|August 2010||TAX POLICY NEWS|
|a monthly newsletter about Texas tax policy|
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In this issue...
Cigars and Tobacco Products Tax
Hotel Occupancy Tax
Recently Adopted Rules
Tax Rate Change for Tobacco Products Other than Cigars and Cigarettes
Pursuant to House Bill 2154 (81st Texas Legislature 2009), the effective tax rate for tobacco products, other than cigars and cigarettes, changes for state fiscal 2011 (Sept. 1, 2010 - Aug. 31, 2011). Beginning Sept. 1, 2010, the new rate will be $1.13 per ounce, plus a proportionate rate on all fractional parts of an ounce.
The new rates for up to two ounces are:
|Total Ounces in Can or Package||Tax for an Individual Can or Package|
|1.2 ounces or less||$1.36|
An expanded rate chart showing tax rates for individual cans or packages weighing up to 15 ounces for state fiscal 2011 and beyond is available on our website.
Franchise Tax and the Construction Industry
This month we'll discuss franchise tax as it relates to the construction industry. In the coming months, we will highlight other industries.
The tax rate is 1 percent for entities in the construction industry, as defined in Division C of the 1987 Standard Industrial Classification Code.
Revenue reportable for franchise tax purposes equals the amounts entered on an entity's federal income tax return, to the extent the amounts entered comply with federal income tax law. Texas Tax Code Section 171.1011(g)(3) allows an exclusion from revenue for certain flow-through funds that are mandated by contract to be distributed to other entities. The specified exclusions include subcontracting payments handled by the taxable entity to provide services, labor or materials for the actual or proposed design, construction, remodeling or repair of improvements on real property or the location of the boundaries of real property.
This exclusion is allowed only when the taxable entity has a contract with its client that states that the taxable entity will subcontract out a specified portion of the work. A general statement saying only that some of the work may be subcontracted out is not sufficient. As provided in Tax Code Section 171.1011(j), any amount excluded from revenue cannot be included in the determination of cost of goods sold or the determination of compensation.
Cost of Goods Sold (COGS) Deduction
Generally, the COGS provisions apply only to entities that sell real or tangible personal property in the ordinary course of business. If not for an exception to the general COGS provisions, most contractors would only be allowed a cost of goods sold for construction materials provided and not for labor. This exception, found in Tax Code Section 171.1012(i), states that "...A taxable entity furnishing labor or materials to a project for the construction, improvement, remodeling, repair, or industrial maintenance of real property is considered an owner of that labor or materials and may include the costs, as allowed by this section, in the computation of cost of goods sold." The caveat is that, to be eligible under this provision, the entity furnishing the labor or materials for a construction project must be physically working on the real property and effecting a change to that property.
A general contractor is hired to construct a private residence. The general contractor's contract with his client states that he will subcontract out all electric, plumbing and HVAC work on the project. The general contractor, therefore, may exclude from revenue the subcontracting payments made to the electrician, plumber and HVAC technician. Once these particular subcontracting payments have been excluded from revenue, they may not be included in the determination of cost of goods sold. Payments made to subcontractors for work not specified in the contract and the costs of direct labor and materials may be included in the cost of goods sold deduction.
An architecture firm is hired to provide all of the design work for a construction project. The architecture firm's contract with the customer says that it will subcontract out the engineering work on this project. Based on this contractual provision, the architecture firm is allowed to exclude from revenue the amounts paid to an engineering firm for work on this project. The architecture firm, however, only produces the plans for the construction project. The architecture firm does not construct, improve, remodel or repair the property (physically work on the real property and effect a change to that property). As a result, the architecture firm is not eligible to take a cost of goods sold deduction for its services.
A general contractor is hired to construct a commercial building. The general contractor hires a transportation company to bring materials to the construction site and haul debris away from the site. The general contractor, who physically works on the real property and effects a change to that property, can include these trucking costs in the cost of goods sold deduction.
