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

Adopted Rules

Collections

34 Tex. Admin. Code § 3.16 (Delinquent Taxpayer Financial Records; Information Exchange) (published at 47 Tex. Reg. 5339 (Sept. 2, 2022))—This rule implements House Bill (H.B.) 1258, 87th Leg., R.S. (2021), which requires financial institutions to provide data to the Comptroller quarterly to facilitate the matching of names of delinquent taxpayers with the names of account holders.

Proposed Rules

Sales and Use Tax

34 Tex. Admin. Code § 3.334 (Local Sales and Use Taxes) (published at 47 Tex. Reg. 6158 (Sept. 23, 2022))—Here we have the latest development in the ongoing saga regarding the sourcing of Texas local sales and use taxes, particularly with regard to orders placed over the internet.

In its 2018 decision in South Dakota v. Wayfair, the U.S. Supreme Court decided that states could impose tax collection requirements on out-of-state sellers lacking physical presence in the state as long as the requirements didn’t impose an undue burden on interstate commerce. In light of this decision, The Comptroller determined that the then-existing Rule 3.334 was inadequate to explain Texas’ local sales and use tax consummation statutes.[2]

However, the Comptroller’s proposed amendments to the rule in January 2020 met with backlash from cities and businesses. A public hearing was held on February 4, 2020, and the Ways and Means Committee of the Texas House of Representatives held an interim hearing to discuss the proposed amendments on February 5, 2020.[3]

Nevertheless, the Comptroller pressed ahead and finalized the amendments in May 2020. Shortly thereafter, the Comptroller amended the rule in 2020, the Cities of Round Rock, Coppell, DeSoto, Humble, and Carrolton sued, challenging the amendments’ validity.[4] Ultimately, a district court in Travis Count at least partially agreed with the cities, finding that the Comptroller failed to substantially comply with procedural requirements for notice of proposed rule.[5] The court remanded the rule to give the comptroller the opportunity to either revise or readopt it through established procedure.[6]

Thus, the Comptroller is now reissuing proposed Rule 3.334 with fuller explanation of the proposed rulemaking.[7]

At the heart of the debate over proposed Rule 3.334 is the sourcing of internet sales. The proposed rule would define the term “place of business of the seller” as “an established outlet, office, or location operated by a seller for the purpose of receiving orders for taxable items from persons other than employees, independent contractors, and natural persons affiliated with the seller.”[8] The location would have to be staffed by one or more sales personnel and these sales personnel would have to accept at least three orders of taxable items at the facility during the calendar year.[9]  The term “place of business of the seller” wouldn’t include “a computer server, Internet protocol address, domain name, website, or software application.”[10]

This change in the definition of “place of business of the seller” places out in proposed Rule 3.334(b)(5), which would provide that “[a]n order that is not received by a salesperson is received at a location that is not a place of business of the seller. Examples are orders received by a computer server through a shopping cart software program and orders received by an automated telephone ordering system.”[11]  This would cause orders that were placed on the internet that were not fulfilled at a place of business of the seller in Texas to be sourced to the location of the purchaser.[12] Currently, some taxpayers have taken the position such orders are received at a place of business of seller, which would mean that these sales would be sourced to that place of business.

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

Sales and Use Tax

Enterprise Zones

Comptroller Decision No. 117,512 (2022)—The ALJ found that a taxpayer that operated a petrochemical production facility that was designated as a Project as part of the Texas Enterprise Zone Program (the “Program”) was not entitled to a refund of sales and use taxes because not enough employees of the Project were residents of an Enterprise Zone.

The Program requires at least 35% of the new permanent jobs of the Project be held by residents of an Enterprise Zone or by economically disadvantaged individuals.[13] An area automatically qualifies for designation as an Enterprise Zone if the area is “designated by the federal government as a Federal Renewal Community, a Federal Empowerment Zone, or a Federal Enterprise Community, including any developable area approved by the federal agency responsible for making that designation.”[14]

The taxpayer identified several of the Project’s employees as residents of the Gulf Opportunity Zone (“GO Zone”). The GO Zone was created pursuant to the Gulf Opportunity Zone Act (Act), signed into law by President George W. Bush in 2005 in the wake of Hurricanes Katrina and Rita. The Act designated certain areas as “disaster areas” affected by the hurricanes, created the boundaries of the GO Zone, and established tax benefits for businesses and individuals in the GO Zone. The GO Zone was not designated by the federal government as a Renewal Community, Empowerment Zone, or Enterprise Community. Congress did not designate the GO Zone as a Renewal Community, Empowerment Zone, or Enterprise Community, and no federal agency designated or approved the GO Zone as such.

Thus, the ALJ found that the GO Zone wasn’t an Enterprise Zone and that the Project failed to meet the employee residency requirement.

