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

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COIN-OPERATED MACHINES TAX

General Business License Holder Must Have Criminal Background Check

Criminal background checks are completed on all persons applying for or renewing a general business license, but are not requested on persons applying for or renewing a registration certificate.

The Texas Coin-Operated Machines Law (Occupations Code Chapter 2153) provides that a person must have a general business license to operate and exhibit a coin-operated amusement machine at another person's place of business. A general business license holder may also manufacture, buy, sell, rent, lease, trade and transport coin-operated amusement machines. See Section 2153.152(b).

The law, in Section 2153.302, requires the Comptroller to deny a general business license to an applicant who has been convicted of a felony within five years of the date of application. Also, an applicant cannot have been placed on community supervision or released on parole for a felony conviction during the two years prior to the date of application.

The Texas Department of Public Safety conducts the criminal background checks. After receiving the criminal history on an applicant, the Comptroller will issue or deny the general business license.

In addition to not being subject to a criminal background check, a registration certificate holder is also exempt from the licensing and recordkeeping requirements of the Coin-Operated Machines Law. Section 2153.008 exempts a person who owns or exhibits a coin-operated amusement machine if the person operates or exhibits the machine only at the person's business; does not own a coin-operated machine located at another person's place of business; and does not have a direct or indirect financial interest in the coin-operated machine industry other than ownership of a coin-operated amusement machine.

The person is, however, required to obtain a registration certificate and to comply with all application information requirements. See Sections 2153.156 and 2153.157, respectively.

Additional information is available in the Coin-Operated Machines Tax section of our website.

FRANCHISE TAX

Determining the Tax Rate for Retailers/Contractors

In recent months, we have discussed the franchise tax as it relates to both the construction industry (August 2010) and the retail industry (January 2011). In this month's article, we discuss the franchise tax rate in relation to entities that have revenue from both retail and construction activity. Examples of such entities may include flooring retailers/contractors, window and door retailers/contractors, heating and air-conditioning retailers/contractors and plumbing retailers/contractors.

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. (Our April 2010 newsletter article provides complete instructions for determining if an entity is primarily engaged in retail or wholesale trade.)

For retailers/contractors, the confusion lies in the first step, Tax Code Section 171.002(c)(1), which involves analyzing and separating total revenue by SIC code 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.

In its introduction to Division C, Construction, the SIC Manual concedes that,

"Establishments primarily engaged in the distribution and construction or installation of equipment often present classification problems."

The introduction further concludes that:

"...separate establishments primarily engaged in the sale and installation of the following illustrative types of structures or integral parts of structures generally site assembled, are classified in construction rather than in trade:
  1. Steel work on bridges or buildings;
  2. Elevators and escalators;
  3. Sprinkler systems;
  4. Central air-conditioning and heating equipment;
  5. Communications equipment; and
  6. Insulation materials.
On the other hand, establishments primarily engaged in the sale and installation of the following illustrative types of preassembled equipment are classified in trade rather than in construction:
  1. Major household appliances, such as refrigerators, dishwashers, clothes washers and dryers, stoves and ranges; and
  2. Partitions for banks, stores, and restaurants."

Therefore, the sale and installation of materials into real property is properly classified as construction activity. The total revenue from a business activity (Construction, Division C) cannot be broken out into components of that business activity to be classified in Division F or G.

Example:

A taxable entity has a retail store where it sells various types of flooring: wood, tile, carpet, etc. Customers come into the store, purchase flooring and remove it from the premises to either install themselves or have a contractor install. The store also offers installation of the flooring, where customers come into the store, choose flooring, and the store installs the flooring for the customer, using either the store's own employees or a subcontractor to complete the job.

Following is the entity's 2010 revenue breakdown:

Materials purchased without installation$5 million
Materials purchased with installation$3 million
Installation services$4 million

To determine if this entity is primarily engaged in wholesale/retail trade and, therefore, eligible for the 0.5 percent franchise tax rate, the entity's total revenue must be separated by SIC Classification. Revenue from materials sold without installation, $5 million, is classified under Division G, Retail Trade. Revenue from the sale of flooring that is installed falls under Division C, Construction, which encompasses the sale and installation of materials and totals $7 million. This entity will not qualify for the 0.5 percent tax rate as the total revenue from activities in construction, $7 million, is greater than the total revenue from activities in retail or wholesale trade, $5 million.

