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

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FRANCHISE TAX

Hearings Summaries: Qualification for the 0.5 Percent Tax Rate

Following are summaries of hearings regarding the 0.5 percent tax rate available to certain retailers and wholesalers. In each hearing, the taxpayer filed the franchise tax report using the 0.5 percent tax rate. The Comptroller determined that the taxpayer was not eligible for the 0.5 percent rate and recalculated the taxpayer's liability using the 1 percent rate. In each hearing, the Administrative Law Judge upheld the Comptroller's position.

Hearing No. 103,786 (2011)
The taxpayer sells automotive parts, supplies and accessories through various locations in Texas. The taxpayer also provides a variety of automotive services such as brakes, alignment, suspension, batteries, mufflers and tires. The taxpayer maintains an inventory of parts, supplies and accessories that it sells to its retail customers, some of which it installs on customers' vehicles and some of which it sells "over the counter" to its retail customers, who take the uninstalled items with them.

The taxpayer filed its 2008 franchise tax report using the 0.5 percent tax rate reserved for taxable entities primarily engaged in retail or wholesale trade. The Comptroller determined that the taxpayer was primarily engaged in automobile servicing and repair and recalculated the taxpayer's liability using the 1 percent tax rate. This redetermination hearing followed.

The taxpayer contended that it is primarily engaged in retail trade because its revenue from the sale of automotive parts and supplies exceeds its revenue from installation labor. The taxpayer said that only the labor charges fall under the Standard Industrial Classification (SIC) Division for Services; the remaining charges fall under the SIC Division for Retail Trade.

Comptroller staff argued that most of the taxpayer's revenue is derived from the sale and installation of automotive parts and not from over-the-counter sales. Both parties agree that the activities involved in over-the-counter sales of automobile parts and supplies are properly classified within Division G, and specifically under SIC Code 5531, for the retail sale of new automobile tires, batteries and other automobile parts and accessories. Comptroller staff, however, noted that the description for SIC 5531 includes the following comment: "Establishments primarily engaged in both selling and installing such automotive parts as transmissions, mufflers, brake linings, and glass are classified in Services, Industry Group 753 [Automotive Repair Shops]."

The Administrative Law Judge concluded that the Legislature defined the term "retail trade" solely by reference to the 1987 SIC Manual, which does not support the taxpayer's contention that the sale of parts may be excluded from the revenue derived from sale and installation services. According to SIC Code 5531, establishments primarily engaged in both selling and installing automotive parts are considered to be engaged in services. The taxpayer may not exclude the value of parts and supplies from the revenue received from that service activity. Therefore, the taxpayer's primary activity is the sale and installation of automotive parts, not retail or wholesale trade, and the taxpayer does not qualify for the 0.5 percent tax rate.

Hearing No. 104,092 (2011)
The taxpayer is engaged in the business of providing environmental control systems, which allow boilers, chillers, air handling units, lighting and land security systems to function in a coordinated manner, for commercial and industrial buildings. The taxpayer sells the control systems and also performs the design and installation services necessary to integrate the control systems into the building. The taxpayer's customers are general contractors, industrial users, building owners, municipalities, universities and similar institutions.

The taxpayer filed its 2008 franchise tax report using the 0.5 percent rate reserved for taxable entities primarily engaged in retail or wholesale trade. The Comptroller determined the taxpayer was primarily engaged in construction, not retail or wholesale trade, and recalculated the taxpayer's liability using the 1 percent tax rate. This redetermination hearing followed.

The taxpayer argued it is appropriately classified under Division F regarding wholesale trades, specifically Standard Industrial Classification (SIC) Code 5075, a classification within Division F for "establishments primarily engaged in the distribution of warm air heating and air-conditioning equipment and supplies." The taxpayer claimed it is "primarily engaged" in the distribution of air-conditioning equipment because 60 percent of its revenue is derived from the sale of the specialized equipment pursuant to its exclusive distribution agreements, and only 40 percent from the ancillary design and installation activities.

Comptroller staff argued that the taxpayer installs the security systems into the commercial buildings and, therefore, is classified not as a retailer or wholesaler but as a contractor. Comptroller staff cited the SIC Manual, Division C, regarding construction and special trade contractors. Comptroller staff said the taxpayer's activities fall within SIC Code 1731, a classification within Division C for "special trade contractors primarily engaged in electrical work at the site," that specifically includes "electronic control system installation-contractors." Comptroller staff stated a construction contractor is not transformed into a wholesaler simply because the materials costs exceed the labor costs. In addition to the definition cited by the taxpayer, SIC Code 5075 also contains the following statement: "Construction contractors primarily engaged in installing warm air heating and air-conditioning equipment are classified in Construction, Industry 1711."

