How did a bank report swap proceeds, repurchase-agreement securities, and federal-fund transactions under the former Texas franchise tax?

Plain-English summary

The bank first had to determine whether accounting rules recognized revenue; only then did gross-versus-net and sourcing rules apply.

The Comptroller addressed three transaction groups.

Swap agreements

When swaps were not sales of capital assets or investments and no principal had been invested, gross proceeds were gross receipts sourced to the payor. For exchange-traded swaps, the 6.5% Texas factor in Rules 3.549(e)(39) and 3.557(e)(35) applied only when the buyer could not be determined. A known buyer required the ordinary location-of-payor rule.

Repurchase-agreement securities

The bank sold securities classified as available for sale and recorded a short-term liability because it agreed to repurchase them. Sections 171.112(a) and 171.1121(a) looked to GAAP and federal income-tax revenue recognition. Recording a liability rather than revenue meant no gross receipt was recognized at that time.

Once revenue was recognized, classification controlled amount:

• inventory: gross sales price;
• investment: net gain;
• held to maturity: generally investment;
• trading: generally inventory; and
• available for sale: generally inventory under the Comptroller's stated practice.

Rule 3.547(d)(2) presumed published financial-statement classifications accurate unless the bank or Comptroller showed otherwise. Earned-surplus inventory-versus-investment treatment followed federal income-tax rules.

Federal funds

Principal repayment when the federal government redeemed debt obligations generally produced no receipt. To the extent a sale of federal funds carried as inventory did produce gross receipts, the bank used gross sales price. If the federal government was the purchaser, those receipts were not Texas receipts.

Currency note: This analysis applies the pre-2008 taxable-capital and earned-surplus tax. Texas replaced it with the margin tax effective January 1, 2008.

What this means for you

Banks and securities dealers

Do not jump directly to apportionment. Determine whether the transaction creates revenue, then identify inventory or investment treatment, then source the resulting receipt.

Tax professionals

The 6.5% factor was a fallback for an unknown exchange buyer, not a blanket rate for all exchange transactions.

Common questions

Q: When did exchange-traded swaps use 6.5% Texas receipts?
A: Only when the buyer could not be determined.

Q: Did a repo sale recorded as a liability create an immediate receipt?
A: No, not until the revenue-recognition test was met.

Q: Were available-for-sale securities inventory or investments?
A: The Comptroller said they were generally treated as inventory, subject to the financial-statement presumption.

Q: Was federal debt principal repayment a receipt?
A: No, assuming no revenue under GAAP or federal tax reporting.

Citations and references

• Texas Tax Code Secs. 171.112(a) and 171.1121(a)
• 34 Tex. Admin. Code Secs. 3.549(e)(39), 3.557(e)(35), 3.547(d)(2), 3.549(e)(27), and 3.557(e)(22)
• Financial Accounting Standards No. 115

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=FIT
• Opinion: https://star.comptroller.texas.gov/view/9906723L

Original ruling text

June 17, 1999

Dear **:

This is in response to your inquiry concerning the apportionment of a Texas
banking corporation's gross receipts. Your first question was directed at swap
agreements that the bank enters into . You have indicated that based on TR
1349, the bank has been apportioning the gross proceeds from the swap
transactions based on the location of payor rule and has used a 6.5% Texas
factor for agreements traded on the stock exchange.

To the extent the bank's swap agreement transactions do not represent sales of
capital assets or sales of investments (i.e., where no principal has been
invested), the gross proceeds from the transactions would be gross receipts as
stated in TR 1349. The receipts would be apportioned to the location of payor.

Franchise Tax Rules 3.549(e)(39) and 3.557(e)(35) hold that receipts from the
sale of securities that are sold over a stock exchange to buyers that cannot be
determined result in 6.5% Texas receipts. With respect to swap agreements that
are traded on a stock exchange, the 6.5% Texas factor could be used only in
those situations where the buyer cannot be determined. When the buyer can be
determined, the location of payor rule must be applied to the transaction.

The second question relates to the same bank. The ruling request states that
the bank regularly sells securities from its portfolio under repurchase
agreements, and agrees to repurchase the securities from the customer at a
specified date. The seller is required to record the securities sold as short
term liabilities on the balance sheet. The securities utilized for this
purpose are all from the category of assets classified under GAAP and federal
regulatory agencies as "Securities Available For Sale".

You have asked if the bank should report the sale of these securities on a
gross
basis or on a net basis?

Before responding to the gross/net question, I'd like to first address the
statutory provisions for gross receipts. Sections 171.112(a) and 171.1121(a)
of the Texas Tax Code define "gross receipts" for taxable capital and earned
surplus, respectively. These definitions look to the Generally Accepted
Accounting Principles (GAAP) and federal income tax (FIT) reporting concepts of
recognizing revenue as the criteria for recognizing gross receipts.

In the fact situation described above, the corporation recognizes a liability
at the time the securities are sold. The fact that a liability is recognized
(rather than revenue) would preclude the sales from being reported as gross
receipts under the Tax Code requirements. A receipt would not be recognized
until the applicable revenue recognition test is established.

The gross/net treatment is based on whether the securities are inventory (in
which the receipts are reported at gross without deduction for related costs)
or are investments (in which the net gain from the sale is reported). The
following guidelines are relevant to the inventory/investment determination for
taxable capital purposes.

Financial Accounting Standard 115 (FAS 115) classifies debt and equity
securities as either (1) held-to-maturity, (2) trading, or (3)
available-for-sale. Those securities in the held-to-maturity category would
generally be treated as an investment (for purposes of the gross vs. net
determination) and those securities in the trading category would generally be
treated as inventory.

Under FAS 115, the available-for-sale category includes securities not
classified as held-to-maturity or trading. As a general rule, we would also
consider securities in the available- for-sale category as inventory. Such
treatment is consistent with the agency's practice of categorizing securities
held for sale by banks. It is also consistent with the treatment for other
industries in categorizing items held for sale in the regular course of
business.

Franchise Tax Rule 3.547(d)(2) holds that factual assertions made for published
financial statements will be presumed to be accurate unless the corporation or
the comptroller can show the assertions are incorrect. This rule would apply
to the manner in which the securities are classified on a bank's financial
statements - the classifications will be presumed to be accurate unless the
bank or comptroller can show that the classifications are incorrect.

A corporation's earned surplus is based on its reportable federal taxable
income. Therefore, federal income tax regulations on inventory/investment
would be controlling for earned surplus reporting.

The next set of questions involve the bank's purchase and sale of federal
funds. The facts presented indicate that GAAP, the Comptroller of the
Currency, and the FDIC require the bank to report the Federal Funds Sold as
short term inventory accounts. Conversely, Federal Funds Purchased must be
recorded as short term liabilities. Typically, these transactions are entered
into for only a few days and are not considered investment transactions.

Question 1: Should the bank report these transactions based on the gross sales
price of the Federal Funds sold?

As noted above, the respective revenue recognition tests must be established in
order for a gross receipt to be recognized. In situations where the federal
government is redeeming its debt obligations, any principal repayments would
presumably not generate revenue under either GAAP or FIT reporting and would
not result in a gross receipt for either tax base component. Please see
Franchise Tax Rules 3.549(e)(27) and 3.557(e)(22).

To the extent the bank had gross receipts from the sales of the funds, the
receipts from the funds carried as inventory should be reported at the gross
sales price.

Question 2: If the answer to the above is affirmative, with the federal
government as the purchaser of the Federal Funds Sold, what portion of the
receipts would be Texas receipts?

To the extent the bank had gross receipts from the sales of these funds, the
receipts would not be Texas receipts if the federal government is the
purchaser.

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