For Texas franchise tax, are a contractor's receipts apportioned as a sale of real property, a sale of goods, or a service - and when are rebilled (resold) services gross receipts?

Plain-English summary

This file holds two related letters to a construction/engineering contractor (a Delaware corporation serving the energy industry): an original ruling (March 29, 2002) and a follow-up (September 20, 2002). Together they explain that (pre-2008) Texas franchise tax apportionment follows the activity that generates the receipts - and they draw the line between a sale of real property, a sale of goods, and a service, plus when rebilled (resold) services count as gross receipts.

• Apportionment tracks the type of activity. The Tax Code sets categories of receipt-generating activities (Secs. 171.105(a), 171.1051(a)) and specific sourcing rules for each (Secs. 171.103, 171.103(a)): tangible personal property (TPP) sources to the delivery state (Secs. 171.103(1), 171.1032(a)(1)), subject to throwback; services source to where performed (Secs. 171.103(2), 171.1032(a)(2)); real property sources to where the property is located.
• Selling completed facilities = sale of real property. In the follow-up, the contractor clarified it sells fully completed petrochemical facilities (and the land) located outside Texas. If it can establish that it buys the real estate, constructs/refurbishes facilities on it, and then sells the completed facilities, the receipts are treated as the sale of real property, and real property outside Texas is not a Texas receipt (Secs. 171.103(5), 171.103(a)(5)). This presumes the contractor is not merely refurbishing or servicing facilities the buyer already owns.
• Providing construction is a service (original ruling). In the original facts, the contractor built a facility outside Texas but used a Texas subsidiary ("Engineer") to perform engineering in Texas, rebilled at cost. The Comptroller treated the contractor's receipts as services. In its $600 example, $500 for construction performed outside Texas was not a Texas receipt, but the amounts attributed to the engineering performed in Texas that were included in the contractor's gross receipts were Texas gross receipts. (If the contractor added a markup - e.g., billed $120 for the engineering - and the extra $20 was for procuring the engineering from its Texas headquarters, the entire $120 would be Texas receipts under Rules 3.549(e)(37) and 3.557(e)(34).) The Comptroller distinguished the real-property rental/lease sourcing rules (Rules 3.549(e)(32), 3.557(e)(28)) because those original receipts were from services, not the sale/lease of real property.
• Reselling services: agent vs. own-account. Addressing the taxpayer's cited hearing decisions (Comptroller's Decisions No. 12,737 and 12,318), the follow-up explains that the question is whether a company acquires services as an agent for another (so the payments it receives are reimbursements, not gross receipts) or acquires them in its own right and resells them (so they are gross receipts). Under the agency's "dollar-for-dollar flow through" policy, charging the exact cost signals agency (not gross receipts); a markup (charging $120 for a $100 service) signals a resale in the company's own right, making the full $120 gross receipts. Recognizing receipts at each step does not violate the separate-entity reporting requirement (Secs. 171.112(d), 171.1121(c)) - it mirrors a resale of TPP ($100 to the vendor, $120 on resale).
• TPP with embedded service costs stays TPP. When a seller includes in the sales price of TPP the cost of services it used to produce the goods, the receipts are apportioned as a sale of TPP (Secs. 171.103(1), 171.1032(a)(1)); the seller's utilized services are not a separate factor. (Rules 3.549(e)(34) and 3.557(e)(29) address transactions that mix a TPP sale and a service.)

Currency note: This applies the pre-2008 franchise tax's apportionment rules, replaced by the current margin tax (House Bills 3 and 3928) effective January 1, 2008. Treat as historical.

What this means for you

Construction, engineering, and EPC contractors

How your receipts are sourced depends on what you are actually selling. Building and selling a completed facility on out-of-state land can be a real property sale (not a Texas receipt); providing construction/engineering services is sourced to where the work is done, so engineering performed in Texas is a Texas receipt even if the finished facility sits elsewhere. Characterize the transaction carefully - and be ready to prove it (e.g., that you bought the land and sold the completed asset).

Companies that rebill or resell third-party services

Whether a rebilled service is your gross receipt turns on agency vs. markup. Pass a vendor's cost through dollar-for-dollar and you are an agent (reimbursement, not gross receipts). Add any markup and you have resold the service in your own right - the full amount is a gross receipt, and reporting it does not offend separate-entity rules.

Accountants and tax professionals

Map each revenue stream to a Tax Code activity category (Secs. 171.105(a)/171.1051(a)) and its sourcing rule before apportioning. Watch for mixed transactions (TPP plus service, Rules 3.549(e)(34)/3.557(e)(29)) and for procurement charges that can pull a rebilled service fully into Texas (Rules 3.549(e)(37)/3.557(e)(34)).

