Texas: Amended Rule Addresses When Taxable Entities Produce Goods for Sale

Effective September 4, 2019, Texas Rule 3.584, which addresses many aspects of computing taxable margin and the various Texas franchise tax rates has been amended. Most of the revisions to the rule affect the definition of when a taxable entity is considered “primarily engaged in a retail or wholesale trade.”  Under Texas law, taxable entities that are primarily engaged in retailing or wholesaling activities are subject to a reduced franchise tax rate. A taxpayer is generally considered engaged in a retail or wholesale trade if three conditions are met: (1) the total revenue from the taxable entity's activities in retail and wholesale trade is greater than the total revenue from its activities in trades other than retail and wholesale trade; (2) less than 50 percent of the total revenue from the taxable entity's activities in retail or wholesale trade comes from the sale of products the taxable entity produces or products produced by an entity that is part of an affiliated group to which the taxable entity belongs; and (3) the taxable entity does not provide retail or wholesale utilities, including telecommunications services, electricity, or gas. One of the amendments to the rule provides that selling telephone prepaid calling cards is not providing telecommunications services.

However, most of the substantive changes to Rule 3.584 address when a taxable entity is considered to produce goods or products. A new definition of the term “produce” means to construct, manufacture, install during the manufacturing or construction process, develop, mine, extract, improve, create, raise, or grow either a product or a component of a product. The amended rule provides that “a taxable entity produces a product that it sells if the taxable entity or an entity that is part of an affiliated group to which the taxable entity also belongs: (i) asserts a software copyright with respect to the product or a component of the product; (ii) asserts a patent right under Title 35 of the United States Code or comparable law of a  foreign jurisdiction with respect to the product, a component of the product, or the packaging of the product; or (iii) produces a component of the product, or acquires the product and makes a modification to the product, unless the taxable entity can demonstrate that the component or modification does not increase the sales price of the product by more than 10 percent.” The Comptroller clarified in the preamble to the revised rule that the new definition of “produce” will be effective for reports originally due on or after September 4, 2019, to the extent that it is inconsistent with prior Comptroller interpretations.

Except as provided above (e.g., when a taxable entity asserts a patent or software right with respect to the product), a taxable entity will not be considered to produce a product that it sells if an unrelated party manufactures the product and all components of the product to the taxable entity’s specifications.  The amended regulation also adopts a  definition of “tangible personal property”--(i) personal property that can be seen, weighed, measured, felt, or touched or that is perceptible to the senses in any other manner; (ii) films, sound recordings, videotapes, live and prerecorded television and radio programs, books, and other similar property embodying words, ideas, concepts, images, or sound, without regard to the means or methods of distribution or the medium in which the property is embodied, for which, as costs are incurred in producing the property, it is intended or is reasonably likely that any medium in which the property is embodied will be mass-distributed by the creator or any one or more third parties in a form that is not substantially altered; and (iii) a computer program, as defined. Please contact Jeff Benson at 214- 840- 6911 with questions on revised Rule 3.584, or other questions on Texas franchise tax issues.