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.
In its introduction to Division C, Construction, the SIC Manual concedes that,
"Establishments primarily engaged in the distribution and construction or installation of equipment often present classification problems."
The introduction further concludes that:
"...separate establishments primarily engaged in the sale and installation of the following illustrative types of structures or integral parts of structures generally site assembled, are classified in construction rather than in trade:
- Steel work on bridges or buildings;
- Elevators and escalators;
- Sprinkler systems;
- Central air-conditioning and heating equipment;
- Communications equipment; and
- Insulation materials.
On the other hand, establishments primarily engaged in the sale and installation of the following illustrative types of preassembled equipment are classified in trade rather than in construction:
- Major household appliances, such as refrigerators, dishwashers, clothes washers and dryers, stoves and ranges; and
- Partitions for banks, stores, and restaurants."
Therefore, the sale and installation of materials into real property is properly classified as construction activity. The total revenue from a business activity (Construction, Division C) cannot be broken out into components of that business activity to be classified in Division F or G.
Example:
A taxable entity has a retail store where it sells various types of flooring: wood, tile, carpet, etc. Customers come into the store, purchase flooring and remove it from the premises to either install themselves or have a contractor install. The store also offers installation of the flooring, where customers come into the store, choose flooring, and the store installs the flooring for the customer, using either the store's own employees or a subcontractor to complete the job.
Following is the entity's 2010 revenue breakdown:
| Materials purchased without installation | $5 million |
|---|---|
| Materials purchased with installation | $3 million |
| Installation services | $4 million |
To determine if this entity is primarily engaged in wholesale/retail trade and, therefore, eligible for the 0.5 percent franchise tax rate, the entity's total revenue must be separated by SIC Classification. Revenue from materials sold without installation, $5 million, is classified under Division G, Retail Trade. Revenue from the sale of flooring that is installed falls under Division C, Construction, which encompasses the sale and installation of materials and totals $7 million. This entity will not qualify for the 0.5 percent tax rate as the total revenue from activities in construction, $7 million, is greater than the total revenue from activities in retail or wholesale trade, $5 million.
(Taken from http://window.state.tx.us/taxinfo/taxpnw/tpn2011/tpn1102.html#toc)
