A private club, providing golf, tennis, swimming, food and beverage services charged taxable membership dues for the use of club facilities, including clubhouse locker rooms. It also charged a taxable monthly "locker rental" fee.

Each member was a given a new lock and two keys for a full-length, wood, furniture-quality locker with a brass nameplate. Members who lost their keys had to pay a third party for a new lock and set of keys. With access to the lockers only during the club's normal hours, members maintained custody of the contents while the taxpayer had custodial rights over the lockers themselves, which were installed in the club's real property.

The taxpayer claimed a resale exemption for its purchase of uninstalled lockers, stating that the lockers were rented to members after installation. Providers of taxable services, including amusement services, can buy items tax free only if they are transferred to the customer's "care, custody, and control."

The Administrative Law Judge denied the claim, finding that care, custody, and control of the lockers were not transferred to the members renting them. The lockers were located on the taxpayer's real property and remained in the taxpayer's custody and control at all times. A member rented the right to use the secure space created by the locker and was given minor custodial rights. While both members and the taxpayer cared for the lockers, it was the taxpayer who primarily maintained them.

An insurance firm hired a company to collect and remove large amounts of paper thrown out from its administrative offices. The other company took title to the paper upon possession, and then recycled and resold the paper.

The insurance firm claimed that it purchased non-taxable recycling services and thus was entitled to a refund of the sales taxes paid to the service provider. Real property services include "removal or collection of garbage, rubbish, or other solid waste" but the statute specifically excludes from taxation the removal or collection of some materials such as hazardous and industrial solid waste. The insurance firm disagreed that the paper was "garbage, rubbish, or solid waste" because it had value: it was "not discarded useless paper, but rather paper that has been intentionally set aside for the purpose of recycling."

The Administrative Law Judge held that the insurance firm's distinctions did not qualify for any exemption and that the charges were for taxable real property services.

The taxpayer operated a soft drink bottling plant. Forklifts loaded empty cans on pallets into a de-palletizer, which separated the rows of cans and pushed them onto a conveyor that moved them to a de-ionized air rinser. From the rinser, the cans went to a filling machine and then to a seaming machine which attached the lids. The cans were moved to a warmer and then to a fill-detector, which eliminated those that were not filled to specifications, before being packaged into six-packs or twelve-packs. Finally, the packages of cans were put on pallets for warehousing and outbound shipment. Throughout the operation, the cans were moved from station to station by conveyors.

The taxpayer argued that prior to October 1, 1997, the Tax Code exempted tangible personal property used in, and necessary and essential to, manufacturing. The statute at the time defined manufacturing as "each operation beginning with the first stage of production of tangible personal property and ending with the completion of tangible personal property having the physical properties (including packaging, if any) that it has when transferred by the manufacturer to another."

The Administrative Law Judge found that the de-palletizers and rinser did not qualify for exemption, since they were used in acts of preparation prior to actual manufacturing. The manufacturing process in this case began with filling the cans. The Administrative Law Judge also held that the conveyors used throughout the process were used solely in providing intraplant transportation and thus were subject to tax both before and after October 1, 1997.

Two recent federal laws may affect corporations' income tax. The Job Creation and Worker Assistance Act of 2002 provided some new depreciation guidelines, while the Jobs and Growth Tax Relief Reconciliation Act of 2003 gave new guidelines for additional bonus depreciation, increased the Section 179 deduction, and expanded the definition of Section 179 property to include off-the-shelf computer software.

The earned surplus component (Schedule B) of the Texas franchise tax is calculated based upon the Internal Revenue Code of 1986 in effect for the tax year beginning January 1, 1996 and before January 1, 1997, and any regulations adopted under that code applicable to that period. Consequently, the new guidelines under the Job Creation and Worker Assistance Act of 2002 and the Jobs and Growth Tax Relief Reconciliation Act of 2003 are not allowed in computing the earned surplus component.

In computing net taxable earned surplus, the amount of Section 179 deduction allowable is $25,000 for federal tax years beginning in 2003 or later.

Any adjustments to federal taxable income required to reconcile to the 1996 Internal Revenue Code in the calculation of earned surplus should be made prior to entering the corporation's federal taxable income on item 19, Schedule B, of the Texas franchise tax report.

