Does a multi-level marketing/direct sales company have to collect and remit Texas sales and use tax on sales made through its independent distributors?

Subject

Direct Sales Organization/Multi — Level Marketing Company — Collection And Remittance Of Tax (A — M)

Plain-English summary

This 1996 letter tells a multi-level marketing/direct sales company that it is treated as a retailer under Rule 3.286(a)(3), and that its independent distributors are considered its agents. The comptroller has had authority since 1961, under Texas Tax Code § 151.024, to treat the supplier -- rather than the independent distributors -- as the party responsible for the tax when doing so is necessary for efficient administration of the tax code. The distributors' solicitation of sales in Texas also gives the company nexus in the state, both for sales/use tax and (the letter notes in passing) for Texas franchise tax.

Because of that agency relationship, the company itself -- which already holds a Texas sales and use tax permit -- must collect and remit Texas sales and use tax on the taxable items sold through its distributors. The individual distributors are not issued their own sales tax permits, and the company is told not to instruct them to apply for one.

The letter then walks through the mechanics:

• State and local rates. The state rate is 6 1/4%. On top of that, city sales/use tax can run 1% to 2%; many counties impose a 1/2% county tax; eight transit authorities have their own rates (Austin, Houston, and Dallas at 1%; San Antonio, Fort Worth, Corpus Christi, and El Paso at 1/2%; Laredo at 1/4%); and voter-approved special purpose districts may add further local tax, allocated and remitted the same way as city tax under Rules 3.374 and 3.375.
• Two ways to account for local tax, depending on the company's sales model:
  • If a distributor takes a customer's order before purchasing the item from the company, the order form should show the tax due and which local jurisdiction it belongs to, and the company accrues tax from copies of those orders (the letter presumes the company ships inventory into Texas from out of state).
  • If a distributor purchases goods from the company before the customer's order is taken, the company collects and reports tax based on the retail sales price and the distributor's local tax rate, using periodic reports from distributors showing sales by jurisdiction, sales in areas with no local tax, and sales to exempt entities.
• Distributor purchases for personal/business use. Items a distributor buys for their own use or business (company products, sales aids, prizes awarded to customers) are taxed on the company's sales price to the distributor, at the rate for the distributor's location.
• Over-collected tax. Any tax the company collects from distributors that isn't actually due should be returned to the distributor per Rule 3.325(b).
• General taxability. Texas sales/use tax applies to all tangible personal property unless a specific exemption applies -- because of the item itself, its use, or purchase by an exempt entity for an exempt purpose.

What this means for you

Multi-level marketing / direct sales companies

If your company sells through a network of independent distributors in Texas, this letter's reasoning treats you -- not your distributors -- as the retailer responsible for collecting and remitting state and local sales/use tax. Your distributors act as your agents for nexus purposes, so you need a Texas sales and use tax permit even if none of your distributors do, and you should not tell them to get their own permits.

Businesses figuring out local tax on distributor sales

Which of the two accounting methods applies depends on your sequencing: whether the distributor takes the customer's order before or after purchasing inventory from you. Either way, you'll need distributor-level reporting (by local jurisdiction, no-local-tax areas, and exempt sales) to compile an accurate company return, and you must refund any tax over-collected from a distributor under Rule 3.325(b).

Accountants and tax professionals

Note the two separate legal bases at work: Rule 3.286(a)(3) classifies the company as a retailer, while Texas Tax Code § 151.024 is the comptroller's general authority (dating to 1961) to designate the supplier, rather than its agents, as responsible for the tax when needed for efficient administration. Local tax stacking can include city, county, up to eight transit authority rates, and special purpose district taxes, so confirm the applicable combination for each distributor's location using Rules 3.374 and 3.375.

Common questions

Q: Who has to collect and remit Texas sales tax -- the MLM company or its individual distributors?
A: The company. Its independent distributors are treated as its agents, so the company must collect and remit the tax; distributors are not issued their own sales tax permits.

Q: Why does the company have nexus in Texas if it ships from out of state?
A: Because its independent distributors solicit sales in Texas and are considered the company's agents, which creates nexus for both sales/use tax and Texas franchise tax.

Q: What's the state sales and use tax rate, and what local taxes can stack on top?
A: The state rate is 6 1/4%. City tax can add 1% to 2%; county tax up to 1/2%; one of eight transit authority rates (1%, 1/2%, or 1/4% depending on the city); and voter-approved special purpose district taxes, allocated the same way as city tax.

