Does warehousing products in Texas for less than a week qualify as a 'necessary delay in transit,' or are the receipts subject to the throwback rule?

Plain-English summary

An auditor asked whether a taxpayer's Texas warehousing qualified as a "necessary delay in transit" (which would keep the receipts out of Texas) or whether the receipts were Texas sales subject to the throwback rule. The taxpayer ships component parts to a plant in Mexico to make locksets, then brings the finished, bar-coded locksets to its Texas warehouse ("CITY B"), from which it ships to automaker customers on daily orders (products stay less than a week). The Comptroller ruled it is not a necessary delay in transit.

• The rule. Rules 3.549(e)(41)(G) and 3.557(e)(37)(G) provide that no Texas receipts are recognized if in-state storage or delivery of tangible personal property results from a "necessary delay in transit."
• What the phrase means. It reflects the Commerce Clause bar on taxing goods in interstate transit. There must be continuity of transit - no interruption from origin to destination - except an interruption that is incidental to the transportation or the means of transportation. Example: goods shipped by a common carrier into Texas solely to transfer to another common carrier for out-of-state delivery are in Texas only because of a necessary delay in transit, and cannot be taxed.
• Why this taxpayer did not qualify. The taxpayer takes possession of the locksets in Texas and recognizes receipts when it ships from its own Texas warehouse to customers. It is therefore making sales in Texas and is subject to the throwback rule if products are delivered to a state where the taxpayer is not subject to tax. The warehouse is not a mere transit stop.
• NAFTA argument rejected. The taxpayer's point that NAFTA forced it to open a Texas warehouse (because a Mexican company could not ship directly into the U.S.) is irrelevant and does not change the agency's policy. The Comptroller cautioned that "necessary delay in transit" should not be broadened, distinguishing the letter (9401170L) the taxpayer relied on.

Currency note: This letter describes the pre-2008 franchise tax and its throwback rule (replaced by the margin tax effective January 1, 2008 under House Bills 3 and 3928). The current margin tax does not use a throwback rule; confirm present law.

What this means for you

Manufacturers and distributors using a Texas warehouse

A short dwell time is not enough. If you take possession at a Texas facility and ship to customers from there, the sales are Texas sales - and under the old franchise tax, receipts thrown into a state where you were not taxable were "thrown back" to Texas. The "necessary delay in transit" exception was reserved for true pass-through, carrier-to-carrier movement.

Supply chains built around trade rules

Business reasons for a Texas distribution point (including trade-law constraints like NAFTA) did not convert a genuine warehousing operation into mere transit. Plan Texas apportionment around where possession and shipment actually occur.

Common questions

Q: What is a 'necessary delay in transit'?
A: An in-Texas interruption of interstate movement that is only incidental to the transportation - e.g., transferring goods from one common carrier to another for delivery out of state - preserving continuity of transit from origin to destination.

Q: Why weren't the taxpayer's warehouse shipments 'in transit'?
A: Because the taxpayer took possession in Texas and made the sales by shipping from its own Texas warehouse - that is a Texas sale, not a pass-through, so the throwback rule applied.

Q: Did NAFTA-driven business necessity change the result?
A: No. The Comptroller said that reason is irrelevant to the agency's policy.

Citations and references

Rules and constitutional authority:

• Franchise Tax Rule 3.549(e)(41)(G), 34 Tex. Admin. Code - no Texas receipts where in-state storage/delivery results from a necessary delay in transit (taxable capital)
• Franchise Tax Rule 3.557(e)(37)(G), 34 Tex. Admin. Code - same rule for earned surplus
• U.S. Constitution, Commerce Clause - states cannot tax goods in interstate transit

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=FIT
• Opinion: https://star.comptroller.texas.gov/view/200203870L

Original ruling text

March 19, 2002

Subject: Necessary delay in transit

Question: Taxpayer sells locksets to major automakers in North America. Each
week, Taxpayer receives a 13-week report setting out its customers' production
requirement of locksets needed for that time period. Based on this report,
Taxpayer ships component parts to its plant at CITY A, Mexico for the
manufacturing of the locksets. Once the locksets are manufactured and
packaged, it is labeled with a custom specific bar code label designating its
customer assembly plant location and shipped to Taxpayer's warehouse facility
in CITY B. All products manufactured for sale in the United States are
shipped to the CITY B warehouse facility.

Although Taxpayer may know the ultimate destination of the products based on
the type of product and the bar code label, Taxpayer does not know the actual
delivery date for some of the locksets. Once the products reach CITY B,
Taxpayer receives a daily electronic report from its customers, and the daily
reports trigger both shipments and billings to the customers. Taxpayer
recognizes receipts when the items are shipped from the CITY B facility. The
daily sales report order may request fewer products than originally reflected
in the 13-week report or may request additional locksets due to changes in a
production schedule. Customers are billed the difference. Taxpayer ships
products on a "first in, first out" basis, meaning that any overages that were
sent from Mexico on prior shipments are the first locksets shipped along with
any incoming supply from Mexico to fill the daily sales report order.

Taxpayer indicates that no products stay in CITY B facility more than a week.
According to the Taxpayer, the reason for the CITY B warehouse facility is
because NAFTA prohibits a Mexican delivery company from shipping products into
the United States and that if NAFTA allowed direct shipments from its
manufacturing plant, there would be no need for the CITY B warehouse facility.
Taxpayer contends that the shipment to CITY B constitutes a "necessary delay in
transit" and that the policy reflected in 9401170L applies. The auditor asks
whether the products qualify as "necessary delay in transit" or whether the
receipts generated from shipment in CITY B are subject to the throwback rule.

Answer: Rules 3.549(e)(41)(G) and 3.557(e)(37)(G) provide that no Texas
receipts are recognized if the storage or delivery of tangible personal
property in Texas is a result of "necessary delay in transit." This policy is
reflected in the letter cited by Taxpayer. Essentially, your question begs
another question -- what does the phrase "necessary delay in transit" mean?
Under the Commerce Clause of the United States Constitution, states cannot tax
goods that are in interstate commerce or transit. There must be a continuity
of transit, which means no interruption from the point of origin and to the
point of destination. Any interruption during the goods movement at an
intermediate point between origin and destination is considered to be a delay
in transit only if the interruption is incidental to the transportation or the
use of the means of transportation. For example, if a product is shipped by a
common carrier into Texas from an out-of-state location for the sole purpose of
transferring that product to another common carrier for delivery outside of
Texas, then the product is in Texas only because of a necessary delay in
transit. Texas cannot impose a tax on that product. Our policy uses
"necessary delay in transit" to recognize this constitutional restriction, and
it should not be broadened. Based on the facts presented, Taxpayer takes
possession of the locksets in Texas and recognizes receipts when shipments are
made from CITY B warehouse facility to customers' locations. Taxpayer is
making sales in Texas and is subject to the throwback rule if the products are
delivered to a state in which Taxpayer is not subject to tax. Taxpayer's
argument that NAFTA led Taxpayer to open a warehouse in Texas is irrelevant and
has no impact on the agency's policy.