Texas Comptroller of Public Accounts Clarifies Qualifications for Franchise Tax Retail Rate

Retailers and wholesalers that sell products manufactured by foreign affiliates may not qualify for the lower "retail/wholesale rate" under the revised Texas franchise tax, according to a new tax policy statement published by the Texas Comptroller of Public Accounts ("Comptroller") on April 14, 2010.

The statement is the latest in a series of guidance by the Comptroller issued since last November in an effort to clarify the statutory qualifications for the preferential tax rate. The franchise tax is levied generally at a rate of 1% of taxable margin, but companies primarily engaged in business activities that fall within the Standard Industrial Classification (SIC) wholesale and retail codes may be taxed at the rate of 0.5% of taxable margin, if they meet the requirements of Texas Tax Code § 171.002(c)(2). That section says that to be "primarily engaged" in wholesale or retail activities, a wholesale business or a retail business other than a restaurant must receive less than 50% of its total revenue from the sale of products it produced or which were produced for it by an affiliate.

Last fall, the Comptroller announced that sales of private label goods would not count toward the 50% total revenue test, as long as the goods were made for the retailer or wholesaler by an unrelated third-party manufacturer. In January 2010, the Comptroller promulgated an amendment to Rule 3.584 to further provide that certain types of modifications retailers make to goods acquired for resale—enhancements such as monogramming or embroidering of shirts and hats—also would not cause those goods to be considered "produced" by the retailer unless the modification increased the price of the good by more than 10%.

The most recent policy statement, released in the March 2010 edition of the Comptroller’s monthly Tax Policy News, sought to answer the question of whether a company would qualify for the retail/wholesale rate if 50% or more of its total revenue came from the sale of goods manufactured for it by a foreign affiliate. Under the facts presented, the foreign affiliate conducted its business and had at least 80% of its payroll and property outside of the United States and, therefore, did not qualify to be included in the taxpayer’s unitary group for franchise tax purposes under Texas Tax Code § 171.1014(a).

The Comptroller said that under such facts, the taxpayer would not qualify for the retail rate. The Comptroller noted that the statutory test for the retail rate refers to goods manufactured by "an entity that is part of an affiliated group to which the taxable entity also belongs" [Texas Tax Code § 171.002(c)(2)]. The Tax Code further defines an "affiliated group" to include entities in which a common owner holds more than a 50% interest [Texas Tax Code § 171.0001(1)]. There is no requirement that an affiliate also be included in the taxpayer’s "combined group," which the Tax Code defines to include taxable entities that are part of an "affiliated group" and engaged in a unitary business.