|August 2009||TAX POLICY NEWS|
|a monthly newsletter about Texas tax policy|
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There has been a great deal of confusion over who qualifies as a management company.
The term “management company” is defined in Texas Tax Code Section 171.0001(11) to mean “a corporation, limited liability company, or other limited liability entity that conducts all or part of the active trade or business of another entity (the 'managed entity') in exchange for: (A) a management fee; and (B) reimbursement of specified costs incurred in the conduct of the active trade or business of the managed entity, including 'wages and cash compensation' as determined under Sections 171.1013(a) and (b).”
Texas Tax Code Section 171.1011(m-1) provides that “a management company shall exclude from its total revenue reimbursements of specified costs incurred in its conduct of the active trade or business of a managed entity, including 'wages and cash compensation' as determined under Sections 171.1013(a) and (b).”
To qualify as a management company, an entity must perform active and substantial management and operational functions; control and direct the daily operations; and provide services such as accounting, general administration, legal, financial and other similar services. If the entity does not conduct all of the active trade or business of the managed entity, the entity must conduct all operations for a distinct, revenue-producing component.
A management company is generally an entity retained by owners to manage properties such as hotels and resorts. Providing services in the regular course of business and services performed under a cost-plus contract do not qualify for the management company provisions under Tax Code Section 171.0001(11). Other examples of services that do not qualify under the management company provisions include providing shipping or accounting services to another company.HOTEL TAX
Permanent Resident Exemption
Editor's note: This is the second in a series of articles on hotel occupancy tax exemptions. The first article in the May 2009 Tax Policy News defined a permanent resident and discussed the basics of the exemption. This article covers the rental of a range of hotel rooms.
Texas state and local hotel tax law, in Tax Code Sections 156.101, 351.002(c) and 352.002(c), excludes from hotel tax a person (individual or company) who has the right to occupy a room in a hotel for 30 or more consecutive days.
Some companies will arrange for lodging in cities where employees often travel. Because the actual number of employees differs each day, the company will contract to rent a range of rooms instead of the same number of rooms each day.
If a contract is for a range of rooms to be rented for at least 30 consecutive days, only the lowest number of rooms in the range rented for 30 consecutive days qualifies for the permanent resident exemption. Rooms rented in addition to the lowest number must be rented for 30 consecutive days to qualify for the permanent resident exemption. See Rule 3.161(b)(6)(E).
For example, an airline company contracts with a hotel to rent 10 to 15 rooms for crew members. Different crew members will occupy the rooms. For the first five days, the airline rented 13 rooms, but on the sixth day only 12 rooms were rented. The company then rented 15 rooms between the seventh and the 30th day and 14 rooms through the 60th day.
The lowest number of rooms rented in the range for the first 30 days was 12, so 12 rooms are exempt. Because at least 14 rooms are rented, beginning on the seventh day, two more rooms became exempt on the 37th day. See the attachment to Rule 3.161(b)(6)(E) for another example.
When the number of rooms rented falls below the contracted number, an interruption in payment occurs. From that point on, the number of rooms qualifying for the permanent resident exemption becomes the highest number of rooms rented per day over the previous 30 consecutive days.
A hotel's records must support the permanent resident exemption, unlike other hotel tax exemptions which require the Texas Hotel Occupancy Tax Exemption Certificate (PDF, 66KB) (Form 12-302) to be completed in order to claim an exemption.INSURANCE TAX
Certain Insurance Entities Excluded From the Texas Franchise Tax
Corporations, limited liability companies and other legal entities are generally subject to the Texas franchise tax. Certain insurance organizations, however, are not subject to the tax on the basis that they are either subject to the gross insurance premium receipts tax as an admitted/licensed/authorized insurer, health maintenance organization or title insurance agent under Title 3 of the Texas Insurance Code, or they paid for that tax year the “unauthorized insurance” premium tax under Section 226 of the Code. Exclusions from the Texas franchise tax are provided in Section 203.001 of the Texas Insurance Code and Section 171.052 of the Texas Tax Code.
