purchased during the Energy Star Sales Tax Holiday, and an exemption certificate is not required.

This tax-free holiday also applies to some Internet and catalog sales of eligible products. Layaway plans can also be used to take advantage of the sales tax holiday, within certain parameters.

See our FAQs for more information about this sales tax holiday.

To learn more about cutting energy costs, contact the State Energy Conservation Office (a division of the Comptroller's office) at (800) 531-5441, ext. 3-1931, or visit the SECO Web site.

SALES TAX

Hearing Summary: Direct Payment Permit Holders — Sales Tax vs. Use Tax: The Certificate Matters

Hearing No. 101,897 (2010)

The difference between sales tax and use tax and the responsibility a seller has when dealing with a direct payment permit holder were the deciding factors in this hearing.

Under Tax Code 321.203, the local sales tax due on a transaction is based on the location where the sale is consummated. During the audit period 2004-2007, Tax Code 321.203(c)(1) provided that if a retailer had more than one place of business in Texas, a sale of a taxable item was consummated at the retailer's place of business from which the retailer shipped the item.

Tax Code 321.205(d) provides that the holder of a direct payment permit who claims a direct payment exemption on the purchase of a taxable item becomes liable for local use tax based on the location where the permit holder first uses the item.

In this hearing, the holder of a direct payment permit purchased oil field equipment from a seller in Texas. The equipment was delivered to, and used at, well sites in Texas located outside of any local sales tax jurisdictions. The equipment was shipped from two of the seller's places of business that were located inside local taxing jurisdictions.

The purchaser did not issue a direct payment exemption certificate to the seller at the time of the transaction. Instead, the permit holder paid state tax, but no local tax, to the equipment seller. The seller then reported and remitted the tax to the state. The seller reasoned that it was collecting use tax due based on where the equipment was used, in accordance with 321.205(d), and remitting it to the state as a courtesy to the purchaser.

During an audit of the equipment seller, the auditor determined that the seller should have collected and remitted local tax along with the state tax, arguing that the tax due was sales tax, not use tax. The auditor determined that the seller was responsible for collecting state and local sales taxes on the transaction because the seller had not obtained a direct payment exemption certificate from the customer at the time of sale.

If the seller had received a direct payment exemption certificate from the purchaser, the seller would not have been responsible for collecting either state or local sales taxes on the transaction. And, if the purchaser had issued a direct payment exemption certificate to the seller, then no local use tax would have been due on the transaction because the equipment was delivered to, and first used by, the direct payment permit holder at locations outside of any local sales tax jurisdictions.

Comptroller policy allows a direct payment permit holder to elect the manner in which they will proceed on any given transaction; the permit holder must choose whether to pay sales tax or use tax. See STAR documents 9007L1032D13 and 9907606L. If a direct payment permit holder chooses to pay use tax, then he must claim the direct payment exemption by providing the seller a valid direct pay exemption certificate at the time of the transaction. The permit holder is then responsible for reporting and remitting both the state and applicable local use taxes directly to the Comptroller. If a direct payment permit holder fails to claim the direct pay exemption at the time of the sale, then the seller is responsible for collecting the state and applicable local sales taxes, as well as any local use taxes that may apply.

The seller obtained a direct payment exemption certificate from the purchaser after the audit began, but longstanding Comptroller policy prohibits allowing a direct payment exemption certificate to relate back in time to cover transactions for which the permit holder has already paid tax. See Comptroller Hearings 22,959 (1990), 34,923 (1997) and 43,887 (2005).

The Comptroller concluded that, because the customer paid tax when it purchased the taxpayer's equipment rather than issuing a direct payment exemption certificate, the customer chose not to act as a direct payment permit holder, and the transactions were correctly deemed to have been consummated at the retailers' place of business from which the items were shipped. Local sales tax based on the locations of those places of business was, therefore, due.

SALES TAX

Hearings Summary: Class Action Refunds Not Authorized

Hearing Nos. 102,508, 102,509, and 102,510 (2010)

Stores frequently offer mail-in rebates for items they sell. When rebates are issued by a seller, the seller is considered to be providing customers with a cash discount after the sale. The discount, like a discount taken at the time of the sale, is a reduction in the amount subject to tax. See Texas Tax Code Section 151.007 (c)(1).

In these hearings, three retailers offered mail-in rebates to customers on certain items sold in stores, by telephone or via the Internet. The customers received cash rebates from the retailers on their purchases, but did not receive refunds of the sales and use tax paid on the rebated portion of the sales price.

The customers, through separate lawsuits involving each of the three retailers, obtained certification as a class, as well as assignments of right to refund from the retailers. They then filed three separate class action refund claims, one per retailer, with the Comptroller. The class action refund claims resulted in these hearings.

The Comptroller denied all three refund claims because there is no statutory authority for a refund to be granted to a class. Although Tax Code Chapter 111 (PDF, 190KB) , which sets out collections procedures, provides that the Comptroller will consider a refund claim filed by an individual, it does not provide for a refund claim filed by a class.

Tax Code Chapter 112 (PDF, 69KB) , provides taxpayers with a judicial remedy for taxation disputes. Although Chapter 112 authorizes taxpayers to bring class action lawsuits concerning tax that was paid under protest, that authorization does not apply to refunds of tax that was not paid under protest.

The Comptroller concluded in all three cases that the class did not have standing to be granted a refund, and the Comptroller did not have authority to grant a refund to a class.

RECENTLY ADOPTED RULES
The following rule adoption was filed with the Secretary of State on April 26, 2010. The publication date is May 7, 2010, effective 20 days after filing.

Motor Vehicle Sales and Use Tax

Section 3.84 — Exemption for Orthopedically Handicapped Person

RECENTLY PROPOSED RULES

The following rules were submitted for filing with the Secretary of State. The publication date was April 2, 2010. The comment period is 30 days after publication.

State Sales and Use Tax

Section 3.344 — Telecommunications Services

Texas Prepaid Wireless 9-1-1 Emergency Service Fee

Section 3.1271 — Imposition and Collection of the Prepaid Wireless 9-1-1 Service Fee

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

Robin Corrigan, Lisa Davis, Don Dillard, Jody Frierson, Gary Johnson, Lavonne Key, Carol McAnnally, Jerry Oxford, Viki Smith, Karen Snyder, Jennifer Specchio, Curt Swenson and Steve White

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