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

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FRANCHISE TAX

Franchise Tax and the Cattle Feedlot Industry

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

Cattle feedlots are described in the Standard Industrial Classification (SIC) Manual as, "establishments primarily engaged in the fattening of beef cattle in a confined area for a period of at least 30 days, on their own account or on a contract or fee basis."

Tax Rate

The tax rate is 1 percent of taxable margin.

Cost of Goods Sold (COGS)

In order to qualify to deduct COGS to compute margin under Texas Tax Code Section 171.1012(a), a taxable entity must be selling "real or tangible personal property (TPP) in the ordinary course of business." The Tax Code defines tangible personal property as "personal property that can be seen, weighed, measured, felt, or touched or that is perceptible to the senses in any other manner." The Tax Code further states that tangible personal property does not include services.

Texas Tax Code Section 171.1012(i) provides that a taxable entity must own the goods it sells or produces in order to deduct COGS. Therefore, ownership of the cattle is a key fact in determining COGS. If the cattle feeder owns the cattle they are raising, then they are allowed to deduct all direct costs of raising the cattle (i.e., all the direct costs of producing the good), including labor costs.

In contrast, if the cattle feeder does not own the cattle, they are generally considered service providers and would not be eligible to compute margin using COGS. Since the cattle feeder is selling feed and medicine in providing its service, however, the mixed transaction provision in Rule 3.588 applies. Rule 3.588(c)(7) provides that in a mixed transaction containing both elements of a service and the sale of TPP, the taxpayer may deduct as COGS the cost of the TPP sold in the transaction. This industry appears to sell the feed and medicine to their customers when providing the feeding service; therefore, they can take COGS related to TPP sold, but not for the service provided.

Company-Owned Cattle

Generally, the following costs will be allowed if they are direct costs:

  • labor
  • cattle
  • feed
  • medicine
  • storage of feed and grain
  • depreciation of production equipment (does not include barns used to house cattle)
  • repair and maintenance of production equipment
  • utilities to operate production equipment
  • rental of production equipment
  • insurance on the cattle and production equipment

All costs that are not specifically excluded from COGS under Section 171.1012(e) will be allowed as indirect costs if allocable to production. Pens and troughs will be considered indirect costs. The amount of indirect costs allowed as COGS is capped at 4 percent of total and indirect administrative overhead costs.

Customer-Owned Cattle

The only costs allowed related to the provision of a feedlot service are the actual costs of feed and medicine. No labor costs, no equipment costs and no other costs will be allowed.

Allocation

If an entity raises both cattle it owns and cattle owned by others, the entity must determine the percentage of cattle owned by the entity for the period upon which the tax is based. This percentage will be applied to all costs incurred by the company in their business to determine the amount of COGS that will be allowed for company-owned cattle.

For example, if repairs and maintenance on production equipment equaled $100,000 for the period upon which the tax is based, and the percentage of company-owned cattle for the period upon which the tax is based is 40 percent, then the amount that will be allowed for the COGS computation will be $40,000.

Indirect costs must be allocated in the same way.

INSURANCE TAX

Surplus Lines and Independently Procured Insurance — Taxability of Policies Sold to State or Federal Agencies and Exemptions/Preemptions

State and federal agencies are not exempt from payment of surplus lines or independently procured taxes on policies purchased. Unless there is a specific exemption or preemption from taxation, policies sold to these agencies are subject to tax. As we will discuss, there are few exemptions or preemptions from taxation for surplus lines and independently procured business.

The Texas Insurance Code, in Sections 225.004 and 226.003, exempts from surplus lines and independently procured taxation respectively, premiums on risks or exposures that are properly allocated to federal waters or international waters or are under the jurisdiction of a foreign government.

"International waters" is defined as being outside the Three Marine League Line, which is approximately 10.4 miles from shore. Texas has full sovereignty over the water; beds and shores; and arms of the Gulf of Mexico within its boundaries, including all land that is covered by the Gulf of Mexico and the arms of the Gulf of Mexico, either at low tide or high tide.

Policies covering risks within 10.4 miles of the Texas coast and Texas inland waters are taxable. Any U.S. possessions or territories as listed with the Office of Territorial and International Affairs of the U.S. Department of the Interior do not qualify as functioning under the jurisdiction of a foreign government; therefore, policies covering risks in these locations remain subject to taxation.