Insurance organizations, including health maintenance organizations, that are authorized by the Texas Department of Insurance to conduct the business of insurance are also known as “admitted” or “licensed” insurers. Such organizations do not include surplus lines insurers that are eligible to write insurance in Texas through licensed surplus lines agents. Surplus lines insurers are not subject to premium receipts tax as authorized insurers and the tax due on surplus lines premiums is a tax due on the policyholders, not the insurers. As a result, surplus lines insurers do not fall under the franchise tax exclusion language of Section 203.001 of the Insurance Code or Section 171.052 of the Tax Code.
Under Title 3 of the Insurance Code, authorized insurance organizations are subject to gross premium receipts tax under Section 221, 222, 223 or 224. Included for taxation under Section 223 are licensed title insurance agents that remit taxes on the basis of a division of premium with authorized title insurance companies. Under Section 222, health maintenance organizations are treated as accident and health insurers for tax purposes.
Under certain instances, non-licensed insurers may be subject to, and would pay, a premium receipts tax under Section 226 of the Insurance Code. For the tax year for which the tax is paid, they would be excluded from the franchise tax for that year only.SALES TAX
Hearing Summary: Preliminary Art or Finished Art?
In Hearing No. 47,841 (2009), the taxpayer purchased design and layout for holiday cards, invitation postcards, mailing stuffers, insert cards, banners, t-shirts, brochures, flyers, trade show inserts, ads and notebooks from Company A. Company A did not collect the tax due from the taxpayer, thus making the taxpayer liable for accruing and remitting the tax due on the purchase of the graphic art work performed by Company A. See Texas Tax Code Section 151.515.
The taxpayer stated that Company A designed and laid out a concept and then electronically forwarded a preliminary draft to the taxpayer for approval in PDF form. The taxpayer either requested changes or recommended that Company A forward the draft to Printer A, a printer designated by the taxpayer. Printer A received the electronic files and made any required changes in the artwork in order to place it into the printing plates. The taxpayer purchased from Printer A the printed cards, t-shirts, inserts and other items imprinted by Printer A using the plates.
The taxpayer contended that, because Printer A made the final approval, and because the taxpayer only viewed the design electronically, the artwork produced by Company A was non-taxable preliminary art.
Under Rule 3.321(a)(6), “preliminary art” is defined as “roughs, visualizations, layouts, and comprehensives submitted by an advertising agency to its client for the client's approval of the advertising concept or message prior to the preparation of the finished art.” Rule 3.321(d)(3), provides that an advertising agency's charge to its customer for preliminary art is not subject to tax, but any portion of the preliminary art that becomes physically incorporated into finished art is taxable.
The reading of Rule 3.321 suggests that if preliminary art does not become part of the finished art for any reason (e.g., it was rejected by a client), but the client must still pay a charge for the preliminary art, then the Comptroller will consider the charge for the preliminary art as the purchase of a non-taxable design service, not a purchase of tangible personal property. If, however, a portion of the preliminary art is incorporated into finished art, the charge for the incorporated portion is subject to tax as the sale of tangible personal property.
The Comptroller determined that by Company A's own admission, the artwork that it produced was incorporated into the cards, t-shirts, inserts and other similar items that the taxpayer purchased from various printers. The taxpayer's argument that it only viewed the design electronically is irrelevant. As provided under Texas Tax Code Section 151.010, the sale or use of a taxable item does not alter the item's tax status. Therefore, the artwork that taxpayer purchased from Company A is finished art, and is taxable as such.SALES TAX
Purchasing Offices: Your Place or Mine for Local Sales Tax Sourcing?
