United States

Texas: Payments Not “Flow-Through Funds” and COGS Deduction not supported by Evidence

May 22, 2017
From KPMG TaxWatch

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An Administrative Law Judge (ALJ) for the Texas Comptroller of Public Accounts recently ruled that certain revenue could not be excluded from the Texas franchise tax base as “flow-through funds” and that a taxpayer failed to demonstrate that certain purchases could be deducted as costs of goods sold (COGS). The taxpayer at issue sold cell phones, cell phone accessories, and cell phone service plans. The Texas franchise tax is imposed upon “total revenue,” which consists of amounts reportable as income on certain lines of the federal income tax return. Before the ALJ, the taxpayer contended that certain amounts it received from customers should not be counted as part of the taxpayer’s total revenue because, outside of a small transaction fee, the payments were subsequently paid to another company.  However, the taxpayer reported all of the payments on its federal return and did not dispute that this complied with federal law.

Under Texas law, there is an exclusion from total revenue for “flow-through funds” required by law or fiduciary duty to be distributed to other entities. The taxpayer presented contracts and bank statements establishing that it made payments to the other company. However, the ALJ determined that this evidence was insufficient to establish a fiduciary relationship between the taxpayer and the other company or between the taxpayer and the customers. In addition to rejecting the taxpayer’s flow-through funds argument, the ALJ likewise denied part of the taxpayer’s proposed COGS deduction due to lack of evidence. Specifically, the ALJ could not verify that certain purchases that the taxpayer was attempting to deduct as COGS were actually shipped to or received by the taxpayer. For more information on this decision, please contact Doug Maziur at 713-319-3866.


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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.