In a corporate restructuring, is a subsidiary doing business in Texas, how are dividends and interest allocated, and is a partnership subject to franchise tax?

Plain-English summary

A representative asked the Comptroller about the (pre-2008) franchise-tax effects of restructuring a client's operations involving a parent (ABC Co.) and subsidiaries (A and B). The Comptroller answered:

1. Subsidiary nexus. Subsidiary B would be doing business in Texas because of the ministerial actions of its officers or directors in Texas. If those ministerial actions were not performed in Texas, Subsidiary B would not be doing business in Texas.
2. (Question 2 was deleted.)
3. Dividends/interest allocation. Any dividends or interest paid by Subsidiaries A or B to ABC Co. are non-Texas gross receipts of ABC Co. for allocating taxable capital. If those dividends and interest are not included in earned surplus, they are not allocated at all for the earned-surplus component.
4. Schedule C dividends. Dividends reported on Schedule C of federal Form 1120 are not part of ABC's taxable earned surplus.
5. Partnership not taxable. A partnership is not subject to the Texas franchise tax, even if it is characterized as a corporation for federal income tax purposes.
6. The sales-tax question was to be answered separately by the sales-tax section.

The Comptroller cautioned that the responses rested on the facts presented and could change if the facts changed.

Important currency note: STAR marks this document partially superseded on 12/15/2014 on the taxation of partnerships. The 2007 legislation (House Bills 3 and 3928) restructured the franchise tax into the current margin tax effective January 1, 2008 and made partnerships subject to the tax, so the entity-level results here are historical. Confirm current law.

What this means for you

Groups restructuring corporate operations

Before 2008, nexus for a subsidiary could turn on where its officers/directors performed even ministerial acts, and a partnership stayed outside the tax regardless of its federal classification. Intercompany dividends and interest were handled differently for the taxable-capital and earned-surplus components. The margin tax has since changed both the partnership result and the apportionment mechanics.

Accountants and tax professionals

Note the component split for dividends/interest (non-Texas gross receipts for taxable capital; not allocated for earned surplus if excluded from earned surplus) and the Schedule C carve-out from earned surplus. These are pre-2008 mechanics — re-verify under the margin tax.

Common questions

Q: Was the partnership subject to Texas franchise tax?
A: No — a partnership was not subject to the pre-2008 franchise tax, even if it was treated as a corporation for federal income tax purposes.

Q: Why was the subsidiary doing business in Texas?
A: Because its officers or directors performed ministerial actions in Texas; had those acts occurred elsewhere, it would not have been doing business in Texas.

Q: How were dividends and interest paid up to the parent treated?
A: As the parent's non-Texas gross receipts for allocating taxable capital; for earned surplus they were not allocated at all if not included in earned surplus.

Citations and references

The letter applied the pre-2008 franchise-tax nexus and allocation framework and the rule that partnerships are not subject to the tax, without 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/9209L1263B01

Original ruling text

STAR SUPERSED INFORMATION
Accession No. —
Supersede type - Partial
Document superseded on - 12/15/14
Issue(s) that caused the document to be superseded — Taxation of partnerships
Reason(s): The Franchise Tax Code was amended by House Bill 3 and House Bill 3928,
Acts 2007, 80th Legislative Session, effective January 1, 2008 and affected Franchise
tax reports due on or after January 1, 2008. One of the many changes to this Tax Code
subjected partnerships (previously not required to file) to the franchise tax reporting
requirement.

September 10, 1992

Dear **:

Thank you for your letter (copy attached) dated November 25, 1991,
amending your original request dated September 25, 1991, concerning
the restructure of your client's operations.

The answer to your questions are as follows:

1. The activities of Subsidiary B would cause it to be considered to
   be doing business in Texas because of the ministerial actions of its
   officers or directors in Texas (see first full paragraph on page 4 of
   attached letter). If the ministerial actions were not done in Texas,
   then Subsidiary B would not be considered to be doing business in Texas.

2. Deleted.

3. Any payments of dividends or interest by Subsidiaries A or B to ABC
   Co.
   would be considered non-Texas gross receipts of ABC Co. for allocating
   taxable capital. However, if dividends and interest are not included
   in earned surplus, then they are not allocated at all for the earned
   surplus component.

4. Dividends included on Schedule C of Form 1120 are not part of ABC's
   taxable earned surplus.

5. A partnership is not subject to Texas franchise tax, even if it is
   characterized as a corporation for federal income tax purposes.

6. Our sales tax section will send you the answer to this question under
   separate cover.

These responses are based on the facts presented in your letter. The
response may change if the facts change or if there are additional relevant
facts.

I apologize for the delay in answering this letter. If I may be of
further assistance, please do not hesitate to write me or call me at
463-4662.

Sincerely,

Jerry Oxford
Tax Administration

NOTE: Previous Accession Number 9308129L.14 and/or 9308129L