Sep 28, 2015
From KPMG TaxWatch
A Texas Administrative Law Judge recently denied a taxpayer’s franchise tax appeal. The taxpayer at issue operated an aquarium that included a gift shop. The taxpayer originally claimed costs of goods sold with respect to expenses for operating and maintaining the aquarium, including rent, utilities, husbandry costs (food, water, climate control and medical care) for animals, salaries of employees, gift shop expenses, and investments in conservation programs. On audit, the Comptroller’s office determined that because the taxpayer’s primary revenue was from the sale of amusement services, not the sale of goods, the taxpayer could deduct COGS associated only with the running the gift shop. The end result was that the taxpayer’s margin was recomputed using the 70 percent of total revenue method, as that method resulted in the lowest tax.
The taxpayer appealed the assessment to the Office of Administrative Hearings, arguing that it should be entitled to deduct its animal husbandry costs as COGS. Under Texas law “goods” is generally defined as real or tangible personal property sold in the regular course of business. Another provision of the statute and regulation defined goods to include the husbandry of animals. The taxpayer argued that because the definition of “good” included the husbandry of animals, it could deduct its costs as COGS. The ALJ rejected this argument. Although the definition of goods included the husbandry of animals, it also required that the taxpayer be selling goods in the regular course of business. In the instant case, the ALJ determined the taxpayer was selling an amusement service, not animals. The taxpayer next argued that it sold tangible personal property in the form of a “sensory experience” in its regular course of business. Thus, it should be allowed to include all costs attributable to acquiring and producing its exhibits as COGS. In support for this position, the taxpayer noted that the Texas Tax Code includes films, sound recordings, live programs and other property embodying words, ideas, concepts, images or sound as types of tangible personal property for purpose of the COGS deduction. Furthermore, in the recent AMC case, which the taxpayer raised when it filed exceptions to the ALJ’s original determination, an appeals court held that a movie theater operator was permitted to deduct movie exhibition costs as COGS because a movie is “perceptible to the senses” and the theater was therefore selling tangible personal property when it sold tickets to patrons. The ALJ rejected the taxpayer’s argument, noting that the taxpayer was not a movie theater nor was it a distributor of films, sound recordings, or live programs. Please contact Doug Maziur at 713- 319-3866 with questions on this Texas ALJ ruling.
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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.