Medical Devices

STAR Accession No. 202208009L (Aug. 15, 2022)—In this private letter ruling, the Comptroller determined that a device used by medical providers in the diagnostic evaluation and monitoring of patients experiencing unexplained symptoms such as dizziness, palpitations, chest pain, and shortness of breath was a therapeutic device and not a prosthetic device or orthopedic appliance.[15] Therefore, the device was exempt from sales and use tax when sold to a patient with a prescription, but was taxable when sold to a medical provider for use in a nontaxable medical service unless and exemption applied.[16] According to the Comptroller, the device:

• was not a prosthetic device, because it didn’t replace a missing part of the body or perform the function of a vital organ, could be removed as soon as the medical provider obtained a diagnosis from the device, and only had a battery life of 3 years;[17]
• was not an orthopedic appliance, because it wasn’t used to treat a deformity or disease of the skeleton, joint, or spine;[18] and
• was a therapeutic device, because it is used as a diagnostic medical tool designed for use in patients with heart conditions.[19]

The Comptroller also ruled that the person selling the device couldn’t accept resale certificates from medical providers because the medical providers were using the devices to perform a nontaxable service.[20]  However, an exemption certificate could be accepted from a medical provider that qualified as an exempt organization under Tex. Tax Code §§ 151.309 (Governmental Entities) or 151.310 (Religious, Educational, and Public Service Organizations).

Credit Reporting Services

STAR Accession No. 202208011L (Aug. 22, 2022)—In this memo to Audit, Tax Policy states that it’s Comptroller policy that credit ratings of legal entities are subject to sales and use tax as a credit reporting service, while credit ratings of debt obligations aren’t taxable.[21]

The analysis hinges on the definition of a “credit reporting service” as “the assembly and furnishing of credit history or information relating to any person.”[22] According to the Code Construction Act, which specifically applies to Title 2 of the Texas Tax Code (which is where the state sales and use tax is found), a “person” includes a “corporation, organization, government or governmental subdivision or agency, business trust, estate, trust, partnership, association, and any other legal entity.”[23]

Thus, the Comptroller takes the position that while the credit rating of legal entity involves the assembly of credit information of a person within the meaning of the definition of a credit reporting service, the credit rating of a debt obligation doesn’t because a debt obligation is not a “person.”

Motor Vehicle Sales, Rental and Use Tax

Apportioned Registration

Comptroller’s Decision No. 117,430, 117,431 (2022)—The ALJ found that a taxpayer who purchased two trucks, registered them with non-apportioned plates, but then later obtained apportioned registration for the vehicles wasn’t entitled to a refund of the motor vehicle sales tax that he had paid on those vehicles.[24]

The ALJ noted Comptroller policy that the registration of a vehicle with non-apportioned plates creates a presumption of intrastate use that must be rebutted to prove the exemption. For instance, this presumption could be rebutted with evidence demonstrating that a vehicle was not operated prior to obtaining apportioned registration. The taxpayer did not produce any such evidence.

The ALJ also rejected the taxpayer’s claims of detrimental reliance on advice from Comptroller personnel, finding that the taxpayer didn’t show that any such advice was provided in writing in a private letter ruling or that any specific advice was incorrect.[25]

Gross Receipts Rental Tax

STAR Accession No. 202207023L (July 15, 2022)—In this private letter ruling, the Comptroller determined that a car-sharing app that enabled vehicle owners to list their personal vehicles as available for sharing to others was not responsible for collecting and remitting gross receipts rental taxes.[26]

For purposes of the motor vehicle sales, rental and use tax, a “rental” means in relevant part “an agreement by the owner of a motor vehicle to give for not longer than 180 days the exclusive use of that vehicle to another for consideration . . . .”[27]  The “owner of a motor vehicle” means “a person named in the certificate of title as the owner of the vehicle . . . or . . . a person who has the exclusive use of a motor vehicle by reason of a rental and holds the vehicle for re-rental.”[28]

Under the facts presented in this ruling, car-sharing app was not the owner of the vehicles being rented, because it was not on the certificate of title of the vehicles. Nevertheless, the people who used the app to rent their motor vehicles to others would have to collect and remit gross receipts rental tax as required under Tex. Tax Code § 152.045 (Collection of Tax on Gross Rental Receipts).

Franchise Tax

Forfeiture of Corporate Privileges / Officer Liability

Comptroller’s Decision No. 117,522 (2022)—The ALJ found that an officer of a corporation was liable for an International Fuel Tax Agreement assessment that the Comptroller had made against the corporation for the periods when the corporation’s corporate privileges were been forfeited due failure to file a franchise tax report.[29]

The officer didn’t argue, and therefore didn’t establish, that the debt was created or incurred over his objection or without his knowledge and that the exercise of reasonable diligence to become acquainted with the affairs of the corporation wouldn’t have revealed the intention to create the debt—which would constitute an exception to officer and director liability.[30]

The ALJ dismissed the officer’s argument that the corporation’s liability for the assessment was in error by noting that a person who is assessed personally as the officer or director of a corporation may not challenge the underlying corporate liability that is administratively final.