Common questions

Q: Are a contractor's receipts from selling a completed out-of-state facility Texas receipts?
A: Not if the transaction is a sale of real property located outside Texas (Secs. 171.103(5), 171.103(a)(5)) - provided the contractor is not merely servicing a facility the buyer owns.

Q: What if the contractor is really providing construction services?
A: Then the receipts source to where the services are performed (Secs. 171.103(2), 171.1032(a)(2)); engineering done in Texas and included in the billing is a Texas receipt.

Q: When is a rebilled service a gross receipt?
A: When the company resells it in its own right (typically with a markup). A dollar-for-dollar pass-through is agency - a reimbursement, not a gross receipt (Comptroller's Decisions 12,318 and 12,737).

Q: Does recognizing receipts at each step double-count between related entities?
A: No. The Comptroller says it does not violate separate-entity reporting (Secs. 171.112(d), 171.1121(c)); each entity recognizes its own receipts, as with a resale of goods.

Citations and references

Statutes, rules, and authorities:

• Texas Tax Code Secs. 171.103(2), 171.1032(a)(2) - services apportioned to where performed
• Texas Tax Code Secs. 171.103(1), 171.1032(a)(1) - TPP apportioned to the delivery state (subject to throwback)
• Texas Tax Code Secs. 171.103(5), 171.103(a)(5) - sale of real property; outside Texas is not a Texas receipt
• Texas Tax Code Secs. 171.105(a), 171.1051(a) - categories of receipt-generating activities
• Texas Tax Code Secs. 171.112(d), 171.1121(c) - separate-entity reporting
• 34 Tex. Admin. Code Secs. 3.549(e)(34), 3.557(e)(29) - transactions mixing a TPP sale and a service
• 34 Tex. Admin. Code Secs. 3.549(e)(37), 3.557(e)(34) - procurement charges
• 34 Tex. Admin. Code Secs. 3.549(e)(38), 3.557(e)(33) - services performed inside and outside Texas
• 34 Tex. Admin. Code Secs. 3.549(e)(32), 3.557(e)(28) - sale/lease of real property
• Comptroller's Decisions No. 12,737 and No. 12,318 (agent vs. resale; dollar-for-dollar flow through)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=FIT
• Opinion: https://star.comptroller.texas.gov/view/200209824L

Original ruling text

September 20, 2002

Dear **:

Thank you for the follow-up letter to my earlier response that addressed
certain gross receipts of your client ("Contractor").

The opinion in that letter was based on the facts presented in the original
ruling request, including the statement:

Contractor is a Delaware corporation headquartered in **.
Contractor provides construction, engineering, procurement, and maintenance
services, primarily to customers in the energy industry. Typical projects
include refineries, processing plants, pipelines, offshore and underwater
facilities, highways, railroads, and similar construction projects.

Based on the above representation, it was our understanding that the receipts
in question were attributed to services performed by Contractor. Thus, our
focus was on the apportionment of receipts from services as provided in Tax
Code Sections 171.103(2) and 171.1032(a)(2).

In your follow-up letter, you indicate that Contractor sells fully completed
petrochemical facilities to its customers. The facilities and the land on
which they are located are outside Texas. Contractor's customers pay
Contractor for a fully completed facility.

If Contractor can establish that it buys real estate, constructs or refurbishes
facilities on the real estate, and then sells the completed facilities to a
buyer, then the receipts from that sale would be considered the sale of real
property. In accordance with Sections 171.103(5) and 171.103(a)(5), the
receipts from the sale of real property outside Texas would not be Texas
receipts. This response presumes that Contractor is not merely refurbishing or
otherwise servicing the facilities the buyer owns.

As noted in my earlier letter ruling, the apportionment of a corporation's
gross receipts is based on the activity generating those receipts. The
receipts from services (based on the location where those services are
performed) are apportioned differently from receipts from the sale of real
property (based on the location of that property).

In your follow-up inquiry, you expressed reservations about our conclusions
concerning the resell of services. I will now try to address some of your
concerns about this matter.

One of the authorities that you cited was Comptroller's Decision No. 12,737.
At issue in the hearing was the treatment of certain services (e.g., legal,
printing, data processing, etc.) that a corporation ("Parent") purchased from
other entities. These services were performed for the benefit of Parent and
for the benefit of some of Parent's subsidiaries. The Parent charged and
received payment from the subsidiaries for their share of the costs of the
services paid for by the Parent. Parent did not include any profit in the
amounts charged the subsidiaries.

