In a reorganization forming a Texas real-estate limited partnership, which entities are subject to Texas franchise tax?

Plain-English summary

A Delaware parent corporation (not doing business in Texas, no certificate of authority) planned a reorganization to hold Texas real estate through a partnership. It would form two Delaware subsidiaries: the first (the limited partner, "LP") would own a 99% limited-partnership interest in a new Texas limited partnership; the second (the general partner, "GP") would own a 1% general-partnership interest and obtain a Texas certificate of authority. The partnership would be formed under Texas law, acquire Texas real estate, and might be treated federally as an association taxable as a corporation under IRC Section 7701. The limited partner would use Texas lawyers and accountants to prepare documents but would keep its bank account, meetings, and officers outside Texas.

On these facts, the Comptroller advised (as to the entities the taxpayer asked about):

1. The 99% limited partner (LP) is not subject to either the taxable-capital or the earned-surplus component of the franchise tax — provided the Texas lawyers and accountants preparing documents do not "represent" LP in business dealings with third parties. Merely preparing legal and financial documents does not subject LP to the tax.
2. The partnership itself is not subject, even if it is treated as an association taxable as a corporation for federal income tax purposes.
3. The parent is not subject (assuming it does business elsewhere) if its only connection to Texas is its interest as a limited partner in a Texas-active limited partnership.

The general partner (GP), which would obtain a Texas certificate of authority, is the entity through which the structure is registered to do business in Texas. The Comptroller noted the responses depended on the stated facts.

Important currency note: STAR marks this document partially superseded on 12/10/2014 on the taxation of partnerships. The 2007 legislation (House Bill 3 and House Bill 3928) restructured the franchise tax into the current margin tax effective January 1, 2008 and made partnerships subject to the tax — reversing the "partnership not subject" conclusion here. Treat the entity-level results as historical and confirm current law.

What this means for you

Businesses holding Texas real estate through a partnership

Before 2008, a foreign parent could hold Texas real estate through a limited partnership and keep both itself and its 99% limited-partner subsidiary outside the franchise tax, so long as the only Texas tie was the passive limited-partnership interest. The general partner carried the Texas registration. The margin tax has since made partnerships themselves taxable, so this exact result no longer holds — re-verify.

Accountants and tax professionals

Note the important caveat on professional services: using Texas lawyers and accountants to prepare documents did not create nexus, but having them represent the limited partner in dealings with third parties could have. Also note that federal "check-the-box" association status did not convert the partnership into a franchise-tax corporation under the pre-2008 rules. Confirm treatment under the current margin tax and its combined-reporting rules.

Common questions

Q: Was the 99% corporate limited partner subject to franchise tax?
A: No — provided the Texas lawyers and accountants only prepared documents and did not represent it with third parties.

Q: Did it matter that the partnership might be an "association taxable as a corporation" for federal tax?
A: No. Under the pre-2008 rules the partnership was still not subject to the franchise tax, even with that federal classification.

Q: Was the out-of-state parent subject?
A: No, where its only Texas connection was the limited-partnership interest and it did business elsewhere.

Citations and references

Statutes and rules:

• Internal Revenue Code Section 7701 (an entity may be classified as an association taxable as a corporation for federal income tax purposes; the letter holds this federal classification did not make the partnership subject to the pre-2008 Texas franchise tax)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=FIT
• Opinion: https://star.comptroller.texas.gov/view/9504781L

Original ruling text

STAR SUPERSED INFORMATION
Accession No. —
Supersede type - Partial
Document superseded on - 12/10/14
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.

April 5, 1995

Dear Mr. **:

Thank you for your letter (copy attached) dated October 6, 1994, concerning the
Texas franchise tax effects of a proposed reorganization. I apologize for the
delay in this response.

1. LP will not be subject to either component of the Texas franchise tax based
   on the facts in your letter, provided that the lawyers and accountants
   preparing documents in Texas do not "represent" the LP in any business dealings
   with third parties. However, the mere preparation of legal and financial
   documents by the lawyers and accountants would not subject LP to Texas
   franchise tax.

2. The Partnership will not be subject to Texas franchise tax, even if it is
   treated as an association taxable as a corporation for federal income tax
   purposes.

3. Assuming the Parent is doing business elsewhere, it will not be subject to
   Texas franchise tax if its only connection to Texas is its interest as a
   limited partner in a limited partnership doing business in Texas.

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 1-800-252-1381, extension 34662.

Sincerely,

Jerry Oxford
Tax Administration

October 6, 1994

Ms. Theresa Comer
Tax Administration Division
Comptroller of Public Accounts
Austin, Texas 78774

Dear Ms. Comer:

This letter is a request for a ruling with respect to the Texas Franchise Tax.

FACTS

Parent is a Delaware corporation that does not do business in Texas and does
not have a certificate of authority to do business in Texas. Parent will form
two new Delaware corporations that will be wholly owned subsidiaries. The first
subsidiary (the "LPN) will own a 99% limited partnership interest in a new
limited partnership (the "Partnership) and will not obtain a certificate of
authority to do business in Texas. The second subsidiary (the "GP") will serve
as the general partner of the Partnership and own a 1 general partnership
interest in the Partnership. The GP will obtain a certificate of authority to
do business in Texas. The Partnership will acquire and own real estate located
in Texas. The Partnership will be formed under the laws of the State of Texas.
For federal income tax purposes, it is possible that the Partnership may be
treated as an association taxable as a corporation under Section 7701 of the
Internal Revenue Code of 1986.

The LP will use Texas lawyers and accountants to prepare legal and financial
documents.

The LP will not have a Texas bank account. The board of directors and
shareholders of the LP will hold their meetings outside Texas. The officers and
directors of the Limited Partner will perform all of their duties outside
Texas. All legal documents of the LP will be executed outside Teas. The LP will
not have a Texas address or telephone number.

OUESTIONS PRESENTED

Please confirm the following:

1. The LP will not be subject to the tax on net taxable earned surplus or the
   tax on net taxable capital for Texas Franchise Tax purposes.

2. The Partnership will not be subject to the Texas Franchise Tax, even if it
   is treated as an association taxable as a corporation for federal income tax
   purposes.

3. The Parent will not be subject to the Texas Franchise Tax by virtue of the
   ownership of its ownership interest in the LP and the GP.

Please give me a call if you have any questions or need any further
information.

Thank you for your assistance.

Sincerely,