Texas Finalizes Regulations for Sourcing Service Receipts
February 09, 2021
By Denisse Moderski and Bill Gentilesco
On January 15, 2021, the Texas Comptroller adopted and finalized revisions to its sourcing rules under 34 Tex. Admin. Code Section 3.591 for franchise tax receipts. While the revisions encompass a multitude of sourcing rules (e.g., advertising services, internet hosting services, loan servicing activities, capital asset and investment services, etc.), the sourcing of services is of specific concern.
The original text of Tex. Admin. Code 34 §3.591(e)(26) stated that the receipts from services were apportioned to the location where the service was preformed, and if the services were performed both inside and outside of Texas, then the receipts were Texas receipts on the basis of fair value of the services that were rendered in Texas. The language of the original regulation caused confusion among taxpayers because the rules were applied differently depending on the circumstances. However, under the newly adopted regulations, Texas has defined the “location of performance” as:
“A service is performed at 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. If there is not a receipts-producing, end-product act, then the locations of all essential acts may be considered. If services are performed both inside and outside Texas for a single charge, then receipts from the services are Texas gross receipts on the basis of the fair value of the services that are performed in Texas. In determining fair value, the relative value of each service provided on a stand-alone basis may be considered. Units of service, such as hours worked, may also be considered. The cost of performing a service does not necessarily represent its value. If costs are considered, costs should be limited to costs directly related to the service and not overhead costs.”
Additionally, Texas provides several examples to clarify the new adopted regulations:
- Admission fees, subscription fees or other charges for an audience to observe live or pre-recorded performances are sourced to the locations where the recipients observe the performance. The location where the live performance was rehearsed, the pre-recorded performance was recorded, and the admission fee or other charge was paid are not determinative.
- Gross receipts from the architectural design of a structure are sourced to the location or locations where the architect performed the work. The delivery location of any tangible work product, such as a blueprint, is not determinative.
- Example I: a law firm with offices in Texas and Louisiana charges a client a lump sum fee of $5,000 to draft a document. Attorneys in the Texas office recorded 20 hours on the project, and attorneys in the Louisiana office recorded five hours on the project at the same billing rate. Texas gross receipts are $4,000. If the law firm does not record hours worked on a project, other measures of direct cost may be considered.
- Example II: a Texas-based landscaper provides grounds maintenance services at its client's four offices in Texas and one office in Oklahoma for an annual fee of $50,000. The landscape services at each of the locations are substantially the same. Texas gross receipts are $40,000. Although the cost of performing the landscaping maintenance service at the Oklahoma office is higher than the cost of performing the service at the other locations because of the additional travel cost, the additional cost is not considered.
For those familiar with the terms “market-based” or “cost of performance sourcing of receipts,” it would be incorrect to define Texas’s new sourcing rules as one or the other. Rather, it is imperative to take each circumstance on a case-by-case basis and consult with a trusted tax advisor to arrive at the best conclusion of a taxpayer’s sourcing of services.
Texas Franchise Tax Bright-Line Economic Nexus
On December 20, 2019, the Texas Comptroller adopted amendments to its franchise "margin" tax nexus rule 34 TAC Sec. 3.586(f) establishing an economic nexus standard with a $500,000 threshold. This change took effect December 29, 2019, and applies to franchise tax reports due on or after January 1, 2020. The changes to Texas’ revenue sourcing rules may impact whether or not an out-of-state business exceeds the new $500,000 franchise tax nexus test.