Rentals Versus Services Under Texas Sales And Use Tax

One of the thorniest issues in Texas sales and use tax is the distinction between the rental of tangible personal property (which is subject to tax) and the provision of a service (which is only taxable if the service is taxable). This distinction not only affects the taxability of charges for the rental or service but also that of equipment that is purchased to provide the rental or service.

What’s a Rental?

The rental of tangible personal property in Texas is subject to sales or use tax.[1] A rental occurs when possession but not title to tangible personal property is transferred for consideration.[2] A person acquires possession of tangible personal property when that person acquires operational control over that property.[3] Operational control, in turn, means that the customer can use, control, or operate the tangible personal property.[4]

What are Taxable Services?

Only the following services are subject to Texas sales or use tax:
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Texas Tax Roundup | April 2023: Pleas To The Jurisdiction, Retail And Wholesale Franchise Tax Rate, And More

Howdy folks, and welcome back to another edition of the Texas Tax Roundup, where we gab about all things Texas tax and perhaps even some things Texas tax adjacent. As ole T.S. once put it, “April is the cruelest month” [1]—although maybe not for the same reasons he had. Because instead of “breeding lilacs out of the dead land”[2] or some such, which implies at least a glimmer of hope (although that might be why he thought it was so cruel, him being a bit of a downer, you know), April 2023 showered us with a string of taxpayer defeats, the one bright spot being a smackdown on a plea to the jurisdiction by the Texas Comptroller.

Court Opinions
Franchise Tax
Plea to the Jurisdiction/Total Revenue

Hibernia Energy, LLC v. Hegar, No. 03-21-00527-CV (Tex. App.—Austin Apr. 21, 2023, no pet. h.)—The Texas Third Court of Appeals affirmed the trial court’s judgment denying the Comptroller’s plea to the jurisdiction but also denying a taxpayer’s/consultant’s claim for refund for franchise taxes attributable to the inclusion in total revenue of gains from the sale of oil-and-gas leasehold interests.

The taxpayer, a limited liability company, acquired oil-and-gas leasehold interests in 2010, and then sold these interests in 2012 and 2014 at a gain of $95,866,370 and $296,691,853 for each year respectively. The taxpayer included these gains in its total revenue for purposes of determining its franchise tax liability for the respective franchise tax report years and paid the taxes.

In 2015, the taxpayer hired a consultant that filed a refund claim on the taxpayer’s behalf for the franchise taxes paid that were attributable to these gains.[3] The reason given for why the taxpayer was entitled to a refund was that it had overstated total revenue by including gains whose inclusion was not required under applicable law.

A limited liability company by default is treated as a partnership for federal income tax purposes.[4] A partnership is required to file a Form 1065, U.S. Return of Partnership Income to “report the income, gains, losses, deductions, credits, and other information about the operation of the partnership.”[5]

Under the Texas franchise tax, the total revenue of a taxable entity treated as a partnership for federal income tax purposes is calculated by first adding up the amounts reportable as income on various lines on the entity’s Form 1065:
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Texas Tax Roundup | March 2023: Flowback, Welding, Local Taxes, And More!

Welcome back to another Texas Tax Roundup! March 2023 brought us a lot of administrative action, especially for Texas sales or use tax. Let’s get started!

Rules

Franchise Tax

Apportionment

34 Tex. Admin. Code § 3.591 (Margin: Apportionment)—The Comptroller adopted his amendments outlined in our previous post to implement the Texas Supreme Court’s opinion in Sirius XM Radio, Inc. v. Hegar, No. 20-0462 (Tex. March 25, 2022).[1]

Notable Additions to the State Tax Automated Research System

Franchise Tax

Apportionment

Comptroller’s Decision No. 116,251, 116,252 (2023)— The ALJ upheld assessments of sales tax and franchise tax against an out-of-state corporate taxpayer for periods in which the corporation had only a single employee in Texas. The taxpayer was in the business of selling telecommunication services. The Comptroller had become aware of the taxpayer’s business activities in Texas due to information from the Texas Workforce Commission. The ALJ found that the presence of an employee in Texas created nexus for purposes of both sales and franchise tax.[2] Outside of asserting that Texas lacked jurisdiction to tax, the taxpayer didn’t provide any evidence showing that the assessments were incorrect.

