On April 30, 2015, in American Multi-Cinema, Inc. (“AMC”) v. Glenn Hegar, the Texas Third Court of Appeals (“Appellate Court”) found that 1) AMC’s exhibited movies constitute tangible personal property (TPP), not intangible property nor a service; and 2) the costs of producing the exhibited movies are not isolated to the screen and speakers but include the entire production area in the auditorium.
One of the allowed subtractions in computing franchise tax is the cost of goods sold (COGS). Tax Code § 171.1012(a)(1) defines “goods” as TPP sold in the ordinary course of business. Subsection (a)(3)(A)(i) defines TPP as “personal property that can be seen, weighed, measured, felt, or touched or that is perceptible to the senses in any other manner.” The Appellate Court determined that the evidence presented to the trial court was legally sufficient to support its findings of fact and that the trial court’s conclusion of law was correct in that AMC’s exhibition of movies produces goods for sale in the ordinary course of business.
The Appellate Court was not persuaded by the Texas Comptroller of Public Accounts (“Comptroller”) that AMC’s customers were purchasing an intangible (license) or a service, and disagreed that the Franchise Tax Code imposed a “take-home” requirement for TPP. It relied on the plain and common meaning of those words: 1) intangible - incorporeal property often evidenced by documents, such as stocks, bonds, or judgments having no intrinsic value; and 2) services - the performance of work commanded or paid for by another that does not produce a tangible commodity. The Franchise Tax statute provides that TPP includes film, sound recordings, live and prerecorded TV, and radio programs “without regard to the means or methods of distribution or the medium in which the property is embodied.” Though not relied upon, the Legislature in 2013 spelled out that COGS for a movie theater shall include “the acquisition, production, exhibition, or use of a film or motion picture.” Because the exhibited movies are TPP, the Appellate Court ruled that AMC was entitled to include in COGS its requested movie exhibition costs.
The Appellate Court only addressed if what AMC sold was TPP for franchise tax purposes, no other facts or tax types. The franchise tax (in Tax Code § 171.1012) and sales tax (in Tax Code § 151.009) both contain the same definition of TPP: “personal property that can be seen, weighed, measured, felt, or touched or that is perceptible to the senses in any other manner.” But the Appellate Court did not hold that anything perceptible to the senses is TPP regardless of whether the purchaser takes possession or title of the item because those criteria are not part of the franchise tax. The Appellate Court found that what AMC sells is TPP because what it sells is perceptible to the senses. It only addressed the provisions that are actually in Chapter 171, related to the franchise tax. Those are, whether AMC sold TPP, which specifically exclude intangible property and services. For franchise tax purposes, it did not sell a service, which is the performance of work, regardless of whether you can see the person or hear the person while he/she is working or see the result of his/her work. Applying the court’s analysis, an entity does not sell the sight, sound, or smell of a freshly cut lawn; it sells the performance of cutting the lawn. Conversely, selling the sight and sounds of a movie is the sale of TPP, not the sale of an intangible or the performance of a service. The Appellate Court addressed AMC facts and determined what it sold.
The sales tax treatment of exhibited movies as a taxable amusement service had no bearing on the case. The sales tax applies a slightly different twist to taxing transactions. Tax Code § 151.005 defines a “sale,” to include “a transfer of title or possession of tangible personal property” and “the performance of a taxable service….” Thus, for sales tax purposes, a transfer of title or possession of the TPP is relevant. In addition, if a transaction falls within one of the 17 taxable services, it will be subject to sales tax as a service. The primary exemption from the sales tax is the manufacturing exemption, which will not apply if an entity’s sales are subject to sales tax as a service. See GTE Southwest, Inc. v. Combs, 2010 Tex. App. LEXIS 4223 (Tex. App.-Austin 2010, pet. denied). In GTE, the Comptroller argued and the court agreed that in the context of the Sales Tax statute, the phrase “tangible personal property for ultimate sale” denotes a sale that is taxed for sales tax purposes as the sale of TPP.
Thus, the AMC case addresses the franchise tax and what costs can be subtracted in computing taxable margin, such as COGS, when an entity sells a good, regardless of whether for sales tax purposes the same sale is treated as a taxable service. Neither the franchise tax nor the sales tax controls the treatment of the exhibition of a movie for purposes of the other.
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