For a credit-card company, how are annual membership fees and merchant discount fees sourced for Texas franchise-tax apportionment?

Plain-English summary

This is an internal franchise-tax policy memo from Franchise Tax Policy to an auditor, addressing how a credit-card company should source two revenue streams for (pre-2008) franchise-tax apportionment. The company issued credit cards, with processing centers in several states and travel agencies throughout Texas.

• Annual membership fees. A cardholder's annual fee for the privilege of holding and using the card was treated by the Tax Policy Committee as the sale of an intangible right (like an annual credit-card fee). The revenue is therefore sourced to Texas based on the location of the payor (the cardholder).
• Merchant discount fees. When a merchant accepts the card, the company remits the sale amount minus a discount fee (e.g., keeping $3 of a $100 sale). This discount fee is really a processing fee for the performance of a service, sourced based on where the service is performed. Because credit-card processing happens at both the front-end (authorization) and the back-end (merchant accounting) — inside and outside Texas — the fee is sourced to Texas based on the fair value of the service performed in Texas.

Important currency note: This memo applies the pre-2008 franchise tax. The 2007 legislation (House Bills 3 and 3928) replaced it with the current margin tax, which has its own receipts-sourcing rules (substantially revised again for reports due on or after January 1, 2021). Treat these sourcing conclusions as historical and confirm current law.

What this means for you

Financial and card-processing businesses apportioning Texas receipts

The memo draws a line that still resonates: intangible-right revenue (membership fees) followed the payor's location, while service revenue (merchant discount/processing fees) followed where the service was performed, split by fair value. Characterizing the receipt drives the sourcing.

Accountants and tax professionals

Note the two-part sourcing logic and the front-end/back-end service split for card processing. This is pre-2008 apportionment; the margin tax's sourcing rules (and the 2021 amendments) differ, so re-verify before applying.

Common questions

Q: How were annual credit-card membership fees sourced?
A: As the sale of an intangible right, sourced to Texas based on the location of the payor (the cardholder).

Q: How were merchant discount fees sourced?
A: As a service (processing) fee, sourced to Texas based on the fair value of the processing service performed in Texas, reflecting both front-end authorization and back-end accounting.

Citations and references

The memo relied on Tax Policy Committee determinations about the character of each fee (intangible right vs. service) rather than citing specific numbered Tax Code sections. See the verbatim text below.

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=FIT
• Opinion: https://star.comptroller.texas.gov/view/200606622L

Original ruling text

Date: June 26, 2006

To: Geovan Gedeon, ** Audit

From: Janet Spies, Franchise Tax Policy

RE: Membership Fees, Credit Card Discounts

In your taxability request, you stated that COMPANY’S primary business is the
issuance of credit cards. This taxpayer has processing centers in Arizona,
Florida, North Carolina and Utah but has travel agencies throughout the state
of Texas.

At issue are two types of charges made by the taxpayer: 1) membership fees and
2) merchant discount fees. I have restated the description of these two fees
along with the treatment of the revenues for franchise tax reporting purposes.

Membership Fees:

A cardholder pays a membership fee for the privilege of having the card and the
ability to use the card anywhere in the world. This fee is paid annually.

Franchise Tax Treatment:

It was determined by the Tax Policy Committee that the sale of a membership
fee, like an annual credit card fee, is the sale of an intangible right. As a
result, the revenue from this transaction should be sourced to Texas based on
the location of payor.

Discount Fees:

When a merchant accepts the credit card for payment of goods and/or services,
the taxpayer remits the amount minus a discount fee to the merchant. For
example, a customer purchases $100 of goods from a merchant, paying with the
credit card. The merchant receives only $97 from the credit card company. The
remaining $3.00 is the discount fee retained by the credit card company, your
taxpayer. This $3.00 is revenue to the taxpayer.

Franchise Tax Treatment:

Upon review, it was determined that the discount fee is really just a
processing fee for the performance of a service and should be sourced based on
where the service is performed. We had previously determined that credit card
processing includes services performed at the front-end of the transaction
where an authorization is given and at the back-end of the transaction where
the merchant accounting is done. As a result, these processing fees could be
for the performance of services done both inside and outside of Texas. The
fees should be sourced to Texas based on the fair value of the service that is
performed in Texas.

If you have any additional questions or if I can provide any additional
information, please let me know.