Sales And Use Tax

Flowback Services
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Texas Mixed Beverage Taxes

The state of Texas imposes two taxes on alcoholic beverages that impact holders of certain permits under the Texas Alcoholic Beverage Code. These taxes are the mixed beverage gross receipts tax and the mixed beverage sales tax. Both are set forth in Texas Tax Code, Chapter 183 (“Chapter 183”) and Texas Comptroller Rule 3.1001 (“Rule 3.1001”).[1]

Who’s Subject to Mixed Beverage Taxes?

The folks who get hit with mixed beverage taxes (other than consumers) are what are called “permittees.” [2] Chapter 183 defines a “permittee” is defined as someone who holds one of the following permits under the Texas Alcoholic Beverage Code:

-a mixed beverage permit;
-a private club registration permit;
-a private club exemption certificate;
-a private club registration permit with a retailer late hours certificate;
-a nonprofit entity temporary event permit;
-a private club registration permittee holding a food and beverage certificate;
-a mixed beverage permit with a retailer late hours certificate;
-a mixed beverage permit with a food and beverage certificate; or
-a distiller’s and rectifier’s permit.[3]


What’s a Mixed Beverage?

Chapter 183 defines a “mixed beverage” as “a beverage composed in whole or part of an alcoholic beverage in a sealed or unsealed container of any legal size for consumption on the premises when served or sold by the holder of a mixed beverage permit, the holder of certain nonprofit entity temporary event permits, the holder of a private club registration permit, or the holder of certain retailer late hours certificates.”[4]

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Texas Tax Rules

Texas Tax Rules
As states confront budgetary deficits due to declining tax revenues and increased government spending, tax authorities aggressively enforce state tax laws to recapture lost revenues.

Sulphur Production Tax
34 Tex. Admin. Code § 3.41 (48 Tex. Reg. 1149)—The Comptroller repealed this rule dealing with sulphur production tax to reflect the Legislature’s repeal of the tax with S.B. 757, 84th Legislature, R.S. (2015). RIP.

Cigarette Tax
34 Tex. Admin. Code § 3.102 (48 Tex. Reg. 1150)—The Comptroller adopted amendments to the rule on cigarette tax to implement S.B. 248, 87th Leg., R.S. (2021), which requires a person in this state who receives unstamped cigarettes from a manufacturer, bonded agent, distributor, or importer to store the cigarettes exclusively in an interstate warehouse. The Comptroller also added a definition of cigar, to remove language regarding sales by a permitted bonded agent from a vehicle, and to provide that a permitted importer is required to be a permitted distributor.

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

Franchise Tax

Research and Development Credit

STAR Accession No. 202302002L (Feb. 6, 2023)
In this memo to Audit, Tax Policy summarizes the federal statutes and regulations relating to internal use software that have been incorporated by reference under Texas law for purposes of the franchise tax research & development credit and the sales tax research & development credit. Tax Policy notes the that current Rules 3.340 (Qualified Research) and 3.599 (Margin: Research and Development Activities Credit) give taxpayers the election between two different versions of Treas. Reg. § 1.41-4(c)(6): the version of that regulation adopted in 2003 as contained in IRB 2001-5 and the one proposed in 2002 as contained in IRB 2002-4.

Mixed Beverage Taxes
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2023 Court Cases And Decisions: Sales And Use Taxes

The Geo Group, Inc. v. Hegar, No. 07-22-00005-CV (Tex. App.-Amarillo Jan. 23, 2023, no pet. hist.)—The Seventh Court of Appeals held that a company that owns and operates correctional and detention facilities under contracts with the state of Texas and the United States was not entitled to a sales tax refund due to the company’s purchases being exempt, affirming the trial court’s decision to that effect.

