United States

Texas: Substance over Form Applies in Determining if Credits Were Allowances under Former Franchise Tax

Apr 06, 2015
From KPMG TaxWatch

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Recently, a Texas appeals court addressed the computation of a taxpayer’s gross receipts for purposes of calculating its apportionment factor under the former franchise tax. In doing so, the court applied the substance over form doctrine and ruled in the taxpayer’s favor. The taxpayer performed environmental disposal and recycling services for oil refineries. Part of the taxpayer’s service involved recovering and selling precious metals harvested from a customer’s spent fuel catalyst. A share of the amounts received from the sale of the metals offset the amount the customer paid for the recycling and disposal services. At times, the taxpayer received no income from providing its services because the amount of the “metals credits” exceeded the cost of the services. On its federal tax returns, the taxpayer erroneously reported its gross receipts without netting out the metals credits. The taxpayer did not correct the federal return because the credits were deducted instead as COGS, meaning that the taxpayer’s federal liability was not affected by the error. It was not disputed that for GAAP purposes, the credits were treated as allowances that reduced gross receipts. One issue before the court was whether the taxpayer was bound, for purposes of computing the gross receipts component of the apportionment factor, by the way it characterized the metals credits on its federal tax returns. In other words, because the taxpayer did not net its receipts from services with the metals credits on its federal return, in the Comptroller’s view it could not retroactively change its accounting method to reduce its franchise tax liability. If the taxpayer was not bound, the issue became whether the metals credit was an “allowance” that could offset revenues for purposes of Comptroller regulations defining “gross receipts.” After a trial court ruled in favor of the Comptroller, the taxpayer appealed.

During the tax years at issue, gross receipts were defined as “all revenues reportable by a corporation on its federal tax returns, without a deduction for costs of property sold, materials used, labor performed, or other costs incurred, unless otherwise specifically provided.” Taxpayers were bound to use the same accounting method to apportion taxable earned surplus as used in computing federal taxable income. However, a Comptroller rule provided that allowances permitted by a seller could reduce gross receipts. The court determined that the taxpayer’s metals credits were allowances and therefore could reduce its gross receipts, despite the Comptroller’s argument that the taxpayer was bound to follow the treatment reported on its federal tax return. The court observed that U.S. Tax Court case law directed courts to look to the substance of a transaction, rather than its form, in determining whether an adjustment should properly be considered an allowance. As such, the taxpayer’s refund claim was granted. Please contact Doug Maziur at 703-319-3866 with questions on Gulf Chemical and Metallurgical Corp. v. Comptroller.


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The following information is not intended to be "written advice concerning one or more federal tax matters" subject to the requirements of section 10.37(a)(2) of Treasury Department Circular 230.

The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.