On August 4, 2016, representatives of the Texas Comptroller of Public Accounts held a limited-invite roundtable to discuss the proposed amendments to 34 Tex. Admin. Code 3.584, relating to the reduced rate available under the Texas Franchise Tax for retailers and wholesalers. As previously reported, these proposed revisions were published in the Texas Register on May 20, 2016 and have the potential to double the tax rate for a substantial number of businesses – namely those in the information technology and pharmaceutical industries.
Members of the Comptroller’s office present included Karey Barton, Associate Deputy Comptroller for Tax, Theresa Bostick, Manager of Tax Policy, William Hammer, Special Counsel for Tax and Jennifer Burleson, Assistant General Counsel. Several representatives of businesses and trade groups, along with legal and accounting professionals, were also present.
Ms. Bostick opened the meeting by reiterating the language of the statute and the proposed regulation, and clarifying the application of the proposed regulation’s language. To briefly summarize, the proposed rule provides that a retailer is considered to produce the products it sells (and therefore may be disqualified from the lower Franchise Tax rate available for retailers) if it “acquires the product and makes modifications to the product that increase the sales price of the product by more than 10 percent.” See proposed Rule 3.584(b)(2)(C)(i). A business will also be considered a producer if it “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 proposals represent substantial changes to both the current version of Rule 3.584 and prior Comptroller interpretations of the retailer/producer distinction, and are not supported by the language of the statute that the Rule purports to interpret.
Ms. Bostick explained that the Comptroller had received several comments on the 10 percent rule (some of which were reiterated at the roundtable, including comments that the 10 percent rule should be interpreted as a safe harbor rather than a ceiling and that it should be applied to both modification and development), and that the Comptroller will consider how to define “modification” in the context of Rule 3.584(b)(2)(C)(i) (such language was not provided at the roundtable). She then focused on Rule 3.584(b)(2)(C)(ii) and the examples provided thereunder, explaining that these provisions are meant to convey that if a taxable entity produces (with “development” being equivalent to “production” in this context) tangible personal property that is incorporated into, installed in, or becomes a component part of a product it sells, that business is considered a producer of the product. Because the Comptroller’s representatives view [...]