Does a retail bakery that bakes and sells its own kolaches and pastries qualify for Texas's reduced retail/wholesale franchise tax rate?

Plain-English summary

A retail bakery that makes and sells kolaches and pastries — plus some soft drinks and milk it doesn't produce itself — asked whether its revenue qualifies for Texas's reduced franchise tax rate available to businesses "primarily engaged in retail or wholesale trade." The bakery gets 88% of its revenue from goods it bakes itself and 12% from resold items like drinks. The Comptroller ruled no, it doesn't qualify for the reduced rate, even though its sales activity is technically "retail trade."

Texas's reduced retail/wholesale franchise tax rate requires meeting a three-part test, and the bakery failed on one prong:

1. More retail/wholesale revenue than other trades — the bakery passed this; 100% of its revenue is retail trade activity (Standard Industrial Classification Industry 5461, Retail Bakeries).
2. Less than 50% of retail/wholesale revenue from self-produced goods (or goods produced by an affiliate) — the bakery failed this: 88% of its revenue comes from bakery items it makes itself, well over the 50% ceiling.
3. Doesn't provide retail/wholesale utilities — the bakery passed this too.

Because a business must satisfy all three parts, failing the self-production cap alone was enough to disqualify the bakery from the reduced rate — even though everything it sells is genuinely "retail trade" revenue. The ruling also addressed a specific statutory carve-out: Section 171.002(c-1) removes the self-production cap for businesses classified as "Eating and Drinking Places" (SIC Major Group 58), but retail bakeries fall under a different SIC group (Major Group 54, Food Stores) — so that exception doesn't rescue this bakery.

What this means for you

Bakeries, food producers, and other retailers who make what they sell

Selling your own baked goods, produce, or manufactured items at retail is genuinely "retail trade" revenue — but if more than half of your retail/wholesale revenue comes from goods you (or a company affiliated with you) produce yourself, you won't qualify for the reduced retail/wholesale franchise tax rate, regardless of how retail-like your operation looks. This can be a real trap for producer-retailers who assume "I run a retail storefront" is enough.

Restaurants and eating/drinking establishments

If your business is classified under SIC Major Group 58 (Eating and Drinking Places), the self-production cap in Section 171.002(c)(2) doesn't apply to you at all, per the Section 171.002(c-1) exception — a meaningfully different (and more favorable) rule than what applies to retail bakeries and other food producers outside that SIC group.

Accountants and tax professionals

The client's own SIC classification matters here, not just the general nature of the business as "retail." A retail bakery (SIC 5461, Major Group 54) is treated differently from an eating/drinking establishment (Major Group 58) for purposes of the Section 171.002(c-1) exception — confirm which SIC group applies before assuming the exception helps a food-service client.

Common questions

Q: If all of a business's revenue is "retail trade" revenue, does it automatically qualify for the reduced franchise tax rate?
A: No — this ruling shows that being "primarily engaged in retail trade" (Section 171.002(c)(1)) is only one of three required conditions. A business can have 100% retail trade revenue and still fail the reduced-rate test on the self-production cap.

Q: What's the cutoff for the self-production limit?
A: Under Section 171.002(c)(2), less than 50% of the entity's retail/wholesale revenue must come from products it (or an affiliated entity in its group) produces. This bakery was at 88% self-produced, well over the line.

Q: Does the restaurant/eating-establishment exception apply to a bakery?
A: Not per this ruling — retail bakeries are classified under SIC Industry 5461, Major Group 54 (Food Stores), not Major Group 58 (Eating and Drinking Places), so the Section 171.002(c-1) exception to the self-production cap doesn't apply.

Citations and references

Statutes:

• Tex. Tax Code § 171.0001(12)(A) (definition of "retail trade")
• Tex. Tax Code § 171.002(b) (Rates; Computation of Tax)
• Tex. Tax Code § 171.002(c)(1)-(3) (three-part "primarily engaged in retail or wholesale trade" test)
• Tex. Tax Code § 171.002(c-1) (exception for Eating and Drinking Places, SIC Major Group 58)

Cited classification authority:

• 1987 Standard Industrial Classification (SIC) Manual, Division G, Major Group 54, Industry 5461 (Retail Bakeries)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=MAR
• Opinion: https://star.comptroller.texas.gov/view/201901035L

Original ruling text

January 11, 2019

RE: Private Letter Ruling No. 20180718144019

**, Taxpayer No. **

Dear **:

We issue this private letter ruling in accordance with Rule 3.1, Private Letter Rulings and General Information Letters.[1] We are responding to your request dated July 13, 2018 and your supplemental submission dated Sept. 12, 2018. Detrimental reliance relief is provided in accordance with Rule 3.10, Taxpayer Bill of Rights.

You requested guidance regarding a taxable entity’s qualification for the reduced retail or wholesale franchise tax rate.