Under the judge's analysis in this decision and the analysis provided in
Comptroller's Decision No. 12,318, the relevant question was whether Parent
acquired the services as an agent for the subsidiaries or whether it acquired
the services in its own right and resold them to the subsidiaries. If Parent
acted as an agent, then the amounts paid by the subsidiaries would be
considered reimbursements to an agent and would not be gross receipts to
Parent. However, if Parent acquired the services in its own right and resold
them to the subsidiaries, the amounts received from the subsidiaries would be
gross receipts to Parent.

Based on the agency's "dollar-for-dollar flow through" policy, Comptroller's
Decision No. 12,318 found that Parent was acting as an agent for the
subsidiaries with respect to certain services that were at issue. The amounts
paid by the subsidiaries to Parent were the exact same amounts that Parent paid
the service providers. The decision held that these amounts were not gross
receipts to Parent.

However, in those instances that did not involve a "dollar-for-dollar flow
through" and did not fall under the agency rule, the judge determined that the
amounts were receipts from services and should be included in Parent's gross
receipts factor even though another entity performed the services.

The same rationale applies to the example in my previous response. In that
example,
the corporation included in its charges $120 for engineering services provided
by another entity. Although I did not discuss the agency rule, the
"dollar-for-dollar" test would not have been met because the corporation
charged the customer $120 for the services that it paid the vendor $100.

As with certain services in Comptroller's Decision No. 12,318 in which the
judge determined that Parent acquired the services in its own right and resold
them to the subsidiaries, the $120 would be considered gross receipts to the
corporation reselling the engineering services. In both instances, the
recognition of receipts by Parent (from the hearing) and the corporation in the
example does not violate the separate entity reporting requirement as provided
for in Sections 171.112(d) and 171.1121(c).

Because there are separate transactions between separate entities, each
transaction results in the recognition of gross receipts, presuming each entity
is subject to franchise tax. The vendor sells the corporation the engineering
services for $100 and recognizes $100 of gross receipts. When the corporation
resells those services for $120, it recognizes gross receipts of $120.

This treatment is consistent with the resale of TPP. A vendor sells TPP to the
corporation for $100 and recognizes gross receipts of $100. The corporation
resells the TPP for $120 and recognizes $120 of gross receipts. There may be
differences in the sourcing of the receipts because of the specific
apportionment requirements set out in Tax Code Sections 171.103 and 171.1032.

Under these provisions, the receipts from the sales of TPP must be apportioned
to the state where the purchaser takes delivery of the property, unless the
throwback rule applies. Sections 171.103(1) and 171.1032(a)(1). Receipts from
services are apportioned to the state where the services are performed.
Sections 171.103(2) and 171.1032(a)(2).

Whenever there is a sale of TPP in which the seller included in the sales price
of the TPP the costs of any services it utilized, the receipts would be
apportioned in accordance with Sections 171.103(1) and 171.1032(a)(1). The
services utilized by the seller are not a factor in apportioning the sales of
TPP. In this situation, the seller's transaction involves only the sale of TPP
(i.e., there are no elements of a service connected with the seller's
transaction with its customer). Rules 3.549(e)(34) and 3.557(e)(29) address
transactions that involve elements of both a sale of TPP and a service.

For example, the seller has a sale of TPP for $100 with delivery of the TPP
occurring in Texas. In producing the TPP, the seller utilized the services
from a vendor located outside Texas. These services cost $30. In accordance
with Sections 171.103(1) and 171.1032(a)(1), the entire $100 would be Texas
receipts.

The same rationale would apply to the sale of real property. If it is
established that the transaction is the sale of real property (with no elements
of a service involved in the transaction between the seller of the real
property and the seller's customer), all of the receipts from the sale would be
apportioned to the state where the property is located.

If the transaction is the sale of a service, Sections 171.103(2) and
171.1032(a)(2) will be controlling. Whenever a transaction involves services
performed inside and outside Texas, then the receipts from that transaction
will be apportioned accordingly.

For example, the corporation provides engineering services to another entity
and charges that entity $100 for the services. It is determined that on the
basis of the fair value of the services rendered in Texas, $40 of the charges
would be Texas receipts. The remainder of the work is performed outside Texas.
Therefore, $60 of the receipts from the charges would not be apportioned to
Texas. We would have the same results if the out-of-state work was
subcontracted out to another entity. Franchise Tax Rules 3.549(e)(38) and
3.557(e)(33).

