Two affiliated trucking companies want to consolidate payroll by having a third related company become the formal employer of all their employees, providing payroll and benefits for a management fee — essentially an employee leasing arrangement. Is the management fee subject to Texas sales tax as a data processing service, and does an intercorporate-affiliate exemption apply?

Plain-English summary

A CPA asked on behalf of a Texas trucking-company client about a proposed payroll restructuring. Two affiliated trucking companies ("B" and "C"), each employing truck drivers, management, and clerical staff, wanted to consolidate payroll by having a third company ("A") become the formal employer of all current and future employees of B and C — providing payroll processing plus employee benefits (retirement, health plans, etc.) in exchange for a management fee covering the full cost plus a service charge. This is essentially an employee-leasing/staff-leasing arrangement.

Are these services taxable as data processing? Trucking, administrative, and management services aren't inherently taxable on their own, but payroll services are normally taxed as data processing services under Rule 3.330(a). However, the described arrangement looks like it falls under Rule 3.364, Texas's staff leasing services rule — and if the requirements of Rule 3.364(b)(1) are satisfied, no tax is due on the staff leasing services at all. Importantly, Rule 3.364(a)(6)'s definition of "staff leasing services" is broad: it covers not just the work performed by the leased/shared employees, but also related personnel management services like employee benefit and payroll administration — so if the arrangement qualifies, everything described (payroll, benefits, the whole management fee) would be exempt together.

What tax rate applies without the exemption? If the staff-leasing exemption doesn't apply, data processing services are subject to 6.25% state tax plus up to 2% local tax (Rule 3.330(g)).

Does an intercorporate-affiliate exemption help? Separately, Rule 3.331 and Tex. Tax Code § 151.346 provide an intercorporate services exemption for data processing performed between qualifying affiliated corporations — parent-to-subsidiary, subsidiary-to-parent, and brother-to-sister corporate relationships are all covered. But the Comptroller couldn't confirm this exemption applied here, because the letter didn't provide enough detail to establish that Companies A, B, and C actually meet the affiliated-entity qualification requirements.

Licensing questions are separate from tax questions. The letter also fielded questions about whether a "controlled group" gets any exemption from Texas staff-leasing licensing requirements (no such exemption exists) and how to structure the arrangement to avoid sales tax (answer: qualify under Rule 3.364) — but licensing itself is handled by the Texas Department of Licensing & Regulation, a separate agency from the Comptroller.

What this means for you

Companies consolidating payroll through a shared/leasing employer entity

Structure the arrangement to meet Rule 3.364(b)(1)'s staff leasing requirements if you want the whole payroll-and-benefits management fee exempt from sales tax — the exemption is broad enough to cover payroll and benefits administration together with the leased employees' work, not just the labor itself.

Affiliated corporate groups considering a data-processing consolidation

If your companies are genuinely affiliated (parent-subsidiary or brother-sister), the intercorporate services exemption under Rule 3.331/Sec. 151.346 may independently apply to data processing charges between them — but be ready to document the actual corporate affiliation, since a bare assertion isn't enough for the Comptroller to confirm the exemption.

Businesses exploring staff leasing/PEO licensing in Texas

Tax exemption and state licensing are two separate questions handled by two separate agencies — qualifying for the Rule 3.364 tax exemption doesn't automatically address (or exempt you from) Texas Department of Licensing & Regulation requirements, and there's no controlled-group exemption from licensing.

Accountants and tax professionals advising staff leasing/PEO arrangements

This letter cleanly maps three potentially overlapping exemption paths — staff leasing (Rule 3.364), intercorporate services (Rule 3.331/Sec. 151.346), and the fallback taxable-data-processing rate (Rule 3.330) — and shows how thin the factual record needs to be before the Comptroller declines to confirm an exemption (as happened here with the intercorporate services question).

Common questions

Q: Are payroll services generally taxable in Texas?
A: Yes, normally as data processing services under Rule 3.330(a) — but a qualifying staff leasing arrangement under Rule 3.364 can make the whole arrangement, including payroll, exempt.

Q: What tax rate applies to data processing services if no exemption applies?
A: 6.25% state tax plus up to 2% local tax, per Rule 3.330(g).

Q: Can an intercorporate-affiliate exemption cover data processing between related companies?
A: Yes, under Rule 3.331 and Tax Code Sec. 151.346, for parent-subsidiary or brother-sister affiliated corporations — but you need to actually demonstrate the qualifying affiliate relationship.

Q: Is there a licensing exemption for staff leasing companies that are part of a controlled corporate group?
A: No — the Comptroller wasn't aware of any such licensing exemption; licensing questions go to the Texas Department of Licensing & Regulation, separate from tax questions.

