Regulatory and Industry News Alerts from Armanino

Texas Issues Revised Franchise Tax Sourcing Rules

by Mark Cummings, Stephanie Shorkley
February 01, 2021


The Texas Comptroller of Public Accounts recently adopted amendments to administrative guidance, significantly affecting the state’s franchise tax apportionment rules. The final adopted rule, 34 Tex. Admin. Code Section 3.591, was published in the Texas Register on Jan. 15, 2021. While most of the amendments are retroactively effective from Jan. 1, 2008, taxpayers may in certain circumstances apply the sourcing procedures under the former rules for prior tax periods.

The adopted rule includes the following changes:

(1) incorporated recent statutory amendments; (2) defined new terms and modified existing definitions; (3) reflected current guidance; and (4) made significant changes to existing provisions for the sourcing of revenue relating to the sale of general services, internet hosting, advertising, digital property, capital assets and investments, financial derivatives and loan servicing.

Key Details

Here are highlights of the formally adopted changes to how revenue is sourced.

General Services

The agency rewrote numerous detailed rules for sourcing dozens of different types of receipts. Notably, for receipts from services that don’t fall under one of the specific rules, the comptroller’s rule codifies the “end-product act” test, which first appeared in a 1980 comptroller hearing (Decision No. 10,028) and was recently employed by the Third Court of Appeals in Hegar v. Sirius XM Radio, Inc., No 03-18-00573-CV (Tex. App.—Austin 2020, pet. filed).

In Hegar v. Sirius XM Radio, Inc., the court held that the receipts-producing, end-product act associated with the provision of satellite radio services was the taxpayer activating a customer’s chip set in a satellite-enabled radio. This occurred where the customer’s radio was located (likely to be the customer’s residence where the customer’s car was located). The Sirius XM case is not yet final; the taxpayer’s petition for review before the Texas Supreme Court is pending.

The regulation further provides that if there is a receipts-producing, end-product act, the location of other acts will not be considered even if they are essential to the performance of the receipts-producing act. This is also consistent with the Sirius XM decision because the appeals court held that producing programming content for satellite radio stations was a non-receipt-producing act, albeit an essential one.

If services are performed in Texas and another state for a single charge, a fair value analysis is required. The finalized regulation provides guidance on determining fair value, as well as a few examples that illustrate that for certain types of services (e.g., legal services), the fair value analysis will apply and receipts will be sourced proportionately based on where the legal services are performed.

Computer Hardware and Digital Property

The revised rules make several changes to the sourcing of receipts from the sale of computer hardware and digital property under Rule 3.591 (e)(3)Hardware, and software receipts are sourced as the sale of tangible personal property if the hardware is sold with software installed on it. Digital property transferred by “fixed physical media” (e.g., compact disc) is sourced as the sale of tangible personal property. Digital property not transferred by fixed physical media is sourced as the sale of an intangible to the location of the payor. Digital property as a service is sourced under the end-product act rule.

Internet Hosting Services

The rules provide that receipts from internet hosting services are sourced to the location of the customer. Internet hosting service is defined as “providing to an unrelated user access over the internet to computer services using property that is owned or leased and managed by the provider and on which the user may store or process the user’s own data or use software that is owned, licensed, or leased by the user or provider” per Rule 3.591(e)(13)(A).

The examples of internet hosting are broader than previous guidance. Internet hosting includes all “real-time, nearly real-time, and on-demand access over the internet to computer services such as: (i) data storage and retrieval; (ii) video gaming; (iii) database search services; (iv) entertainment streaming services; (v) processing of data; and (vi) marketplace provider services” per Rule 3.591(e)(13)(B). It does not include: (i) telecommunications service; (ii) cable television service; (iii) internet connectivity service; (iv) internet advertising service; or (v) internet access solely to download digital content for storage and use on the customer's computer or other electronic device” per Rule 3.591(e)(13)(C).

The new guidance also distinguishes between purchasing access to a computer service and purchasing or leasing hardware or digital property, per Rule. 3.591(e)(13)(D).

Loans and Other Financial Services

Gross receipts from loan servicing are sourced to the location of real property secured by the loan. If the loan is not secured by real property, receipts are sourced based on the end-product act, under Rule 3.591(e)(16). Loans and securities held as inventory are sourced to the location of payor, under Rule 3.591(e)(17). Gross receipts from the settlement of financial derivative contracts (hedges, options, swaps, futures, forward contracts, etc.) are sourced to the location of payor, per Rule 3.591(e)(10).


The changes in gross receipts sourcing indicate that Texas appears to be shifting from cost-of-performance (COP) to market sourcing. Previously, if services were performed inside and outside Texas, such receipts were Texas receipts based on the fair value of the services rendered in Texas. While the “fair value of services rendered” was somewhat unclear, it was generally more aligned with the traditional COP sourcing methods than market sourcing. As with the Sirius case, the state is clearly wanting to go in a different direction.

Out-of-state taxpayers may be affected by the revised amendments that will source a more significant amount of gross receipts to Texas. SaaS companies have been specifically targeted by the comptroller.

In-state Texas services entities should review their previous filing positions and consider filing protective claims if they sourced their revenue to Texas under the prior interpretation of the regulations. The comptroller is applying these changes retroactively.

For questions on how your business may be exposed to income tax liability by the adopted amendments, contact our experts.

February 01, 2021

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Mark Cummings - Tax, Armanino
Managing Director
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