In a proposed acquisition using tiered partnerships, which corporate partners are subject to Texas franchise tax and how is their income apportioned?

Plain-English summary

A taxpayer described a proposed acquisition structured through tiered partnerships — referred to as ABC, ABC II, and Acquisition — and asked how the (pre-2008) franchise tax would apply to the various partners. The Comptroller advised:

• Corporate general partners are subject. After the acquisition, the corporate general partner of ABC (its administrative entity) and the corporate general partner of Acquisition (XYZ) would be doing business in Texas for franchise-tax purposes.
• Apportionment. Assuming each general partner's only Texas gross receipts are those allocable to it from ABC, ABC II, and Acquisition, and assuming the income is unitary, its taxable capital and earned surplus apportioned to Texas equals a fraction: the numerator is its proportionate share of each partnership's gross receipts (or net profits, if applicable) from business done in Texas, and the denominator is that general partner's gross receipts from its entire business.
• Corporate limited partners are not subject. The corporate limited partners of ABC and Acquisition would not be doing business in Texas.
• Individuals and partnerships are not subject to the franchise tax.

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Important currency note: STAR marks this document partially superseded on 12/15/2014 on the taxation of partnerships.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

Businesses acquiring or restructuring through partnerships

Under the pre-2008 rules, only the corporate general partners were pulled into the franchise tax; corporate limited partners, individuals, and the partnerships themselves stayed out. Groups used thin general-partner corporations to hold the Texas exposure. The margin tax has since made partnerships themselves taxable, changing this result.

Accountants and tax professionals

Note the apportionment mechanics: a general partner apportioned to Texas its proportionate share of each partnership's Texas gross receipts (or net profits) over its entire-business gross receipts, assuming unitary income. Re-verify under the margin tax's combined-reporting and apportionment rules.

Common questions

Q: Which partners owed Texas franchise tax?
A: The corporate general partners of ABC and Acquisition, because they were doing business in Texas.

Q: Were the corporate limited partners taxable?
A: No — they were not doing business in Texas.

Q: How was a general partner's income apportioned to Texas?
A: By a fraction of its proportionate share of each partnership's Texas gross receipts (or net profits) over its total gross receipts, assuming unitary income.

Citations and references

The letter applied the general pre-2008 franchise-tax nexus and apportionment framework for corporate partners (a general partner of a Texas-active partnership is doing business in Texas; a limited partner is not; individuals and partnerships are not subject) 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/9312L1276B08

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.

December 17, 1993

Dear *:

Thank you for your letter (copy attached) dated December 2, 1993,
concerning the application of franchise tax to a proposed business structure.

A and B. After the Acquisition, the corporate general partner of ABC
(Administrative) and the corporate general partner of Acquisition (XYZ) will be
doing business in Texas for Texas franchise tax purposes.

C. Assuming that the only gross receipts from business done in Texas
attributable to the corporate general partner of ABC (which is also a general
partner of ABC 11) and the corporate general partner of Acquisition are the
gross receipts (or, if applicable, net profits) allocable to them from ABC, ABC
II, and Acquisition, and assuming the income is unitary, then the taxable
capital and taxable earned surplus of each of the corporate general partners
that will be apportioned to Texas will be equal to a fraction, the numerator of
which is their proportionate share ofthe gross receipts (or, if applicable, net
profits) of each of ABC, ABC II, and Acquisition, respectively, that constitute
gross receipts (or, if applicable, net profits) from business done in Texas,
and the denominator of which is each general partner's gross receipts from its
entire business.

D. The corporate limited partners of ABC and Acquisition will not be
doing business in Texas for Texas franchise tax purposes.

E and F. Individuals and partnerships are not subject to Texas franchise
tax.

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

If you have any questions, please do not hesitate to write me or call me
toll free at 1-800-531-5441, extension 34662.

Sincerely,

Jerry Oxford
Tax Administration

December 2, 1993

Dear *:

I am requesting a written ruling in response to the fact situation and
conclusions set forth below.

FACTS

A. Current Business Structure and Operations.

1. ABC is a limited partnership currently consisting of ABC Acquisition
   LP., a Delaware limited partnership ("Acquisition"), as managing general
   partner; ABC Administrative Corporation, a Delaware corporation
   ("Administrative"), as the administrative general partner (with general
   partnership interests in ABC of 69.66% and 0.099%, respectively); and various
   other entities and individuals as limited partners, with combined limited
   partnership interests of 30.241%.

2. The partners of Acquisition are XYZ, a Delaware corporation that owns
   a 1% general partnership interest in Acquisition, and HIJ Limited Partnership
   ("HIJ") with a limited partnership interest of 99%. See Schedule 1, enclosed.

3. The limited partners of ABC and Acquisition currently have no
   contacts with the State of Texas. In addition, none of the corporate limited
   partners are Texas corporations, or corporations authorized to do business in
   Texas.

