Texas ~ Corporate Income Tax: Policy Change Announced for Subcontracting Payments Eligible for Exclusion and COGS Deduction

CCH Tax Day Report

The Texas Comptroller has issued a Texas franchise tax letter ruling revising its policy with regard to subcontracting payments eligible for exclusion under Sec. 171.1011(g)(3) and qualifying activities for the cost of goods sold (COGS) deduction under Sec. 171.1012(i) based on two Texas court decisions in Titan Transportation, LP v. Combs and Combs v. Newpark Resources, Inc. These changes are effective immediately and taxable entities may file amended franchise tax reports for years that are open within the statute of limitations.

Flow-through funds

The revised policy letter clarifies that a payment is mandated by contract to be distributed to other entities and qualifies as flow-through funds if the taxable entity has (1) a contract with its customer providing that a subcontractor may be used and requiring payment to the subcontractor; or (2) a written contract between the subcontractor and the taxable entity that states that the payment is based on the funds paid to the taxable entity by the taxable entity’s customers. The revised policy letter states that the timing of the payments does not determine if a payment qualifies as a flow-through fund.

The letter also states that the taxable entity may exclude from revenue payments which qualify as flow-through funds and have a reasonable nexus to the actual or proposed design, construction, remodeling, or repair of improvements on real property or the location of boundaries of real property.

COGS

Taxable entities that furnish labor or materials to a project for the construction, improvement, remodeling, repair, or industrial maintenance of real property are determined to be an owner of that labor or materials and may include the costs in the computation of COGS.

The Comptroller notes that it is expanding the interpretation of what is considered to be furnishing labor or materials to a project for the construction, improvement, remodeling, repair, or industrial maintenance of real property and will no longer require an entity to actually physically touch the property or make a change to the property to qualify for the COGS deduction.

The Comptroller clarifies that costs that are too far removed from the construction, improvement, remodeling, repair, or industrial maintenance of real property do not qualify for either an exclusion from revenue or a COGS deduction.

The revised policy does not change the treatment of taxable entities renting or leasing equipment to others for use in or during such projects. Taxpayers who rent or lease equipment other than heavy construction equipment, like fencing or port-a-potties, to others for use in projects for the construction, improvement, remodeling, repair or industrial maintenance of real property, are not eligible for the COGS deduction.

Letter No. 201606856L, Texas Comptroller of Public Accounts, June 30, 2016, ¶404-165

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