INSURANCE TAX

Surplus Lines Premium Tax Prepayments, Including Penalty and Interest Considerations

Premium tax is collected from three groups of taxpayers: insurance companies, surplus lines agents and policyholders who have purchased policies of insurance outside Texas from companies that are not licensed to do business here. Insurance companies, including health maintenance organizations, pay the greatest portion of premium tax. The second largest group of premium taxpayers is surplus lines agents.

Until Jan. 1, 2000, surplus lines agents were required to maintain separate tax trust accounts in the name of the Texas Department of Insurance (TDI), with the agent shown as a trustee on the accounts, for the deposit of premium taxes collected on policies placed in the surplus and excess lines insurance market. The TDI adopted rules in an effort to require agents to monitor the balances in such accounts so that the accounts remained below the Federal Deposit Insurance Corporation's $100,000 insured limit. While this did afford some protection of state tax monies in the event of a bank insolvency, it failed to provide adequate protection of state funds when multiple agents maintained accounts at the same financial institution since all accounts in the name of the TDI that carried the TDI federal tax identification number were considered together for purposes of FDIC insurance.

In an effort to address this situation, House Bill 3211 (passed by the Texas legislature in 1999) removed the requirement for a separate account and has since required agents to prepay taxes by the 15th of the month following any month in which the accrued taxes equal or exceed $70,000. The prepayment amount must equal the accrued liability at the end of the month in which the $70,000 prepayment threshold is reached. The surplus lines prepayment form (PDF, 50KB) is not required if prepayments are made electronically.

During an audit of an agent or agency's premium tax returns, the tax prepayments that were made will be compared to the monthly tax liability according to the agent or agency's books and records. If the auditor finds that taxes were prepaid late, and if the taxpayer did not exercise reasonable diligence in making these prepayments, these payments are subject to penalty assessment. Regardless of a finding of reasonable diligence, accrued interest will be assessed for these late prepayments. Remember that the reports produced by the Surplus Lines Stamping Office of Texas are not to be used for tax reporting and payment purposes.

In addition to prepayment penalty and interest, the auditor will separately evaluate any audit penalty and interest that might be assessed on additional tax due.

SALES TAX

The Sales Tax Export Exemption - An Overview

Tax Code Section 151.307 provides an exemption from Texas sales and use tax on tangible personal property purchased in Texas and exported to another country.

Texas sales tax is not due when a purchaser buys an item here and has the seller ship it to another country, or has the seller send it directly to a freight forwarder for export. Shipping documentation must be maintained in the seller's records to show why tax was not collected on these types of sales.

A receipt from a common carrier, such as the United States Postal Service, United Parcel Service (UPS) or Federal Express, is sufficient to show that the seller shipped the item to another country provided the receipt includes a description of the item or items being exported.

When the seller delivers the item to a freight forwarder, the seller must receive both a freight forwarder's receipt and a copy of the original bill of lading issued by a licensed and certificated carrier that describes the property being exported to document the exemption. In some cases, customers purchase items from several retailers and the freight forwarder ships in one shipment with one bill of lading.

Even though the shipment is exported with only one shipper (consignor) showing on the bill of lading, the shipment leaves the country with several invoices, thus more than one shipper. In these instances, a copy of the bill of lading together with the receipt from the freight forwarding company showing that the seller delivered the items are sufficient to prove export. See STAR letter 9303L1230B12.

A seller must collect sales tax when a customer picks up or takes delivery of taxable items in Texas, even if the customer later exports those items.

Once the items have been exported, the purchaser may request a refund of the tax paid from the store where the purchase was made, or, in some situations, directly from our office, as long as the purchaser provides the necessary proof of export documentation, and the applicable waiting period has passed.

Examples of acceptable proof are a bill of lading, customs broker's exemption certificate, or entry documents from the destination country. Only one type of proof relating to a particular piece of property is necessary. See Rule 3.323 for more information.

Use Before Export Causes Loss of Exemption

If the owner uses the goods before exporting them, the export exemption is lost.

