Besides federal contracts, the court decision in Strayhorn v. Raytheon E-Systems, Inc., 101 S.W.3d 558 (Tex. App. - Austin 2003, pet. denied) has also changed the Comptroller's policy with respect to overhead items used by taxpayers performing state contracts.

Contractors in Texas have been able to claim a resale exemption on the purchase of goods that are resold to state governmental entities as direct costs in performing contracts. Prior to the Raytheon case, contractors had to pay tax on overhead materials that were indirectly used in completing these contracts and materials consumed by the contractor were not exempt.

Now, under certain conditions, overhead goods indirectly charged to a government contract can be purchased for resale. The contract must contain language that explicitly and unambiguously conveys title of the overhead items to the exempt governmental entity. And the contractor must establish that the purchases were made and that the allocated charges can be traced to the contract.

Not all items purchased by a contractor qualify for the resale exemption. Capitalized equipment is not exempt because title does not transfer. Intangibles, rentals, and taxable services do not qualify. Computer software licenses usually do not qualify because the purchaser does not receive title to the software, only the right to use it.

Charges for direct materials continue to qualify for the resale exemption under the prior court decision in Day & Zimmermann. Taxable services can also be purchased tax free for resale when those services are passed directly to the government under a facilities-related contract.

Contractors still must pay tax on items indirectly consumed and allocated to contracts other than qualifying state government contracts. When a contractor does not know at the time of purchase whether the item can be charged to a qualifying or non-qualifying contract, the contractor can issue a resale or exemption certificate. Tax must then be accrued and reported on those items used on the non-qualified contracts.

If a contractor is improving realty for an exempt governmental entity, the contractor should also take notice of the exemptions available under Tax Code Section 151.311 for incorporated materials, necessary and essential consumable supplies that are completely consumed at the job site, and taxable services either integral to the performance of the contract or expressly required to be purchased by the contractor in performing the contract.

Texas has participated as an implementing state in the Streamlined Sales Tax Project but has not enacted legislation to be in full compliance with the agreement. Because of this, Texas is neither a member nor associate member of the governing board.

Many states, like Texas, use place of origin as the basis of local sales tax on intrastate sales and services and are thus not able to comply with the agreement's destination-based provisions. These states have been reluctant to change the basis of local sales tax because of potential effects on local government revenue and increased burdens to businesses trying to determine the correct local taxing jurisdictions at the point of delivery. In fact, Texas is still delaying implementation of the July 2004 legislation that would have shifted the tax basis of taxable services to destination.

Recently, Texas proposed an amendment (called the Utah amendment because Utah, an associate member, put it forward) to the agreement that would have allowed a state to source local sales tax on intrastate sales and services under its own laws (origin or destination basis). Ohio also proposed its own amendment on sourcing. Neither amendment passed at the governing board meetings in Indianapolis in April 2006. Therefore, Texas, as well as other origin-based states, will likely not be able to move forward with streamlined sales tax under the current agreement.

Currently, there are only 13 member states said to be in compliance with the streamlined sales tax agreement. More information about the Streamlined Sales Tax Project is online at http://www.streamlinedsalestax.org/.

Just in time for back-to-school shopping, Texas' eighth annual sales tax holiday for clothing and footwear begins at 12:01 a.m. on Friday, August 4, and ends at midnight on Sunday, August 6.

The rules for the 2006 Sales Tax Holiday are the same as in previous years. Additionally, every city and local taxing jurisdiction in the state will participate in the holiday, so the tax break will apply to both state and local sales taxes. Shoppers can save up to $8.25 on every $100 they spend on exempted items.

Texas Tax Code Section 151.326 and Sales Tax Rule 3.365, Sales of Clothing and Footwear During a Three-day Period in August, define terms and provide guidance on the taxability of various transactions during the holiday. The law does not limit the number of tax-exempt items a customer can purchase.

Exempt items - During the holiday, retailers will not collect state and local sales or use tax on most clothing and footwear sold for $99.99 or less. The tax exemption applies to school uniforms, work uniforms, dresses, shorts, neckwear and ties, belts with attached buckles, pajamas, socks, and underclothes. Baseball caps, jogging suits, baseball and football jerseys, basketball shoes, tennis shoes, and other athletic clothes and shoes commonly worn on the street are also eligible for the tax exemption.

Taxable items - Clothing and footwear primarily designed or used for athletic activity or protection are not exempt. For example, bike helmets, football pads, and cleated golf shoes are taxable, as are backpacks, school supplies, computers, bedding to be used at school, and fabric and notions to make school clothing. Accessories such as jewelry, handbags, purses, briefcases, luggage, umbrellas, wallets, and watches also are not eligible for the sales tax holiday.

Furthermore, clothing rentals, dry cleaning, shoe repairs, alterations, and similar services continue to be subject to state and local sales or use tax.

Layaway sales - A sale of eligible clothing under a layaway plan will qualify for exemption if the customer places the qualifying merchandise on layaway during the holiday or if the customer makes the final payment during the holiday.