The location of a seller's place of business determines the Texas local sales and use taxes due on most sales of taxable items. The point of delivery determines whether additional use taxes may be owed on those sales. For a few specific types of transactions, the total local sales and use taxes due are not based on the seller's place of business, but are instead determined solely by the point of delivery. See the “Exceptions” section on page 11 of our publication Guidelines for Collecting Local Sales and Use Tax (PDF, 827KB) for more information about these specific types of transactions.
A “place of business” is defined in the Texas Tax Code as “an established outlet, office, or location operated by the retailer or the retailer's agent or employee for the purpose of receiving orders for taxable items and includes any location at which three or more orders are received by the retailer during a calendar year.” See Texas Tax Code Section 321.002(a)(3).
House Bill 3534, 78th regular Legislative Session, amended 321.002 (a)(3), effective Sept. 1, 2003, to provide that “An outlet, office, facility, or location that contracts with a retail or commercial business engaged in activities to which this chapter applies to process for that business invoices or bills of lading onto which sales tax is added is not a 'place of business of the retailer' if the comptroller determines that the outlet, office, facility, or location functions or exists to avoid the tax imposed by this chapter or to rebate a portion of the tax imposed by this chapter to the contracting business.”
This provision requires the Comptroller's office to determine whether a procurement company or purchasing office qualifies as a “place of business” for the purpose of determining which local jurisdiction's sales tax should be collected on items sold by the procurement company or purchasing office.
For the purposes of administering the provisions of 321.002 (a)(3) established by HB 3534, the Comptroller's office looks for the following indicators that the business location is a bona fide place of business:
- Separate books and records
- An operating office (phone lines, office area, signage)
- All products are sold for an amount equal to or greater than cost.
- The office orders the products, pays for the products, tracks the orders and deals directly with vendors when shipments are late, lost or substandard.
- The office is not relocating from one city to another in order to obtain a local tax rebate.
The Comptroller's office may also consider any or all of several other aspects of the business to make the determination, including whether:
- all, or substantially all, sales of a business are made to a related entity, such as a parent (i.e., there are no or only nominal sales to other entities);
- a related entity has other operations at the business location;
- the business uses employees of a related entity under a service agreement (as opposed to hiring its own employees) to conduct all, or substantially all, of its operations;
- the business has been opened solely for the purpose of reducing or eliminating local tax liabilities.
A third-party procurement company or purchasing office, that operates under an agency agreement with an entity to process and consolidate orders, is not a bona fide place of business for the purpose of determining which local sales and use taxes are due on taxable items sold by the contracting seller.
The law changes effective on Sept. 1, 2003, provided a grandfather clause that allowed procurement companies or purchasing offices in existence on May 27, 2003, to continue to operate as places of business for sales tax collection purposes only until Sept. 1, 2005.
HB 3534 also provided direction for when our office determines that a location is not a valid place of business by adding Subsection (l) to Section 321.203. That subsection states, “If there is no place of business of the retailer because the comptroller determines that an outlet, office, facility, or location contracts with a retail or commercial business to process for that business invoices or bills of lading and that the outlet, office, facility, or location functions or exists to avoid the tax imposed by this chapter or to rebate a portion of the tax imposed by this chapter to the contracting business, a sale is consummated at the place of business of the retailer from whom the outlet, office, facility, or location purchased the taxable item for resale to the contracting business.”ABOUT THE NEWSLETTER
The Comptroller's office publishes this newsletter to keep you informed about state taxes. Tax questions can be complicated, so please use these summaries as guidelines only.
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For a copy of a proposed rule or information about a proposed rule, write to Bryant Lomax, Tax Policy Division, 1700 North Congress Avenue, Austin, Texas, 78701-1436, or submit a request via Texas Tax Help.
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Contributors to This Month's Issue
Jeane Acord-Ramirez, Teresa Bostick, Robin Corrigan, Donald Dillard, Jody Frierson, Gary Johnson, Carol McAnnally, Jerry Oxford, Viki Smith, Karen Snyder, Jennifer Specchio and Steve White