In recent months, we have discussed the franchise tax as it relates to both the construction industry (August 2010) and the retail industry (January 2011). In this month's article, we discuss the franchise tax rate in relation to entities that have revenue from both retail and construction activity. Examples of such entities may include flooring retailers/contractors, window and door retailers/contractors, heating and air-conditioning retailers/contractors and plumbing retailers/contractors.

Specific instructions for determining if an entity is eligible for the 0.5 percent tax rate are provided in Texas Tax Code Section 171.002. Subsection (b) of this section allows a rate of 0.5 percent of taxable margin for those taxable entities primarily engaged in wholesale and retail trade as described in Division F and G of the 1987 Standard Industrial Classification (SIC) Manual. Subsection (c) provides three steps to determine if an entity is primarily engaged in retail or wholesale trade. (Our April 2010 newsletter article provides complete instructions for determining if an entity is primarily engaged in retail or wholesale trade.)

For retailers/contractors, the confusion lies in the first step, Tax Code Section 171.002(c)(1), which involves analyzing and separating total revenue by SIC code to determine if total revenue from activities in retail or wholesale trade is greater than the total revenue from activities in trades other than retail or wholesale trade.

Tax Rate

The tax rate is 0.5 percent for entities primarily engaged in wholesale or retail trade, as defined in Division F and G of the 1987 Standard Industrial Classification (SIC) Manual.

A taxable entity is primarily engaged in retail or wholesale trade only if:

• the total revenue from its activities in wholesale or retail trade is greater than the total revenue from its activities in trades other than the wholesale and retail trades;
• less than 50 percent of the total revenue from activities in wholesale or retail trade comes from the sale of products it produces or products produced by an entity that is part of an affiliated group to which the taxable entity also belongs (a product is not considered to be produced if modifications made to the acquired product do not increase its sales price by more than 10 percent); and
• the taxable entity does not provide retail or wholesale utilities, including telecommunications services, electricity or gas.

Note: A thorough discussion of an entity's qualification for the 0.5 percent tax rate appeared in the April 2010 Tax Policy News. Also, as discussed in our article on the restaurant industry in the October 2010 issue, eating and drinking places are considered to be engaged in retail trade even though they produce the products they sell.

Cost of Goods Sold (COGS)

Generally, the COGS provisions apply to entities that sell real or tangible personal property in the ordinary course of business and include all direct costs of acquiring or producing the goods. Wholesalers and retailers typically acquire and then resell tangible personal property and can include as COGS the costs incurred from the acquisition of the goods through to the point of putting the goods on display for sale, as allowed in Texas Tax Code Section 171.1012. Costs incurred once the goods are displayed are considered selling costs and are not allowed as COGS.

Costs allowed as COGS include:

• the purchase price of the goods;
• repackaging costs;
• inbound transportation costs; and
• storage costs, but not rental of storage space. See Tax Code Section171.1012(e)(1).

Costs not allowed as COGS under Section171.1012(e) include:

• selling costs;
• distribution costs (including outbound transportation);
• advertising costs;
• rehandling costs; and
• officers' compensation.

Example 1

A department store chain that sells clothing for men, women and children has several retail stores throughout Texas. The department store chain owns a centrally located distribution center that supplies the retail stores with the acquired apparel.

The following costs are allowed as COGS:

• the cost of acquiring the apparel;
• compensation and other expenses (travel, etc.) related to purchasing agents;
• the cost of transporting apparel to the distribution center;
• depreciation of the distribution center;
• depreciation on equipment used in the distribution center;
• distribution center utility costs;
• the cost of transporting apparel from the distribution center to the retail stores; and
• the cost of utilities for the storage area only at the retail stores.

The following costs are not allowed as COGS:

• rent paid to shopping centers for retail store space;
• utility costs for the retail store display areas;
• display racks and display shelving;
• compensation paid to sales managers and sales personnel;
• the cost of cash registers;
• credit card company fees;
• shopping bags; and
• tissue.

Example 2

A grocery store chain has stores located throughout central Texas and rents a distribution center located in San Antonio.

The following costs are allowed as COGS:

• the cost of acquiring the groceries;
• compensation and other expenses (travel, etc.) related to purchasing agents;
• the cost of transporting the groceries to the distribution center;
• depreciation on equipment used in the distribution center;
• distribution center utility costs;
• the cost of transporting groceries from the distribution center to the grocery stores; and
• compensation paid to employees that stock the shelves.

