Tax Policy News - October 2002

The Comptroller's toll-free number for tax practitioners is 1-800-248-4093. Tax specialists are available from 7:30 a.m. to 5:30 p.m. Call volume is lowest early in the morning and late in the afternoon.

Rylander v. Palais Royal, Inc. and 3 Beall Brothers 3, Inc.
Cause No. 03-01-00224-CV
Issue: Whether the earned surplus component of the franchise tax is constitutional
A Travis County district court ruled the earned surplus component of the franchise tax was unconstitutional because fiscal year taxpayers were treated differently from calendar year taxpayers. The Third Court of Appeals in Austin reversed this decision on July 26, 2002.

The Court of Appeals ruled that because all taxpayers were treated the same in the implementation of the earned surplus component, there was no denial of equal taxation or equal protection in the Comptroller's application of the earned surplus component. The court also denied the taxpayer's contentions concerning state or federal retroactivity provisions, the federal-takings clause, and due process. Thus, the court held that the earned surplus component of the Texas franchise tax is constitutional.

A petition for review to the Supreme Court of Texas has been filed in this case.

Guaranty assessments are allowed as a credit directly against premium tax liability at a prescribed percentage of the assessment paid as provided in each statute.

At the insurer's option, unused guaranty assessment credits may be carried forward and taken over an additional number of years, except that Class A assessments paid to the Life, Accident, Health, and Hospital Service Insurance Guaranty Association can only be taken in the year paid.

The balance of any assessment credit not claimed can be reflected in the books and records of the insurer as an admitted asset for all purposes as provided by each statute, including exhibition in annual statements, excluding Class A assessments.

Agents act on behalf of clients and pay charges, including taxes, directly to the hotel for their clients' rooms. The hotels are responsible for remitting taxes to the Comptroller. Any difference between what the agent charges a client and pays the hotel is considered a commission and not subject to hotel tax. Agents may only reserve the number of rooms requested by their clients. The policy on cancellations must be set by the hotel, not the agent.

Companies that rent out Texas hotel rooms must collect and pay state hotel taxes, but only on the difference between the amount of tax collected and the amount paid to the hotel. "Renting rooms" means a company must have a contractual right to control occupancy prior to making the rooms available to the public. Since the location of the rented rooms is a factor in determining whether a company is responsible for collecting hotel tax, even non-Texas companies that conduct all business activities outside the state are responsible for the tax.

For example, an out-of-state company may contract for a block of hotel rooms in Texas to be made available to the public. The company sets room prices and cancellation policies, establishes attrition fees for no shows, and chooses who occupies the rooms. The company thus has control of hotel rooms located in Texas and under Section 156.053 of the Tax Code must collect taxes from its customers on the amount charged for the rooms, remitting to the state any tax beyond what it paid to the hotel. (200208379L and 200209424L)

The administrative law judge rejected this contention, noting that Tax Code Section 151.302(c) provides that internal or external wrapping, packing, and packaging supplies used to further the sale of tangible personal property cannot be purchased for resale, and subsection (d) defines wrapping, packing, and packaging supplies to include cartons and labels. Given that the taxpayer is a retailer and not a manufacturer, its purchases of the labels and cartons were intended to further the sale or lease of the videotapes, and the purchases were taxable. (200205217H)

Twin Plants - Twin Exemption?
Hearing No. 39,602
Issue: Whether a utility study showing predominantly tax-exempt electricity use at one location may be applied to comparable locations
Natural gas or electricity that is used for both exempt and taxable purposes under a single meter is either totally exempt or totally taxable, depending upon the predominant use (Rule 3.295). To claim an exemption, a taxpayer must perform a utility study showing that the predominant use is for processing, manufacturing, or other exempt activity. The study must list the time, amount, and type (taxable or exempt) of all utility use. The taxpayer must complete the study and have it on file at its business location before giving an exemption certificate to the utility company. Without the study, the claim for exemption will be presumed to be invalid.

The taxpayer had an electricity consumption study prepared and certified for one of its plants. The study concluded that the taxpayer's electricity purchases were exempt because 78.34 percent of the electricity was used in exempt manufacturing operations. The taxpayer claimed a similar exemption for electricity used at another plant, where no study had been performed, arguing that the two plants were comparable.

The administrative law judge denied the exemption because the taxpayer did not have a utility study for the facility as required by Rule 3.295. (200206332H)

Poultry Processor Cools Down and Pays Tax
Hearing No. 37,790
Issue: Whether materials in a refrigeration system for a poultry plant are exempt from tax for agricultural purposes
A Comptroller auditor assessed tax on a refrigeration system installed in a taxpayer's processing plant for chickens and turkeys, which were raised by the taxpayer.

At an administrative hearing, the taxpayer argued that it was entitled to exemptions provided for original producers of agricultural products and the refrigeration equipment was exempt since it was used in processing the products and consisted of structural components installed solely for controlling humidity and temperature essential for the processing of poultry. Poultry processors must maintain plant temperatures of less than 50 degrees to inhibit the growth and spread of bacteria and other harmful organisms.

Although there was some indication that the equipment was needed to prevent spoilage, the administrative law judge upheld the assessment. The judge concluded that the taxpayer did not submit sufficient evidence as required by Rule 3.296(i) to show which items were structural components whose "sole justification for installation" was to meet temperature requirements essential to the processing of animals or foodstuffs. (200204161H)

The proposal notice lets the public know the Comptroller's intended interpretation and administration of the statute. Taxpayers may comment on the proposed rule during the 30 days following its publication. After reviewing the public comments, the Comptroller may make changes in the proposed text and formally adopts the new rule or amendment. The final, adopted rule is published in the Texas Register.