The transportation company, however, is not allowed a cost of goods sold deduction. A transportation company is a service provider and does not sell tangible personal property in the ordinary course of business. Transporting materials to or from a construction site is not effecting a change to the real property and does not qualify for the COGS deduction. Also, the transportation company cannot subtract from revenue any subcontracting payments made to independent truckers. The exclusion from revenue for subcontracting payments is allowed only for entities that provide services, labor, or materials for the actual or proposed design, construction, remodeling or repair of improvements on real property or the location of the boundaries of real property.HOTEL OCCUPANCY TAX
Hotel Tax Exemptions for the Texas Military Forces (Texas National Guard and Texas State Guard)
The Texas Military Forces consist of the Texas Army National Guard, the Texas Air National Guard and the Texas State Guard. Whether or not a member or employee of the Texas Military Forces may claim exemption from hotel tax often depends on what duty — federal or state — the member or employee is serving when traveling.
Texas National Guard
The Texas National Guard is made up of the Texas Army National Guard and the Texas Air National Guard. The National Guard is composed primarily of civilians who serve on a part-time basis. In addition, the National Guard has both full-time federal employees and full-time state employees.
A Texas National Guardsman serves a dual state-federal mission and holds membership in the National Guard of the United States and the Texas National Guard. When on "federal active service," a Texas National Guardsman traveling on official business is exempt from state and local hotel occupancy tax as a federal employee. This includes training, required drills, field exercises, encampments, National Guard and military service schools and when attending small arms competitions. See 10 U.S.C. Section 101(d)(3) and 32 U.S.C. Sections 315, 502, 504, 505 and 513. Proof of exemption is documentation, such as federal travel orders, that the National Guardsman is traveling on federal active status.
When called to serve by the governor of Texas, however, members of the National Guard are on "state active duty" and considered state employees. A Texas National Guardsman traveling on official business when on state active duty is not exempt from state or local hotel occupancy tax.
The Texas National Guard, like all Texas state agencies, can request a refund of hotel tax paid to a hotel or reimbursed to an employee. See Tax Code Sections 156.103(b) and (c), 156.154, 351.006(b) and (d) and 352.007(b) and (d).
Full-time federal employees of the National Guard may claim exemption from state and local hotel occupancy tax when traveling on official business. Proof of exemption is a U.S. military ID indicating the person is a federal employee or documentation the employee is traveling on federal status (e.g., federal travel orders).
Full-time state employees of the National Guard, however, are not exempt from state or local hotel occupancy tax, unless called to federal active status. The Texas National Guard may request a refund of hotel tax paid to a hotel or reimbursed to a National Guardsman.
Texas State Guard
The Texas State Guard is a citizen-volunteer force that serves only a state mission. Members of the Texas State Guard are called into service by the governor of Texas and are considered state employees and may not claim an exemption from hotel occupancy tax. The Texas State Guard may request a refund of hotel tax paid to a hotel or reimbursed to a State Guardsman.INSURANCE TAX
HR 4173 and the Impact to State Taxes
Multi-state surplus lines policies have long been an issue for the industry. Some states require payment of the entire tax to their state if the insured is resident or domiciled in their state. Some states require the premium to be allocated to each state that is afforded coverage under the policy. Complicating this further is the fact that there are no national standards on allocation of premium or tax.
Several years ago, Congress proposed legislation called the Nonadmitted and Reinsurance Reform Act (NRRA) in an effort to streamline the reporting of surplus lines taxes and provide guidance for uniformity on business conducted in the nonadmitted insurance market. The provisions of this act were inserted into HR 4173, the financial reform bill signed into law by the President on July 21, 2010.
Under this bill, only the home state of an insured can collect tax on a policy, whether it is a stand-alone or multi-state policy. In order for states to receive their share of taxes on a multi-state policy, states would need to join a compact or other agreement to participate in the allocation of taxes. Currently, a compact of this nature does not exist.
If a state chooses not to join a compact or other agreement, it appears the state would receive and keep 100 percent of the tax on all policies for which it is the home state of the insured. States that follow this method of taxation are commonly referred to as single-situs or non-allocation states.
In 2007, the Texas Legislature enacted House Bill 3315 that gives the Comptroller the authority to join a compact or other agreement for the collection and allocation of multi-state surplus lines taxes. If joining a compact or other agreement is not the most advantageous or appropriate method to protect state insurance tax revenues, the Comptroller has the authority, by rule, to become a single-situs state and would retain the taxes on all multi-state policies for which Texas is the home state.INSURANCE TAX
Reinsurance or Stop-Loss?