For example, if a customer buys a hat in Texas and wears it, the purchaser may not request a refund of the tax paid on the hat, even if the purchaser subsequently exports it when leaving the U.S. Wearing the hat is a taxable use of the item in this state.

Property kept in Texas for more than 30 days from the date of purchase is presumed to have been stored, a taxable use of the property under Texas law. Property stored in Texas by the owner loses its exemption as an export. Property in the hands of a freight forwarder is not covered by this provision.

Motor Vehicle Maintenance and Repair

Texas tax is due on motor vehicle repair and replacement parts (including tires, batteries and windshield wipers) installed on a motor vehicle in Texas, even if the vehicle is licensed or registered in another country. The export exemption does not apply, and the purchaser is not eligible for a refund of tax paid on such parts.

Since the vehicle on which the parts are installed is in Texas at the time of the service, any driving, storage or movement of the vehicle after installation constitutes a use of the parts here.

As an example, a customer from Nuevo Laredo brings his car to a tire shop in Laredo to have new tires installed. After the tires are installed, the customer immediately drives the vehicle back to Nuevo Laredo. In this scenario, the customer must pay tax on the tires at the time of purchase and is not eligible for a refund of tax paid on the tires. Since the vehicle on which the tires were installed was driven in Texas, the tires were used here prior to export and thus are not eligible for the exemption.

The export exemption does, however, apply to parts exported to another country before being installed on a vehicle.

For example, an auto parts store in Brownsville sells a battery and windshield wipers to a purchaser who plans to export them to Somalia to be installed on a truck there. The purchaser must pay tax on the parts at the time of purchase because he is taking possession of the goods in Texas.

If the parts are not installed on a vehicle, or otherwise used in Texas before export, the purchaser may apply for a refund of the tax paid on the purchase after the parts are exported by providing the appropriate documentation.

Although the general exemption under Section 151.307 for exported items does not apply to motor vehicle repair and replacement parts installed on a motor vehicle while in Texas, Tax Code Section 151.3071 does provide a specific exemption for electronic audio equipment (such as car stereos) purchased for use outside the U.S., even if the equipment is installed in a vehicle while in Texas.

Under this exemption, a person who purchases electronic audio equipment for use outside the U.S. must still pay tax on the goods at the time of purchase, but can seek a refund of the tax after the equipment has been exported.

Internet Purchases and Exports - Original Receipt Required

Texas Tax Code Section 151.1575 provides that a purchaser seeking a refund of Texas tax paid on exported items must provide an original receipt to a Texas licensed customs broker to receive an export certification. In addition, the purchaser must show the original receipt and the appropriate export documentation to the seller in order to obtain a refund. An original receipt has traditionally been a cash register receipt issued to the customer by the seller at the time of purchase.

When a customer purchases an item over the Internet, a cash register receipt may not be provided, and many online sellers recommend that purchasers print a confirmation page as proof of purchase. A receipt printed by the customer for an Internet purchase, however, is not sufficient documentation for export certifications and refunds.

Packages shipped to Texas locations from Internet vendors should contain an invoice, shipping document or original receipt printed by the seller showing the amount of Texas tax collected on the sale. Rule 3.286(d)(3) specifies that the amount of sales tax collected must be separately stated on a bill, contract or invoice to the customer.

When applying for an export certification for Internet purchases, customers must provide the shipping documentation or receipt enclosed in the package by the vendor.

The shipping documentation or receipt should provide a description of the items purchased; clearly display the amount of Texas tax collected on the sale; and indicate that the package was received by the customer in Texas.

If the shipping documentation included with the package does not include all of the information required, the customer may provide a receipt printed from a personal computer in addition to the seller's shipping documentation.

Exports by U.S. Citizens and Legal U.S. Residents - Customs Broker Certifications

Whether a purchaser is a U.S. citizen or legal U.S. resident (with a green card) is not a determining factor in obtaining a refund of Texas sales and use tax.

Anyone who purchases taxable items in Texas for export may seek a refund of the taxes paid on those items as long as they provide the necessary proof of export documentation as outlined in Rule 3.323(c).

According to Rule 3.360, however, a licensed Texas customs broker may only issue an export certification form to a permanent legal resident of the U.S. or a U.S. citizen if the customs broker, an authorized employee or a verification contractor personally witnesses the property being transported across the U.S. border or personally witnesses the property being placed on a common carrier for delivery outside U.S. territorial limits.

