United States: Texas Comptroller Amends Revised Texas Franchise Tax Cost Of Goods Sold Rule

On June 5, the Texas Comptroller of Public Accounts amended the administrative rule governing the Revised Texas Franchise Tax (RTFT) cost of goods sold (COGS) deduction.1 The Comptroller's amendments to the rule interpreting the existing statute that authorizes and defines the COGS deduction2 are effective retroactive to the January 1, 2008 effective date of the RTFT to the extent a taxpayer's statute of limitations remains open. The most significant changes contained in the rule are the allowance of certain amended reports and the adoption of certain Internal Revenue Code (IRC) Section 263A (UNICAP) principles, which may allow indirect labor costs and property taxes to be treated as direct (100 percent) COGS deductions. However, there may be situations under which costs previously considered to be fully deductible could now be reclassified as service costs subject to a 4 percent COGS limitation.

Significant Rule Changes

Margin Computation Method Changes Allowed

The amendment memorializes the relatively new Comptroller policy which allows taxpayers to file amended returns to change their margin computation method. Taxpayers now have the option to change their method of computing margin among the COGS deduction, the compensation deduction, 70 percent of total revenue or E-Z computation methods (to the extent the COGS and/or E-Z computation methods are available). Previously, the rule did not allow for taxpayers to amend their franchise tax reports to change their method to the COGS or compensation methods.3 The rule also confirms that an election may be changed as part of an audit. This policy shift was first adopted by the Comptroller in June 2012.4 Guidance on Direct and Indirect Labor Costs

The Comptroller has concluded that the COGS statute5 allows taxable entities to include fully in their COGS deduction both direct and indirect labor costs, other than certain service costs, that are of the type of costs subject to capitalization or allocation under IRC Sections 263A and 460.6 The Comptroller does not directly address situations in which a taxable entity is not subject to IRC Sections 263A or 460; situations in which a taxable entity did not properly apply UNICAP principles on its federal tax return; or situations where a taxable entity has deducted current period UNICAP expenses on its federal tax return but has not reported the expenses on Treas. Form 1125-A. However, the Comptroller's reference to the type of costs subject to capitalization or allocation under IRC Sections 263A and 460 and the preamble to the regulations7 would suggest the Comptroller's intent to apply UNICAP principles to all of these situations. The allowance of indirect labor costs as direct COGS deductions is a significant shift in Comptroller policy, as this issue has been the source of many audit controversies.8

Labor costs have been expanded to include IRS Form W-2 wages, IRS Form 1099 payments for labor, temporary labor expenses, payroll taxes, pension contributions, and employee benefits expenses, including, but not limited to, health insurance and per diem reimbursements for travel expenses, to the extent those expenses are deductible for federal tax purposes.9

"Service Costs" Defined

Pursuant to statute, indirect or administrative costs, including mixed service costs which are allocable to the acquisition or production of goods, may be considered COGS, though the includible amount cannot be more than 4 percent of the taxpayer's total indirect or administrative overhead costs (including the mixed service costs.10 For the first time, the Comptroller has formally defined the term "service costs" in the amended rule, as follows:

". . . indirect and administrative overhead costs that can be identified specifically with a service department or function, or that directly benefit or are incurred by reason of a service department or function . . . [A] service department includes personnel (including costs of recruiting, hiring, relocating, assigning and maintaining personnel records or employees); accounting (including accounts payable, disbursements, any payroll functions); data processing; security; legal; general financial planning and management; and other similar departments or functions.11

While the definition in the rule definition parallels the definition contained in Treas. Reg. §1.263A-1(e)(4)(i), it should be noted that the Comptroller is defining the term "service costs," and not "mixed service costs," the term actually used in the statute. Further, the rule uses the terms "service costs" and "indirect or administrative overhead costs"12 interchangeably, which is distinct from the phrase "indirect or administrative overhead costs, including all mixed service costs" that is used in the statute.