Close corporations with 35 or fewer shareholders, Subchapter S corporations, and corporations with taxable capital of less than one million dollars are eligible to report taxable capital using the federal income tax accounting (FIT) method. An eligible corporation that elects to report taxable capital using the FIT method applies the accounting methods used in its most recent federal income tax return originally due on or before the date on which the corporation's franchise tax report is originally due.

For example, a corporation with a calendar year end qualifies and elects to use the FIT method to compute its taxable capital for the 2004 franchise tax report. The corporation's allowable Section 179 deduction reported on its 2003 federal income tax return is $100,000. The full amount of the Section 179 deduction, $100,000, is allowable in computing taxable capital for the 2004 franchise tax report. However, the corporation is limited to a Section 179 deduction of $25,000 in computing earned surplus.

The proposal notice informs the public of the Comptroller's intended interpretation and administration of a particular statute. Taxpayers may comment on the proposed rule during the 30 days following its publication in the Register. After reviewing the public comments, the Comptroller may make changes to the proposed text when the new or amended rule is formally adopted. Notice of the formal adoption of the rule is published in the Texas Register. The adoption preamble provides detailed information on all changes made to the rule text since publication of the proposal notice.

Last month the Comptroller proposed amendments to several rules. Notice of those amendments was published in the March 12, 2004, issue of the Texas Register. A summary of each of the proposals follows.

GENERAL RULES
Proposed amendment to Rule 3.5-Waiver of Penalty or Interest
The amendment to Rule 3.5 adds information regarding the standard of review to be used when a taxpayer contests the initial denial of a penalty or interest waiver.

HOTEL OCCUPANCY TAX
Proposed amendments to Rule 3.161-Definitions, Exemptions, and Exemption Certificate
Rule 3.161 was amended to incorporate legislative changes under House Bill 2424 (78R). The proposed amendment adds the requirement that public and private institutions of higher education must be Texas institutions to be exempt from state hotel occupancy tax; provides for good faith acceptance, with proper documentation, of hotel occupancy tax exemption certificates by persons required to collect the tax; and requires the Comptroller to produce and maintain a list of organizations that have received a letter of exemption under Tax Code, Section 156.102, and to make the list available on the Comptroller's Web site. In addition, Subsection (c)(2) was added to prescribe the support documentation required to accept an exemption certificate in good faith, including when appropriate, a printed copy of the Comptroller's Web site that shows the organization is exempt for hotel tax.

MOTOR VEHICLE SALES TAX
Proposed amendments to Rule 3.96-Imposition and Collection of a Surcharge on Certain Diesel-Powered Motor Vehicles
Rule 3.96 was proposed for amendment to implement changes to Tax Code, Sec. 152.0215, under House Bill 1365 (78R). Effective July 1, 2003, the surcharge applies to the purchase or use of all diesel-powered motor vehicles with a gross registered weight of more than 14,000 pounds. Accordingly, subsections (a) and (b) of the rule were amended to include all model years and vehicles purchased out of state, and to specify surcharge rates by model year. In addition, subsection (f) was added to the existing rule to disallow the offset of the surcharge by sales or use tax paid to other states on the purchase of the motor vehicle.

STATE SALES AND USE TAX
Proposed amendments to Rule 3.325-Refunds, Interest, and Payments Under Protest
Rule 3.325 was amended to implement legislative changes and the codification of existing policies in House Bill 2425 (78R). The amendments describe when and how persons may obtain a refund of tax paid in error. Provisions relating to limitations in subsection (a) have been reorganized in a new subsection (c) and the remaining subsections have been relettered accordingly.

Proposed amendments to Rule 3.331-Transfers of Common Interests in Tangible Personal Property; Intercorporate Services
Rule 3.331 has been reorganized and updated. The amended rule sets out the exemption criteria for joint research and development ventures, and clarifies current policy regarding intercorporate exemption.

CENTRAL ADMINISTRATION-Practice and Procedure
Adopted amendments to Rule 1.5-Initiation of a Hearing and Rule 1.15-Reply to the Position Letter or Notice of Setting
The amendments to Rules 1.5 and 1.15 were adopted without changes to the proposed text as published in the February 13, 2004, issue of the Texas Register. The amendments implement certain provisions of House Bill 2425 (78R). Rule 1.5 was amended to clarify the timeline for filing a request for redetermination of a deficiency. Under House Bill 2425, a taxpayer must file the written request within 30 days from the date of the deficiency determination. Rule 1.15 was amended to add provisions that allow the Comptroller to issue a written demand for documents in connection with a refund claim. Per House Bill 2425, the Comptroller must give the taxpayer at least 180 days to produce the relevant documentary evidence. Notice of the adoptions was published in the April 2, 2004, issue of the Texas Register. The amended rules are effective as of April 11, 2004.

