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Supreme Court of Texas Allows Decision to Stand in Southwestern Bell Yellow Pages v. Combs, Changing the Taxability of Component Parts of Printed Materials

Tax Development Dec 15, 2009

The Supreme Court of Texas has refused to review an Appellate Court decision imposing use tax on out-of-state printing services to produce printed materials that were then delivered into the state, as well as separately purchased raw materials like ink and paper that were supplied to the printer and incorporated into the printed materials.

As a result, the decision in Southwestern Bell Yellow Pages v. Combs, No. 03-07-00638-CV, Court of Appeals, Third District (January 8, 2009) is now final and will create a new use tax expense for many companies.

The case turned on the Court’s interpretation of a 2003 amendment to Texas Tax Code § 151.011 and the statute’s impact on the tax treatment of “printed material.” The statute, with the amended language underlined, reads:

Except as provided by Subsection (c) of this section, “use” means the exercise of a right or power incidental to the ownership of tangible personal property over tangible personal property, including tangible personal property other than printed material that has been processed, fabricated, or manufactured into other property or attached to or incorporated into other property transported into this state.

The Legislature added the language to the statute to reverse the effects of Sharp v. Morton Buildings, Inc., 953 S.W.2d 300 (Texas App.—Austin 1997, pet. denied), in which the Court found that use tax did not apply to raw materials that were purchased out of state when converted into another product by the purchaser or a third party before that product entered Texas. However, the language was amended on the House floor by its sponsor, Rep. Brian McCall, R-Plano, to add the words “other than printed material” in an effort to preserve the raw materials exclusion for “printed material.” McCall subsequently reiterated his intent in a letter to the Comptroller of Public Accounts in which he stated that he intended to preserve the exclusion for “printed material and component parts of printed material.”

To that end, Southwestern Bell Yellow Pages argued that it was due a refund of use tax paid on printing services it obtained and used out of state in the printing of directories that were then distributed in Texas. The company said that “printing services” are deemed to be “printed material” under the Court’s holding in May Dep’t Stores Co. v. Strayhorn, No. 03-03-00729 CV, Court of Appeals, Third District (August 26, 2004, pet. denied), in which the Court said that a sale of “printing services” constituted a sale of tangible personal property for use tax purposes because the essence of the transaction was the purchase of the final printed product itself.

The Comptroller, however, argued that McCall’s amendment only preserved the exclusion for the raw materials that go into printed materials, such as ink and paper, not printing services.

The Court disagreed with the interpretation both parties gave the statute, stating:

Regardless of how "printed material" is defined, the plain and unambiguous meaning of the amended statute does not exclude all printed material from the use tax. As the statute reads, it excludes only printed material “that has been processed, fabricated, or manufactured into other property or attached to or incorporated into other property transported into this state. Texas Tax Code 151.011 (emphasis added). Therefore, only printed material that serves as a component of some other finished product is excluded from the use tax.

The Court noted McCall’s letter as to his intent but said it was insufficient to establish legislative intent under Texas law. And, the Court said that while McCall’s letter states that he intended to cover “printed material and component parts of printed material,” his amendment was not so worded. The Court wrote:

[T]he phrase "component parts of printed material" does not appear in the statute. Rather than excluding the component parts, such as paper and ink, of all printed material from the use tax, the legislature excluded only printed material that is itself a component part of a final product.

Since Southwestern Bell Yellow Pages had conceded in oral arguments that its telephone directories were a final product that was not incorporated into any other product, the Court said the tax applied.

Ryan expects the Comptroller to propose an amendment to its use tax regulation, 34 TAC § 3.346, to reflect the Court’s decision. Although the parts of the decision addressing raw materials are dicta, Ryan expects the proposed amendment to the rule to provide that paper and ink supplied to a third-party printer for incorporation into printed materials are now subject to use tax. Comptroller representatives have said they expect this change to be applied prospectively in recognition of well-established prior agency policy.