Texas Tax Roundup | June 2022

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Texas Tax Roundup | June 2022

Things have been heating up this summer. Let’s see what’s been cooking with the Texas Comptroller’s office.

Cases

U.S. Fifth Circuit Court of Appeals

Texas Entertainment Association (TEA) v. Hegar, 10 F.4th 495 (5th Cir. 2021)—On June 21, 2022, the U.S. Supreme Court denied the Comptroller’s petition for writ of certiorari with respect to the Fifth Circuit’s opinion.

  • The case involved the sexually oriented business fee under Bus. & Com. Code § 102.052 (Fee Based on Admissions; Records). This fee is imposed on certain commercial enterprises that provide live nude entertainment or performances, with “nude” meaning “entirely unclothed” or “clothed in a manner that leaves uncovered or visible through less than fully opaque clothing any portion of the breasts below the top of the areola of the breasts, if the person is female, or any portion of the genitals or buttocks.” See id. §§ 102.051(1), (2) (Definitions), 102.052(a).
  • The Comptroller had enacted a rule defining “clothing” to exclude “[p]aint, latex, wax, gel, foam, film, coatings, and other substances applied to the body in a liquid or semi-liquid state . . . .” 34 Tex. Admin. Code § 3.722(a)(1) (Sexually Oriented Business Fee). The rule was aimed in part at so-called “latex clubs,” which required that dancers wear shorts and opaque latex over their breasts.
  • The Fifth Circuit held that the Comptroller’s rule violated the First Amendment to the U.S. Constitution because the rule was directed at the essential expressive nature of latex clubs’ business and the Comptroller had made no showing that the rule was narrowly tailored to serve a compelling state interest. The Court also held that the retroactive application of the rule upon latex clubs violated the Due Process Clause of the Fourteenth Amendment to the U.S. Constitution.
  • However, the Fifth Circuit determined TEA had not shown that the rule violated the Equal Protection Clause of the Fourteenth Amendment, because there was no showing that latex clubs were treated differently from similarly situated establishments. The TEA had argued that sports bars with scantily clad waitresses and concerts, body paint competitions, and bodybuilding competitions where latex was worn were similar to latex clubs. But, the Fifth Circuit wasn’t buying it.
  • With denial of cert, the Fifth Circuit’s decision in this case stands.

Texas Supreme Court

Hegar v. Health Care Service Corporation, No. 21-0080 (Tex. June 17, 2022)—The Texas Supreme Court held that premiums from Blue Cross Blue Shield’s stop-loss policies sold to employers who self-funded their employee’s health insurance (i.e., the policies indemnified the employers for amounts paid to reimburse healthcare claims over a certain threshold) were subject to insurance premium and maintenance taxes.

Texas Third Court of Appeals

Hegar v. El Paso Electric Company, No. 03-18-00790-CV (Tex. App.—Austin March 5, 2021)—On June 16, 2022, the Texas Supreme Court denied the Comptroller’s petition for review, meaning that it’s basically on board with the Third Court of Appeals’ decision in favor of the taxpayer, an electricity manufacturer.

  • The taxpayer had claimed a refund of sales or use tax that it had paid on the purchase of meters and collars that it installed at customer locations and that were used in conjunction with step-down transformers (equipment installed in customer areas to reduce the voltage of electricity entering a customer location to make it usable). The meters provided data on how the transformers were functioning, including their voltage. The collars were installed on the meters and allowed the taxpayer to send a signal to shut off a customer’s electricity service.
  • The taxpayer claimed that these items were exempt from sales and use tax under the manufacturing exemption, which provides a specific exemption for “telemetry units that are related to the step-down transformers.” Tax Code § 151.318(a)(4) (Property Used in Manufacturing).
  • The trial court ruled in favor of the taxpayer.
  • On appeal, the Third Court of Appeals rejected the Comptroller’s contention that the trial court erred in refusing to grant its plea to the jurisdiction. The Court held that the Comptroller was put on notice of the taxpayer’s claims under the manufacturing exemption, thus meeting the requirements of Tax Code § 111.104 (Refunds). Any failure of the taxpayer to comply with the timeframe for amending its statement of grounds under 34 Tex. Admin. Code 1.11(g) (Statement of Grounds; Preliminary Conference) did not have jurisdictional effect.
  • The Third Court of Appeals also held that the customer meters were telemetry units, were clearly related to step-down generators, and therefore qualified for the manufacturing exemption.