Adopted amendment to Rule 1.42-Definitions
The Comptroller adopted an amendment to Rule 1.42 to reinstate the definition of "Tax Division." No comments were received regarding the amendment and no changes were made to the proposed text as published in the January 23, 2004, issue of the Texas Register. Notice of the adoption was published in the March 19, 2004, issue of the Texas Register. The amended rule is effective as of March 25, 2004.

FRANCHISE TAX RULES
Adopted amendment to Rule 3.544-Reports and Payments
The amendment to Rule 3.544 was adopted without changes to the proposed text as published in the January 23, 2004, issue of the Texas Register. The adopted rule reflects the provisions of House Bill 2424 (78R), which changed the definition of "beginning date" for foreign corporations and allows for electronic filing of the Public Information Report. The amendment deleted the reference to the date a foreign corporation's certificate of authority takes effect for the purpose of determining the date the corporation became liable for franchise tax. In accordance with House Bill 2425 (78R), the adopted rule requires corporations to report to the Comptroller within 120 days the results of certain administrative proceedings that affect franchise tax liability. Notice of the adoption appears in the April 2, 2004, issue of the Texas Register. The amended rule is effective as of April 11, 2004.

Adopted amendment to Rule 3.580-Credit for Hiring Persons with Disabilities
Rule 3.580 was adopted without changes to the proposed amendment as published in the January 23, 2004, issue of the Texas Register. The adopted rule revises the limitation guidelines for claiming the franchise tax credit for hiring persons with disabilities. In compliance with House Bill 2424 (78R), the amended rule provides that, for reports due on or after January 1, 2004, a corporation may not claim a credit that exceeds 50 percent of the amount of franchise tax due, before (instead of after) any other applicable tax credits are taken, for the report on which the credit is claimed. The adoption notice was published in the April 2, 2004, issue of the Texas Register. The amended rule is effective as of April 11, 2004.

PROPERTY TAX ADMINISTRATION-Appraisal District Administration
Adopted amendments to Rule 9.415-Applications for Property Tax Exemptions
The amendment to Rule 9.415 was adopted without changes to the proposed text as published in the December 19, 2003, issue of the Texas Register. The amended rule reflects legislative changes and includes a new model application form, deletes an existing form, and revises the remaining forms. All of the adopted forms include new language regarding the confidentiality of driver's license numbers, personal identification numbers, or Social Security numbers provided on exemption applications, except for disclosure to appraisal office employees who appraise property, or as authorized by Tax Code, Sec. 11.48(b). Some of the proposed model forms were revised based on comments submitted to the Comptroller. The notice of adoption, which provides a summary of all comments along with the Comptroller's response, was published in the March 19, 2004, issue of the Texas Register. The amended rule is effective as of March 25, 2004.

Adopted amendments to Rule 9.419-Procedures for Determining Property Tax Exemption for Motor Vehicles Leased for Personal Use
The Comptroller adopted the amendment to Rule 9.419 as published in the January 2, 2004, issue of the Texas Register. This rule was amended to revise the model exemption application form in accordance with House Bill 500, effective September 1, 2003, which requires that the chief appraiser keep confidential any driver's license number, personal identification number, or social security number provided on the exemption application, except for disclosure to appraisal office employees who appraise property, or as authorized by Tax Code, Sec. 11.48(b). The Comptroller received no formal comments on the proposed amendment; however, text was added to the adopted Lessor's Rendition or Property Report for Leased Automobiles (Form 50-288) form to explain the change in Tax Code, Sec. 22.23(b), that on written request, the chief appraiser must extend the filing deadline to May 15 of the tax year and may extend the deadline another 15 days upon good cause shown in writing by the property owner. The Comptroller also added language informing taxpayers of the penalties for failure to file a rendition or property report in a timely manner pursuant to Tax Code, Secs. 22.01(a) and (b). The adoption notice was published in the March 19, 2004, issue of the Texas Register. The amended rule is effective as of March 25, 2004.