Federal preemptions to state taxation for surplus lines or independently procured insurance exist for premiums on policies that are issued for the following entities: the Federal Deposit Insurance Corporation (FDIC) under 12 U.S.C. §1825 (b), when it acts as the receiver of a failed financial institution that holds the property being insured; the National Credit Union Administration under 12 U.S.C. §1787 (b), when acting as conservator for a liquidating agent for Federal Credit Unions; and a federally chartered credit union under 12 U.S.C. §1768.

The Federal Indian Reorganization Act of 1934 (Act) provides special protection from taxation on activities that occur on tribal lands. Section 1151, Title 18, U.S.C., states that "Indian country" is limited to territory within the United States. Generally, the terms "Indian tribes," "Indian country," "tribal nations" and "Indian reservations" refer to the American Indian tribal lands within the borders of the United States. The limitation on taxation provided by the Act is specific to activities that occur on the tribal lands.

The state, therefore, recognizes a federal preemption from surplus lines and independently procured taxation for insurance that covers exposures within the borders of tribal lands, but not on insured exposures of the tribal nation located outside its borders.

For example, no tax is due for insurance on buildings, equipment or automobiles if they are located within or garaged within the tribal lands. If the buildings, equipment or automobiles are owned by the tribal nation but not located within or garaged within the tribal lands, and are insured under a surplus lines or independently procured policy, tax is due.

Surplus lines or independently procured tax is due on property/building exposures that are leased by a tribal nation. No tax is due for liability insurance exposures on activities that occur within the tribal lands. Liability coverage on activities by a tribal nation that occur outside of the tribal lands is subject to surplus lines or independently procured tax.

The surplus lines tax is due March 1 of each year for business from the previous calendar year and the rate is 4.85 percent of the taxable premium. The independently procured tax is due May 15 following the calendar year in which the insurance was procured, continued or renewed and the rate is 4.85 percent of the taxable premium.

MIXED BEVERAGE GROSS RECEIPTS TAX

Coupons, Tickets and Tokens Redeemed for Alcoholic Beverages

Springtime in Texas means it's time for fairs, carnivals, rodeos and livestock shows to be held throughout the state. Operators of these events often use a redemption sales system (such as coupons, tickets or tokens) instead of cash for attendees' use to purchase food and beverages. By not using cash, an operator is better able to account for sales and may also prevent theft.

In STAR document 200912974L, a livestock fair and rodeo concessionaire claimed that using tokens to purchase alcoholic beverages was against Texas Alcoholic Beverage Commission (TABC) policy. He said he would have to report alcoholic beverage sales based on the total number of tokens sold, and not just those redeemed for alcoholic beverages.

The TABC confirmed this was not the case, and that it had no policies prohibiting using a redemption sales system for purchasing alcoholic beverages.

The Comptroller also does not prohibit an operator from using a redemption sales process to purchase food and alcoholic beverages. Mixed Beverage Gross Receipts Tax Rule 3.1001 provides in subsection (c)(10) that taxable gross receipts include receipts from, "all sales of coupons, tokens, tickets, etc. that are redeemed or used in any manner to purchase or pay for the service of an alcoholic beverage."

Under a redemption sales system, mixed beverage gross receipts tax is calculated based on the number of coupons, tickets, tokens, etc. redeemed for an alcoholic beverage and not on the total number of coupons, tickets, tokens, etc. sold.

The mixed beverage permittee should account for the number of units and dollar amount for each class of beverage (liquor, beer and wine) purchased with a coupon, ticket, token, etc. The permittee must also account separately for the redemption of differently priced drinks, such as call and well drinks. See STAR document 9702248L.

SALES TAX

City Environmental Fee on Plastic Bags Not Taxable

Several Texas cities — including Brownsville, South Padre Island and Fort Stockton — have imposed, or are considering imposing, bans that restrict most businesses from providing non-reusable plastic bags to customers at checkout counters.

In Brownsville, merchants may continue to provide non-reusable plastic bags to customers upon request, but in order to encourage the use of recyclable paper bags, reusable bags or biodegradable bags, the city has imposed a $1 environmental fee on consumers who choose to use non-reusable plastic shopping bags at the checkout. Since this fee is imposed on the purchaser and not the seller, the fee is not subject to sales tax.

In addition, retailers should note that despite the imposition of the city fee on consumers for the use of plastic bags, the resale exemption still does not apply to retailers' purchases of external packaging, including non-reusable plastic bags. Texas Tax Code Section 151.302(c) provides that external packaging, such as bags used for packaging tangible personal property for the purpose of furthering the sale of the tangible personal property, may not be purchased for resale. Rule 3.314(c) provides that sales tax is due on packaging supplies sold to retailers.

