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Texas Enacts Economic Nexus Regulation for Franchise (Margin) Tax

On December 20, 2019, the Texas Comptroller of Public Accounts (Comptroller) finalized proposed amendments to Rule 3.586 to implement an economic nexus based on a threshold of $500,000 of gross receipts in Texas. Some months ago, the Comptroller’s office proposed making such amendments to the regulation to implement the decision in Wayfair which pertained to sales tax within the Supreme Court ruling; with the state extending such application to the Franchise tax.

In most states, corporate tax nexus standards is commonly applied using a “doing business” standard, often resulting in broad activities establishing nexus unless otherwise federally protected. In many cases, such activity includes deriving income attributable to sources within the state, or directing activities at state customers for the purpose of selling them goods or services. Although many states are unclear if they incorporate a sales type threshold in determining nexus, it is unquestionable that in many of these states, economic nexus could be triggered with sales sourced to the state.

In contrast to most states, previously Texas has explicitly applied a physical nexus standard for the franchise tax. Even after the Wayfair decision in 2018, the state expressed that they have not moved away from the physical presence requirement for franchise tax.

For more information on the Nexus Regulation, please contact a member of the Tax Services Group.

Implications
The amendment might have far-reaching effects that are more than when a usual state that enacts economic nexus for a number of reasons. Such considerations include:

  • The franchise tax is not based on a business’s profit, but computed on margin, without taking into account if the business is in a loss position or not;
  • The tax is levied against flow-through entities, such as partnerships, and results in a entity level tax, also possibly without a full resident credit offset in a partner’s resident state;
  • Historically, the state’s position has been that PL 86-272 (protection from the imposition of income tax to sellers of tangible personal property) does not apply to the franchise tax; resulting in service providers being subject to the tax; and/or
  • For businesses that file group combined returns in the state, Texas has applied “Joyce” reporting; where that only entities on a separate basis that have nexus would include the Texas sales within the sales numerator of the apportionment.

With the state adopting the new bright-line receipts nexus threshold, sellers of tangible personal property or service providers that exceed such threshold within the state, would have a filing requirement within the state; resulting in tax based on gross receipts with limited margin base exclusions.

Author: Jason Rosenberg, CPA, CGMA, EA, MST | jrosenberg@withum.com

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