Internet, catalog, and custom orders - An item of eligible clothing or footwear may be purchased tax free through the Internet, catalog, or by custom order if (1) the item is both delivered to and paid for by the customer during the exemption period; or (2) the customer orders and pays for the item and the retailer accepts the order during the exemption period for immediate shipment, even if delivery is made after the exemption period.

Publication 98-490, Sales Tax Holiday, contains a list of apparel qualifying for this tax-free holiday.

The sun is high in the Texas sky and that means sales are up on many summer products. To help retailers beat the heat, here is a reminder about the taxability of many seasonal products.

Water, including bottled and carbonated water, isn't taxable unless it's flavored.

Juice drinks containing more than 50 percent fruit or vegetable juice by volume is exempt unless it is sold ready for immediate consumption (i.e., with a cup or straw).

Beer and wine are subject to sales tax when sold at a grocery or convenience store.

Flavored waters, Slurpees, sports drinks, sodas, and bottled or canned diluted juices that are not more than 50 percent juice are taxable.

Individual servings of ice cream sundries, such as ice cream bars and sandwiches, sherbet push-up pops, or ice cream cones, and half pints of ice cream are taxable. However, no tax is due on ice cream sundries that are sold in prepackaged containers with two or more servings. In the past, these ice-cream products were only exempt from tax if the package included six or more items.

Ice pops, juice pops, and popsicles that do not contain milk products are not ice cream sundries. These items are taxable regardless of how many are in the package, unless they contain more than 50 percent fruit juice.

Watermelons and other fresh fruit and vegetables are not taxable unless sold ready for immediate consumption (i.e., with a plate or eating utensils).

Charcoal and firewood are taxable. However, grill and lantern bottles filled with propane and kerosene are exempt from sales tax.

Ice is taxable.

Sunscreen with an SPF factor is not taxable, but products to treat sunburn are taxable unless medicated.

Mosquito and bug sprays are taxable. Insect repellants for lawns and yards are also taxable.

Schools and school groups that sell taxable items must obtain a sales tax permit and collect and remit tax on all sales of taxable items unless the sales are otherwise tax-exempt. Tax exemptions are specific and based on a variety of reasons, conditions, and circumstances. Tax is due on any sale not covered by an exemption. The entity making the taxable sale is a retailer/seller and responsible for collecting and remitting the tax.

Organizations that qualify for an exemption under Section 151.310(a)(1) or (2) [e.g., religious, educational, and charitable organizations and organizations exempt under IRS Section 501 (c)(3), (4), (8), (10), or (19)] and their bona fide chapters can hold two tax-free sales or auctions during a calendar year. A day is considered a consecutive 24-hour period. See Tax Code Section 151.310(c), subsection (h) of Rule 3.322 on sales by exempt organizations, and Tax Publication 96-122.

Qualifying educational organizations include Texas school districts, individual public schools, and private schools that have received sales tax exemption as educational organizations from the Comptroller's office. A group of students can qualify as a bona fide chapter of the school if it is organized for some activity other than just to have a tax-free sale day. A qualifying group is one that is recognized by the school and elects officers and holds meetings. Examples of bona fide chapters include such groups as a Drama Club, Spanish Club, FFA, and Student Council, but not a specific class of instruction, such as the first period Journalism class or fifth period Algebra.

Non-student nonprofit organizations, such as PTAs/PTOs and booster clubs, can qualify for certain exemptions on their own.

• A PTA that is affiliated with the state or national PTA organization, or an independent PTA or PTO that has qualified with the Comptroller's office as an educational or 501(c)(3) organization, can hold two one-day tax-free sales or auctions each calendar year. To qualify for the tax-free sales days, a booster club must first obtain exempt status from the IRS. A booster club that gets a Section 501(c)(3) federal exemption should complete AP-204 and submit it with a copy of the IRS exemption letter to the Comptroller's office. After the Comptroller's office notifies the club of its exempt status, the club can hold two one-day, tax-free sales or auctions each calendar year.
• The guidelines for applying for sales tax exemption are available online. For questions about applying for a sales tax exemption, call Tax Assistance Monday through Friday at 1-800-252-5555 during the hours of 7:30 AM to 5:30 PM Central Time or write to us at exempt.orgs@cpa.state.tx.us.
• For information on how to apply for federal exemptions, contact the IRS at 1-877-829-5500 or online at http://www.irs.gov/.
• Tax Code sections 151.314(d)(1) for PTAs and PTOs and (e)(1) for booster clubs provide an exemption for fundraising food sales for groups associated with schools. Sales tax is not due on the sale of food, including meals, candy, and soft drinks, by a PTA/PTO or by a group (e.g., booster club) associated with a public or private elementary or secondary school when the sale is part of a fund-raising drive sponsored by the organization and all net proceeds go to the organization for its exclusive use. If the qualifying group is the "seller" of the food as part of its own fundraising drive, food sales are not taxable. To claim the exemption, the organization can give an exemption certificate in lieu of paying the tax citing the appropriate statutory exemption for fund-raising food sales by PTA/PTO organizations or by school associated groups/booster clubs. If the organization holds a sales tax permit, it can choose instead to issue a properly completed resale certificate. The exemption does not apply if the qualifying group is not the seller, and the for-profit entity making the sales must collect sales tax even if it donates the proceeds to a qualifying exempt organization.
• Section 151.3101 of the Tax Code provides for an exemption for the sale of an amusement service, such as admission to a school carnival, provided exclusively by a PTA or booster club. See Rule 3.298(g) on amusement services.

