In Gulf Chemical and Metallurgical Corporation v. Glenn Hegar, the Third Court of Appeals (“Appellate Court”) on March 26, 2015, found that 1) certain credits to customers constituted allowances and 2) the allowances should be netted against total receipts when calculating the apportionment factor despite the fact that the taxpayer had not recorded the credits on its federal tax return as allowances.
On the issue whether the credits constituted allowances, the Appellate Court found that the Comptroller’s position ignored the legal and accounting substance of the transactions and that Gulf Chemical and Metallurgical Corporation (“Gulf”) did provide evidence that the amounts at issue constituted “allowances.” The sales transactions were accounted for using the accrual method of accounting, which is governed by Generally Accepted Accounting Principles (GAAP). In Emerging Issues Task Force (EITF) Issue No. 01-09, GAAP provides that consideration given by a vendor is presumed to reduce the selling price.
On the issue whether the allowances could then be netted against Gulf’s sales, the Comptroller argued that the federal income tax return treatment of an amount (whether sales, sales allowance, expense, cost of goods sold, etc.) was an “accounting method” that could not be changed retroactively. The Appellate Court found that the federal tax return treatment of an amount is not an accounting method and that Gulf was not bound by the characterization of the amount at issue on its federal income tax return. In looking at the transactions and contracts, the Appellate Court concluded that the amounts were “allowances” that reduce gross receipts under the now repealed Comptroller’s Rule in 34 Tex. Admin. Code Section 3.557(e) and other persuasive case law, irrespective of how the amounts were reflected on Gulf’s federal income tax return.
During the claim period, the language in Tax Code Section 171.1121(a) provided that “‘gross receipts’ means all revenues reportable by a corporation on its federal tax return, without deduction for the cost of property sold, materials used, labor performed, or other costs incurred, unless otherwise specifically provided in this chapter.” Except for replacing the reference to “corporation” with “taxable entity,” the language in the current version is the same. In addition, Tax Code Section 171.1121(b) during the claim provided that “[e]xcept as otherwise provided by this section, a corporation shall use the same accounting methods to apportion taxable earned surplus as used in computing reportable federal taxable income.” The current version of Section 171.1121(b) also changes the “corporation” reference, and in addition, it removes the reference to “reportable federal taxable income.” Specifically, Section 171.1121(b) provides that “…a taxable entity shall use the same accounting methods to apportion margin used in computing margin.”
Since the Appellate Court concluded that the federal income tax return treatment is not an accounting method, it is critical to consider the actual legal and accounting substance of sales transactions to determine the proper amount of gross receipts for apportionment purposes. A reduction to both the numerator (Texas gross receipts) and the denominator (Everywhere gross receipts) may have a significant impact on a taxpayer’s apportionment factor.
TECHNICAL INFORMATION CONTACTS:
Eric L. Stein
Principal
Ryan
512.476.0022
eric.stein@ryan.com
Sandi Farquharson
Director
Ryan
512.476.0022
sandi.farquharson@ryan.com