On January 5, the Texas Comptroller of Public Accounts filed proposed amendments to 34 Tex. Admin. Code §3.591 with the Secretary of State in response to the Texas Supreme Court’s unanimous decision in Sirius XM Radio Inc. v. Hegar. On March 14, it formally adopted those amendments.
Background
By statute, Texas applies a traditional performance-oriented sourcing method for gross receipts from sales of services for the sales factor of the Texas franchise tax apportionment formula. If the performance of a service occurs in more than one state, then service receipts are allocated based on a fair value calculation. In January 2021, Texas revised its franchise tax apportionment rules under 34 Tex. Admin. Code §3.591 to adopt a market-based receipts-producing, end-product sourcing method.
The 2021 amendment still sourced gross receipts from sales of services to the location where performed but adopted the receipts-producing, end-product act test to determine that location. On March 25, 2022, in Sirius XM Radio, the Texas Supreme Court invalidated the receipts-producing, end-product test. On remand, an appellate court ruled that costs of performance can be a valid means to allocate the fair value of services performed in Texas and any other states.
The 2023 amended rule revises the definition of location of performance of services by removing the receipts-producing, end-product act test invalidated by Sirius XM Radio. In its place, the amended rule clarifies that a service is performed where the service provider’s personnel or property[1] do the work they were hired to perform. Any activities not directly used to provide a service should not be considered in determining the location where the service is performed.
The amended rule also removes location of performance examples (admission fees, subscription fees, gross receipts from the architectural design of a structure, etc.) provided by the 2021 amended rule. It also provides that a taxpayer may use only direct costs of performing a service when determining an allocation of the fair value of the service.
The amended rule limits what costs may be considered when determining where a service is performed to those for the taxpayer’s personnel or property doing the work and excludes any costs not directly used to provide the service. Taxpayers that previously used costs to allocate the fair value of services inside and outside Texas should review their costs used to consider how the amended service sourcing rules would change sourcing.
A taxpayer that used the receipts-producing, end-product act test should consider how the recent amendments would change the service sourcing. If the amendments would have an adverse effect, the taxpayer should consider either filing refund claims for the open years or seeking a voluntary disclosure agreement with the Comptroller’s office.
[1] The phrase “personnel or property” replaces the Court’s phrase “personnel or equipment” to provide a broader definition.