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January 2011 TAX POLICY NEWS
a monthly newsletter about Texas tax policy

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FRANCHISE TAX

Attention Tax Practitioners: New Electronic Filing Method for 2011

Each year, the Comptroller's office works with tax preparation software vendors in the approval of the forms they develop for reporting Texas franchise tax. The software helps tax preparers calculate accurate franchise tax returns, which they print and mail to us for processing.

New for 2011 is the Franchise Tax Web Service. With this technology, software vendors can develop software using XML schemas to securely transmit franchise tax reports and payments to the Comptroller. Tax practitioners using this software will be able to electronically submit tax returns for their clients. The main advantage of this method of electronic submission is receiving immediate feedback about a return's accuracy. Approved vendors will have a "dashboard" (or similar method) to allow a practitioner to log in and check the status of the returns filed.

For example, a practitioner might receive a message that a particular return was received, but accounting year information was omitted for two affiliates. This process will give the preparer time to correct the errors before the Comptroller sends a notice to the taxpayer.

Practitioners will be able to file on behalf of their clients if they have either the taxpayer's WebFile number (included with the "report due" letter we send each taxpayer in February), or if they know the taxpayer's total revenue as reported on the last report on file.

Texas' electronic reporting system is recommended for even the largest taxpayers with multiple affiliates. Three major software vendors are currently in "pending approval" status.

FRANCHISE TAX

Franchise Tax and the Retail Industry

In recent months, we have discussed the franchise tax as it relates to different industries. This month's article highlights the retail industry.

Tax Rate

The tax rate is 0.5 percent for entities primarily engaged in wholesale or retail trade, as defined in Division F and G of the 1987 Standard Industrial Classification (SIC) Manual.

A taxable entity is primarily engaged in retail or wholesale trade only if:

  • the total revenue from its activities in wholesale or retail trade is greater than the total revenue from its activities in trades other than the wholesale and retail trades;
  • less than 50 percent of the total revenue from activities in wholesale or retail 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 (a product is not considered to be produced if modifications made to the acquired product do not increase its sales price by more than 10 percent); and
  • the taxable entity does not provide retail or wholesale utilities, including telecommunications services, electricity or gas.

Note: A thorough discussion of an entity's qualification for the 0.5 percent tax rate appeared in the April 2010 Tax Policy News. Also, as discussed in our article on the restaurant industry in the October 2010 issue, eating and drinking places are considered to be engaged in retail trade even though they produce the products they sell.

Cost of Goods Sold (COGS)

Generally, the COGS provisions apply to entities that sell real or tangible personal property in the ordinary course of business and include all direct costs of acquiring or producing the goods. Wholesalers and retailers typically acquire and then resell tangible personal property and can include as COGS the costs incurred from the acquisition of the goods through to the point of putting the goods on display for sale, as allowed in Texas Tax Code Section 171.1012. Costs incurred once the goods are displayed are considered selling costs and are not allowed as COGS.

Costs allowed as COGS include:

  • the purchase price of the goods;
  • repackaging costs;
  • inbound transportation costs; and
  • storage costs, but not rental of storage space. See Tax Code Section171.1012(e)(1).

Costs not allowed as COGS under Section171.1012(e) include:

  • selling costs;
  • distribution costs (including outbound transportation);
  • advertising costs;
  • rehandling costs; and
  • officers' compensation.

Example 1

A department store chain that sells clothing for men, women and children has several retail stores throughout Texas. The department store chain owns a centrally located distribution center that supplies the retail stores with the acquired apparel.

The following costs are allowed as COGS:

  • the cost of acquiring the apparel;
  • compensation and other expenses (travel, etc.) related to purchasing agents;
  • the cost of transporting apparel to the distribution center;
  • depreciation of the distribution center;
  • depreciation on equipment used in the distribution center;
  • distribution center utility costs;
  • the cost of transporting apparel from the distribution center to the retail stores; and
  • the cost of utilities for the storage area only at the retail stores.

The following costs are not allowed as COGS:

  • rent paid to shopping centers for retail store space;
  • utility costs for the retail store display areas;
  • display racks and display shelving;
  • compensation paid to sales managers and sales personnel;
  • the cost of cash registers;
  • credit card company fees;
  • shopping bags; and
  • tissue.

Example 2

A grocery store chain has stores located throughout central Texas and rents a distribution center located in San Antonio.

The following costs are allowed as COGS:

  • the cost of acquiring the groceries;
  • compensation and other expenses (travel, etc.) related to purchasing agents;
  • the cost of transporting the groceries to the distribution center;
  • depreciation on equipment used in the distribution center;
  • distribution center utility costs;
  • the cost of transporting groceries from the distribution center to the grocery stores; and
  • compensation paid to employees that stock the shelves.