Stop-loss or excess loss insurance is a type of indemnity insurance, generally purchased by a self-funded health plan, to reimburse the policyholder for losses that it incurs over a specified threshold on a specific, individual, or on a total basis over a set period of time. It is designed to cut off an insurer or self-insurer's losses at a given point with traditional insurance coverage that is purchased from a licensed insurance company. In effect, stop-loss coverage guarantees the loss ratio of the insurer. This type of insurance can also be used to limit losses on self-funded property and casualty exposures.
Stop-loss insurance is sometimes referred to as "reinsurance." Reinsurance is the acceptance by an insurer, called the reinsurer, of all or a part of the risk of loss covered by another insurer, called the ceding company. It is a way for an insurer to spread its risk and avoid having to pay for large or catastrophic losses. Reinsurance occurs only between insurance companies and is defined as such in several statute references in the Texas Insurance Code, including Chapter 492. In addition, the Merriam-Webster Dictionary defines "reinsure" to mean:
- to insure again by transferring to another insurance company all or a part of a liability assumed, and
- to insure again by assuming all or a part of the liability of an insurance company already covering a risk.
The fact that an insurer cedes business to a reinsurer has no bearing on the taxability of its premiums. Sections 221.002(c)(3) and 222.002(c)(3) govern the taxation of these insurance premiums. Both tax statutes cited provide an exclusion from determining an insurers' taxable premium for premiums received from another authorized insurer for reinsurance. This exclusion from the tax base is to prevent double taxation of premiums, not to prevent taxation completely.
The original insurer is subject to premium and maintenance tax on its gross premiums, regardless of the amount of premium that it cedes to a reinsurer. The reinsurer does not include any assumed reinsurance premium in its tax base because the original insurer has already remitted tax on this premium.
Since stop-loss insurance does not meet the statutory definition of reinsurance between insurers, an insurer should include premiums for stop-loss in its taxable premiums.SALES TAX
Charges to Customers to Recover Texas Franchise Taxes Paid by a Seller
The Texas franchise tax is imposed on most companies that are chartered or organized in Texas or that are doing business in this state. Taxes, like other business expenses such as payroll and insurance, are part of a company's overhead cost of doing business. Many companies incorporate this cost into the prices they charge for their services or goods. A company may, however, choose to charge customers a separately stated fee as a way to recover this cost.
STAR document 201008847L addresses such a charge made by a phone company on billing invoices sent to customers. The Comptroller determined that such a charge, referred to as a "Recovery Charge," is permissible as long as certain parameters are maintained.
A company choosing to bill customers a Recovery Charge may explain to its customers that the charge is made in order to recoup money paid by the company for taxes imposed on it. The company may not, however, represent the charge as a tax imposed directly on the customer. To this end, the Recovery Charge must not appear in the "Government Fees and Taxes" (or similar section) of the customer's bill, invoice or contract. Further, the company should disclose that the Recovery Charge is not a tax the company is required to collect from its customers by law.
If a company collects amounts that are represented to the customer as being a tax on the customer, then those amounts must generally be paid to the state. See Texas Tax Code Section 111.016(a) which provides that, "any person who receives or collects a tax or any money represented to be a tax from another person holds the amount so collected in trust for the benefit of the state and is liable to the state for the full amount collected plus any accrued penalties and interest on the amount collected."
The company may use the term "State Cost-Recovery Fee" to describe any charge it assesses to recoup costs of the Texas franchise tax.
It should avoid using any of the following terms (or variations of them) to describe its Recovery Charge:
- Texas Margin Fee Reimbursement;
- Texas State Margin Fee Reimbursement;
- Gross Receipts;
- Franchise Tax;
- Margin Fee; or
- Texas Margin Fee.
Although the matter is not addressed in the STAR letter mentioned above, the Recovery Charge is part of the total sales price of a taxable item sold by the company. Therefore, it is subject to sales tax in the same manner as the item sold.SALES TAX
Court Case Summary: Southwestern Bell Yellow Pages v. Susan Combs
Printed Material that Serves as a Component Part of another Finished Product is Excluded from Use Tax
On Jan. 30, 2009, the Third Court of Appeals decided Southwestern Bell Yellow Pages v. Combs, 2009 Tex. App. LEXIS 582 (Tex. App. - Austin Jan. 30, 2009, pet. denied). The Texas Supreme Court denied the taxpayer's petition for review, and the case is now final.