Recently Proposed Rules
Hotel Occupancy Tax
Proposed amendment to Rule 3.161-Definitions, Exemptions, and Exemption Certificate
The proposed amendment to Rule 3.161 incorporates legislative changes to Tax Code, Chapter 156. These changes remove the requirement that public and private institutions of higher education be Texas institutions to be exempt from state hotel occupancy tax. To implement the new law, we've added or amended several subdivisions of the rule to provide new definitions and to clarify existing text.

Under subsections (a)(4) and (a)(5), we've added definitions for "permanent resident" and "private club." In subsection (b), we've deleted the language concerning private clubs, provided detailed information regarding the permanent resident exemption, and added the criteria for obtaining a permanent resident exemption. Subsection (d), regarding "Exclusions," has been added to the rule to clarify that dormitories and other housing facilities operated by institutions of higher education are excluded from the definition of a hotel, and that private clubs do not collect hotel tax on room rentals to club members. The amendment includes nonsubstantive clarifications to various other subsections.

For the complete text of the proposed amendment, refer to page 9143 of the September 27, 2002, issue of the Texas Register.

Recently Adopted Rules
State Sales and Use Tax
Adopted new Rule 3.318-Water-Related Exemptions
The Comptroller adopted a new Rule 3.318, without changes to the proposed text as published on page 6806 of the August 2, 2002, issue of the Texas Register. The new rule implements Senate Bill 2 and Senate Bill 312 (77th Legislature, 2001). That legislation added Tax Code, Section 151.355, which exempts certain equipment, services, and supplies that are used exclusively for brush control, desalination of surface water or groundwater, precipitation enhancement, reduction or elimination of water use; or in the construction or operation of certain water supply or waste water systems. Equipment and supplies that are used exclusively for rainwater harvesting or for water recycling and reuse are also exempt. In addition, this new rule provides useful information regarding the sales tax exemption for water and the taxability of flavored water and brine water. The adopted rule also includes information regarding exemptions that are available to nonprofit water supply or sewer service corporations that are financed by the Rural Water Assistance Fund or the Economically Distressed Areas Program (EDAP).

We received no comments regarding adoption of the rule. Notice of the adoption appears in the October 4, 2002, issue of the Texas Register. The new rule is effective on October 9, 2002.

Adopted amendment to Rule 3.354-Debt Collection Services
The Comptroller adopted an amendment to Rule 3.354, without changes to the proposed text as published on page 6807 of the August 2, 2002, issue of the Texas Register. The amendment adds subsection (d)(3) to the existing rule to incorporate changes made to Tax Code, Section 151.0036, under House Bill 2833 (77th Legislature, 2001). Taxable debt collection services do not include the services of a trustee in connection with the foreclosure sale of real property under a lien created by a mortgage, deed of trust, or security instrument. Various other subsections have been amended for the purpose of clarity.

We received no comments regarding adoption of the amendment. Notice of the adoption appears in the October 4, 2002, issue of the Texas Register. The amended rule is effective on October 9, 2002.

Municipal Sales and Use Tax
Adopted amendment to Rule 3.372-Adopting, Increasing, Decreasing, or Abolishing City Tax
The Comptroller adopted an amendment to Rule 3.372, without changes to the proposed text as published on page 6810 of the August 2, 2002, issue of the Texas Register. This rule was amended pursuant to House Bill 445 (77th Legislature, 2001) to allow a municipality to impose an additional tax at a rate of one-fourth of 1.0 percent for the purpose of maintaining and repairing municipal streets that exist on the date of the election to adopt the tax. Unless reauthorized, the new tax expires on the fourth anniversary of the date on which it originally took effect or the first day of the first calendar quarter occurring after the fourth anniversary of the date on which the tax was last reauthorized. The amendment also adds the definition of a municipal street.

We received no comments regarding adoption of the amendment. Notice of the adoption appears in the October 4, 2002, issue of the Texas Register. The amended rule is effective on October 9, 2002.

ABOUT THE NEWSLETTER:

The Comptroller's office publishes this newsletter to keep you informed about state taxes. Tax questions can be complicated, so use these summaries as guidelines only. For specific tax questions, call 1-800-248-4093 or 512-463-4600.

For a Copy of a Proposed Rule: For a copy of proposed rules or questions about a proposed rule, write to Bryant Lomax, Tax Policy Division, 111 West 6th St., Austin, TX 78701-2913, or e-mail <tax.help@cpa.state.tx.us>.
For a Copy of a Publication or Rule: For a copy of an agency publication, adopted rule or notice, write to the Revenue Processing Division, Microfilm and Retention Section, 111 E. 17th Street, Austin, Texas 78774-0100. The fax number is 512/475-0397.
Americans with Disabilities Act: In compliance with the Americans with Disabilities Act, this document may be requested in alternative formats by calling 512/463-4600. From a telecommunications device for the deaf (TDD), hearing impaired taxpayers may call toll free 1-800-248-4099, or 1-800-RELAY-TX. In Austin, the local TDD number is 512-463-4621.
Contributors: Tina Allen, Virgie Bradsby, Rita Catania, Adina Christian, Judy Cox, Donald Dillard, Lowell Dunn, Kevin Koller, and Mike Wegner