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Breaking News: Texas Comptroller Publishes Retroactive Rule Targeting IT, Pharmaceutical Retailers; Clock Running on Comment Period

On May 20, 2016, the Texas Comptroller of Public Accounts published proposed amendments to 34 Tex. Admin. Code 3.584 – relating to the reduced rate available under the Texas Franchise Tax for retailers and wholesalers – in the Texas Register. As previously reported, these proposed revisions have the potential to double the tax rate for a substantial number of businesses – namely those in the information technology and pharmaceutical industries.

The proposed changes to Rule 3.584 were first circulated as draft amendments to interested parties in April.  Although some interested parties opposed the draft, the official published version has remained unchanged after that initial informal review.  To summarize, entities “primarily engaged in retail or wholesale trade” are subject to a Texas Franchise Tax rate that is half the rate imposed on other businesses – 0.375 percent versus 0.75 percent for reports originally due on or after January 1, 2016.  To qualify for this reduced rate, a business must (among other statutory requirements) earn less than 50 percent of its retail or wholesale trade revenues from the sale of products it or an affiliate entity “produces.”  Tex. Tax Code § 171.002(c).  In a substantial change from the current version of Rule 3.584, the proposed amendments – which have a retroactive effective date of January 1, 2008 – provide that a retailer is considered to produce the products it sells if the business “manufactures, develops, or creates tangible personal property that is incorporated into, installed in, or becomes a component part of the product that it sells.”  See proposed Rule 3.584(b)(2)(C)(ii). The proposed Rule offers two examples of businesses that will now be considered “producers” rather than retailers: (1) a business that produces a computer program, such as an application or operating system, that is installed in a device that is manufactured by a third party; and (2) a business that produces the active ingredient in a drug that is manufactured by an unrelated party.  These proposed changes create a regulation that is neither consistent with the language of the statute it purports to interpret nor supported by the common sense understanding of what it means to be a “producer” versus a “retailer.”

Although the proposed changes to Rule 3.584 have the potential to double the tax rate for those retailers and wholesalers who also engage in “development” activities and a retroactivity period of over eight years, the Chief Revenue Estimator, Tom Currah, has determined that “for the first five-year period the rule will be in effect, there will be no significant revenue impact on the state or units of local government” – and there is “no significant anticipated economic cost to individuals who are required to comply with the proposed rule.”  Mr. Currah also has determined that for each year of the first five years the rule is in effect, the anticipated public benefit will be “conforming the rule to current legislation and policy.”  No statement of fiscal implications for small businesses is required.

The publication of the proposed revisions in the Texas Register has started the clock for the submission of public comments.  Comments must be received no later than 30 days from the date of publication; i.e., by Monday, June 20, 2016.  Comments may be submitted to Teresa G. Bostick, Director, Tax Policy Division, P.O. Box 13528, Austin, Texas 78711-3528.

© 2020 McDermott Will & EmeryNational Law Review, Volume VI, Number 142

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Stephen P. Kranz Lawyer McDermott Will
Partner

Stephen P. Kranz is a partner in the law firm of McDermott Will & Emery LLP and is based in the Firm’s Washington, D.C., office.  He engages in all forms of taxpayer advocacy, including audit defense and litigation, legislative monitoring, and the formation and leadership of taxpayer coalitions.  Steve is at the forefront of state and local tax issues, including developments arising in the world of cloud computing and digital goods and services.  He assists clients in understanding planning opportunities and compliance obligations for all states and all tax types. ...

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Counsel

Diann Smith is counsel in the law firm of McDermott Will & Emery LLP and is based in the Firm’s Washington, D.C., office.  Diann focuses her practice on state and local taxation with an emphasis on tax challenges relating to compliance, controversy, planning and legislative activity.   

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Eric Carstens Tax Attorney McDermott Will Emery
Associate

Eric D. Carstens is an associate in the law firm of McDermott Will & Emery LLP and is based in the Firm’s Washington, D.C., office. He focuses his practice on state and local tax matters.

Eric assists clients with state tax controversy, compliance and multistate planning across all states for a variety of tax types and unclaimed property. He engages in all forms of taxpayer advocacy, including litigation, legislative monitoring and audit defense. He works closely with several of the Firm’s taxpayer coalitions focused on specific state tax...

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