Did out-of-state sales solicitation and warranty repair make an ATM manufacturer subject to tax there for Texas throwback purposes?

Plain-English summary

Sales solicitation and warranty work could defeat throwback, but the answer differed between taxable capital and earned surplus because Public Law 86-272 protected some solicitation.

An ATM manufacturer used employees and outside representatives to sell machines and trained subcontractors to perform warranty repairs. The question was whether those activities made the corporation subject to taxation in other states.

For taxable capital:

• representatives promoting sales counted as doing business under Rule 3.546(c)(4); and
• subcontractor contract performance and in-state warranty repair counted under Rule 3.546(c)(1).

Those activities established other-state taxability for Rule 3.549(e)(41)(I) throwback.

For earned surplus, Rule 3.557(e)(37)(I) asked whether a net-income tax could constitutionally be imposed without violating Public Law 86-272. Protected solicitation of tangible-personal-property orders, sent outside the state for approval and filled from outside, did not establish taxability. Warranty work by subcontractors was not protected and did.

The corporation bore the burden of proving other-state taxability. Sales delivered to purchasers in foreign countries were not Texas receipts because "another state" covered U.S. states, D.C., Puerto Rico, and U.S. territories or possessions—not foreign countries.

Currency note: This is a pre-2008 two-component throwback analysis. Confirm current Texas and destination-state law.

What this means for you

Manufacturers with multistate representatives

The same solicitation activity could satisfy the former taxable-capital nexus test but remain protected for earned surplus.

Businesses providing warranty service

In-state warranty work was a stronger nexus fact and defeated the P.L. 86-272 protection described.

Common questions

Q: Did sales solicitation establish taxable-capital taxability?
A: Yes.

Q: Did solicitation alone establish earned-surplus taxability?
A: Not when it met Public Law 86-272's protected conditions.

Q: Did warranty repair establish taxability?
A: Yes, for both analyses described.

Q: Were foreign-country sales thrown back?
A: No.

Citations and references

• 34 Tex. Admin. Code Secs. 3.549(e)(41)(I), 3.546(c)(1), 3.546(c)(4), 3.557(e)(37)(I), and 3.554(d)(20)
• Public Law 86-272

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=FIT
• Opinion: https://star.comptroller.texas.gov/view/9903588L

Original ruling text

March 11, 1999

Dear Mr. **:

Thank you for the information contained in your letter of March 5, 1999
concerning the activities of a manufacturer of automatic teller machines
(ATMs). This response represents the Texas franchise tax implications of the
situation described in the ruling request.

You have indicated that the corporation is a manufacturer of ATMs which are
sold by company sales persons and outside representatives. The corporation
also trains subcontractors that have the ability to repair the ATMs under
company warranties.

The question is whether the activities of the sales representatives and
subcontractors in other states would constitute "subject to taxation" for
purposes of the throwback rule.

For your reference, the following franchise tax rules apply to the situation
described:

Rule 3.549 - Taxable Capital: Apportionment
Rule 3.546 - Taxable Capital: Nexus
Rule 3.557 - Earned Surplus: Apportionment
Rule 3.554 - Earned Surplus: Nexus

Franchise Tax Rule 3.549(e)(41)(I) addresses throwback for taxable capital.
The rule holds that if a corporation performs any of the activities listed in
Rule 3.546(c) in the other state, it will be considered "subject to taxation"
in the other state.

Rule 3.546(c)(4) provides that having employees or other representatives in
Texas to promote sales of goods constitutes doing business for the taxable
capital component of the franchise tax. Rule 3.546(c)(1) holds that the
performance of a contract in Texas by a subcontractor constitutes doing
business in the state. The rule also specifies that repairing property in the
state under a warranty is doing business. These activities would, therefore,
be considered subject to taxation in another state for throwback in the
apportionment of the corporation's taxable capital.

Rule 3.557(e)(37)(I) addresses throwback for earned surplus reporting. This
rule provides that a corporation is subject to taxation in another state if it
is chartered in that state or has sufficient contact with that state so that a
tax on net income could be imposed on the corporation without violating Public
Law 86-272.

Rule 3.554(d)(20) states that any activity listed as doing business in Rule
3.546 which is not protected by Public Law 86-272 constitutes doing business
for earned surplus. The warranty work performed by subcontractors would fall
into this category. Such activity would be considered subject to taxation in
another state for throwback in the apportionment of the corporation's earned
surplus.

Pursuant to Public Law 86-272, if the only business activity within the state
is the solicitation of orders for sales of tangible personal property, which
orders are sent outside the state for approval or rejection, and, if approved,
are filled by shipment or delivery from a point outside the state, then the
corporation is not subject to the earned surplus component. See Rule 3.554 for
a more detailed discussion of Public Law 86-272. For purposes of the throwback
rule in the apportionment of earned surplus, a corporation whose only
activities in another state are protected by Public Law 86-272 would not be
subject to taxation in the other state.

In applying the above throwback guidelines, the apportionment rules for taxable
capital and earned surplus specify that a corporation has the burden of
proving that it is subject to taxation in the other state.

With respect to sales of tangible personal products that are delivered to
purchasers in another country, such sales are not Texas receipts. The
throwback provision of the apportionment rules provides that "another state"
means a state of the United States, the District of Columbia, Puerto Rico, or
any territory or possession of the United States.

This response is based on the facts presented. If there are different or
additional facts, the response may change.

If you have any questions, please call toll-free 1-800-531-5441, extension
3-4496 or (512) 463-4496.

Sincerely,

Jerry Bobbitt
Tax Policy Division