I’ve posted two blogs that cover the first two steps in computing the Texas Franchise Tax – the computation of “taxable margin” and the computation of the appropriate “apportionment factor.” Those posts can be found here and here. In this post, I’ll discuss the third step – determining and applying the correct tax rate.
Applicable Tax Rates
Once the apportioned margin has been computed, taxpayers must apply the appropriate tax rate to determine the amount of Texas Franchise Tax they’re responsible for paying. Texas Tax Code § 171.002(a) provides that the standard rate is 0.75% of the apportioned margin. [1] However, there is a separate rate of 0.375% of the apportioned margin that applies to entities “primarily engaged in retail or wholesale trade.” [2]. This raises two questions: (i) what is “retail or wholesale trade,” and (ii) when is an entity considered “primarily engaged” in such trade?
- Retail or Wholesale Trade
While the Texas Tax Code does not define “retail trade” or “wholesale trade,” the Comptroller’s regulations do. With respect to Texas Franchise Tax reports originally due on or after January 1, 2014, Comptroller Rule 3.584(b)(5)(C) defines “retail trade” to include the following:
- The activities described in Division G of the SIC Manual;
- Apparel rental activities classified as Industry 5999 or 7299 of the SIC Manual;
- The activities classified as Automotive Repair Shops, Industry Group 753 of the SIC Manual;
- Rental-purchase agreement activities regulated by Business & Commerce Code, Chapter 92;
- Rental or leasing of tools, party and event supplies, and furniture, classified as Industry 7359 of the SIC Manual; and
- Heavy construction equipment rental or leasing activities, classified as Industry 7353 of the SIC Manual. [3]
The first category above is the broadest. The 1987 SIC Manual (Standard Industry Classification Manual) is used to classify various occupations into industries and is used in many tax-related contexts, including the Texas Franchise Tax and the federal income tax. Division G (Retail Trade) includes the following general industries:
- Building Materials, Hardware, Garden Supply, and Mobile Home Dealers
- General Merchandise Stores
- Food Stores
- Automotive Dealers and Gasoline Service Stations
- Apparel and Accessory Stores
- Home Furniture, Furnishings, and Equipment Stores
- Eating and Drinking Places
- Miscellaneous Retail [4]
Comptroller Rule 3.584(b)(7) defines “wholesale trade” to mean “the activities described in Division F of the SIC Manual.” [5] Division F of the SIC Manual, in turn, generally covers businesses engaged in selling goods to retailers, contractors, professional business users, or other wholesalers. [6]
Revenue from either of these categories will be considered derived from “retail or wholesale trade” for Texas Franchise Tax purposes.
- Primarily Engaged
Texas Tax Code § 171.002(c) states that a taxable entity is primarily engaged in retail or wholesale trade only if:
- The total revenue from its activities in retail or wholesale trade is greater than the total revenue from its activities in trades other than the retail and wholesale trades;
- Except as provided by Subsection (c-1), less than 50 percent of the total revenue from activities in retail or wholesale 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; and
- The taxable entity does not provide retail or wholesale utilities, including telecommunications services, electricity, or gas. [7]
The exception noted under #2 applies only to businesses falling within the retail group category of “Eating and Drinking Places” – total revenue from these businesses will not be considered in this factor.
If a taxable entity is not part of a “combined group” and does not provide retail or wholesale utilities, the only relevant factor is #1. This involves weighing the total revenue attributable to “retail or wholesale trade” against total revenue from other trades. If the “retail or wholesale trade” revenue is greater than the other trade revenue, the taxable entity will be eligible for the 0.375% tax rate.
My recent posts regarding the computation of the Texas franchise tax are only a brief summary of the steps involved – each of the computations involves many additional steps, sub-steps, and nuances, and are further complicated by current and pending case law interpreting the applicable Texas Tax Code provisions. There are also some exceptions to the entire framework discussed in these posts, which I’ll cover in a final post to come. However, if you think you may be subject to the Texas Franchise Tax or need assistance in computing the amount of this tax, please contact Freeman Law for a consultation.
[1] Tex. Tax. Code § 171.002(a).
[2] Tex. Tax Code § 171.002(b).
[3] 34 Tex. Admin. Code § 3.584(b)(5)(C).
[4] See SIC Manual, Division G, available at https://www.osha.gov/data/sic-manual/division-g.
[5] 34 Tex. Admin. Code § 3.584(b)(7).
[6] See SIC Manual, Division F, available at https://www.osha.gov/data/sic-manual/division-f.
[7] Tex. Tax Code § 171.002(c).
