Amended Texas Franchise Tax Apportionment Regulation Adopts Significant Sourcing Changes
By: Jeff Glickman, partner-in-charge of Aprio’s SALT practice
At a Glance:
- The Main Takeaway: The Texas Comptroller of Public Accountants has adopted final amendments to its franchise tax apportionment regulation.
- Impact on Your Business: These updates may require businesses to revise the way in which they source their gross receipts.
- Next Steps: Below, we provide a brief breakdown of notable changes to consider, though it’s important to review the revised regulation in its entirety to fully understand whether your business is affected.
Need professional assistance with reviewing this regulation and understanding its impact on your business? Contact Aprio’s State and Local Tax (SALT) team.
The full story:
Recently, the Texas Comptroller of Public Accounts adopted final amendments to its franchise tax apportionment regulation. The amendments make many changes to how businesses will source gross receipts for apportionment purposes, and a few notable changes are described in more detail below.
In addition, please note that it is the Comptroller’s position that, unless specifically stated otherwise, these changes are applicable to franchise tax reports due on or after January 1, 2008, as they essentially represent clarifications of existing policy, and that any prior inconsistent rulings are superseded.
Net gains from the sale of capital assets and investments
Subsection (e)(2) of the rule was amended to reflect the Texas Supreme Court’s decision in the Hallmark case, which ruled that only “net gains” are included in the apportionment factor and not “net losses.” Thus, if a taxpayer engaged in three sales of Texas capital assets and one resulted in a gain of $100, another in a loss of $125 and the third in a $50 gain, the net gain of $25 would go in the numerator and the denominator of the gross receipts apportionment factor. However, if the third transaction never happened, then the resulting net loss of $25 would be excluded entirely from the factor (i.e., it would not reduce other gross receipts).
However, effective for reports due on or after January 1, 2021, the rule was further amended to provide that net gains and net losses must be determined on a sale-by-sale basis, meaning that a net loss on one capital asset may not offset the net gain on another capital asset. Therefore, in the example above, the taxpayer would have net gains of $150, and the net loss of $125 on the second capital asset would not be allowed to offset the gain.
Computer hardware and digital property
Subsection (e)(3) of the rule was amended to provide sourcing rules for receipts from sales of computer hardware and digital property. This subsection previously addressed the sourcing of receipts from sales of computer software services and computer programs, with the former treated as a sale of a service and sourced to where the service was performed, and the latter treated as a sale of an intangible asset and sourced to the legal domicile of the payor.
Under the revised regulations, digital property includes computer programs and certain other digital content, and the sourcing of digital property depends on the manner in which it is provided. Most notably, it appears that software accessed remotely will be treated as the sale of an “internet hosting service” and the receipts will be sourced to the location of the customer. This specific treatment applies to franchise tax reports due on or after January 1, 2014. Below is an excerpt from one of the examples:
Software Company designs bookkeeping software for personal use . . . Software Company sells an online version of its bookkeeping software in which end users can enter and store data online using the Software Company’s website for a periodic fee . . . Software Company’s receipts from the sale of its online version are from the sale of an internet hosting service and sourced to the location of the customer under paragraph (13) of this subsection.
Subsection (e)(26) provides the sourcing rule for services not otherwise specifically covered in the regulation, and receipts from the sale of services will continue to be sourced to the location where the service is performed. The rule was amended to provide specifically that:
[A] service is performed at the location of the receipts-producing, end-product act or acts. If there is a receipts-producing, end-product act, the location of other acts will not be considered even if they are essential to the performance of the receipts-producing acts. If there is not a receipts-producing, end-product act, then the locations of all essential acts may be considered.
For example, receipts from the sale of tickets to observe a live or pre-recorded performance are sourced to the location where the recipients observe the performance. The location of the rehearsals and recording of the performance are not determinative. This amendment adopts the state’s longstanding position that was most recently addressed by the Third Court of Appeals in the Sirius XM case.
Businesses should review the entire revised regulation carefully and determine if any of their prior return positions may create tax exposure or a possible refund. We constantly monitor these and other important state tax topics, and we will include any significant developments in future issues of the Aprio SALT Newsletter.
This article was featured in the March 2021 SALT Newsletter.
 34 Texas Admin. Code § 3.591 (see page 6 of the linked document).
 Hallmark Marketing Co., LLC, v. Hegar, et al., No. 14-1075 (Tex. Sup. Ct., April 15, 2016). You can read about this case in our Aprio 2016 SALT Newsletter article. The state subsequently issued additional guidance on a policy revision to apply the Hallmark decision to both the numerator and the denominator of the gross receipts factor, which is summarized in our February 2020 SALT Newsletter article.
 An “internet hosting service” is a new category of receipts under the amended rule and is defined as “providing to an unrelated user access over the internet to computer services using property that is owned or leased and managed by the provider and on which the user may store or process the user’s own data or use software that is owned, licensed or leased by the user or provider.” 34 Texas Admin. Code § 3.591(e)(13)(A) (emphasis added).
 Hegar v. Sirius XM Radio, Inc., No. 03-18-00573-CV (Tex. App, 3rd Dist. – Austin, May 1, 2020). You can read about this case in more detail in our June 2020 SALT Newsletter. This decision is not yet final because the taxpayer has petitioned the Texas Supreme Court to review that case, and the petition is still pending.
Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or under any state or local tax law or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Please do not hesitate to contact us if you have any questions regarding the matter.