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

I hope that the above explanations and examples along with the cited
authorities clarify our position on the apportionment issues. If you have any
questions, please give me a call at 463-4496.

Sincerely,

Jerry Bobbitt
Tax Policy Division

March 29, 2002

Dear **:

Thank you for the information contained in your franchise tax ruling request
concerning the gross receipts of a contractor that provides construction,
engineering, procurement, and maintenance services. I appreciate your patience
while we worked on this response.

You have provided us with the following facts:

Contractor is a Delaware corporation headquartered in **.
Contractor provides construction, engineering, procurement, and maintenance
services, primarily to customers in the energy industry. Typical projects
include refineries, processing plants, pipelines, offshore and underwater
facilities, highways, railroads, and similar construction projects.

A customer hired Contractor to construct a facility (the "facility"). The
facility (after construction) would be located outside of Texas.

Contractor required engineering services in order to construct the facility.
Contractor's subsidiary, ("Engineer"), is a Delaware corporation headquartered
in **. Engineer's business includes providing engineering services
for use in constructing petrochemical facilities. Contractor engaged Engineer
to provide engineering services for use in constructing the facility.

Engineer performed engineering services at locations within Texas for use in
constructing the facility (i.e., Engineer didn't perform the services at the
job site). Contractor constructed the facility at a location outside of Texas.
Engineer invoiced Contractor for its engineering services at cost, and
Contractor paid Engineer. Contractor invoiced the customer for the
construction costs of the facility (plus Contractor's profit), and the customer
paid Contractor. Contractor's gross receipts from the customer included, as a
component, Engineer's charge to Contractor (i.e., Contractor rebilled the
engineering services to the customer).

In calculating its apportionment factor for Texas franchise tax purposes,
Engineer treated its receipts from Contractor for the engineering services as
everywhere and Texas gross receipts (based on the location where the services
were performed).

The following are your specific questions:

Is any portion of the gross receipts Contractor received from the customer a
gross receipt from business done in Texas for purposes of either the earned
surplus or taxable capital components of the Texas franchise tax? If so, what
portion, and what is the legal authority you rely on? If not, why not, and
what is the legal authority you rely on?

Based on the facts presented, we would characterize the receipts attributed to
Contractor's construction of the facility as receipts from a service. The
billings to the customer for this service included the cost of the engineering
services that Contractor required to complete the construction.

For example, assume the total gross receipts are $600 (i.e., the amount
Contractor bills customer for the construction services). Included in this
total is $100 attributed to the costs of the engineering services.

$500 of the total receipts are attributed to Contractor's construction services
performed at the facility located outside Texas. Because these services were
performed outside Texas, the $500 would not be apportioned as Texas gross
receipts for both tax components. Because the engineering services were
performed in Texas, the $100 of gross receipts attributed to these services
would be Texas gross receipts for both tax base components. Sections
171.103(2) and 171.103(a)(2), Texas Tax Code.

In addition, assume Contractor actually billed the customer $120 for the
engineering services. If the $20 was for procuring the engineering services
from Contractor's headquarters in **, the entire $120 would be
Texas receipts. See Franchise Tax Rules 3.549(e)(37) and Rule 3.557(e)(34).

In your ruling request, you noted that receipts from the sale, lease, or
sublease of real property are apportioned to the location of the property under
Franchise Tax Rules 3.549(e)(32) and 3.557(e)(28). We would distinguish the
Contractor's situation from these specific provisions because Contractor's
receipts are from services and are not receipts from the sale, lease, or
sublease of real property.

For franchise tax apportionment purposes, the Tax Code provides specific
categories of activities that generate gross receipts (e.g., receipts from the
sale of tangible personal property, receipts from each service, rental, or
royalty, and other business). Sections 171.105(a) and 171.1051(a), Texas Tax
Code.

Sections 171.103 and 171.103(a) provide the specific sourcing requirements for
each type of receipt. For example, the receipts from the rental of property
located in Texas are apportioned as Texas receipts; if the property is located
outside Texas, the receipts are not Texas receipts. Receipts from services are
Texas receipts if the services are performed in Texas; if the services are
performed outside Texas, the receipts are not Texas receipts.

Based on the above authorities, we have concluded that the amounts attributed
to the engineering services performed in Texas that are included in
Contractor's gross receipts for providing construction services are Texas gross
receipts.

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

If you have any questions, please call toll-free 1-800-531-5441, extension
3-4496 or (512) 463-4496.

Sincerely,

Jerry Bobbitt
Tax Policy Division