In some fundraising activities, the school, school group, PTA/PTO, booster club, or other exempt organization is merely acting as a sales representative for a retailer/seller, and sales tax is due. This is often the case for taxable items such as candy, gift-wrapping, Christmas ornaments, candles, and similar items. An exempt organization is not considered the seller if it receives a commission for the sales. Instead, the for-profit entity is the seller and, consequently, the tax-free sale provisions do not apply. The exempt organization should collect sales tax on the taxable sales and then forward the tax collected on the orders to the for-profit retailer, who reports and remits the tax.

The taxpayer, a permitted distributor of gasoline and supplier of diesel fuel, gave qualified customers its own proprietary credit cards, which could be used only at its outlets. The outlets were open to the general public and also accepted third-party credit cards for purchases.

When customers failed to make payment on the proprietary cards, the taxpayer claimed bad debt credits on its tax returns. The credits were denied and the taxpayer was sent notices of tax due. The taxpayer timely requested a redetermination.

The taxpayer contended that bad debt credits should be allowed because the sales were made on account, were not paid for by the customers, and were not reimbursed by any other party, in contrast to sales paid for with major credit cards, for which the seller receives payment from the card issuers.

Tax Code Sections 153.1195(a) and 153.2225(a), in effect during the relevant periods, allow a permit holder to take bad debt credits on fuel sold on account, if an account has been determined uncollectible and has been written off as a bad debt on the seller's books.

The administrative law judge cited language from Comptroller Decision No. 42,911 (2005), which held that the legislature made no distinctions between types of credit cards in its clearly expressed statutory restriction that bad debt credits are not allowed for credit card charges. Under Sections 153.1195(d) and 153.2225(d), the bad debt credits are not available for the "sale of gasoline or diesel fuel that is delivered into the fuel supply tank of a motor vehicle or a motorboat and for which payment is made through the use and acceptance of a credit card." The judge further stated that Rule 3.193(b) (1) defines a credit card as "any card, plate, key, or like device by which credit is extended to and charged to the purchaser's account."

The administrative law judge did not agree with the taxpayer's contention that when proprietary cards are used sales are not "credit card transactions" as defined in the Chapter 301 of the Finance Code. The judge noted that tax exemptions must be determined by reference to the Tax Code and Rules, and not consumer protection legislation. See Rule 3.193 and STAR document 200504187H.

Editor's Note - Chapter 153 was repealed effective January 1, 2004, and replaced by Chapter 162 and similar provisions 162.126 and 162.228.

Loan servicing is considered the performance of a service. Generally, services are apportioned to the location where the service is performed unless otherwise provided. If performance of the service is both inside and outside Texas, the amount of Texas gross receipts will be calculated based on the fair value of the services performed in this state.

Comptroller's policy regarding servicing of real property loans has changed. The new policy provides that gross receipts from the servicing of real property loans will be Texas receipts to the extent the collateral real property securing the loan is located in Texas.

This change is effective for reports originally due on or after April 21, 2006. Both franchise tax apportionment rules, 3.549 and 3.557, are being amended to reflect this change in policy.

The Volunteer Fire Department Assistance Fund Assessment for the 2005 tax year is due August 1, 2006. The Comptroller's office mailed billings to 420 affected taxpayers on May 31, 2006. The assessment is based on each property and casualty insurer's net direct premiums in certain categories of coverage in proportion to the premiums of all licensed insurers for these categories.

The Legislature authorized this assessment in 2001 to help volunteer fire departments buy equipment and train personnel. The assessment, which raises $15 million annually, is set to expire September 1, 2011.

The Comptroller adopts administrative rules to clarify and explain Texas tax laws. Before a new rule or an amendment to an existing rule goes into effect, the Comptroller first publishes a proposal notice, and later an adoption notice, in the Secretary of State's weekly Texas Register. The Register is available on the Secretary of State's website at http://www.sos.state.tx.us/texreg/index.html.

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.

COASTAL PROTECTION FEE
Rule 3.692-Definitions, Reporting Requirements, and Amount of Fee
The Comptroller is amending rule 3.692 to change the rate of the coastal protection fee and the maximum and minimum thresholds for the Coastal Protection Fund, pursuant to Senate Bill 1863 (2005). Effective September 1, 2005, the fee rate was reduced from two cents per barrel of crude oil or condensate down to one and a third (1.333) cents per barrel. In addition, the fee will now be suspended when the fund balance reaches $20 million rather than $25 million; and if the fund balance falls below $10 million, the fee will be reinstated. For the full text of the proposed amendment, see the July 7, 2006, issue of the Texas Register.

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