The Administrative Law Judge determined that the taxpayer's activities fall within the SIC Division C classification for special trade contractors engaged in installation of electronic control systems, as cited by Comptroller staff. The taxpayer would be primarily engaged in wholesale trade only if its revenue from distribution of specialized equipment that it did not install exceeded its revenue from equipment that it did install. The taxpayer has not alleged or proved it acted only as a distributor with regard to any of the specialized equipment. The taxpayer does not qualify for the 0.5 percent tax rate.

Hearing No. 103,340 (2011)
The taxpayer, a Texas-based corporation, markets cosmetics and skin care products and treatments that are researched, developed, manufactured and distributed by the taxpayer's parent company which is located outside of the United States. The taxpayer filed a 2008 franchise tax report applying the 0.5 percent tax rate reserved for retailers and wholesalers. The Comptroller found that the taxpayer did not qualify as a retailer or wholesaler because most of its revenue is derived from the sale of products that it produces or that are produced by an affiliated company. The Comptroller recalculated the taxpayer's liability using the 1 percent tax rate. This redetermination hearing followed.

In the hearing, the taxpayer argued that it qualified as a retailer or wholesaler under Texas Tax Code 171.002(c)(2) because the restriction regarding the sale of products produced by an affiliated entity did not apply to its parent. The taxpayer claimed that it and its parent are not members of the same affiliated group.

The taxpayer stated three contentions: (1) the taxpayer and its parent company are not affiliated because they do not share common owners; (2) the taxpayer and its parent company are not affiliated because the owners of its parent company do not directly own the taxpayer; and (3) Franchise Tax Rule 3.590(b)(1) clearly contemplates that an affiliated group requires a singular common owner, which is not present in the taxpayer's present case.

Comptroller staff cited Texas Tax Code 171.0001(1), which defines an affiliated group as one or more entities in which a controlling interest is owned by a common owner or owners, either corporate or noncorporate, or by one or more of the member entities. Under section 171.0001(8)(A), a controlling interest in a corporation is either a greater than 50 percent, owned directly or indirectly, of the total combined voting power of all classes of stock of the corporation, or, more than 50 percent, owned directly or indirectly, of the beneficial ownership interest in the voting stock of the corporation. Comptroller staff asserts that, given that the parent company wholly owns the taxpayer, the two are members of the same affiliated group.

The Administrative Law Judge determined that the taxpayer's interpretation is not supported by the language of Subsection 171.0001(1). The statute clearly contemplates the ownership structure in this case, with the parent company holding a controlling interest in the taxpayer. Subsection 171.0001(1) explicitly provides that the affiliated group may consist of entities in which a member entity holds the controlling interest. Consequently, the taxpayer's parent is a member of the same affiliated group as the taxpayer, thus disqualifying the taxpayer from using the 0.5 percent tax rate under Tax Code Section 171.002(c)(2).

INSURANCE TAX

Automobile Burglary and Theft Prevention Authority Assessment (ABTPA): Semi-Annual Payment is Due Aug. 1, 2011

The Comptroller's office collects the Automobile Burglary and Theft Prevention Authority (ABTPA) assessment under interagency contract with the Texas Department of Motor Vehicles. The assessment is due as prescribed in Vernon's Texas Civil Statutes, Title 70, Chapter 9, Article 4413(37).

All licensed property and casualty insurance companies that have written any form of motor vehicle insurance in Texas, as defined in Article 5.01(e), Insurance Code, are required to compute and pay the ABTPA assessment. These types of insurance companies include interinsurance or reciprocal exchanges, mutual associations, Mexican Casualty companies or Lloyd's Plans.

Insurers must pay the assessment by August 1 of each year for policies delivered, issued for delivery or renewed from January 1 through June 30. Payments should be made using Form 25-107 (PDF, 896KB) and must reflect the actual assessment due. If no motor vehicle policies have been written for the first six months of the year, Form 25-107 is not due.

The assessment for policies that are delivered, issued for delivery or renewed from July 1 through December 31 of each year must be paid by March 1 of the next calendar year using Form 25-106 (PDF, 95KB) or by using the WebFile system. This report must be filed even if no assessment is due.