SALES TAX

Internet and Catalog Orders

When the Texas sales tax was originally passed in 1961, it included a provision intended to protect Texas vendors from unfair competition from out-of-state vendors: use tax. Texas use tax is complementary to the sales tax and is imposed on any tangible personal property or taxable service delivered into Texas for storage, use or other consumption here.

All purchases of taxable items in Texas, or items purchased outside of Texas that are shipped or brought into Texas for use here, are subject to state and local sales or use tax.

Both in-state and out-of-state sellers of taxable items who are engaged in business in Texas are required to hold a Texas sales and use tax permit, and to collect and remit sales or use tax on all sales of taxable items used or consumed in Texas.

E-commerce (e.g., Internet) and catalog sellers engaged in business in Texas are required to collect tax in the same way as "brick-and-mortar" businesses. There is no difference regarding the application of sales and use tax for purchases made online, by mail or through a physical location. See Rule 3.286, related to seller's and purchaser's responsibilities.

When a purchaser buys a taxable item from an out-of-state seller for use in Texas, the purchaser is liable for both state and local use tax if the item is stored, used or consumed in Texas. This applies whether the item was purchased from a "brick-and-mortar" store, a catalog or an online seller.

If an out-of-state seller does not collect Texas tax on the transaction, and the purchase does not qualify for exemption from Texas tax, the purchaser must report and remit the state and any local use tax due on the purchase. Tax is due on the entire amount charged by the seller, including shipping and handling, even if separately stated, and should be reported and remitted to our office in the period the taxable item is first stored, used or consumed in Texas.

A purchaser who holds a Texas sales tax permit may report the transaction as a "Taxable Purchase" on their sales and use tax return. If the purchaser does not have a sales tax permit, the purchaser should file a Texas Occasional Use Tax Return (Form 01-156) (PDF, 49KB) .

The state use tax rate is the same as the state sales tax rate. The local use tax due is based on the location where the item is first stored, used or consumed in Texas. See Rule 3.346, related to use tax.

SALES TAX

Sales Tax Deductions on Federal Income Tax Returns

Texans who itemize deductions on their federal income tax are able to deduct state and local sales or use taxes when they file their 2010 income tax returns. The deductions include sales or use taxes on big-ticket items such as cars and boats. The state sales and use tax rates of 6.25 percent and up to 2 percent local tax applies to purchases of tangible personal property and taxable services unless the purchaser may claim a valid exemption.

Eligible taxpayers can claim the federal deduction for state sales and/or use tax in one of two ways: they can keep receipts and claim the actual amount of taxes paid, or they can use the tax tables provided by the IRS.

Taxpayers who built a new home or improved their home in 2010 may be able to deduct sales taxes paid on the materials used in the real property improvement. Labor is not taxable for new construction or residential repair and remodeling.

In order for a homeowner to be eligible for such a deduction, the homeowner must have purchased the materials directly from, and paid tax to, the building materials supplier, or worked with a contractor under a separated contract. Lump sum (one price) contracts are not eligible for the deduction. This is because, under Texas Tax Code Section 151.056(a), a contractor performing a contract for a lump sum price covering both the performance of the service and the furnishing of the necessary material is considered the consumer of all materials incorporated into the project. As the consumer, the contractor pays the sales tax on materials and does not collect tax from the customer. See Rule 3.291. Since the customer did not pay tax to the contractor, the customer cannot deduct the tax on the federal income tax return.

SALES TAX

Taxability of Fuel Surcharges

When fuel prices increase, many businesses impose a fuel surcharge on customer billings. For Texas sales tax purposes, fuel surcharges are considered transportation or delivery charges. As such, fuel surcharges billed by the seller of an item become part of the sales price of the item and are subject to sales and use tax in the same manner as the item being sold. If the item sold is taxable, then the surcharge is also taxable, even if separately stated or identified as a dollar-for-dollar reimbursable expense. See Rule 3.303 regarding transportation and delivery fees.

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

Robin Corrigan, Lisa Davis, Don Dillard, Laurie Gallagher, John Huffman, Lindey Osborne, Carol McAnnally, Jerry Oxford, Jo Samuel, Viki Smith, Karen Snyder, Jennifer Specchio, Karen Specht and Steve White

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