Texas Tax Roundup — July 2022
Aloha! It’s summer doldrums round here at Texas Tax Roundup this month. Everybody in Texas tax world must be off on vacation in some tropical paradise somewhere where it’s not too hot and the Mai Tais flow more abundantly than our more circumspect mixed beverages back home.
Except for me and them administrative law judges, apparently. Let’s see what they have to say.
Notable Additions to the State Automated Tax Research (STAR) System
General
Burden of proof/Detrimental Reliance/Insolvency
Comptroller’s Decision No. 115,242 (2022)—The administrative law judge (“ALJ”) upheld a sales and use tax assessment against a taxpayer that operated an advertising agency when the taxpayer didn’t provide documentation showing that the assessment was incorrect.[1] The administrative law judge also determined that the taxpayer couldn’t rely on advice that it was purportedly provided during a previous audit, because such advice wasn’t in the form of a private letter ruling.[2] Finally, the administrative law judge found that the taxpayer hadn’t provided all of the documentation required for an insolvency settlement.[3]
Hotel Occupancy Tax
Estimated Audits
Comptroller’s Decision No. 118,352 (2022)—The ALJ found that when a taxpayer failed to provide complete records to the auditor, an audit estimating tax based on the taxpayer’s hotel occupancy tax history, sales and use tax returns, and franchise tax reports was valid.[4]
Franchise Tax
Total Revenue
Comptroller’s Decision Nos. 117,954, 117,955, and 117,956 (2022)—The ALJ ruled that a taxpayer failed to demonstrate that its reporting of income from long-term contracts on its federal income tax returns complied with federal tax law and, therefore, that the taxpayer hadn’t established that its amended franchise tax returns were properly calculated.
Comptroller’s Decision Nos. 117,086 and 117,087 (2022)—The ALJ found that a taxpayer had not established that its revenue should be reduced by the exclusion of income from uniform replacement charges under a reimbursement theory.[5]
Cost of Goods Sold
Comptroller’s Decision No. 110,947 (2022)—The ALJ found that a taxpayer that primarily installed parts that it purchased into aircraft that it didn’t own wasn’t entitled to deduct labor costs associated with such installation as cost of goods sold.[6]
Comptroller’s Decision No. 118,267 (2022)—The ALJ ruled that a taxpayer engaged in the business of building and selling houses could only include costs and fees that it paid while it owned the properties in its cost of goods sold deduction.[7] Such costs and fees paid after the houses were sold could not be deducted.
Forfeiture of Corporate Privileges
Comptroller’s Decision No. 116,927 (2022)—The ALJ determined that the officer of a company whose corporate privileges had been forfeited due to failure to file a franchise tax report was liable for the sales and use tax assessment against the company during the period of forfeiture.[8] The ALJ also ruled that the officer could not challenge the underlying corporate tax liability that is administratively final without paying the liability and requesting a refund.
Sales and Use Tax
Telecommunications Services
Comptroller’s Decision No. 117,876 (2022)—The ALJ found that a taxpayer that electronically transmitted television commercials and syndicated programming to broadcasters had not shown that any of such content was exempt from sales and use tax by reason of being transmitted outside the state.[9]
Security Services
Comptroller’s Decision No. 116,947 (2022)—The ALJ found that a taxpayer licensed as a security services contractor was required to collect sales tax from customers on charges for guard services performed by off-duty police officers.[10]The taxpayer couldn’t detrimentally rely on advice provided during a previous audit, because such advice was not communicated directly to the taxpayer in a private letter ruling and the Comptroller’s office has long included a disclaimer in its notification of audit results that taxpayers cannot sue the audit to assert detrimental reliance in a subsequent audit.[11] The administrative law judge also rejected the taxpayer’s arguments that its purchase of uniforms for its security officers was exempt under the resale exemption (the ALJ found that this exemption didn’t apply because the taxpayer didn’t transfer care, custody, or control over the uniforms to its customers)[12] or the manufacturing exemption (the ALJ noted that the taxpayer wasn’t a manufacturer).[13]
Comptroller’s Decision No. 117,142 (2022)—The ALJ found that canine explosive detection services purchased by a taxpayer prior to September 1, 2019, was a taxable security service under the Texas sales and use tax.[14] The ALJ also determined that a security service purchased by an amusement service provider didn’t qualify for the sale for resale exemption because a security service wasn’t an integral part of an amusement service.[15] Furthermore, the ALJ rejected the argument that the federal Support Anti-Terrorism by Fostering Effective Technologies (SAFETY) Act, which was part of the Homeland Security Act of 2002 and which incentivizes the deployment of anti-terrorism technologies by creating systems of risk and litigation management, preempted Texas sales and use tax laws.[16] In this regard, the ALJ noted that the taxpayer had failed to cite to any legal authority to support its preemption claim.
Manufacturing Exemption
Comptroller’s Decision Nos. 117,870 and 117,997 (2022)—The ALJ ruled that a taxpayer’s purchases of returnable containers used to package the chemicals that it manufactured were not exempt from sales and use tax under the manufacturing exemption.[17] The ALJ reasoned that the taxpayer was required to pay tax on its purchase of the returnable containers, because its sales of the returnable containers would be exempt from tax under Tex. Tax Code § 151.322(a)(3) (Containers).[18] [Tip: The Comptroller tends to get testy when someone selling an item tax free attempts to purchase that item tax free, even if the plain language of the statute supports that result.] The ALJ also found that the taxpayer’s purchases of cleaning services performed on the returnable containers were not exempt from tax under Tex. Tax Code § 151.3111 (Services on Certain Exempted Personal Property) because the containers themselves were not exempt from tax.