Facts Presented

** (Taxpayer), is a bakery that makes kolaches and pastries. Taxpayer receives 100 percent of its revenue from the retail sales of kolaches, other baked items such as pastries, and miscellaneous items such as soft drinks and milk. Taxpayer estimates that 88 percent of its total revenue is from baked items it produces and 12 percent of its total revenue is from the sale of soft drinks, milk and other items that are not produced by the Taxpayer.

Taxpayer files a single entity franchise tax report and is not a member of a combined group. Taxpayer did not list a Standard Industrial Classification (SIC) Code on its franchise tax reports but states that Taxpayer’s business is a retail bakery under SIC Industry 5461.

Question, Ruling, and Analysis

Our restatement of your question is shown below, followed by our response and analysis.

Question

Is Taxpayer’s revenue from retail bakery sales of kolaches and other baked items eligible for the reduced retail or wholesale franchise tax rate?

Ruling

Revenue from retail bakery sales of kolaches and other baked items is revenue from retail trade; however, Taxpayer is not primarily engaged in retail or wholesale trade and does not qualify for the reduced retail or wholesale franchise tax rate.

Analysis

The Texas Tax Code defines the term “retail trade” as “the activities described in Division G of the 1987 Standard Industrial Classification Manual.” Section 171.0001(12)(A) (Definitions). Retail Bakeries, Industry 5461, Major Group 54 (Food Stores), Division G of the 1987 SIC Manual describes retail bakery activities as “the retail sale of bakery products…[that] may be purchased from others or made on the premises.” Taxpayer bakes and sells kolaches and pastries on its premises. Since the Taxpayer’s activities are described in Industry 5461 of Division G, the Taxpayer’s revenue from retail bakery sales of kolaches and other baked items is revenue from retail trade.

Although Taxpayer’s revenue from bakery sales is revenue from retail trade, Section 171.002(b) (Rates; Computation of Tax) requires that the taxable entity be primarily engaged in retail or wholesale trade to qualify for the reduced retail or wholesale trade tax rate. (Emphasis added). Section 171.002(c) states:

A taxable entity is primarily engaged in retail or wholesale trade only if:

(1) the total revenue from its activities in retail or wholesale trade is greater than the total revenue from its activities in trades other than the retail and wholesale trades;

(2) except as provided by Subsection (c-1), less than 50 percent of the total revenue from activities in retail or wholesale trade comes from the sale of products it produces or products produced by an entity that is part of an affiliated group to which the taxable entity also belongs; and

(3) the taxable entity does not provide retail or wholesale utilities, including telecommunications services, electricity, or gas.

Section 171.002(c)(1) requires that the total revenue from Taxpayer’s activities in retail or wholesale trade be greater than the total revenue from its activities in trades other than the retail and wholesale trades. Taxpayer receives 100 percent of its revenue from the retail sale of bakery items and non-bakery items such as soft drinks and milk. Since Taxpayer’s total revenue from retail trade activities is greater than the total revenue from activities in other trades, Taxpayer meets the requirements set forth under Section 171.002(c)(1).

Under Section 171.002(c)(2), Taxpayer must have less than 50 percent of its total revenue from activities in retail or wholesale trade from the sale of products it produces or products produced by an entity that is part of an affiliated group to which Taxpayer also belongs. Taxpayer receives 88 percent of its total revenue from baked items it produces and 12 percent of its revenue from the sale of soft drinks, milk, and other items that it does not produce. Since Taxpayer receives more than 50 percent of its total revenue from the sale of bakery items that it produces, it has not met the requirements of Section 171.002(c)(2).

Section 171.002(c)(3) requires that the Taxpayer does not provide retail or wholesale utilities, including telecommunications services, electricity, or gas. Since the Taxpayer does not provide wholesale utilities, Taxpayer meets the requirements of Section 171.002(c)(3).

Under Section 171.002(c-1), Section 171.002(c)(2) does not apply to entities described in the SIC Manual, Major Group 58 (Eating and Drinking Places). Industry 5461, which covers Taxpayer’s activities, is in Major Group 54. Accordingly, Section 171.002(c-1) does not apply to the Taxpayer.

Since the Taxpayer does not meet all of the requirements in Section 171.002(c), Taxpayer is not primarily engaged in retail trade and is not eligible for the reduced retail or wholesale franchise tax rate.

The Texas Tax Code and Texas Administrative Code are accessible at www.comptroller.texas.gov/taxes/.

If you have questions about this private letter ruling, please email us through our website at https://comptroller.texas.gov/web-forms/tax-help/ and reference Private Letter Ruling No. 20180718144019.

Sincerely,

Tax Policy Division – Direct Taxes

Texas Comptroller of Public Accounts

ENDNOTE:

[1] Unless otherwise indicated, all references to “Section” are to the Texas Tax Code, and all references to “Rule” are to Title 34 of the Texas Administrative Code.