Inclusion of Property Taxes in COGS Deduction

The inclusion of taxes in the COGS deduction has been expanded to include property taxes paid on buildings and equipment related to acquiring or producing any material.13 Although not stated in the rule, this inclusion logically could extend to property taxes paid upon inventory for sale. Similar to the allowance of indirect labor, the allowance of property taxes as a direct COGS deduction is a shift in policy by the Comptroller.14


The Comptroller's policy changes with respect to amended returns, indirect labor costs, property taxes and the recognition and adoption of federal UNICAP principles present potential opportunities for taxpayers. Because the rule amendments apply retroactively, benefits may be recognized by amending prior year reports or revisiting prior audit results, to the extent the statute of limitations remains open. In addition, taxpayers should assess the potential ASC 740 impacts of the retroactively amended rule for financial reporting purposes.

The distinction between indirect labor costs fully includible in the COGS deduction and service costs includible at 4 percent, at most, in the COGS deduction remains unclear. The Comptroller's adoption of the definition of service costs in the rule, and the application of that term, potentially expands the law's definition and application of "indirect or administrative overhead costs, including all mixed service costs."15 The effect of this expansion is that more costs could be subject to the 4 percent limitation and may not be fully deductible under the rule, in contrast to what the law would suggest.

Consider, for example, a taxpayer who has a single department responsible for hiring employees for both its headquarters and its manufacturing facility. Because this department handles both production and non-production hiring, the labor costs for this department should be considered mixed service costs.16 As a result, costs that previously may have been includible, in whole or in part, in the Texas COGS deduction could now be subject to the 4 percent indirect COGS deduction limitation under the amended rule.17

Alternatively, consider the example of a taxpayer that has a department solely responsible for hiring employees for its manufacturing facility or function. The labor costs for this department would be considered to be "service costs that directly benefit or are incurred by reason of the performance of the production or resale activities of the taxpayer."18 The costs are not "mixed service costs" for federal UNICAP purposes, and are capitalizable service costs for federal tax purposes.19 The corollary to this treatment is that the costs would be fully includible in the RTFT COGS deduction.20 But as a result of the Comptroller's application of "service costs" in lieu of "mixed service costs," the subject costs may be limited to the 4 percent indirect COGS deduction limitation under the amended rule.

The Comptroller's changes to labor costs, service costs, and property taxes rely heavily on federal UNICAP principles. The allowance of property taxes as a direct COGS deduction results from the Comptroller's recognition of IRC Section 263A principles. The reliance on UNICAP principles for labor costs and property taxes may allow for similar interpretations and treatment of other costs where taxpayers are lacking direct guidance.


1 34 TEX. ADMIN. CODE § 3.588.

2 TEX. TAX CODE ANN. § 171.1012.

3 34 TEX. ADMIN. CODE § 3.588(c)(3).

4 Letter No. 201206444L, Texas Comptroller of Public Accounts, June 12, 2012.

5 TEX. TAX CODE ANN. § 171.1012(c)(1) provides that COGS includes all direct costs of acquiring or producing goods, including labor costs.

6 34 TEX. ADMIN. CODE § 3.588(d)(1). The rule specifically references Treas. Reg. §§ 1.263A-1(e) and 1.460-5.

7 Texas Register, Vol. 38, No. 22, 3415 et seq., May 31, 2013.

8 See Letter No. 201108182L, Texas Comptroller of Public Accounts, Aug. 30, 2011, which guidance should now be rendered obsolete.

9 34 TEX. ADMIN. CODE § 3.588(d)(1)(A).

10 TEX. TAX CODE ANN. § 171.1012(f).

11 34 TEX. ADMIN. CODE § 3.588(b)(9).

12 34 TEX. ADMIN. CODE § 3.588(f).

13 34 TEX. ADMIN. CODE § 3.588(d)(11).

14 See Letter No. 201002890L, Texas Comptroller of Public Accounts, Feb. 2, 2010, which guidance should now be rendered obsolete.

15 TEX. TAX CODE ANN. § 171.1012(f).

16 Treas. Reg. § 1.263A-1(e)(4)(ii)(C).

17 34 TEX. ADMIN. CODE § 3.588(b)(9), (f).

18 Treas. Reg. § 1.263A-1(e)(4)(ii)(A).

19 Treas. Reg. § 1.263A-1(e)(4)(iii)(B).

20 TEX. TAX CODE ANN. § 171.1012(c)(1); 34 TEX. ADMIN. CODE § 3.588(d)(1).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Similar Articles
Relevancy Powered by MondaqAI
Grant Thornton LLP
In association with
Related Topics
Similar Articles
Relevancy Powered by MondaqAI
Grant Thornton LLP
Related Articles
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions