Does a foreign (non-Texas) corporation that owns oil-and-gas working (mineral) interests in Texas have franchise-tax nexus, even if an independent contractor operates the interests?

Plain-English summary

An adviser described a plan to form a foreign (non-Texas) corporation or LLC to buy working interests in East Texas oil and gas. The new entity would join the operating agreement and division orders for each property but would hire an independent contractor to actually operate the interests. The question: does that create Texas franchise-tax nexus?

• The answer is yes. Owning real property in Texas creates nexus for both franchise-tax components - taxable capital under Comptroller Rule 3.546(c)(5) and earned surplus under Rule 3.554(d)(16)(J).
• Mineral interests are real property. The Comptroller considers mineral interests to be real property for franchise tax purposes (citing STAR Accession No. 9208L1216A12). So owning mineral interests in Texas subjects a corporation to both components of the franchise tax.
• Using a contractor does not avoid it. Because nexus here comes from owning the interests (real property), hiring an independent contractor to operate them does not change the result.
• Caveat. The response is based on the facts presented and current law; different or additional facts could change it.

Currency note: This letter describes the pre-2008 franchise tax (taxable capital and earned surplus), replaced by the current margin tax effective January 1, 2008 (House Bills 3 and 3928). Franchise-tax nexus rules have evolved since; confirm current law before relying on this letter.

What this means for you

Out-of-state investors in Texas oil and gas

Holding Texas mineral or working interests is, for franchise-tax purposes, holding Texas real property - and that alone established nexus under the old tax. Structuring operations through a contractor did not insulate a non-Texas entity from the franchise tax if it owned the interests.

Advisers structuring energy investments

Do not assume a passive, contractor-operated interest is nexus-free. Under this letter the ownership of the mineral interest itself created nexus for both taxable capital and earned surplus; the operating arrangement was beside the point.

Common questions

Q: Are mineral interests treated as real property for Texas franchise tax?
A: Yes. The Comptroller considers mineral interests to be real property (STAR Accession No. 9208L1216A12).

Q: Does owning Texas mineral interests create franchise-tax nexus?
A: Yes - for both components: taxable capital (Rule 3.546(c)(5)) and earned surplus (Rule 3.554(d)(16)(J)).

Q: Does hiring an independent contractor to operate the interests avoid nexus?
A: No. Nexus arose from owning the real property (the mineral interests), not from operating it directly.

Citations and references

Rules:

• Comptroller Rule 3.546(c)(5), 34 Tex. Admin. Code - owning real property creates nexus for the taxable-capital component
• Comptroller Rule 3.554(d)(16)(J), 34 Tex. Admin. Code - owning real property creates nexus for the earned-surplus component

Related STAR document:

• STAR Accession No. 9208L1216A12 - the Comptroller considers mineral interests to be real property for franchise tax purposes

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=FIT
• Opinion: https://star.comptroller.texas.gov/view/200207284L

Original ruling text

July 24, 2002

TO: **

Dear **:

Thank you for your email regarding nexus for a foreign corporation with oil and
gas working interests in Texas. Jerry Bobbitt forwarded me your email and
asked me to respond.

The rules I mention below, as well as other related information, are available
online at http://www.window.state.tx.us/taxinfo/franchise/index.html.

You indicate your client intends to form a foreign (non-Texas) corporation or
limited liability company for the purpose of purchasing working interests in
East Texas. The entity will join in the operating agreement and division
orders for any property, but the entity will hire an independent contractor to
actually operate the interests.

According to Comptroller's Rule 3.546(c)(5) and Rule 3.554(d)(16)(J), owning
real property creates nexus for taxable capital and earned surplus,
respectively. Furthermore, the Comptroller considers mineral interests to be
real property for franchise tax purposes. See Star Accession No. 9208L1216A12.
Therefore, owning mineral interests in Texas will subject a corporation to
both components of the Texas franchise tax.

This response is based on the facts presented and current law. If there are
different or additional facts, the response may change.

If you need any additional information, please feel free to call me at
1-800-531-5441, extension 34629.

Sincerely,

Lowell Olsen Dunn
Tax Policy Division