Does a corporation that controls a trust leasing railcars in Texas have franchise-tax nexus, and how are the trust's receipts and distributions apportioned?

Plain-English summary

A California corporation that provides lease financing was the sole beneficiary of a Connecticut trust (trustee: a national bank based in Delaware) that would buy railcars and lease them to a Texas limited partnership, which would sublease them to third parties. The corporation could direct and remove the trustee. The railcars would be in Texas less than 20% of the time. The corporation asked four questions about nexus and apportionment.

• Nexus: yes. As a corporate beneficiary having control over a trust that is doing business in Texas, the corporation is subject to Texas franchise tax.
• No look-through of the trust. The existence of the trust cannot be ignored, so the receipts of the trust do not flow through to the corporation.
• The trust's legal domicile. Under Rule 3.549(b)(6), a trust's legal domicile is its principal place of business - the location of its day-to-day operations. Where operations are conducted equally or fairly evenly in more than one state, the principal place of business is the trust's commercial domicile - the principal place from which the trust's business is directed. On the facts given, the trust's commercial domicile is outside Texas, though the Comptroller needed more information (how much time the railcars spend in Texas versus other states, Canada, and Mexico) to fix the legal domicile.
• Distributions. Under Rule 3.549(e)(47), distributions to trust beneficiaries are apportioned based on the legal domicile of the trust (see the domicile analysis above).

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

What this means for you

Equipment-leasing and structured-finance companies

Putting assets in a controlled trust did not shield the corporate beneficiary from Texas nexus when the trust did business in Texas - but the trust was still respected as a separate entity, so its receipts were not attributed to the beneficiary, and the beneficiary's distributions were sourced by the trust's domicile, not by where the railcars happened to sit.

Accountants and tax professionals

Three moving parts: (1) control over a Texas-active trust creates beneficiary nexus; (2) no look-through of trust receipts; (3) the trust's legal domicile (day-to-day operations, or commercial domicile when operations span states) governs distribution sourcing under Rule 3.549(e)(47). Nailing down the legal domicile is fact-intensive.

Common questions

Q: Does controlling a trust that operates in Texas create franchise-tax nexus?
A: Yes. A corporate beneficiary with control over a trust doing business in Texas is subject to the franchise tax.

Q: Are the trust's receipts treated as the beneficiary's?
A: No. The trust is not looked through, so its receipts do not flow through to the beneficiary.

Q: How are trust distributions apportioned?
A: Based on the trust's legal domicile (its principal place of business, or commercial domicile if operations span several states) under Rule 3.549(e)(47).

Citations and references

Rules:

• 34 Tex. Admin. Code Sec. 3.549(b)(6) (legal domicile of a trust)
• 34 Tex. Admin. Code Sec. 3.549(e)(47) (trust distributions apportioned by the trust's legal domicile)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=FIT
• Opinion: https://star.comptroller.texas.gov/view/200401316L

Original ruling text

January 9, 2004

Dear **:

Thank you for your letter concerning railcar leasing transactions.

According to your letter, Taxpayer is a California corporation headquartered in
California. Taxpayer provides lease financing for the purchase of large
assets. The Taxpayer is in the process of entering into a leasing transaction
for railcars that will be used in Texas, other states, Mexico and Canada.

The Taxpayer will be the sole beneficiary of a trust created under Connecticut
law. The Trust will be located and administered in the state of Connecticut.
The Trustee of the Trust will be a national banking association with its
principal place of business in Delaware. Pursuant to the terms of the Trust
document, the Taxpayer has the right to direct the actions of the Trustee as
long as the actions are not inconsistent with the terms of the operative
documents for the leasing transaction, the Trustee can only act at the
direction of the Taxpayer and the Taxpayer has the right to remove the Trustee.

The Trust will purchase railcars that will be leased to a Texas limited
partnership that will in turn sublease the railcars to third party users. The
Lessee and Sublessees are not related to the Taxpayer. The railcars will be
purchased with 20% equity provided by the Taxpayer and 80% debt provided by
unrelated lenders through a separate pass-through trust structure. The Lessee
has represented to Taxpayer that the railcars will be located in Texas less
than 20% of the time and otherwise will be used in other states, Canada and
Mexico.

Listed below are your questions followed by a response.

Question 1:

State whether under the current policy of the Comptroller's Office the Taxpayer
will be treated as having nexus with Texas as a result of the transaction if
the Taxpayer does not otherwise have nexus with Texas.

Response:

As a corporate beneficiary having control over a trust that is doing business
in Texas, Taxpayer is subject to Texas franchise tax.

Question 2:

Confirm that for apportionment purposes, the Comptroller's Office will not look
through the Trust and treat the receipts of the Trust as receipts of the
Taxpayer.

Response:

The existence of the trust cannot be ignored for franchise tax purposes. Thus,
the receipts of the Trust do not flow-through to the Taxpayer.

Question 3:

State whether the Trust will have a legal domicile outside of Texas? Since the
railcars will be located in Texas less than 20% of the time and will be used in
other states and countries for the rest of the time, please confirm that this
will be considered as being used "equally or fairly evenly in more than one
state." Also since the business of the Trustee will be conducted in
Connecticut, please confirm that the commercial domicile of the Trust is
outside of Texas.

Response:

Rule 3.549(b)(6) defines the legal domicile of a trust as the principal place
of business of the trust. A trust's principal place of business is defined as
the location of its day-to-day operations. The rule also states that where a
trust's operations are conducted equally or fairly evenly in more than one
state, the trust's principal place of business is its commercial domicile. A
trust's commercial domicile is the principal place from which the trade or
business of the trust is directed.

In order to determine the location of the Trust's day-to-day operations, and
therefore legal domicile, additional information is required. Please provide
how much time the railcar spends in Texas and the amount of time spent in the
other states, Canada and Mexico. Based on the information provided the Trust's
commercial domicile is outside Texas.

Question 4:

State whether the distributions from the Trust will be treated as non-Texas
receipts in computing the Taxpayer's apportionment factor for Texas franchise
taxes.

Response:

Rule 3.549(e)(47) states that distributions to beneficiaries of a trust are
apportioned based on the legal domicile of the trust. See response to Question
3 regarding the determination of the Trust's legal domicile.

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

If you have questions about this, please call me at 1-800-531-5441, extension
59952. You may write me at Tax Policy Division, Comptroller of Public
Accounts, P.O. Box 13528, Austin, Texas 78711-3528.

Sincerely,

Teresa Bostick
Tax Policy Division