Notable Additions to the State Automated Tax Research (STAR) System

General

Personal Liability

Comptroller’s Decision Nos. 117,436, 117,441 (2022)—The administrative law judge dismissed personal liability assessments against a bar owner because the Comptroller had not shown by clear and convincing evidence that the bar owner took an action or participate in a fraudulent scheme or fraudulent plan to evade the payment of the bars mixed beverage taxes. In coming to this conclusion, the administrative law judge relied on findings that the bar owner had no role in calculating the amounts of mixed beverage sales to report to the Comptroller, reporting such amounts to the Comptroller, or making payments of mixed beverage sales tax and mixed beverage gross receipts tax to the Comptroller.

Franchise Tax

Unitary Business

Comptroller’s Decision Nos. 116,584, 117,455, 117,900 (2022)—The administrative law judge found that a taxpayer that was a wholly owned subsidiary of its parent and was acting as a purchasing agent for its parent and its parent’s other subsidiaries was engaged in a unitary business with its parent and these other subsidiaries. In reaching this decision, the administrative law judge noted that the taxpayer’s activities were coordinated by its parent, prices for transactions between the taxpayer and affiliates lacked profit motive, and taxpayer was dependent on other affiliates to carry out specific functions. Moreover, the taxpayer did not dispute that it was affiliated with the other subsidiaries of its parent, and 34 Tex. Admin. Code § 3.590(b)(6)(B) (Margin: Combined Reporting) provides affiliated companies are presumed to be in a unitary business.

Cost of Goods Sold

Comptroller’s Decision Nos. 115,992, 115,993, 115,994, 115,995, 115,996, 115,997 (2022)—The administrative law judge determined that payments made by a cigarette manufacturer pursuant to a master settlement agreement with 46 states relating to claims for past conduct and future conduct related in any way to the use of or exposure to tobacco products were not properly included in cost of goods sold because they were not costs related to the construction, manufacture, development, mining, extraction, creation, raising, or growth of cigarettes.  See Tex. Tax Code § 171.1012(c) (Determination of Cost of Goods Sold). The administrative law judge made a similar determination with respect to quota buyout payments to offset the cost of federal subsidies to tobacco farmers. The administrative law judge also found that both types of payments were not postproduction costs that were includible in cost of goods sold under Tex. Tax Code § 171.1012(d) and rejected the taxpayer’s argument that it had insufficient nexus with Texas to justify taxation, since it was undisputed that the taxpayer had inventory, leased property, and employees located in Texas.

Mixed Beverage Taxes

Complimentary Drinks/Fraud Penalty

Comptroller’s Decision No. 117,273, 117,274 (2022)—The administrative law judge ruled that a taxpayer that operated a bar and claimed an allowance for complimentary drink failed to provide sufficient evidence because the taxpayer did not provide service checks for each individual or party service complimentary alcoholic beverages nor daily summaries including complimentary alcoholic beverages dispensed. See 34 Tex. Admin. Code § 3.1001(l)(2), (k)(1)(E) (Mixed Beverage Gross Receipts Tax). The administrative law judge also upheld the imposition of the 50% fraud penalty against the taxpayer, because the taxpayer’s overall error rate was more than 50% and was thus a gross error (see Tex. Tax Code § 111.205(b) (Exception to Assessment Limitation)) and there was no evidence that the employees that handled the taxpayer’s mixed beverage gross receipts tax returns or mixed beverage sales tax returns during the periods in question were engaged in an independent course of conduct when calculating the sales to be reported or when the fraudulent tax returns were filed (see 34 Tex. Admin. Code § 3.15(b) (Penalty for Fraud, Intent to Evade Tax or the Alteration, Destruction, or Concealment of Records))

Sales and Use Tax

Information Services/Data Processing Services/Nontaxable Services

STAR Accession No. 202206008L (June 10, 2022)—In this private letter ruling, the Comptroller found that an online educational program used to train professional healthcare students was not subject to sales or use tax.  Specifically, the Comptroller determined that the online educational program was not an information service because it was not the sale of general or specialized news or other current information as described by Tex. Tax Code § 151.0038 (“Information Service”) and did not resemble other examples of information services in 34 Tex. Admin. Code § 3.342(a)(6) (Information Services).  Additionally, while the online educational program had elements of data processing in that compiled students’ responses during simulations, generated scores rating performance, and provided responses and scores to professors (see Tex. Tax Code § 151.0035 (“Data Processing Service”); 34 Tex. Admin. Code 3.330 (Data Processing Services)), the Comptroller exercised his exclusive jurisdiction to interpret whether are services are taxable (see Tex. Tax Code § 151.0101(b) (“Taxable Services”)) to determine that the online educational program was not a data processing service and was not taxable.