Are data-processing services an owner provides to his own S corporations exempt in Texas as transactions between affiliated entities?

Plain-English summary

The question: are data processing services that an individual provides to several Subchapter S corporations — in each of which that individual owns more than 50% of the stock — exempt from Texas sales tax as transactions between affiliated entities? The Comptroller said no; the services are taxable.

Here's why the exemption doesn't reach this arrangement:

• Tax Code § 151.346 exempts services that became taxable after September 1, 1987 when they are performed between affiliated entities that report their income on a consolidated return for the tax year of the transactions.
• "Affiliated entities" is defined by reference to 26 U.S.C. § 1504 as one or more chains of includible corporations connected through stock ownership with a common parent corporation that is itself an includible corporation.
• The individual's S corporations do not appear to be owned by a parent corporation as required. The fact that the corporations' income and expenses are reported on the individual's personal income tax return does not satisfy the corporate-ownership requirement, and it does not meet the requirement of filing a consolidated corporate income tax return.

So the affiliation exists only through common individual ownership, not through a common parent corporation filing a consolidated return — and that is not enough for the § 151.346 exemption.

What this means for you

Owners of multiple S corporations

Common ownership by one person does not make your companies "affiliated entities" for this Texas exemption. If your commonly owned S corporations buy taxable services (like data processing) from each other or from you, expect those services to be taxable — the exemption is built around a corporate parent-subsidiary structure with a consolidated return, which individually owned S corporations generally don't have.

Structure and filing determine the exemption

The exemption turns on two technical facts: a common parent corporation (per 26 U.S.C. § 1504) and a consolidated corporate return. Flowing the entities' income through your personal return doesn't substitute for either. Confirm your structure before assuming intercompany services are exempt.

Common questions

Q: Are services between my commonly owned S corporations exempt in Texas?
A: Not under these facts. The Comptroller held the § 151.346 affiliated-entity exemption did not apply because the corporations weren't owned by a common parent corporation and didn't file a consolidated corporate return.

Q: What does the affiliated-entity exemption require?
A: Services that became taxable after September 1, 1987, performed between affiliated entities — chains of includible corporations connected through a common parent corporation (26 U.S.C. § 1504) — that report income on a consolidated return.

Q: Does reporting the corporations' income on my personal return count?
A: No. The Comptroller said that does not satisfy the corporate-ownership requirement or the consolidated-corporate-return requirement.

Q: Can I rely on this 1988 letter today?
A: Treat it as guidance only. It is based on the facts presented and can change with different facts; on the STAR system it binds the Comptroller only as to the taxpayer it was issued to and may no longer reflect current policy.

Citations and references

• Tex. Tax Code § 151.346 — exempts, from tax, services that became taxable after September 1, 1987 when performed between affiliated entities that file a consolidated return.
• 26 U.S.C. § 1504 — supplies the definition of "affiliated entities" (chains of includible corporations connected through a common parent corporation) the exemption relies on.

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/8807L0887B13

Original ruling text

July 7, 1988

Dear ***:

Thank you for your letter of June 24, 1988, regarding the taxability of
data
processing services provided by an individual to Subchapter S
corporations in
which the individual owns over 50 percent of the stock in each
corporation.

The data processing services provided to the Subchapter S corporations
are
taxable because the exemption provided under Section 151.346 of the Tax
Code
does not apply. Section 151.346 exempts from tax services that became
taxable after September 1, 1987, when performed between affiliated
entities
that report their income on a consolidated return for the tax year in
which
the transactions occur. "Affiliated entities" is defined in 26 U.S.C.
1504
as "one or more chains of includible corporations connected through stock
ownership with a common parent corporation which is an includible
corporation..." (Emphasis added)

The Subchapter S corporations do not appear to be owned by a parent
corporation as prescribed. The fact that the corporations' income and
expenses are filed on the individual's personal income tax return does
not
overcome the corporate ownership requirement nor does it meet the
requirement
of filing a consolidated corporate income tax return.

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

If you have any questions or need more information, please call our
toll-free
number 1-800-531-5441. The regular number is 512/463-4600. You may
write me
at Tax Correspondence, Comptroller of Public Accounts.

Sincerely,

Eddie C. Washington
Tax Correspondence