The company had argued that the detention and rehabilitation services that it provided are a quintessential governmental function, making the company an “instrumentality” of the state and federal governments and thereby rendering the company’s purchases exempt from sales or use tax under 34 Tex. Admin. Code 3.322(c) (Exempt Organizations).

The court of appeals noted that “instrumentality” isn’t defined in the Texas Administrative Code and the Black’s Law Dictionary defines “instrumentality” as: “1. A thing used to achieve an end or purpose. 2. A means or agency through which a function of another entity is accomplished, such as a branch of a governing body.”[1] Finding the first definition to be too broad to serve any purpose (virtually any independent contractor employed by the government could be an instrumentality under this definition), the court of appeals determined that the second definition of “instrumentality”— relating the term to “a branch of a governing body”—was more in harmony with the exemption in question.

The court of appeals found that while the company housed federal detainees and was required to comply with specific government regulations, the company was a distinct entity engaged in commercial for-profit activities, wasn’t controlled by the federal or state or federal government and didn’t contract exclusively with the federal or state government. For all of these reasons, the court of appeals held that the company wasn’t an instrumentality of the federal or state government that was exempt from sales or use tax.

Collections

Tax Liens
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Taxation In The United States Virgin Islands

The United States Virgin Islands (“USVI”) is an unincorporated territory of the United States.[1] But that doesn’t mean that they’re subject to exactly the same laws as in the United States—especially when it comes to taxes.

The Mirror Code

As a territory, the U.S. Congress is empowered to “make all needful Rules and Regulations respecting” the USVI.[2] As far as taxes go, Congress requires that the USVI impose an income tax that “mirrors” the U.S. federal income tax found in United States Code, Title 26 (also known as the “Internal Revenue Code” or “IRC”).[3] Because of this requirement, USVI’s income tax law is commonly called a “mirror code.” One of the basic principles used in the application of the “mirror code” is the substitution principle, according to which “Virgin Islands” generally is substituted for “United States” wherever that phrase appears in the IRC.[4]

Under the IRC, the United States taxes citizens and residents on their worldwide income and nonresident aliens on income from sources within the United States or that is effectively connected with the conduct of a United States trade or business.[5] For these purposes, the United States includes only the States and the District of Columbia.[6]

The USVI applies similar rules to its residents and nonresident aliens under the mirror code.[7]

Non-Bona Fide Residents

A U.S. citizen or resident who isn’t a bona fide resident of the USVI during the entire taxable year and who has income derived from USVI sources or effectively connected with a trade or business within the USVI is required to file income tax returns in the taxable years with both the United States and the USVI.[8] The income taxes that such a person is required to pay to the USVI is determined by multiplying the income taxes imposed under the IRC by the “applicable percentage,” which means the percentage that USVI adjusted gross income bears to adjusted gross income.[9] USVI gross income is adjusted gross income determined by only taking into account income from USVI sources and deductions allocable to that income.[10]

Bona Fide Residents
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Court Cases Franchise Tax

Welcome back to another for another edition of Texas Tax Roundup! We got some franchise tax apportionment, some sales and use tax in the oil and gas industry, and some mulling over the age-old question: Is a franchise tax an occupation tax? Let’s dive in!

Court Cases

Franchise Tax

Distinction from Occupation Tax

Swift Transp. Co. of Az., LLC v. Hegar, No. 13-21-00010-CV (Tex. App.—Corpus Christi-Edinburg Nov. 10, 2022)—The Thirteenth Court of Appeals held that the franchise tax wasn’t an occupation tax. Thus, Tex. Transp. Code § 20.001 (Certain Carries Exempt from Gross Receipts Tax), which exempts certain motor carriers from any occupation tax measured by gross receipts, didn’t apply to franchise tax. The court of appeals observed that Texas franchise taxes and occupations tax dated back to at least 1880, that both types of taxes were in existence when Section 20.001 was enacted, and that various statutes implied a distinction between these types of taxes. The court of appeals also distinguished as dicta (and thus nonbinding) insinuations in the case law that the franchise tax was an occupation tax or that that a franchise tax and an occupation was basically the same.[1]

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Getting Out | Expatriation And Federal Taxes

Are you U.S. citizen or resident? Have you ever just wanted to leave the whole U.S. federal tax system behind? Well, you can . . . try at least. But there’s a cost.

