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Texas amends service sourcing rule to rely on location of personnel, property
March 2023
In brief
Texas generally sources revenue from services to the location where the service was performed.
On March 25, 2022, the Texas Supreme Court rejected the “receipt producing, end-product act” test as a factor in determining the location of where a service is performed for apportionment sourcing purposes. On November 10, 2022, the Texas Court of Appeals, on remand, determined that the taxpayer’s cost-of-performance methodology was acceptable in determining the fair value of services performed in Texas.
On March 10, 2023, the Comptroller amended its Texas Margin rule to delete its receipt producing, end-product act discussion and related examples. The Comptroller also amended the rule to incorporate the Texas Supreme Court’s decision that “the most natural reading of ’service performed in this state’ supports locating the performance of the service at the place where the taxpayer's personnel or equipment is physically doing useful work for the customer.”
The takeaway. The amended rule incorporates the Texas Supreme Court’s decision in Sirius XM Radio, Inc. V. Hegar (click here for our Insight) and uses that decision to limit the potential impact of the appellate decision for the issues that were reviewed on remand. Specifically, the rule narrows what costs may be analyzed in determining where a service is performed. However, the amendments do not include changes to internet hosting services or internet advertising provisions adopted by the Comptroller on January 15, 2021.
[Texas Register (March 10, 2023)]
In detail
Texas Supreme Court rejects “receipt producing, end-product act” test
On March 25, 2022, the Texas Supreme Court held that amounts received for radio satellite services are sourced to where services are performed rather than to where services are received. Texas law provides that receipts from service revenue are sourced to where the services are “performed.” The Comptroller argued that such performance is located where the “end-product act” occurs, which is at the location of the customer where the radio signal is decrypted. The Court disagreed and found that the performance of the service is located where the taxpayer’s personnel or equipment is physically doing useful work for the customer.
Appellate Court decision on remand determining “fair value”
The appellate court on remand affirmed using cost-of-performance as a method in determining fair value of services performed in Texas; however, the court did not opine on what costs may be included when determining cost of performance. (Click here for our Insight) Because the court did not examine what costs should be included, an open question remained regarding the elements of a cost-of-performance analysis.
Amendment to sourcing rule for unspecified services – Location of personnel or property
Effective March 10, 2023, rule 3.591(e)(26) removes references to the “receipts-producing, end-product act" to determine the location of where a service is performed for sourcing purposes.
The Comptroller states that the amended rule interprets the Supreme Court’s phrase “useful work for the customer” to mean “work that the customer hired the taxable entity to perform,” and that the phrase does not include “activities that enable the taxable entity to do business in general or are not directly used in the provision of a service to the customer.” The Comptroller also chose to use the term “property” rather than “equipment” because in some cases property may be used to perform services and the property may not be considered equipment.
The rule adds the following language: “a service is performed at the location or locations where the taxable entity's personnel or property are doing the work that the customer hired the taxable entity to perform. Activities that are not directly used to provide a service are not relevant when determining the location where a taxable entity performs a service.”
Amendment to sourcing rule for unspecified services – Fair value and direct costs
The rule previously provided that “if services are performed both inside and outside Texas for a single charge, then receipts from the services are Texas gross receipts on the basis of the fair value of the services that are performed in Texas. In determining fair value, the relative value of each service provided on a stand-alone basis may be considered. Units of service, such as hours worked, may also be considered. The cost of performing a service does not necessarily represent its value. If costs are considered, costs should be limited to costs directly related to the service and not overhead costs.” (emphasis added).
The rule strikes the above highlighted language: “directly related to the service and not overhead costs.” The rule replaces the stricken language with guidance that such costs should be limited to “the direct costs of doing the work that the customer hired the taxable entity to perform and should not include any costs that are not directly used to provide a service to the customer.”
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