Texas Appellate Court Says Company Qualified for Reduced Rate & Cost of Goods Sold Deduction

Thoughtware Alert Published: Sep 27, 2021
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On August 31, 2021, a Texas appellate court affirmed the trial court’s findings regarding Texas Tax Code Section 171.0001(18) and Texas Tax Code §171.1012(a)(1). The Texas Comptroller of Public Accounts asserted that a company engaged in the retail and wholesale distribution of printing and publishing systems, including the selling of various types of business equipment through the use of certain finance lease contracts, i.e., sales-type leases, did not qualify for the reduced Texas franchise tax rate (0.5 percent). In addition, the Comptroller argued the company was not allowed to include the costs related to the sales-type leases in its cost-of-goods-sold (COGS) deduction for Texas franchise tax purposes. The trial court and the appellate court held for the taxpayer.

The appellate court held the substance of the sales-type leases rather than their form dictated that the sales-type leases constituted a “wholesale trade” under Texas Tax Code §171.0001(18). The determination that the activity constituted a wholesale trade allowed the company to meet the required threshold to be “primarily engaged” in a wholesale trade pursuant to Texas Tax Code 171.002(c)(1). In addition, the trial court determined the revenue from sales-type leases is classified as revenue from sales under Financial Accounting Standards No. 13 (FAS 13), which falls into the scope of wholesale trade. 

The appellate court agreed with the trial court that property leased under these sales-type leases could be considered “sold” under the ordinary meaning found in Texas Tax Code §171.1012(a)(1) and could be included in the COGS deduction. Notably, the ordinary meaning of “selling,” “sold,” or “sale” does not require the passage of title, but it does require the transfer of the item being sold. In the case, the sales-type leases were generally for the entirety of the economic life of the leased equipment, which effectively represented a sale. 

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