Q: How should the company account for local tax if a distributor takes an order before buying from the company?
A: The order should indicate the tax due and the local jurisdiction it belongs to, and the company accrues the tax from copies of those orders.

Q: How should the company account for local tax if the distributor buys inventory first?
A: The company collects and reports tax on the retail sales price at the distributor's local rate, using periodic distributor reports on sales by jurisdiction, no-local-tax sales, and exempt sales.

Q: What if the company collects tax from a distributor that wasn't actually due?
A: It should be returned to the distributor as outlined in Rule 3.325(b).

Citations and references

• Tex. Tax Code § 151.024 (comptroller's authority to treat the supplier, rather than independent distributors, as responsible for the tax)
• 34 Tex. Admin. Code § 3.286(a)(3) (treating the company as a retailer)
• 34 Tex. Admin. Code § 3.374 and § 3.375 (allocation, collection, and remittance of local sales taxes)
• 34 Tex. Admin. Code § 3.325(b) (returning over-collected tax to distributors)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9607L1426A08

Original ruling text

July 24, 1996

Dear *****:

It has come to our attention that your company is a multi-level marketing
company/direct sales company. Rule 3.286 (a)(3) provides that your company
be treated as a retailer.

The comptroller was given the authority in 1961 to consider the supplier
rather than the independent distributors as agents [Texas Tax Code 151.024].
This section allows the comptroller to determine what is necessary for the
efficient administration of the tax code. The independent distributors are
considered agents for your company and their solicitation for sales of
taxable items gives your company nexus in Texas. By the way, the
independent distributors give your company nexus for Texas franchise tax.

As a result, your company is required to collect and remit Texas sales and
use taxes for its independent distributors. The independent distributor
will not be issued sales tax permits. Your company should not tell the
independent distributors to apply for a sales tax permit. Procedures to
collect and remit tax are set out in this letter. You company does have a
Texas sales and use tax permit.

The current state sales and use tax rate is 6 1/4% and there are several
types of local sales and use taxes that may be due on a transaction. The
city rate may range from 1% to 2% for those Texas cities imposing the
city sales and use tax. Many counties impose a 1/2% county sales and use
tax. There are eight transit areas that have varying sales and use tax
rates: Austin, Houston, and Dallas at 1%; San Antonio, Fort Worth, Corpus
Christi, and El Paso at 1/2%; and Laredo at 1/4%. Special purpose districts
are allowed and may also impose local sales and use taxes; these rates are
determined by the voters of the local jurisdiction. These taxes are allocated,
collected, and remitted in the same manner as city sales taxes (Rules 3.374 and
3.375). Please refer to the enclosed brochure, "Sales Tax Rates in Texas" for
further information.

We suggest the following methods for accounting for local taxes which are due:

If the distributor takes orders before purchasing from your company, the order
blank should indicate the amount of tax due and to which local taxing
jurisdiction(s) it should be allocated. Your company in turn should accrue
the appropriate taxes from the copies of the orders. I presume that your
company ships the inventory from outside Texas.

If the distributor purchases the goods before the customer's order is taken,
your company should collect and report the amount of tax based on the retail
sales price and the tax rate in effect for your distributor's location.
Periodically, the distributors should submit reports indicating the amount
of sales in each local taxing jurisdiction, the amount of sales in areas
having no local taxes and any sales to exempt entities. Your company's
return should reflect the compilation of these reports and the regular sales
for that reporting period. Any amount of tax your company collects from
distributors which is not due should be returned to them as outlined in
Rule 3.325(b).

All sales of items to a distributor for personal or business use should have
tax computed on your company's sales price to the distributor and at the rate
of tax for the distributor's location. Examples of these items include your
company's products, sales aids, and prizes awarded to customers.

Texas sales or use tax is due on all items of tangible personal property,
unless the item is specifically exempted because of the item itself, because
of its use, or because it is purchased by an exempt entity for use that
promotes the entity's exempt function.

If you have any questions or need more information, you may call our toll
free number 1-800-531-5441, extension 50892. My direct number is
512/475-0892. You may write Tax Policy Division, Comptroller of Public
Accounts.

Sincerely,

John J. Fitzgibbons, CPA
Tax Policy Division