4. ABC is in the business of providing pre-recorded broadcasts to its
   customers. Its primary place of business is located outside the State of Texas
   (State A). The executive, administrative, and certain recording and
   duplicating functions are performed in State A. Locations outside of State A
   (which currently do not include Texas) primarily perform sales functions, but
   they are also responsible for local distribution and technical activities. One
   location in State B provides the signal feed for Direct Broadcast Satellite
   ("DBS") transmission.

5. ABC plans to acquire the assets of certain Franchisees (as hereinafter
   defined), along with certain other assets to be acquired from an unrelated
   party (the "Purchase"). After the Purchase, ABC will have over twenty-five
   locations in approximately twenty-three states, including Texas. Prior to the
   Purchase, ABC will have had no contacts with Texas.

6. ABC is the franchisor of almost two hundred independent franchises
   (the "Franchisees") - approximately 85% of the Franchisees are located
   throughout the United States and the remainder in thirteen foreign countries.
   The Franchisees conduct all local sales activities and provide broadcast
   services to their customers on a local basis. They are independently owned.
   Some Franchisees, especially in Europe, conduct their own private signal feed
   activities.

7. The franchise customers receive broadcasts through the following
   methods:

(1) broadcast by private signal or DBS; and (2) specially-created
cassettes for on-premises play.

8. In exchange for the use of these broadcast services, the Franchisees
   pay ABC various fees (the "Fees") and royalties (the "Royalties"). The Fees
   (an initial fee, recorded media charges, and adjunct service charges) are in
   exchange for services. ABC pays state tax to State A on that portion of the
   Fees derived from services rendered within State A.

9. The Royalties are typically of two types: (1) generally a royalty of
   10% of the income received by each Franchisee from customers within its
   territory; and (2) in the case of Franchisees who use the DBS service, a
   royalty surcharge of 1% to 1.75% of that income.

B. Proposed Reorganization and Subsequent Division of Business
Activities.

1. ABC proposes to segregate the Royalty-producing aspects of its DBS
   activity into a newly-created general partnership domiciled in Texas ("ABC II
   "). Acquisition and Administrative, the general partners of ABC, would be the
   managing general partners of ABC IT, with a combined 1% general partnership
   interest. ABC would be the investor partner, with all remaining general
   partnership interests (99%). ABC II would enter into licenses with
   Franchisees, some of whom are located in the State of Texas.

2. In connection with the creation and capitalization of ABC II, and as
   a contribution to capital, ABC would transfer the following rights to ABC II:

a. A sublicense to utilize in ABC II's DBS activities all licenses and
other agreements with the copyright owners of broadcast materials and their
representatives, and a license to use the ABC broadcast library; and

b. An assignment of contracts with Franchisees.

3. After the transfer of these rights from ABC to ABC II, ABC would
   retain the Fee-producing aspects of its business as well as other business
   activities not reflected in this letter.

4. ABC II would enter into a service and processing agreement with ABC,
   under which ABC would provide ABC II with the following services (the
   "Administrative Services"):

a. collection of customer accounts (including Royalties) for ABC II's
benefit under strict accounting requirements for segregation of ABC II's funds
from those of ABC;
b. accounting and related record keeping services; and
c. marketing assistance and advice.

5. ABC II would pay ABC fees for providing ABC II the Administrative
   Services.

RULINGS REQUESTED

We request your confirmation of the following conclusions about the Texas
franchise tax consequences of the proposed business activities of ABC and ABC
II, and the partners thereof, after the proposed business reorganization.

A. After the Acquisition, the corporate general partner of ABC
(Administrative) will be doing business in Texas for Texas franchise tax
purposes under Texas Tax Code 171.001 because it will be acting as a general
partner in a limited partnership (ABC) doing business in Texas (directly and
through ABC II), and as a general partner in a general partnership (ABC II)
doing business in Texas.

B. After the Acquisition, the corporate general partner of Acquisition
(XYZ) will be doing business in Texas for Texas franchise tax purposes under
Texas Tax Code .171.001 because it will be acting as a general partner in a
limited partnership (ABC) that is doing business in Texas (indirectly through
ABC and ABC II).

C. Assuming that the only gross receipts from business done in Texas
attributable to the corporate general partner of ABC (which is also a general
partner of ABC II) and the corporate general partner of Acquisition are the
gross receipts (or, if applicable, net profits) allocable to them from ABC, ABC
II, and Acquisition, then the taxable capital and taxable earned surplus of
each of the corporate general partners that will be apportioned to Texas will
be equal to a fraction, the numerator of which is their proportionate
share (FOOTNOTE: The direct share of ABC Acquisition LP. in the gross
receipts of ABC is 69.66%; the combined direct and indirect share of ABC
Acquisition LP. in the gross receipts of ABC II is 69.4634%. The direct share
of ABC Administrative Corporation in the gross receipts of ABC is 0.099%. The
direct and indirect share of ABC Administrative Corporation in the gross
receipts of ABC II is 0.59801%. The indirect share of XYZ in ABC and ABC II is
0.6966% and 0.69434%, respectively. See attached Schedules 1 and 2.)
of the gross receipts (or, if applicable, net profits) of each of ABC,
ABC II, and Acquisition, respectfully, that constitute gross receipts (or, if
applicable, net profits) from business done in Texas, and the denominator of
which is each general partner's gross receipts from its entire business.