Travel documentation (such as a passport, airline ticket or bus ticket) cannot be used by a U.S. citizen or legal resident to obtain export certification from a licensed Texas customs broker.

Travel documentation may only be used to obtain an export certification when the purchaser is a citizen of, and resides in, another country, and the destination country is where the purchaser resides. See Rule 3.360 (b) (3) for additional information.

Sales to Mexican Retailers for Resale

Retailers from Mexico may claim an exemption from Texas sales and use tax when purchasing taxable goods that they will resell in the normal course of business in Mexico by issuing a properly completed Texas Sales and Use Tax Resale Certificate (Form 01-339) (PDF, 57KB) or the Border States Uniform Sale for Resale Certificate (Form 01-909) (PDF, 47KB) to suppliers at the time of purchase.

The resale certificate must show the retailer's Mexico Federal Taxpayers Registry (RFC) identification number, and the retailer must give a copy of their Mexican Registration Form to the Texas supplier. A resale certificate may not be issued or accepted for taxable items that will be resold in any other country. See Rule 3.285.

Maquiladoras

A maquiladora enterprise is a business entity chartered by the government of the United Mexican States and authorized by that government to make duty-free imports of raw materials, component parts or other property into Mexico to be used in manufacturing, processing or assembling items by the business entity in Mexico primarily for export from Mexico.

A maquiladora enterprise wishing to make tax-free purchases in Texas for export to Mexico may file a Texas Application for Maquiladora Export Permit (Form AP-153) (PDF, 331KB) with our office, including a copy of the maquiladora authorization form issued by the Mexican Secretaria de Comercio y Fomento Industrial showing the number by which the company is listed in the registry of in-bond companies.

When buying taxable goods that will be exported to Mexico, a maquiladora export permit holder may claim an exemption from tax at the time of purchase by providing the seller a Texas Maquiladora Exemption Certificate (Form 01-374) (PDF, 90KB) and a copy of the maquiladora export permit issued by our office to the seller.

Do Export Certifications Issued by a Licensed Texas Customs Broker Expire?

The statute of limitations for seeking a refund of Texas sales and use taxes is four years from the date the tax was originally due and payable. Once a purchaser has obtained an export certification from a licensed Texas customs broker, the purchaser may seek a refund of tax paid on exported items for up to four years from the date of purchase.

The expiration date printed on the certificate is the date that the export certification stamp attached to the certification expires, not the date that the certification itself expires.

Export certification stamps expire each calendar quarter and are color coded and numbered so our office can easily monitor them. Texas licensed customs brokers must purchase new stamps each quarter and cannot issue a stamp after its expiration date has passed.

An export certification stamp attached and assigned to an export certification prior to the stamp's expiration date is valid for four years. The export certification stamp expiration date does not affect the validity of the purchaser's refund claim.

Sales and Use Taxes Paid to Other States

The provisions related to obtaining a refund of Texas sales and use taxes on exports apply only to taxable items purchased in Texas.

Sellers in Texas should not issue a refund of tax based on export documentation for items purchased in other states, even if the purchase was made at another branch of the same company or an affiliated company. For example, a purchaser who buys a television set at a Wal-Mart in Oklahoma and exports it cannot obtain a refund of the taxes paid to Oklahoma on that purchase from a Wal-Mart in Texas.

Purchasers who bought items in another state and paid tax must contact that state for information about obtaining a refund.

RECENTLY ADOPTED RULES

State Sales and Use Tax - Section 3.346 Use Tax

The following rule adoption was filed with the Secretary of State on Jan. 20, 2011, with a publication date of Feb. 4, 2011, effective 20 days after filing.

Section 3.346 - Use Tax

State Sales and Use Tax - Section 3.333 Security Services

The following rule adoption was filed with the Secretary of State on Feb. 02, 2011, with a publication date of Feb. 18, 2011, effective 20 days after filing.

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 website.

Contributors to This Month's Issue

Teresa Bostick, Robin Corrigan, Lisa Davis, Don Dillard, Carol McAnnally, Lindey Osborne, Jerry Oxford, Jo Samuel, Viki Smith, Karen Snyder, Jennifer Specchio and Steve White

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