Jul 11, 2016
From KPMG TaxWatch
The Texas Comptroller recently announced that, as a result of its losing two 2014 franchise tax cases, it has revised certain policies regarding when amounts qualify as exclusions from total revenue and which taxpayers can deduct COGS. Under Texas law, a taxpayer can exclude from total revenue certain flow-through funds that are mandated by contract to be distributed to other entities. In Titan Transportation, a case addressing a flow-through exclusion specific to construction activities, the Comptroller asserted that the taxpayer could only qualify for the exclusion if it was a construction company, had a written contract with its customers mandating that the taxpayer and its subcontractors split fees, and the subcontractor received the actual dollars paid to the taxpayer by its customers. The court disagreed with the Comptroller and held that the payments at issue could be excluded from total revenue. As a result of this case, the Comptroller’s revised policy is that payments mandated by contract to be distributed to other entities will qualify as flow-through funds if the taxpayer has a contract with its customer providing that a subcontractor may be used and requiring payment be made to the subcontractor. Alternatively, there can be a written contract between the taxpayer and the subcontractor where the payment is based on the funds paid to the taxpayer by its customers. The timing of the payment does not determine if a payment qualifies as a flow-through fund. 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, will qualify for the exclusion at issue in Titan Transportation.
In Newpark Resources, the court held that a subsidiary of an integrated oilfield services company was entitled to a COGS deduction for costs associated with removing and disposing of drilling mud waste. On audit, the Comptroller disallowed the deduction on the basis that the disposal and removal of drilling waste was a service that did not qualify for a COGS deduction. The court of appeals determined that the labor and materials used by the taxpayer to provide the waste removal services qualified as COGS because the activity was essential to the drilling process (which qualified as construction or improvement to real property). Under the revised policy, the Comptroller is expanding its 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 policy changes apply to all years open under the statute of limitations. Please contact Doug Maziur at 713-319-3866 with questions on these policy changes.
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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.