United States: Texas Comptroller Issues Franchise Tax Guidance Regarding

For purposes of the Texas franchise tax, the Texas Comptroller of Public Accounts recently issued an internal memo from the Tax Policy Division to the Audit Division outlining the treatment of vendor funded incentives (VFIs) received by retailers related to goods acquired for resale.1 VFIs are allowances, credits and rebates offered to retailers by wholesalers and manufacturers and include items such as volume-based purchase price adjustments and sales-based incentives.


The computation of the cost of goods sold (COGS) deduction is an important component in determining a taxpayer's total franchise tax liability.2 As the statute governing the COGS deduction is relatively complex and not completely tied to what a taxpayer reports for federal income tax purposes, taxpayers and the Comptroller have differed as to what types of costs should be factored into the COGS calculation.

The treatment of VFIs for purposes of the COGS deduction only arises in the case where such VFIs are not included as an income item in the computation of federal taxable income. If VFIs are recorded as part of income for federal income tax purposes (e.g., Lines 1 through 10 of Form 1120, U.S. Corporation Income Tax Return), the amounts should be included in total revenue for franchise tax purposes3 and a COGS issue should not exist. If the VFIs are not reported as income for federal income tax purposes, however, a taxpayer must determine if the VFIs are treated as: (i) reductions to the COGS deduction as contra-COGS expenses (essentially increasing the franchise tax base); or (ii) as "selling costs" or "advertising costs" that are excluded from the COGS computation by statute.4

Treatment of VFIs Clarified

Given the lack of statutory and regulatory guidance on the treatment of VFIs for franchise tax purposes, the Comptroller issued a memo that describes the various types of VFIs and indicates the state's treatment of each type of VFI with respect to the recipient (retailer). The memo does not address the wholesaler/manufacturer treatment of the VFIs.

According to the memo, the following VFIs relate to advertising or selling activities and are excluded from the COGS computation:

  • Advertising – Vendor payments for costs incurred in publishing an advertisement
  • Coupon program-handling fees – Vendor payments for handling costs incurred in producing a coupon.
  • Product demonstrations – Vendor payments for costs incurred in conducting a product demonstration.
  • Product placement – Vendor payments for strategic placement of goods.
  • Shows/seminars – Vendor payments for costs incurred in presenting a product show/seminar.

The memo states that the following VFIs are sales-based incentives (i.e., related to the goods for sale) and are included in the COGS computation as contra-COGS expenses if not reported as revenue for federal income tax purposes:

  • Coupon program-face value – Vendor payments for the face value of coupons that are used to reduce the selling price to the customer.
  • Depletion allowance/volume incentives – Vendor payments received once a sales goal is reached.
  • Markdown funding – Vendor payments received as part of an exit strategy (i.e. phaseout) of a product that are used to reduce the selling price to the customer.
  • New item allowances – Vendor payments for costs incurred in getting a new item to the shelf.
  • Sales-based incentives – Vendor payments received based on a reduction in the selling price to the customer.
  • Temporary price reductions – Vendor payments received as part of a short-term promotion that are used to reduce the selling price to the customer.


By acknowledging in its memo that various types of VFIs are treated differently, the Comptroller may be indicating that a variety of positions as to how VFIs should be treated may exist, resulting in current audit assessment and refund controversies. As a specialty area of revenue and cost accounting, accounting for VFIs can be a complex and challenging topic. For retailers with significant VFIs and Texas operations, refund opportunities may exist as a result of the memo, particularly in the case of VFIs previously included as reductions to the COGS deduction and related to advertising, coupon program-handling fees, product demos, product placement or shows and seminars. On the other hand, some retailers may be faced with potential franchise tax exposure to the extent contra-COGS accounts may not have been applied to reduce the COGS deduction. The memo may also have ASC 740 implications regarding current and prior year tax return positions. Given that the memo is described as a "clarification" of policy, the positions are implied to be effective as of January 1, 2008 (subject, of course, to the statute of limitations).

The logic applied in the memo is, on its face, not unlike that of a Comptroller letter ruling issued in 2014, in which sales commissions paid as a percentage of sales for the right to sell goods are excluded from the COGS deduction as selling costs.5 The distinction between the 2014 ruling and the memo covering VFIs lies in the level of analysis contained in the two documents. The 2014 ruling was directed to the COGS treatment of a specific taxpayer's fact pattern. The VFI memo provides general guidance for retailers on how to treat a particular stream of income in many different situations.

Unfortunately, the VFI memo does not contain any discussion and analysis of potentiallygoverning federal income tax authorities, which leads one to query whether the memo may have been issued quickly in anticipation of litigation. The memo fails to acknowledge that federal income tax methods govern the COGS computation prior to adjustment for Texas-specific provisions6 and that the provisions of Internal Revenue Code (IRC) Sections 263A, 460 and 471 specifically apply to the Texas COGS deduction.7 With respect to IRC Section 263A (capitalization and inclusion in inventory costs of certain expenses), selling costs and advertising costs are specifically addressed and treated in a manner consistent with Texas-specific provisions governing those costs.8 The memo also does not address the franchise tax treatment of the incentive by the vendor and whether or not the costs of the incentives can be included in the vendor's COGS.

Likewise, the memo's discussion on the different types of VFIs that exist is brief. The two most common VFIs issued to retailers are the volume purchase discount (a per-unit discount as a certain level of purchases is met or exceeded) and the early pay discount (a percentage discount on an entire order if the invoice is paid immediately rather than waiting until payment is due). Volume purchase discounts appear to be included with the "volume incentives" category created by the Comptroller in its memo. However, it is unclear as to how early pay discounts would be treated. The practitioner is left to consider if these VFIs are reductions to the purchase price of goods, thus reducing the COGS deduction, or are excluded costs in the nature of interest expense, an excluded cost9 like selling and advertising costs.

Finally, it should be noted that while VFIs were discussed in the memo as a transaction between a retailer and wholesaler, companies throughout the supply chain are often engaged in VFI relationships with other entities, particularly volume and early pay discounts. Therefore, companies should consider whether similar implications exist with respect to their calculation of COGS.


1 Memo No. 201608950L, Texas Comptroller of Public Accounts, Aug. 11, 2016.

2 TEX. TAX CODE ANN. § 171.1012.

3 TEX. TAX CODE ANN. § 171.1011.

4 TEX. TAX CODE ANN. § 171.1012(e)(2) and (4), respectively.

5 Letter Ruling No. 201412007L, Texas Comptroller of Public Accounts, Dec. 30, 2014.

6 TEX. TAX CODE ANN. § 171.1012(h).

7 TEX. TAX CODE ANN. § 171.1012(g).

8 Treas. Reg. § 1.263A-1(e)(3)(iii)(j).

9 TEX. TAX CODE ANN. § 171.1012(e)(9).

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