Note that insurers making overpayments for the first six months of a year will not receive a refund of any overpayment if they wait until they file Form 25-106 in March of each year. In order to qualify for a refund, a written request must be filed with the ABTPA within six months after the date the assessment is paid as prescribed by Rule 57.51 related to refund determinations.

House Bill 1541 Creates New Assessment Rate Effective Sept. 1, 2011

House Bill 1541, passed in the 82nd Legislative Session, increases the assessment from $1 to $2 per motor vehicle year and applies to policies issued, delivered or renewed after the bill's effective date of Sept. 1, 2011. This has no impact on the assessment due August 1; however, the assessment due March 1, 2012, will be calculated at two rates. Policies issued, delivered or renewed prior to Sept. 1, 2011, will be subject to an assessment of $1 per motor vehicle year and policies issued, delivered or renewed on or after Sept. 1, 2011, will be subject to an assessment of $2 per motor vehicle year. The change will be reflected on the forms that are due March 1, 2012.

If you have refund requests or questions regarding the assessment, please contact the ABTPA at (512) 374-5101. If you need help completing these forms, please call our office at (800) 252-1387, or email us via Texas Tax Help.

SALES TAX

Battling Drought — Sales Tax Exemptions for Items Used to Enhance the Availability of Water

The severe drought covering most of the state has prompted many Texans to examine ways they can save water. Similarly, the rising cost of living has many of us looking for ways to save money. The sales tax exemptions authorized under Tax Code Section 151.355 can help with both objectives.

The exemption applies to equipment, supplies and services used solely for certain types of water conservation. For the purpose of this exemption, "solely" means the equipment, services or supplies are used exclusively for the reason stated.

Items that do not meet the "sole purpose" test, such as water-efficient appliances; pumps for fountains or water displays; artificial turf; tools used for landscaping or lawn care; lawnmowers; shredders; low-flush toilets and water hoses, are not exempt.

For example, a water dam in a toilet tank is used only to save water; therefore it qualifies for the exemption. But, the purchase of a toilet, even if it is a low-water use toilet, does not qualify since the item is not solely used to reduce or eliminate water use.

What Conservation Activities Are Exempt?

The exemption applies to various types of equipment, supplies and/or services used solely in the types of conservation activities listed below.

  • Rainwater harvesting: Tangible personal property used solely for capturing and storing rainwater for subsequent use, such as rainwater filtration and purification equipment and supplies, is exempt from sales tax. Piping or plumbing used to distribute water inside a house or other structure is not considered part of rainwater harvesting equipment and is not exempt from sales tax. Examples of qualifying rainwater harvesting equipment include: rain barrels; gutters used solely to route the water into rain barrels or rainwater collection systems; tanks and cisterns; roof washers used in a harvesting systems; screens and filters for the gutters, barrels, tanks, cisterns and roof washers; and a collection surface area that is not used as a roof of a structure or storage area.
  • Water recycling and reuse: Pipes, pumps or other equipment or supplies (such as chemicals, tanks and cisterns) and water recycling systems for washing machines qualify for exemption when used solely to capture and recycle water.
  • Reduction or elimination of water use: Items used solely to reduce or eliminate water use qualify for exemption. For example, water dams for toilets; timers attached to sprinkler systems; water displacement devices for toilet tanks; and faucet sensors that shut off water flow are exempt. Items such as low-flow shower heads; xeriscaping; native and drought-resistant plants; rock gardens; and artificial turf do not qualify since they are not used solely to reduce water use.
  • Desalination of surface water or groundwater: Desalination is the process of removing salts from undrinkable or brackish surface water or groundwater to obtain useable fresh water or high-quality drinking water. Equipment, services or supplies used solely for desalination such as reverse osmosis systems; cleaning and pickling valves; filters; membranes; pre-filter pumps; product flow meters; salinity meters; and high-pressure control valves qualify for exemption.
  • Brush control designed to increase the availability of water: Brush control is the selective control, removal or reduction from watershed rangelands of mesquite, prickly pear, salt cedar or other deep-rooted woody plants to enhance the availability of water. Equipment, services or supplies used solely for brush control are exempt from sales tax. Bulldozers, root plows, crawler tractors, hydro axes, chains, roller choppers, aerial sprayers, sling blades and similar equipment qualify for exemption when used solely for brush control. Repair services performed on such equipment also qualify for the exemption. Examples of exempt supplies include oil and batteries for qualifying equipment and herbicides used solely for brush control.
  • Precipitation enhancement: Precipitation enhancement is an activity, such as cloud seeding, done to artificially induce rain clouds to produce rain. Purchases of equipment, services and supplies used solely for precipitation enhancement are exempt from sales tax. Examples include end-burning cloud-base flares; acetone solution wing-tip generators; pressure transducers; spectrometer probes; and calibration equipment.
  • Water or wastewater system: Equipment, services and supplies used to construct or operate a water or wastewater system certified by the Texas Commis-sion on Environmental Quality (TCEQ) as a regional system and water or wastewater systems constructed or operated as a public-private partnership qualify for exemption. The exemption also covers a water supply or wastewater system built or operated by a private entity if the system is certified by a political subdivision or by a non-profit water supply corporation created and operated under Chapter 67 of the Texas Water Code. See Rule 3.318 regarding Water-Related Exemptions and Water and Wastewater Systems (Pub. 94-123) (PDF, 1004KB).
  • Fracturing at an oil or gas well: Production and completion require fracturing, which requires injecting a large volume of fresh water into the well to fracture rock formations and release the oil or gas. Recycling and reusing the recovered contaminated wastewater reduces the amount of fresh water used in oil and gas drilling. Equipment and supplies specifically used to process, reuse or recycle the wastewater resulting from the fracturing at an oil or gas well qualify for sales tax exemption.