The following costs are not allowed as COGS:

• rent paid for the distribution center;
• rent paid for the grocery store space;
• refrigerated display cases;
• shelving for grocery display;
• compensation paid to cashiers and baggers;
• the cost of cash registers;
• credit card company fees; and
• grocery bags.

Each year, the Comptroller's office works with tax preparation software vendors in the approval of the forms they develop for reporting Texas franchise tax. The software helps tax preparers calculate accurate franchise tax returns, which they print and mail to us for processing.

New for 2011 is the Franchise Tax Web Service. With this technology, software vendors can develop software using XML schemas to securely transmit franchise tax reports and payments to the Comptroller. Tax practitioners using this software will be able to electronically submit tax returns for their clients. The main advantage of this method of electronic submission is receiving immediate feedback about a return's accuracy. Approved vendors will have a "dashboard" (or similar method) to allow a practitioner to log in and check the status of the returns filed.

For example, a practitioner might receive a message that a particular return was received, but accounting year information was omitted for two affiliates. This process will give the preparer time to correct the errors before the Comptroller sends a notice to the taxpayer.

Practitioners will be able to file on behalf of their clients if they have either the taxpayer's WebFile number (included with the "report due" letter we send each taxpayer in February), or if they know the taxpayer's total revenue as reported on the last report on file.

Texas' electronic reporting system is recommended for even the largest taxpayers with multiple affiliates. Three major software vendors are currently in "pending approval" status.

The following rules were submitted for filing with the Secretary of State with a publication date of Dec. 31, 2010. The comment period is 30 days after publication.
3.322 - Exempt Organizations
3.325 (Repealed) - Refunds, Interest and Payments Under Protest
3.325 - Refunds and Payments Under Protest
3.339 (Repealed) - Statute of Limitations
3.339 - Statute of Limitations

The Texas Appliance Mail-In Rebate Program, which began Dec. 20, 2010, allows qualifying Texas residents with a valid Texas residential address to apply for a rebate of up to $1,000 for the purchase of an eligible ENERGY STAR appliance.

The rebates offered through this program do not reduce the amount of sales tax due on the sale of eligible appliances.

Rebates issued after a sale occurs, that are sent directly to a consumer by someone other than the seller, (such as a manufacturer or government agency) do not reduce the sales price the retailer charges the customer, nor do they reduce the amount of sales tax due on the purchase of a taxable item. The retailer must calculate the amount of tax due on the total sales price of the item at the time of sale, and cannot reduce the taxable sales price by the amount of rebate a purchaser will receive.

For example, a qualifying refrigerator sold for $1450 during the program is eligible for a rebate of up to $250. A customer buys the refrigerator for $1450 then mails in the required documentation to apply for the $250 rebate. Since the rebate will be paid directly to the purchaser after the sale, the rebate does not reduce the sales price of the new appliance and the retailer must collect tax on the total amount charged to the customer.

Taken from "Tax Policy News" at http://www.window.state.tx.us/taxinfo/taxpnw/tpn2011/tpn1101.html#issue5

In general, nonprofit organizations are required to collect sales tax on their sales of taxable items and services. A nonprofit religious, educational or charitable organization, or an organization exempted under Internal Revenue Code, Sections 501(c)(3), (4), (8), (10), or (19) may apply for and receive exemption from sales tax on its purchases, based on criteria in Texas Tax Code Sections 151.310(a)(1) and (a)(2). Once exempt, the organization and each of its bona fide chapters is permitted to hold two one-day, tax-free sales each calendar year. This exemption is found under Texas Tax Code Section 151.310(c).

A qualified organization that has obtained sales tax exemption, as described above, must designate in its records prior to the sale which two one-day sales will be exempt that calendar year. This may require careful planning and coordination for organizations operating on a fiscal year basis. For example, PTAs, PTOs and other school groups commonly plan events based on school years rather than calendar years. When planning fundraising activities for a new school year, school groups should verify the number of tax-free fundraisers conducted by the organization during the prior school year that occurred during the current calendar year.

See School Fundraisers and Texas Sales Tax (Pub. 94-183) (PDF, 412KB), Exempt Organizations - Sales and Purchases (Pub. 96-122) (PDF, 407KB) and Rule 3.322 for more information about fundraisers and exempt organizations.

Taken from "Tax Policy News" at http://www.window.state.tx.us/taxinfo/taxpnw/tpn2011/tpn1101.html#issue5