The Texas Comptroller of Public Accounts recently proposed amendments to 34 Tex. Admin. Code 3.584 relating to the reduced rate available under the Texas Franchise Tax for retailers and wholesalers. These proposed revisions, which appear to formalize elements of informal guidance issued in August of 2015, have the potential to substantially impact a great number of businesses, specifically in the information technology and pharmaceutical industries.
The Texas Franchise Tax is imposed on taxable business entities, including corporations, partnerships and limited liability companies, doing business in the state of Texas. The generally applicable tax rate is 0.75 percent of “taxable margin”—which is itself computed under a complex set of statutes and regulations—however, the rate is reduced to 0.375 percent for entities “primarily engaged in retail or wholesale trade. To qualify for the reduced rate, a business must meet two statutory thresholds: first, it must earn more revenue from retail or wholesale trade activities than it earns from all other business activities; and second, it must 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). The current version of Rule 3.584 (the Rule) clarifies that, for purposes of the second statutory threshold, a product is not considered to be produced by the retailer if “modifications made to the acquired product do not increase its sales price by more than 10 percent.” In other words, there is a safe harbor under the Rule for retailers who make some modifications to products they sell; so long as those modifications do not increase the product’s sale price by more than 10 percent, the sales of those products will not factor into the second statutory threshold. This is currently the only guidance provided by regulation regarding the scope of the “primarily engaged in” standard.