Q: Can I rely on this letter for my own staff leasing or payroll consolidation plan?
A: No. This opinion is based on the facts presented, and if there are additional or different facts, the opinion may change; it can be relied on only by the taxpayer it was issued to.

Citations and references

Statutes and rules:

• 34 Tex. Admin. Code Rule 3.330(a) (data processing services — payroll services generally taxable)
• 34 Tex. Admin. Code Rule 3.330(g) (data processing services — state and local tax rates)
• 34 Tex. Admin. Code Rule 3.364(a)(6) (staff leasing services — definition including payroll/benefit administration)
• 34 Tex. Admin. Code Rule 3.364(b)(1) (staff leasing services — exemption requirements)
• 34 Tex. Admin. Code Rule 3.331 (intercorporate services exemption)
• Tex. Tax Code § 151.346 (intercorporate services exemption)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9811028L

Original ruling text

November 20, 1998

Dear Ms. **:

Thank you for your recent letter concerning staff leasing services and related
data processing.

You are a CPA in **, Arkansas. One of your clients, a Texas
corporation, has requested advice from you regarding a payroll arrangement they
would like to establish. They would like to know what sales tax liability they
will incur by changing the way they handle their payroll situation.

Situation: Companies B and C are trucking companies. They each employ truck
drivers, management, administrative, and other clerical personnel. The
companies would like to consolidate the payroll function. They are proposing
that Company A become the employer of all current and future employees of
Companies B & C. Company A will provide payroll as well as other employee
benefits (retirement plans, health plans, etc.) for the employees. Companies B
& C: will remit to Company A a management fee. This fee will cover the entire
cost of the payroll and benefits and will include a charge for the services
provided. The arrangement would be similar to an employee leasing arrangement.

It is your understanding that the only services subject to sales tax would be
the data processing services. You asked the following questions:

1. Would the sales tax be based on the gross fees associated with payroll costs
   for those specific employees?

Response. Trucking, administrative, and management services are not in
themselves taxable services. They can be taxable when in connection with the
sale of taxable items or services. Payroll services are normally taxable as
data processing services. See enclosed Rule 3.330 subsection (a).

However, the above arrangement appears to fall under enclosed Rule 3.364
concerning staff leasing services. If the requirements of (b)(1) are met, tax
is not due on the staff leasing services. Please note that the definition of
staff leasing services Rule 3.364(a)(6) includes not only the services
performed by the employees under the shared employment relationship, but also
related personnel management services such as employee benefit and payroll
services. In short, if you qualify, all of the services that you stipulated
above would be exempt.

2. What sales tax rate would apply?

Response. Presuming that the services are performed under a qualifying staff
leasing arrangement, none. Without the exemption, data processing services are
subject to 6.25% state tax and up to 2% local tax. See Rule 3.330(g)
concerning local taxes for data processing services.

3. Does Rule 3.331(d) "Intercorporate services" apply to this situation? If so,
   does this exempt only the transactions between A & B or would transactions
   between A & C be exempt also because of "Brother/ Sister" relationship?

Response. The intercorporate services exemption stated in Rule 3.331 and
Section 151.346 of the Texas Tax Code does apply to data processing services
performed between qualifying affiliated corporations. This includes parent to
subsidiary sales, subsidiary to parent sales and brother to sister corporation
sales. You did not give enough information to determine that the entities in
your scenario meet the qualifications for affiliated entities.

4. What would be the benefits of attempting a license to offer staff leasing
   services?
5. Are we exempt from the licensing requirements due to the controlled group
   status?

Response. I am not aware of any exemptions from licensing for controlled
groups. For questions concerning licensing or benefits associated with staff
leasing, you may wish to contact the Texas Department of Licensing &
Regulation. You may contact them at:

Texas Dept. of Licensing & Regulation
920 Colorado
P.O. Box 12157
Austin, Texas 78711
Toll-Free (in Texas) 800-803-9202
Tel: (512) 463-6599
Fax: (512) 475-2854
E-mail: [email protected]

Administrative Rules of the Texas Department of Licensing and Regulation can be
accessed at http://www.license.state.tx.us/SLS/rules/slsrules.htm

6. How would such an arrangement be structured so that the fees or other
   charges will not be subject to Texas sales tax?

Response. See enclosed Rule 3.364.

This opinion is based on the facts presented. If there are additional or
different facts, the opinion may change. You may call me toll free at
1-800-531-5441, ext. 5-0613. The direct line is 512/475-0613. You may also
write to Tax Policy Division, Comptroller of Public Accounts.

Sincerely,

Kevin Koller
Tax Policy Division