The Problem

U.S. citizens and residents are subject to federal income tax on their worldwide income.[1] They’re subject to federal estate tax based on all assets wherever located upon death.[2] And, they’re subject to gift tax on the transfer of all property, whether it be real or personal, tangible or intangible.[3]

Noncitizens-nonresidents, on the other hand, are subject to federal income tax only on certain U.S. source income and income that’s effectively connected with the conduct of a U.S. trade or business.[4] They’re subject to federal estate tax only with regards to assets situated within the United States upon death.[5]  And, they’re generally subject to gift tax only when the gift is real estate or tangible personal property located in the United States at the time of the gift.[6]

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The Methods (And Madness) Of Transfer Pricing For Tangible And Intangible Property

Transfer pricing has to do with the allocation of income among parties controlled by the same persons (controlled parties) that engage in transactions with each other (controlled transactions).[1] In the international context where controlled parties may operate in different countries with different tax burdens, the concern is that the controlled parties may shift income from a higher-taxed country from a lower-taxed country. Here’s a simple example:

The Example

Here ProdCo and WidgCo are controlled parties because they are both 100% owned by Owner. And they’re engaged in a controlled transaction, because ProdCo is purchasing Widgets from WidgCo, which ProdCo then incorporates into Product which it sells to consumers for $100 a pop. ProdCo is based out of Country A, which has a 20% income tax rate, while WidgCo is based out Country B with a 10% income tax rate.

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Court Cases: Sales And Use Tax, Franchise Tax, Collections, Adopted Rules, Proposed Rules

Court Cases

Sales and Use Tax

Manufacturing Exemption

Hegar v. Tex. Westmoreland Coal Co., Case 21-1007 (Tex. Sept. 30, 2022)—In this case, the Texas Supreme Court denied the Comptroller’s petition for review, leaving the decision of the Third Court of Appeals in favor of the taxpayer in place.  The Court of Appeals had held that equipment used to break apart lignite coal from a coal formation qualified for the manufacturing exemption from sales and use tax.[1] The Court of Appeals disregarded the Comptroller’s argument that the manufacturing exemption didn’t apply because the equipment was used on real property to create tangible personal property, holding that there was no basis in the statute for any requirement that an input to the manufacturing process had to be tangible personal property.

Franchise Tax

Apportionment

Citgo Petroleum Corporation v. Hegar, 21-0997 (Tex. Sept. 30, 2022)—The Texas Supreme Court denied the taxpayer’s petition for review in this case, so the decision of the Third Court of Appeals in favor of the Comptroller remains the law of the land. The Court of Appeals had held that only the net proceeds of sales of commodity futures contracts and options on commodity futures contracts could be included in the calculation of the taxpayer’s apportionment factor for purpose of calculating Texas franchise tax.

Rules

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TL FAHRING - International Tax Withholding: Chapter 3 Of The Internal Revenue Code

One of the more confusing areas of international tax law is determining when withholding is required. Getting it wrong can have dire consequences.

Currently, U.S. international withholding provisions can be found in Chapters 3 and 4 of the Internal Revenue Code.  Chapter 3 contains the withholding provisions that are intended to approximate a foreign person’s U.S. federal income tax liability. Chapter 4, on the other hand, deals with withholding provisions put in place by the Foreign Accounts Tax Compliance Act of 2010 and is primarily aimed at obtaining information regarding account holders of foreign financial institutions and owners of certain foreign entities.

In this post, we’ll focus on Chapter 3 withholding, setting aside Chapter 4 for another time.

But first . . .

Why International Tax Withholding?

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