On November 30, 2021, the Texas Supreme Court heard oral arguments in the franchise tax case of Sirius XM Radio, Inc. v. Hegar. The Court’s opinion was delivered on March 25, 2022. At issue was the application of Texas’s sourcing of receipts from services. Sirius XM produces radio programming, which it transmits using satellites, and its subscribers pay monthly fees to access said programming. Under Texas Tax Code § 171.103(a)(2), receipts from “each service performed in this state” are included in Texas gross receipts for franchise tax apportionment purposes.
Prior to 2021, the related Texas Regulation, 34 TAC § 3.591(e)(26), read: “[r]eceipts from a service are apportioned to the location where the service is performed.” Applicable to periods after that covered in Sirius XM’s case, the Texas Comptroller amended Rule 34 TAC § 3.591(e)(26) to add subsection (A), which states that the location of performance is the “location of the receipts-producing, end-product act or acts. If there is a receipts-producing, end-product act, the location of other acts will not be considered even if they are essential to the performance of the receipts-producing acts.”
In this case, the state was claiming that the service the subscribers paid for did not occur until the encrypted signal from the satellite radio service was decoded by a chip in a customer’s automobile radio, enabling the radio signal to be heard. Thus, Texas was the location of the receipts-producing, end-product act. Sirius XM contended that it did not own the equipment performing the signal decryption, and more importantly, it performed its programming and transmission activities outside the state of Texas.
The question before the Texas Supreme Court was where the service was performed. The Court looked to the ordinary meaning of “service” and “performed in this state,” which is understood to mean labor done for the benefit of another in Texas. Further, the Court explains that where “useful labor” is “done” is “where the employees do their work, since businesses act only through their agents.” However, when technology performs the useful act, you look to the location of that equipment.
Relying on hearings that originally introduced the “receipts-producing, end-product act” test, the Court concludes that the test was not well-established and “served only to distinguish between the ‘support services’ that enable the entity to do business and the ‘receipt-producing’ services for which a customer actually pays.” Thus, the “test aimed to tell the Comptroller what qualifies as the ‘service performed.’ It did not tell the Comptroller where a service is performed.” As such, the Court determined the test should not play any role in its decision.
As a result, determining the relevant location required looking at the nature of the services performed. Considering the economic realities, Sirius XM’s subscribers paid for “access to radio content.” The relevant location is “where the taxpayer’s personnel or equipment is physically doing useful work for the customer.” Providing access to radio content involved radio production and transmission, little of which was performed by equipment or personnel in Texas. Therefore, the court of appeals decision apportioning to Texas all of the subscriber receipts was reversed. However, because the wrong test had been applied, the court of appeals never addressed whether the taxpayer had provided sufficient evidence of the fair value of the services that were rendered in Texas. Thus, the Court remanded the case to the extent the parties still disagreed on whether Sirius XM’s cost of performance study provided sufficient evidence of the fair value of the services done in the state.
Our Texas Franchise Tax team has advocated for the “act done” analysis for years and can assist in gathering the facts necessary to establish the nature of the services performed by your business, the identification of the requisite personnel, and equipment performing those services to determine the fair value of any services performed in Texas for proper apportionment purposes.
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Eric L. Stein
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