Enterprise Projects
Comptroller’s Decision No. 116,600 (2022)—The ALJ determined that a business wasn’t entitled to a refund of taxes paid on taxable items that it purchased for use at a qualified business site at an enterprise project when the municipality nominating the business for an enterprise project zone designation didn’t approve the business’s name change for the designation.[19] Apparently, project designation was for a business whose name didn’t match the federal employer identification number included in the designation.
See you next time and stay cool!
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[1] See 34 Tex. Admin. Code § 1.26(a), (d) (Burden and Standard of Proof in Contested Cases).
[2] See 34 Tex. Admin. Code §§ 3.1(c), (d) (Private Letter Rulings and General Information Letters), 3.10(c) (Taxpayer Bill of Rights).
[3] See 34 Tex. Admin. Code § 1.30 (Settlement in a Contested Case Based on Insolvency).
[4] See Tex. Tax Code § 111.0042(d) (Sample in Auditing; Projecting Assessments).
[5] The starting point for calculating Texas franchise tax is income as reported on the taxpayer’s federal income tax return. See Tex. Tax Code § 171.1011(c) (Determination of Total Revenue from Entire Business); 34 Tex. Admin. Code § 3.587(d) (Margin: Total Revenue). Under the federal income tax, a taxpayer may deduct ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business in calculating its taxable income. See 26 U.S.C. § 162 (Trade or Business Expenses).
[6] In this connection, the ALJ cited Hegar v. Autohaus, L.L.P., 514 S.W.3d 897 (Tex. App. —Austin 2017, pet. den.).
[7] See Tex. Tax Code § 171.1012(i) (Determination of Costs of Goods Sold) (“A taxable entity may make a subtraction under this section in relation to the cost of goods sold only if that entity owns the goods.”); 34 Tex. Admin. Code § 3.588(g)(2), (9) (Margin: Cost of Goods Sold). However, a taxpayer generally may not deduct expenses made with a right or expectation of reimbursement, because they are in the nature of loans or advancements and are not ordinary and necessary business expenses. Burnett v. Comm’r, 356 F.2d 755 (5th Cir. 1966), cert. denied, 385 U.S. 832 (1966); Flower v. Comm’r, 61 T.C. 140 (1973), aff’d memo., (5th Cir. Dec. 12, 1974); Rev. Rul. 78-‑388, 1978-2 C.B. On the other hand, amounts received in reimbursement of such expenditures also wouldn’t be included in taxable income. The Comptroller had applied this analysis in Comptroller’s Decision No. 107,457 (2014).
[8] For forfeiture of corporate privileges due to failure to file a franchise tax report, see Tex. Tax Code § 171.255(a) (Liability of Director and Officers).
[9] Telecommunications services are subject to Texas sales and use tax only if the transmission originates and terminates in Texas. See Tex. Tax Code § 151.323 (Certain Telecommunications Services); 34 Tex. Admin. Code § 3.344(a)(4), (5), (b)(4), (5) (Telecommunications Services).
[10] See Tex. Occ. Code § 1702.322 (Law Enforcement Personnel); 34 Tex. Admin. Code § 3.333(i) (Security Services).
[11] See 34 Tex. Admin. Code §§ 3.1(c), (d) (Private Letter Rulings and General Information Letters), 3.10(c) (Taxpayer Bill of Rights).
[12] For the resale exemption, see Tex. Tax Code §§ 151.006 (“Sale for Resale”), 151.302 (Sales for Resale); 34 Tex. Admin. Code § 3.285 (Resale Certificate; Sales for Resale).
[13] For the manufacturing exemption, see Tex. Tax Code § 151.318 (Property Used in Manufacturing); 34 Tex. Admin. Code § 3.300 (Manufacturing; Custom Manufacturing; Fabricating; Processing (Tax Code, §§151.005, 151.007, 151.318, and 151.3181)).
[14] See Tex. Tax Code §§ 151.0075 (“Security Service”), 151.0101 (“Taxable Services”); Tex. Occ. Code § 1701.102(a)(1) (Security Services Contractor License Required; Scope of License) (as amended by S.B. 616, 86th Leg., R.S. (2019) (removing guard dogs from security license requirements)).
[15] See Tex. Tax Code § 151.006(a) (“Sale for Resale”) (defining a “sale for resale” in part as a sale of “tangible personal property or a taxable service to a purchaser who acquires the property or service for the purpose of reselling it as a taxable item as defined by Section 151.010 in the United States of America or a possession or territory of the United States of America or in the United Mexican States in the normal course of business in the form or condition in which it is acquired or as an attachment to or integral part of other tangible personal property or taxable service . . . .”).
[16] Preemption may occur when the scheme of federal regulation is so pervasive as to make reasonable the inference that Congress left no room for the States to supplement it. See U.S. Const., art. VI, cl. 2; Hyundai Motor Co. v. Alvarado, 974 S.W.2d l, 9 (Tex. 1998).
[17] For the manufacturing exemption, see Tex. Tax Code § 151.318 (Property Used in Manufacturing); 34 Tex. Admin. Code § 3.300 (Manufacturing; Custom Manufacturing; Fabricating; Processing (Tax Code, §§151.005, 151.007, 151.318, and 151.3181)).
[18] As authority for this, the ALJ cited 34 Tex. Admin. Code § 3.314(g)(3) (Wrapping, Packing, Packaging Supplies, Containers, Labels, Tags, Export Packers, and Stevedoring Materials and Supplies) (sellers of taxable items in returnable containers must pay sales and use tax on its purchases of the containers because its sales of the containers are exempt).
[19] For enterprise zones, see Tex. Gov’t Code ch. 2303 (Enterprise Zones); Tex. Tax Code § 151.429 (Tax Refunds for Enterprise Projects); 34 Tex. Admin. Code § 3.329 ( Enterprise Projects, Enterprise Zones, and Defense Readjustment Zones).