The taxpayer purchased paper from various paper mills outside Texas, and the paper was shipped to an out-of-state printer. The taxpayer requested the printer produce telephone books from the provided paper. The telephone books were delivered throughout the United States, including within Texas. The taxpayer paid use tax on the printing charges associated with the telephone books delivered into Texas, and then sought a refund based on Texas Tax Code Section 151.011(a). (Note: Printing is subject to Texas sales and use tax as the production of tangible personal property and is not regarded as a service. See Rule 3.312(b).
Prior to 2003, Section 151.011(a), in relevant part, defined "use" as, "Except as provided by Subsection (c) of this Section, ‘use’ means the exercise of a right or power incidental to the ownership of tangible personal property over tangible personal property."
In Sharp v. Morton Buildings, Inc., 953 S.W.2d 300, 303 (Tex. App. - Austin 1997, pet. denied), the Court held that when raw materials are transformed into other items outside Texas, those raw materials are not subject to the Texas use tax because the raw materials no longer exist.
To reverse the effects of the Morton case, the Legislature amended Section 151.011(a) in 2003 to provide, in relevant part, that "Use means the exercise of a right or power incidental to the ownership of tangible personal property over tangible personal property, including tangible personal property, other than printed material, that has been processed, fabricated, or manufactured into other property or attached to or incorporated into other property transported into this state."
In the case presented, the taxpayer argued that the phrase "other than printed material" in the revised statute does not permit the imposition of use tax on charges for printing performed out of state. The Comptroller argued that the taxpayer was not entitled to a refund because the amendment to Texas Tax Code Section 151.011(a) was intended to exclude the raw materials that make up printed material (i.e., the paper and ink) from the use tax, but not the actual printing.
The Court ruled that the clear, unambiguous language of Texas Tax Code Section 151.011(a) excludes from use tax only printed material that is itself a component part of a final product. The statute does not exclude all printed material as argued by the taxpayer. Nor does the statute exclude purchases of component parts of printed material, such as paper and ink, as argued by the Comptroller.
The Court denied the taxpayer's request for refund.
Following the Court's decision, taxpayers will owe Texas use tax on the total cost of printed materials, including printing, paper and ink, purchased out of state and then shipped or delivered into Texas.
Use tax does not, however, apply to printed materials purchased outside of Texas that have been processed, fabricated or manufactured into other property or attached to, or incorporated into, other property prior to being transported into this state. For example, in Hearing No. 44,048, the taxpayer purchased order forms that were printed outside Texas and subsequently incorporated into catalogs outside of Texas. The catalogs entered Texas at the direction of the taxpayer. The charges paid by the taxpayer to the printer for the catalogs did not include the charges for printing the order forms. As a result, the charges for the order forms were excluded from tax. The charges for the catalogs were subject to Texas use tax.
The Comptroller will amend Rule 3.346, concerning use tax, to implement the Court's decision.RECENTLY ADOPTED RULES
Motor Fuel Tax
The following rule adoption was filed with the Secretary of State on Aug. 4, 2010. The publication date was Aug. 20, 2010, effective 20 days after filing.
Section 3.443 - Diesel Fuel Tax Exemption for Water, Fuel Ethanol, Biodiesel, Renewable Diesel, and Biodiesel and Renewable Diesel Mixtures
State Sales and Use Tax
The following rule adoption was filed with the Secretary of State on Aug. 20, 2010. The publication date is Sept. 3, 2010, effective 20 days after filing.
Section 3.369 - Sales Tax Holiday - Certain Energy Star ProductsABOUT 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
Contributors to This Month's Issue
Teresa Bostick, Robin Corrigan, Lisa Davis, Don Dillard, Jody Frierson, Laurie Gallagher, Gary Johnson, Carol McAnnally, Jerry Oxford, Viki Smith, Karen Snyder, Jennifer Specchio and Steve White