The purchaser of qualifying items used for the sole purpose of water conservation or reuse must present to the seller a Texas Sales and Use Tax Exemption Certificate (Form 01-339) (PDF, 57KB) stating valid qualifications for the exemption. The certificate must also show the purchaser's name and address; description of the item; the reason the purchase is tax exempt; the purchaser's signature; the date; and the seller's name and address.

SALES TAX

Daily Deals

Daily deals offered by sellers through third parties, such as social media networks and radio stations, are treated as gift certificates. Sales tax is not due on the sale of a deal by a third party.

When the deal is redeemed for a taxable item (either by the original purchaser or someone who may have received the deal as a gift), the deal is treated like cash given for the purchase of the item. If the item purchased is taxable, sales tax is due on the full sales price, including any amount paid with the use of the deal.

For example, a customer purchases a daily deal through an online site that offers $50 worth of food for $25 at a local restaurant. Tax is not due on the customer's purchase of the deal from the online site. When the customer redeems the deal at the restaurant, tax is due on the menu price of the meals and drinks. The value of the daily deal is then applied against that amount.

SALES TAX

Hearings Summary — Use Tax Was Due on a Fishing Vessel Purchased Out of State and Used for Less than One Year Before it Was Brought into Texas

The release of a tax lien did not affect the taxability of the purchase because the lien release did not involve a judicial determination by any party that the assessment was made in error.

Hearing No. 100,446
The Comptroller held that use tax was due under Texas Tax Code Sections 151.101(a), 151.102, and 151.105 on an 85.9-foot fishing vessel1 that was purchased out of state and brought into Texas where it remained. The presumption that the fishing vessel was purchased for use or storage in Texas applied and was supported by the facts, such as the vessel's registration history in Texas and the taxpayer's acknowledgment that it purchased fishing tags from the Texas Parks and Wildlife Department for use when the vessel entered Texas waters.

In order for the Section 151.105 presumption not to apply, the taxpayer had to show that the vessel was used outside of Texas for more than a year. Sales Tax Rule 3.346(c)(5)2. The taxpayer failed to present evidence to show that the vessel had been used outside of Texas for a year; therefore, the Comptroller concluded that the presumption in Section 151.105 had not been avoided.

Additionally, the Comptroller held that a decision to release a lien does not operate as res judicata against reconsideration of the use tax assessment. The Comptroller issued a Release of State Tax Lien filed in Error, which had been filed as a result of the tax assessed on the taxpayer's purchase of the vessel. The release of the lien did not affect the taxability of the purchase because the lien release did not involve a judicial determination by any party that the assessment was made in error.

1 The vessel was subject to sales and use tax, not the boat and boat motor sales tax, because it was over 65 feet in length.

2 The rule has been amended since the hearing became final. This provision is now found in Rule 3.346(e)(2) in the Feb. 9, 2011, amendment of Rule 3.346.

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, Elizabeth Wilson Davis, Lisa Davis, Carol McAnnally, Lindey Osborne, Jerry Oxford, Jo Samuel, Viki Smith, Karen Snyder, Jennifer Specchio and Karen Specht

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