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Texas Revises Policy on the Inclusion of Net Gains in the Gross Receipts Factor

Several years after a Texas Franchise Tax case determined that only net gains, but not net losses, are included in the denominator of the apportionment factor, Texas has issued revised policy guidance that now applies those same principles to the numerator of that factor as well, thereby increasing the apportionment percentage for certain taxpayers for prior periods.

By Jeff Glickman, SALT Partner

Almost four years ago, in our Aprio 2016 SALT Newsletter, we wrote an article about a Texas case that ruled that for purposes of computing the denominator of the gross receipts apportionment factor (i.e., gross receipts everywhere) under the Texas Franchise Tax (“TFT”), only “net gains” from investments/capital assets are included.[1]  Subsequent to that case, on July 7, 2017, Texas issued a policy document explaining the application of that decision, which impacted only the denominator of the gross receipts factor.

On January 22, 2020, Texas issued guidance that it was making a policy revision and was now going to apply the principles of the Hallmark decision to both the numerator and the denominator of the gross receipts factor.[2]

Let’s take a look at what this change means in the two examples below.  Assume the following net gains/losses from the sale investments or capital assets (Texas-sourced net gains/losses are identified):

EXAMPLE 1
 Item A – net gain $10,000
 Item B – net loss ($15,000) (Texas)
 Item C – net loss ($5,000)
 Item D – net gain $12,000 (Texas)
EXAMPLE 2
 Item A – net gain $10,000
 Item B – net loss ($15,000) (Texas)
 Item C – net loss ($5,000)
 Item D – net gain $12,000 (Texas)

In example 1, under the original guidance, the numerator would be a net loss of $3,000, which would offset other Texas gross receipts.  The denominator would be a net gain of $2,000, which would get added to all other receipts.

Under the revised guidance, the denominator would still be a net gain of $2,000, but because the Texas-sourced items resulted in a net loss, the numerator for such items would be zero, effectively increasing the overall apportionment factor.

In example 2, pursuant to the original guidance, the numerator would be a net loss of $3,000, which would offset other Texas gross receipts.  The denominator, since it results in an overall net loss of $1,000, would be zero.

Under the revised guidance, since the Texas-sourced items resulted in a net loss, the numerator would be zero, and the denominator would remain zero.

Let’s modify the facts of example 2 and assume that Item A and not Item B is Texas-sourced.  Then, under both the original and the revised guidance, the numerator of the gross receipts factor would be a net gain of $22,000, and the denominator of the gross receipts factor would be zero (since it results in a net loss).  In this case, it is possible, after including all of the other receipts in the numerator and denominator as required, that the factor could be larger than 100% (i.e., the numerator is greater than the denominator).  In this case, the guidance makes clear that the factor would be 100%.

This policy change, which essentially provides symmetry to the rules for both the numerator and denominator, will have the effect of increasing the overall apportionment factor compared to the guidance prior to this policy revision.  Of significance, the guidance states that the “revised policy is effective for all open periods within the statute of limitations,” which is four years from the date that the tax becomes due and payable.[3]  It is unclear how aggressive the state will be in auditing and assessing taxpayers that owe tax as a result of this revised guidance.

Therefore, taxpayers and their advisors should take a look at TFT reports for which the statute of limitations is still open to determine if the apportionment factor would change under the revised guidance and whether there is any exposure as a result.  Aprio’s SALT team has experience with the TFT and can assist businesses with understanding the impact of this guidance, whether it has an impact on their TFT liability in prior years, and potential steps for addressing any liability with the state.  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.

Contact Jeff Glickman, partner-in-charge of Aprio’s SALT practice, at jeff.glickman@aprio.com for more information.

This article was featured in the February 2020 SALT Newsletter.

[1] Hallmark Marketing Co., LLC, v. Hegar, et al., No. 14-1075 (Tex. Sup. Ct., April 15, 2016)

[2] Texas Policy Memo, STAR Doc. 202001008L (Jan. 22, 2020), revising Texas Policy Memo, STAR Doc. 201707002L (July 7, 2017). To see the revised 2017 policy memo, click here.

[3] Tex. Tax Code Ann. § 111.201.

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.

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