On January 27, 2023, the Texas Supreme Court (the “Court”) denied the Comptroller’s Petition for Review in the case Hegar v. Xerox Corporation, No. 21-1011. Previously, the Court of Appeals had upheld awarding Xerox Corporation (“Xerox” or the “taxpayer”) a tax refund resulting from the use of the 0.5% tax rate rather than 1.0% tax rate on its 2008 and 2009 franchise tax reports. Tax Code § 171.002(c) allows use of the lower rate by an entity that is primarily engaged in a wholesale trade. The Court of Appeals had also denied the Comptroller’s counterclaim attempting to reduce the taxpayer’s cost of goods sold (COGS) subtraction.
Xerox’s Tax Rate
Texas Tax Code § 171.002(c) allows a taxable entity to use the one-half tax rate (which currently is .375%) to compute its franchise tax when its total revenue is primarily from a retail or wholesale trade and less than 50% of those revenues come from products it or an affiliate produces. The selling of merchandise qualifies as wholesale trade activities described by SIC Code Manual, Division F.
Xerox had a large sales force that distributed its equipment and supplies for sale to commercial customers. In many cases, a financing lease was used to acquire the equipment, which qualified for sales-type lease accounting treatment. Though the accounting treatment is not controlling, the relevant facts and substance of the transactions showed that Xerox was engaged in selling merchandise. Its means of financing its sales did not convert Xerox’s activities into a leasing service. The Comptroller argued that “in substance” Xerox’s sales-type leases were leases, not sales, because there was no transfer of title, ignoring the most basic elements of a sale—the transfer of an item for consideration. The Comptroller ignored the entirety of the factors, such as whether possession was transferred for the economic life of the asset, whether the total payments received equaled or exceeded 90% of its fair value, and Xerox’s selling activities.
Comptroller’s COGS Counterclaim
Under the provision addressing the subtraction for COGS, Tax Code § 171.1012(a)(1) defines “goods” as “real or tangible personal property sold in the ordinary course of business of a taxable entity.” Indisputably, Xerox had substantial sales related to paper, toner, and other supplies. However, it also had outright sales of equipment. Though the Comptroller argued against COGS using the same transfer of title arguments used for the rate issue, the Comptroller was unable to show that the allowed amount of COGS was less than 30% of Xerox’s total revenue, which it proposed. Therefore, Xerox was able to subtract its originally reported COGS in this case.
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