D. The corporate limited partners of ABC and Acquisition will not be
doing business in Texas for Texas franchise tax purposes under Texas Tax Code
Section 171.001 because their only contact with Texas will be ownership of
interests as limited partners in a limited partnership (i.e., ABC and
Acquisition) that is doing business in Texas (through ABC and ABC II). As a
result, no corporate limited partner of ABC or Acquisition will be subject to
either the taxable capital or the earned taxable surplus component of the Texas
franchise tax.

E. The individual limited partners of ABC and Acquisition will not be
subject to Texas franchise tax.

F. ABC, ABC II, and Acquisition will not be subject to Texas franchise
tax

DISCUSSION

A corporation (but not a partnership) that does business in Texas is
liable for the franchise tax, even if it is not incorporated in Texas or
qualified to transact business in Texas. Texas Tax Code Section 171.001(a).
Under the Comptroller's rules, for a corporation be considered "doing business"
in Texas for either the taxable capital or earned surplus component of the
franchise tax, the corporation must have sufficient contacts with the state so
as to the taxable without violating the United States Constitution. 34 T.A.C.
Sections 3.546(b), 3.554(b).

The Comptroller's rules list examples of some specific activities that
constitute doing business in Texas, including acting as a general partner in a
general partnership that is doing business in Texas, and acting as a general
partner in a limited partnership that is doing business in Texas. 34 T.A.C.
Section 3.546(c). Section 3.546(c)(12)(B), however, specifically states: "A
foreign corporation which is a limited partner in a limited partnership is not
doing business in Texas." 34 T.A.C. Section 3.546(c)(12)(B).

The franchise tax payable by a corporation doing business in Texas is
generally equal to the sum of (i) the product of 0.25% and the corporation's
net taxable capital for a privilege period, and (ii) the difference between (A)
the product of 4.5% and the corporation's net taxable earned surplus for the
privilege period, and (B) the amount determined in clause (i) above for the
privilege period. Texas Tax Code Section 171.002. Net taxable capital and net
taxable earned surplus are generally computed by apportioning taxable capital
and taxable earned surplus to Texas. See Texas Tax Code Section171.101 and
Section 171.110. Taxable capital and taxable earned surplus are apportioned to
Texas by multiplying each such amount by a fraction, the numerator of which is
the corporation's gross receipts from business done in Texas, and the
denominator of which is the corporation's gross receipts from it's entire
business. Texas Tax Code Section 171.106. For purposes of apportioning
taxable capital, gross receipts from a partnership are determined either by
apportioning net profits based on the principal place of business of the
partnership, or by apportioning the gross receipts of the partnership as if the
partnership did not exist and the receipts passed through it directly to the
corporation. 34 T.A.C. Section 3.549(e)(29). For purposes of apportioning
taxable earned surplus, gross receipts from a partnership are apportioned as
though the corporation directly earned its share of the partnership's gross
receipts. 34 T.A.C. Section 3.557(e)(24).

CONCLUSIONS

The corporate general partner of ABC II (Administrative) will be subject
to Texas franchise tax because its activities will constitute doing business in
Texas to the extent ABC II is doing business in Texas. Similarly, the
corporate general partner of ABC (also Administrative) will be considered to be
conducting business in Texas directly to the extent ABC is doing business in
Texas, and indirectly by virtue of ABC serving as a general partner of ABC TT.
The corporate general partner of Acquisition (XYZ) will be considered to be
conducting business in Texas by virtue of Acquisition serving as a general
partner of ABC, to the extent ABC is considered to be conducting business in
Texas either directly or through ABC II. The corporate limited partners of ABC
and Acquisition, assuming they have no other contacts with the state of Texas,
will not be considered to be doing business in Texas merely by virtue of their
ownership of limited partnership interests in ABC and Acquisition. Each
corporate general partner's taxable capital and taxable earned surplus will be
apportioned to Texas by taking into account its proportionate share as set
forth above of the gross receipts (or, if applicable, net profits of ABC, ABC
II, and Acquisition that are attributable to business done in Texas.

We respectfully request that your office issue a written ruling as set
forth in the Rulings Requested portion of this letter confirming the franchise
tax consequences of the proposed Purchase by, and reorganization of, ABC. As
it is anticipated that all or a portion of the proposed reorganization will be
completed in December, we respectfully request a written response by telecopy
(***) as soon as possible. Please call me at ***** if you
have any questions or need any additional information.

Thank you for your assistance.

Very truly yours,

NOTE: Previous Accession Number 9311149L.7 and/or 9311149L