Mixed Beverage Taxes

Depletion Analysis

Comptroller’s Decision Nos. 117,651, 117,652 (2022)—The ALJ determined that there was no error in auditors presuming that all alcohol purchased by a bar during an audit period was sold during that period when the bar didn’t provide any documentation establishing opening and closing inventory.[31] The ALJ further found that allegations “that the auditors consumed alcohol during the pour observation, that the pour test observation sheet was forged, and that the lead auditor attempted to bully and intimidate [one of the bar’s owners] do not present justiciable issues for the ALJ to consider in the contested case hearing.”

Have a question? Contact TL Fahring, Freeman Law.

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[1] Tangible personal property directly used or consumed in or during the actual manufacturing, processing, or fabrication of tangible personal property for ultimate sale qualifies for the manufacturing exemption if the use or consumption of the property is necessary or essential to the manufacturing, processing, or fabrication operation and directly makes or causes a physical change to the product being manufactured, processed, or fabricated for ultimate sale.  Tex. Tax Code § 151.318(a)(2).

[2] 47 Tex. Reg. 6158.

[3] See id. at 6158-6159; Hearing on Interim Charges, Ways & Means, Tex. House of Representatives (Feb 5, 2020).

[4] Id. at 6159.

[5] Id.

[6] Id.

[7] Id.

[8] Id. at 6159.

[9] Id.

[10] Id.

[11] Id. at 6161.

[12] Id.

[13] Tex. Gov’t Code §§ 2303.003(6), 2303.402.

[14] Tex. Gov’t Code § 2303.101(2).

[15] A therapeutic device is a “device that is designed to alleviate pain or for use during the treatment or cure of human sickness, disease, suffering, or deformity.”  34 Tex. Admin. Code § 3.284(a)(14) (Drugs, Medicines, Medical Equipment, and Devices (Tax Code §151.313)).

[16] Tex. Tax Code § 151.313(a)(6) (Health Care Supplies); 34 Tex. Admin. Code § 3.284(d)(11)(C).

[17] See id. § 3.284(a)(13) (defining a “prosthetic device” as “an item that is artificial and replaces a missing part of the body, performs the function of a vital organ or appendage of the human body, or is permanently implanted in the body.”).

[18] See id. § 3.284(a)(12) (defining an “orthopedic appliance” as an “appliance or device designed specifically for use in the correction or prevention of human deformities, defects, or chronic diseases of the skeleton, joints, or spine.”).

[19] See id. § 3.284(a)(14).

[20] See Tex. Tax Code § 151.006(c) (“Sale for Resale”) (“A sale for resale does not include the sale of tangible personal property or a taxable service to a purchaser who acquires the property or service for the purpose of performing a service not listed as a taxable service . . . .”).

[21] A credit reporting service are a taxable service. See Tex. Tax Code 151.0101(a)(7) (“Taxable Services”).

[22] Tex. Tax Code § 151.0034 (Credit Reporting Service) (emphasis added).

[23] See Tex. Gov’t Code §§ 311.002 (Application), 311.005(2) (General Definitions); Tex. Tax Code § 101.002 (Construction of Code).

[24] A tax is 6.25% is imposed on the retail sale of a motor vehicle in the state. Tex. Tax Code § 152.021(a) (Retail Sales Tax). However, certain interstate motor vehicles are exempt from this tax. Id. § 152.089 (Exempt Vehicles). An “interstate motor vehicle” is “a motor vehicle that is operated in this state and another state or country and for which registration fees could be apportioned if the motor vehicle were registered in a state or province of a country that is a member of the International Registration Plan.” Id.

[25] See 34 Tex. Admin. Code § 3.10(c) (Taxpayer Bill of Rights):

Detrimental Reliance Policy. The comptroller will give relief to a taxpayer who follows erroneous advice given to the taxpayer by an agency employee. The taxpayer, however, must have provided complete and accurate information to the agency employee. . . .

(1) Unless otherwise provided by this section, a taxpayer must affirmatively prove and provide records as requested by the comptroller to show that it meets all four parts of the following test:

(A) the substance of the information or advice and its direct communication to the taxpayer must be in writing in accordance with §3.1 of this title;

(B) the taxpayer followed the information or advice;

(C) the taxpayer gave sufficient information to have resulted in correct advice and did not misrepresent information or withhold or conceal information that would affect the advice; and

(D) the taxpayer has suffered, or will suffer, harm based on the erroneous advice unless the comptroller provides relief to the taxpayer.

[26] Gross rental receipts from the rental of a motor vehicle are taxed at a rate of 10% if the rental is for 30 days or less or at a rate of 6.25% if the rental is for longer than 30 days. Tex. Tax Code § 152.026(a), (b) (Tax on Gross Rental Receipts).

[27] Tex. Tax Code § 152.001(5)(A) (Definitions).

[28] Id. § 152.001(9).

[29] A corporation’s failure to file a franchise tax report can result in the forfeiture of corporation’s corporate privileges.  Tex. Tax Code § 171.251 (Forfeiture of Corporate Privileges).  One consequence of the forfeiture of a corporation’s corporate privileges is that each of the corporation’s directors and officers becomes liable for each debt of the corporation created after the date on which the report is due and before corporate privileges are revived. Id. § 171.255 (Liability of Director and Officers).

[30] See id. § 171.255(c).