Texas Rules that Combined Group Member’s Gain from Stock Sale is Not Included in Sales Factor Numerator
December 14, 2017
Texas’ combined group apportionment percentage includes Texas receipts only from group members that have nexus in the state. In this case, the parent did not have nexus because it did not maintain a place of business or perform services in Texas.
By Tina Chunn, SALT senior manager
One of the many income tax issues on which states differ deals with the computation of a combined group’s sales/gross receipts factor of the apportionment calculation. Specifically, the issue is whether or not receipts of a member of the combined group are included in the numerator of that factor. In a combined group return, some of the members of the combined group may not have nexus with the reporting state. 
Some states look at the nexus of each member of the group individually and only require that the in-state receipts of nexus members (sometimes referred to as taxable members) be included in the numerator of the sales factor. Other states take the position that the in-state receipts of all members are included in the numerator because the nexus of any one member is attributed to all of the members (i.e., each member is deemed to have nexus in the state). The former set of states are referred to as “Joyce” states, and the latter set are referred to “Finnigan” states. 
Recently, Texas issued a private letter ruling that addresses its approach regarding amounts to be included in the gross receipts factor for the combined apportionment calculation under the Texas franchise tax.  In this case, the combined group consists of a parent limited liability company (“LLC”), which is a holding company that owns the stock of two corporations. The LLC does not have any operations or nexus in Texas. The LLC sold the stock of one of its subsidiary corporations to an unrelated Texas corporation. 
The LLC requested clarification from Texas as to whether the gain from the sale of its subsidiary is included in the numerator of the gross receipts apportionment factor. Texas ruled, in accordance with Joyce, that since the LLC does not have nexus in Texas, the net gain from the sale would not be included in the numerator of the sales apportionment factor in calculating the group’s taxable margin.
When calculating the combined group’s gross receipts from business in Texas (i.e., the numerator of the apportionment factor), a combined group must include the gross receipts of each entity that is a member of the combined group AND that individually has nexus in Texas.  Therefore, the gross receipts of members that do not have nexus in Texas are not included as Texas gross receipts, even if the receipts are sourced to Texas.
Texas provides that activities that establish nexus and subject a taxable entity to Texas franchise tax include maintaining a place of business in Texas or managing, directing and/or performing services in Texas for subsidiaries. Since the LLC does not maintain a place of business in Texas and does not manage, direct or perform services in Texas for its subsidiaries, it does not have nexus with Texas. Therefore, although the LLC sold the stock of its subsidiary to a Texas corporation (which is treated as a Texas receipt), the gain from this sale is not included in the numerator of the apportionment factor since the LLC did not have nexus in Texas.
One side issue worth noting is that for federal income tax purposes, the LLC was treated as an S-corporation and each of the subsidiaries was a disregarded subchapter S subsidiary. Therefore, the sale by the LLC of the stock of its subsidiary was treated for federal income tax purposes as a sale of assets by the LLC. However, since Texas does not follow federal entity classification rules and views all LLCs and corporations as regarded entities, the sale by LLC was treated as a stock sale for Texas franchise tax purposes.
The state rules governing the apportionment of income and calculation of the apportionment factors are complex, particularly with regard to combined group returns. Specific attention should be paid to transactions outside the ordinary course of business to make sure that the apportionment factors, and therefore taxable income, are not overstated.
Aprio’s SALT team at Aprio is experienced with evaluating the multi-state apportionment requirements and structuring transactions in order to minimize state income tax liability. We constantly monitor these and other important state tax issues, and we will include any significant developments in future issues of the Aprio SALT Newsletter.
This article was featured in the November/December 2017 SALT Newsletter.
 In states that require combined reporting, the combined group typically consists of corporations meeting certain common ownership levels and that are engaged in a unitary business. At least one of those members will have nexus with the state, but it is usually not a requirement that each member have nexus.
 Joyce and Finnigan refer to the two California cases setting forth these two positions. California was originally a Finnigan state, then became a Joyce state and is now back to being a Finnigan state. This is an issue that arises only in the context of a combined/unitary group return.
 Letter No. 201709010L, Texas Comptroller of Public Accounts, Sept. 12, 2017. Texas utilizes a single gross receipts factor apportionment formula.
 Under Texas’ sourcing rules, the gain is considered a Texas receipt for sales factor apportionment purposes. See Tex. Admin. Code 3.591(e)(2).
 See Tex. Admin. Code 3.590(d)(5)(B).
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.
About the Author
Tina is a senior manager with Aprio’s State & Local Tax group. She has over 24 years of experience assisting companies and their owners to minimize their tax liability and maximize their profitability. Some of the industries Tina serves include professional services, manufacturing, warehousing and distribution, telecommunications, real estate, retailers and wholesalers. Tina has extensive experience dealing with corporate tax issues, including state and local tax returns; state and federal tax credits; state and local sales; and use, income, escheat, business licenses and property tax issues.