Texas Court of Appeals Rules on Apportionment and Cost of Goods Sold

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On May 1, 2020 the Texas Court of Appeals Third District ruled in favor the Texas Comptroller of Public Accounts in the matter of Hegar et al. v. Sirius XM Radio, Inc., et al., Tex. App. Ct. (3rd Dist.), No. 03-18-00573-CV, and reversed the refund that was awarded to Sirius XM Radio, Inc. by the Travis County District Court in Sirius XM Radio, Inc. v. Hegar, Cause No. D-1-GN-16-000739 (261st Dist. Ct., Travis County, Tex. Aug. 3, 2018).



Sirius XM Radio, Inc. (hereinafter “Taxpayer”) is a foreign corporation that operates a satellite subscription-based satellite radio service, consisting of more than 150 channels of music, sports, news, talk, entertainment, traffic, and weather channels to subscribers throughout the United States.  During the 2010 and 2011 franchise tax report years (collectively the “Report Years”) Taxpayer’s headquarters, transmission equipment, and production studios were located almost exclusively outside of Texas.  Approximately 70 percent of Taxpayer’s programming consisted of original content produced by Taxpayer specifically for its subscribers and could be obtained only by subscribing to Taxpayer’s services.  This original content was produced from multiple studios owned and operated by Taxpayer, primarily in New York City and Washington D.C., and in smaller remote studios in Cleveland, Los Angeles, Memphis, Nashville, and Orlando.  Taxpayer’s production from Texas was limited to one channel, which transmitted five days a week for no more than five hours a day from a location in Texas which was not owned or leased by Taxpayer.  To deliver its programming, Taxpayer transmitted its programs to satellites from facilities outside of Texas.

For the Report Years, Taxpayer filed franchise tax returns apportioning its subscription receipts based on the location of where its primary production facilities were located, which were outside of Texas.  When the Texas Comptroller of Public Accounts (hereinafter “Comptroller”) audited Taxpayer’s franchise tax reports for the Report Years, the Comptroller argued that Taxpayer’s subscription receipts should be apportioned to Texas based on the locations where the satellite transmissions were received by Taxpayer’s subscribers and adjusted Taxpayer’s Texas apportionment factor accordingly.  Additionally, during the audit, Taxpayer requested that it be allowed to revise its Cost of Goods Sold (“COGS”) deduction to include the revenue share and hardware subsidy payments that it made to automobile manufacturers in exchange for the manufacturers’ installation of satellite-enabled radios in their vehicles.  The Comptroller rejected this request.

Taxpayer disagreed with the Comptroller’s additional assessment of tax, paid the additional tax assessed and filed a lawsuit requesting a refund in district court in Travis County.  At trial, Taxpayer argued that it had correctly apportioned it subscription receipts based on the location where Taxpayer’s services were produced and on the location of the fair market value of the services in Texas.  Further Taxpayer argued that it was entitled to include the revenue share and hardware subsidy payments that it made in its COGS deduction.

District Court Ruling

The district court found in favor of the Taxpayer.  The district court cited to the end-product-act test and determined that it was origin-based.  The court found that since the Taxpayer performed its services both inside and outside the state of Texas, its receipts were properly apportioned to Texas based on the fair market value of the services performed in Texas. Additionally, the district court found that the Taxpayer had correctly apportioned its Texas receipts for the Report Years and was entitled to a refund on the additional taxes it had paid.

Further, the district court found that the Taxpayer was entitled to include in its COGS deductions its direct costs of producing acquiring and using its live and prerecorded radio programs.  The court also ruled that the Taxpayer was not entitled to include expenses characterized as revenue share and hardware subsidies in the COGS calculation.  Interestingly, the district court provided no analysis as to its rulings regarding the COGS calculation or why it allowed a COGS deduction for items that Taxpayer had not requested.

Appeals Court Opinion

On appeal, the Comptroller challenged the district court’s holdings regarding both apportionment and also the COGS.  The Comptroller argued on appeal that the district court had misapplied the end-product-act test in determining that the “receipt producing, end product” act was the location of Taxpayer’s production and distribution activities.  The Comptroller argued that the only activity that could be plausibly described as the “receipt producing, end product act” was the actual performance of audible radio services for the customers.  Put another way, the Comptroller argued that every subscription receipt from a Texas customer is a receipt from a service performed in Texas.

The Court of Appeals agreed with the Comptroller’s argument.  The Appeals Court found that the evidence established that the services for which the Taxpayer’s customers contracted, and that resulted in the subscription revenue at issue, was the receipt of Taxpayer’s programming. Per the terms of the contract signed by the subscriber, each subscription was tied to one receiver, which unscrambles and decodes an encrypted satellite signal.  The receipt producing, end-product act occurred where the satellite-enabled radio was located, which can be reasonably be presumed to be where the subscriber resides.

With regards to COGS, the Taxpayer argued that because the radios were necessary for customers to receive the programming, the costs related to the radios was deductible.  The Court of Appeals found that while radio programs are included in the definition of “tangible personal property,” Taxpayer’s customers receive only a right to access the listen to the program content, which does not qualify as sale of tangible persona’ property, and there are not goods for the purposes of calculation COGS.


This is a curious case as it really does little to resolve the issue of sourcing of services.  Additionally, this opinion does little to distinguish itself from the Westcott Commc’ns, Inc. v. Strayhorn, 104 S.W.3d 141 (Tex. App.—Austin 2003, pet. denied).  Westcott held that for receipts to be taxable by Texas, the act done or property producing the income must be located in Texas; it is the localization of the transaction in Texas and not the place of physical handing over or receiving of money that is significant.  This ruling in Westcott, in my opinion, could be construed to almost be contrary to the above ruling.  However, the Third Court of Appeals did not overturn the holding in Westcott, but it also provided little on how to distinguish the two cases.  It will be interesting to see if the Taxpayer appeals this decision to the Texas Supreme Court, and how the Texas Supreme Court would rule.


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