The Texas Supreme Court has declined to review the Texas Court of Appeals' decision in Titan Transportation, LP v. Combs,1 which held that a taxpayer may exclude subcontractor payments as flow-through funds from its total revenue for Revised Texas Franchise Tax (RTFT) purposes.2 Because the Texas Supreme Court declined to review the Texas Comptroller's appeal of this case, the Court of Appeals' decision in favor of the taxpayer stands.
Background
The taxpayer subcontracted transportation services to deliver "aggregate" (a construction material) to construction sites. In computing its total revenue for RTFT purposes, the taxpayer excluded these flow-through funds that were mandated by contract and paid out to third parties. The taxpayer claimed that this exclusion was allowed by a statute that allows an exclusion from total revenue for "subcontracting payments handled by the taxable entity to provide services, labor, or materials in connection with the actual or proposed design, construction, remodeling, or repair of improvements on real property or the location of the boundaries of real property."3 The Court of Appeals concluded that the services, labor or materials provided to a real property project do not have to be directly related to "construction" in order to qualify for the exclusion. As it stands, services, labor or materials need only be logically connected to the construction, remodeling, design or repair work. Accordingly, taxpayers may be entitled to the exclusion from total revenue of subcontracting payments that qualify under the Court of Appeals' ruling.
Arguments in Briefs before Texas Supreme Court
Following the decision by the Texas Court of Appeals, the Comptroller and the taxpayer each provided briefs on the merits of the case to the Texas Supreme Court.4 The Comptroller argued that the taxpayer's payments to its drivers were not "flow-through funds, the funds that the taxpayer received from its customers were not "mandated by contract to be distributed" to the drivers, and that the equitable terms "double taxation" and "parity" were not applicable in this matter.
The taxpayer asserted in its brief that its subcontractor payments qualified for the flowthrough funds revenue exclusion, based on the common financial accounting meaning of the term "flow-through funds," and evidence demonstrating the flow-through nature of the payments. The taxpayer also argued that a timing requirement sought by the Comptroller went beyond the statute and ignored the economic reality of the transaction. The taxpayer also noted that the taxpayer was required by contract to pay its subcontractors, and that a clarifying amendment to the statute in 2013 also supported its position.5 As an alternative, the taxpayer claimed that it qualified for a cost of goods sold (COGS) deduction,6 claiming that the Comptroller agreed that such deduction should be allowed, and that the record supported this contention.
The Comptroller's reply brief analyzed the plain meaning of the flow-through funds statute, stating that in order to exclude funds from revenue, the taxpayer must not have had legal rights to the funds. Rather, the taxpayer could only have handled the funds for the purposes of paying the funds to the true legal owner. The Comptroller also argued that even though the taxpayer could recover some amount based on its COGS position, this recovery was not dispositive of the issues in the case and that prior to calculating a refund based on COGS, a decision would first need to be made on the primary flowthrough funds" position.
Commentary
The Texas Supreme Court's decision to decline review of the case was not surprising given the intervening legislation that effectively clarified the intent of the Texas legislature. This decision should present refund opportunities for taxpayers who engage subcontractors to provide services "logically and reasonably" connected with construction projects and activities. Types of taxpayers that may benefit from the decision include independent contractors, truckers, installers of building materials and service providers that enter into subcontracting arrangements with contractors and installers. Taxpayers should review their subcontracting payments with this decision in mind and consider whether their activities would be considered logically and reasonably connected to any of these types of work. Furthermore, while it appears that the subcontractors involved in this case were "owner-operators," other independent contractors and truckers might also qualify for the exclusion allowed in this case. In addition to businesses in the transportation and construction industries, opportunities may also be available for businesses in other industries, including installers of building materials and retailers that enter into subcontracting arrangements with installers.
The decision also provides supporting arguments for a COGS deduction for labor or materials furnished to a construction project. Although the Court of Appeals did not specifically address the taxpayer's alternative COGS argument, the taxpayer's arguments in its brief to the Texas Supreme Court, along with several of the findings and the legal and factual analyses above may serve as support for the COGS deduction. It should be noted the provision allowing the COGS deduction to "[a] taxable entity furnishing labor or materials to a project for the construction . . ." is not parallel to the revenue exclusion at issue.7 While the COGS language is more restrictive than the total revenue exclusion language,8 the Court of Appeals' analysis in Titan presumably may apply to the COGS deduction.
Footnotes
1 433 S.W.3d 625 (Tex. Ct. App. 2014). For a detailed discussion of this case, see GT SALT Alert: Texas Appellate Court Rules Subcontractor Payments for Transportation Services Excluded from Total Revenue.
2 The petition for review was denied by Hegar v. Titan Transportation, LP, Texas Supreme Court, No. 14-0307, May 1, 2015.
3 TEX. TAX CODE ANN. § 171.1011(g)(3) (as in effect through Dec. 31, 2013). Effective January 1, 2014, this was amended to exclude "subcontracting payments made under a contract or subcontract entered into by the taxable entity . . ."
4 The Comptroller filed its original brief with the Texas Supreme Court on Dec. 14, 2014, the taxpayer filed its brief on Feb. 2, 2015, and the Comptroller filed a reply brief on Feb. 27, 2015.
5 Ch. 1232 (H.B. 500), Laws 2013, adding TEX. TAX CODE ANN. § 171.1011(g-8). This new section provides in relevant part that "[a] taxable entity that is primarily engaged in the business of transporting aggregates shall exclude from its total revenue . . . subcontracting payments made by the taxable entity to independent contractors for the performance of delivery services on behalf of the taxable entity." A similar provision was also included for barite transporter subcontracting payments made "to nonemployee agents for the performance of transportation services on behalf of the taxable entity." Ch. 1232 (H.B. 500), Laws 2013, adding TEX. TAX CODE ANN. § 171.1011(g- 10). The general exclusion from total revenue language contained in TEX. TAX CODE ANN. §§ 171.1011(g) and 171.1011(g)(3) was expanded by adding "or subcontract" to the "by contract" clause and replacing payments "handled" with payments "made under a contract or subcontract entered into," respectively (Ch. 1034 (H.B. 2766), Laws 2013).
6 Pursuant to TEX. TAX CODE ANN. § 171.1012(i).
7 TEX. TAX CODE ANN. § 171.1012(i) (emphasis added).
8 The comparable total revenue statutory language currently provides for the exclusion of "subcontracting payments made under a contract or subcontract entered into by the taxable entity to provide services, labor, or materials in connection with the actual or proposed design, construction, remodeling, remediation, or repair of improvements on real property or the location of the boundaries of real property." TEX. TAX CODE ANN. § 171.1011(g)(3) (emphasis added).
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