The following costs are not allowed as COGS:

  • rent paid for the distribution center;
  • rent paid for the grocery store space;
  • refrigerated display cases;
  • shelving for grocery display;
  • compensation paid to cashiers and baggers;
  • the cost of cash registers;
  • credit card company fees; and
  • grocery bags.
HOTEL OCCUPANCY TAX

Hearing Summary: Audit of Hotel that Only Accepted Cash Upheld

Hearing No. 101,635 (2010)

During an audit of a hotel, the only available hotel records the examining auditor had for the audit period were three federal income tax returns, some bank statements and customer questionnaires. The hotel only accepted cash as payment for hotel rooms and did not maintain detailed or summary reports that could support what the hotel had reported as taxable room receipts.

Because of the lack of records, the auditor estimated the audit on the best records available, as authorized in Texas Tax Code Sections 111.0042, 111.0043 and 111.008. The auditor determined an average room price from rates provided in customer questionnaires. He determined an average occupancy rate from regional hotel reports during the audit period for the area where the hotel was located. The auditor multiplied the average room rate by the number of rooms available for rent and then by the occupancy rate to calculate the estimated room revenue. Credit was given for taxable room receipts the hotel had reported and the 6 percent state hotel occupancy tax was assessed on the difference. Penalty and interest were added to the tax, as provided in Tax Code Sections 111.060 and 111.061.

The hotel, on redetermination, contended that the audit should be based on bank statements, loan documentation and partner distribution documents. Comptroller staff, however, found that the documentation was unreliable. Monthly deposits did not match the summary records the hotel did have, nor did they match monthly debits and checks. The hotel only accepted cash from guests and there were no internal controls to verify that all hotel receipts were deposited.

In response to the Comptroller's position, the hotel provided additional records and documents, but did not explain the documents or show how they supported an alternate method for an audit. The administrative law judge ruled the hotel had not met the required burden of proof that the audit was inaccurate and recommended no changes to the audit.

INSURANCE TAX

Allocation of Premiums on Various Life Insurance Products

Insurers licensed in Texas must allocate premiums according to the requirements of the applicable tax statutes in the Insurance Code without regard to National Association of Insurance Commissioners (NAIC) guidelines or Statutory Accounting Principles (SAP) for completion of the NAIC Annual Statement. Insurers are subject to a tax audit adjustment if their premium tax allocation for Texas does not agree with the tax statutes.

Statutory Accounting Principles were promulgated with a focus on insurer solvency. As the income of the insurer is not the focus of the SAP, NAIC guidelines for allocating premiums are incompatible with the Texas insurance tax statutes because they allow flexibility in the allocation of premiums to the states on Schedule T of the annual statement. If an insurer has exercised this option for annual statement reporting, and uses Schedule T as the basis for the payment of premium tax, it would be subject to an audit adjustment plus applicable penalty and interest for any underpayment of taxes.

As an example, "company-owned life insurance" (COLI) and "business-owned life insurance" (BOLI) involve insurance on employees where the employer is the named beneficiary. The owners of such policies are generally the employer or a trust set up to hold and administer the insurance coverage. In these situations, a company, such as a bank, may purchase life insurance policies for officers of the bank. NAIC Schedule T guidelines allow insurers to allocate such premiums to the state of the bank's home office or where the "trust" that owns the policies is located. For tax purposes, if Texas residents are covered by such a policy or policies, a portion of the premium is subject to Texas premium and maintenance taxes, regardless of how the insurer allocates the premium on Schedule T.

Another example is "stranger-owned/originated life insurance" (STOLI/SOLI) or Speculator Initiated Life Insurance (SPINLife). These policies and their complex arrangements are typically marketed to seniors by promoters or investors who encourage them to purchase a significant amount of life insurance. The promoter will often lend the senior the money to pay the premiums up front, plus an additional amount of cash as an added incentive. If the senior does not wish to keep the policy after two years, then the policy can be transferred to the investor and when the senior dies, the "stranger" will receive the death benefit. Instead of being used as an estate planning tool, this policy becomes an investment vehicle for the promoters and investors. The Texas Department of Insurance, in addition to the insurance departments of other states, has been investigating this type of arrangement, primarily because there does not appear to be an insurable interest in the life of the insured by the investor/promoter. The premiums paid for these policies are properly allocated to the state in which the senior or the person whose life is insured resides.

During the 2007 session, the Texas Legislature clarified the taxation of life, health and accident policies and coverage by Health Maintenance Organizations. Section 2 of House Bill 3315 amended Section 222.002 (b) of the Insurance Code to state that taxpayers:

". . . shall include the total gross amounts of premiums, membership fees, assessments, dues, revenues, and other considerations received by the insurer or health maintenance organization in a calendar year from any kind of health maintenance organization certificate or contract or insurance policy or contract covering risks on individuals or groups located in this state . . ."

Taxpayers should be aware of the statutory basis for the taxation of premiums for COLI, BOLI and STOLI/SOLI/SPINLife policies and ensure that they report correctly for premium and maintenance tax purposes.

SALES TAX

Hearing Summary: Cases and Holders Used in the Repackaging of Coins

Hearing No.102,623 (2010)

The taxpayer operates a jewelry store where it also sells collectible coins. The taxpayer purchased coin cases and holders to package its coins for sale and shipment to its customers. The cases and holders were purchased free of tax.

The taxpayer was audited for the period April 1, 2005, through July 31, 2008. The auditor scheduled the purchases of the cases and holders as taxable packaging supplies. The taxpayer requested a redetermination of the sales and use tax assessment made by the auditor on the purchases of the cases and holders.

In the hearing, the taxpayer claimed the coin cases and holders become an integral part of the coins and that the cases and holders are necessary to preserve the value of the coins.

Comptroller staff argued the taxpayer was a retailer and its purchases of coin holders and cases were taxable packaging supplies under Texas Tax Code Section 151.302(c). This section does not allow a resale exemption for packing and wrapping supplies purchased in the furtherance of a sale of tangible personal property. Additionally, Tax Code Section 151.302(c) provides that packaging supplies used in wrapping or packing tangible personal property for the purpose of furthering the sale of tangible personal property may not be purchased for resale.

The Administrative Law Judge determined that the taxpayer was a retailer, not a manufacturer, and that as such, the taxpayer was not eligible to claim an exemption for packaging and wrapping supplies.

SALES TAX

Tax-Free Sales by Qualified Nonprofit Organizations: It's a New Calendar Year

In general, nonprofit organizations are required to collect sales tax on their sales of taxable items and services. A nonprofit religious, educational or charitable organization, or an organization exempted under Internal Revenue Code, Sections 501(c)(3), (4), (8), (10), or (19) may apply for and receive exemption from sales tax on its purchases, based on criteria in Texas Tax Code Sections 151.310(a)(1) and (a)(2). Once exempt, the organization and each of its bona fide chapters is permitted to hold two one-day, tax-free sales each calendar year. This exemption is found under Texas Tax Code Section 151.310(c).

A qualified organization that has obtained sales tax exemption, as described above, must designate in its records prior to the sale which two one-day sales will be exempt that calendar year. This may require careful planning and coordination for organizations operating on a fiscal year basis. For example, PTAs, PTOs and other school groups commonly plan events based on school years rather than calendar years. When planning fundraising activities for a new school year, school groups should verify the number of tax-free fundraisers conducted by the organization during the prior school year that occurred during the current calendar year.

See School Fundraisers and Texas Sales Tax (Pub. 94-183) (PDF, 412KB), Exempt Organizations - Sales and Purchases (Pub. 96-122) (PDF, 407KB) and Rule 3.322 for more information about fundraisers and exempt organizations.

SALES TAX

Texas Appliance Mail-In Rebate Program - Rebate Does Not Reduce Taxable Sales Price

The Texas Appliance Mail-In Rebate Program, which began Dec. 20, 2010, allows qualifying Texas residents with a valid Texas residential address to apply for a rebate of up to $1,000 for the purchase of an eligible ENERGY STAR appliance.

The rebates offered through this program do not reduce the amount of sales tax due on the sale of eligible appliances.

Rebates issued after a sale occurs, that are sent directly to a consumer by someone other than the seller, (such as a manufacturer or government agency) do not reduce the sales price the retailer charges the customer, nor do they reduce the amount of sales tax due on the purchase of a taxable item. The retailer must calculate the amount of tax due on the total sales price of the item at the time of sale, and cannot reduce the taxable sales price by the amount of rebate a purchaser will receive.

For example, a qualifying refrigerator sold for $1450 during the program is eligible for a rebate of up to $250. A customer buys the refrigerator for $1450 then mails in the required documentation to apply for the $250 rebate. Since the rebate will be paid directly to the purchaser after the sale, the rebate does not reduce the sales price of the new appliance and the retailer must collect tax on the total amount charged to the customer.

OTHER NEWS

Interest Rates for 2011

Delinquent taxes accrue interest beginning on the 61st day after the due date until paid.

This year, the interest rate is 4.25 percent (.0425) or 0.01164 percent per day.

Refund claims filed with the Comptroller's office accrue credit interest at either Treasury Pool rate or Prime +1, whichever is less. The Treasury Pool interest rate this year is 0.921 percent (.00921) per day.

For more information about how the interest rate is applied (as well as the interest rates for this year and previous years), please see the Interest on Credits and Refunds and On Tax Due section of our website.

RECENTLY PROPOSED RULES

State Sales and Use Tax

The following rules were submitted for filing with the Secretary of State with a publication date of Dec. 31, 2010. The comment period is 30 days after publication.

3.322 - Exempt Organizations

3.325 (Repealed) - Refunds, Interest and Payments Under Protest

3.325 - Refunds and Payments Under Protest

3.339 (Repealed) - Statute of Limitations

3.339 - Statute of Limitations

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 website.

Contributors to This Month's Issue

Teresa Bostick, Robin Corrigan, Lisa Davis, Don Dillard, Gary Johnson, Carol McAnnally, Stefanie Medack, Jerry Oxford, Viki Smith, Karen Snyder, Jennifer Specchio, Karen Specht, Eric Stearns and Steve White

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