34 Tex. Admin. Code § 3.588 - Margin: Cost of Goods Sold
(a)
Effective Date. The provisions of this section apply to franchise tax reports
originally due on or after January 1, 2008, except as otherwise
noted.
(b) Definitions. The
following words and terms, when used in this section, shall have the following
meanings, unless the context clearly indicates otherwise.
(1) Arm's length--The standard of conduct
under which entities that are not related parties and that have substantially
equal bargaining power, each acting in its own interest, would negotiate or
carry out a particular transaction.
(2) Computer program--A series of
instructions that are coded for acceptance or use by a computer system and that
are designed to permit the computer system to process data and provide results
and information. The series of instructions may be contained in or on magnetic
tapes, printed instructions, or other tangible or electronic media.
(3) Goods--Real or tangible personal property
sold in the ordinary course of business of a taxable entity.
(4) Heavy construction
equipment--Self-propelled, self-powered, or pull-type equipment that weighs at
least 3,000 pounds and is intended to be used for construction. The term does
not include a motor vehicle required to be titled and registered.
(5) Lending institution--An entity that makes
loans and:
(A) is regulated by the Federal
Reserve Board, the Office of the Comptroller of the Currency, the Federal
Deposit Insurance Corporation, the Commodity Futures Trading Commission, the
Office of Thrift Supervision, the Texas Department of Banking, the Office of
Consumer Credit Commissioner, the Credit Union Department, or any comparable
regulatory body;
(B) is licensed
by, registered with, or otherwise regulated by the Department of Savings and
Mortgage Lending;
(C) is a "broker"
or "dealer" as defined by the Securities Exchange Act of 1934 at
15 U.S.C. §
78c; or
(D) provides financing to unrelated parties
solely for agricultural production.
(6) Principal business activity--The activity
in which a taxable entity derives the largest percentage of its "total
revenue".
(7)
Production--Construction, manufacture, installation occurring during the
manufacturing or construction process, development, mining, extraction,
improvement, creation, raising, or growth.
(8) Related party--A person, corporation, or
other entity, including an entity that is treated as a pass-through or
disregarded entity for purposes of federal taxation, whether the person,
corporation, or entity is subject to the tax under this chapter or not, in
which one person, corporation, or entity, or set of related persons,
corporations, or entities, directly or indirectly owns or controls a
controlling interest in another entity.
(9) Service costs--Indirect costs 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. For purposes of this section, a
service department includes personnel (including costs of recruiting, hiring,
relocating, assigning, and maintaining personnel records or employees);
accounting (including accounts payable, disbursements, and payroll functions);
data processing; security; legal; general financial planning and management;
and other similar departments or functions.
(10) Tangible personal property--
(A) includes:
(i) personal property that can be seen,
weighed, measured, felt, or touched or that is perceptible to the senses in any
other manner;
(ii) films, sound
recordings, videotapes, live and prerecorded television and radio programs,
books, and other similar property embodying words, ideas, concepts, images, or
sound, without regard to the means or methods of distribution or the medium in
which the property is embodied, for which, as costs are incurred in producing
the property, it is intended or is reasonably likely that any medium in which
the property is embodied will be mass-distributed by the creator or any one or
more third parties in a form that is not substantially altered; and
(iii) a computer program, as defined in
paragraph (2) of this subsection.
(B) does not include:
(i) intangible property or
(ii) services.
(c) General rules for
determining cost of goods sold.
(1) Affiliated
entities. Notwithstanding any other provision of this section, a payment made
by one member of an affiliated group to another member of that affiliated group
not included in the combined group may be subtracted as a cost of goods sold
only if it is a transaction made at arm's length.
(2) Capitalization or expensing of certain
costs. The election to capitalize or expense allowable costs is made by filing
the franchise tax report using one method or the other. The election is for the
entire period on which the report is based and may not be changed after the due
date or the date the report is filed, whichever is later. A taxable entity that
is allowed a subtraction by this section for a cost of goods sold and that is
subject to Internal Revenue Code, §§263A, 460, or 471 (including a
taxable entity subject to §471 that elects to use LIFO under §472),
may elect to:
(A) Capitalize those costs in
the same manner and to the same extent that the taxable entity capitalized
those costs on its federal income tax return, except for those costs excluded
under subsection (g) of this section, or in accordance with subsections (d),
(e), and (f) of this section. A taxable entity that elects to capitalize costs
on its first report due on or after January 1, 2008, may include, in beginning
inventory, costs allowable for franchise tax purposes that would be in
beginning inventory for federal income tax purposes.
(i) If the taxable entity elects to
capitalize those costs allowed under this section as a cost of goods sold, it
must capitalize each cost allowed under this section that it capitalized on its
federal income tax return.
(ii) If
the taxable entity later elects to begin expensing those costs allowed under
this section as a cost of goods sold, the entity may not deduct any cost
incurred before the first day of the period on which the report is based,
including any ending inventory from a previous report.
(B) Expense those costs, except for those
costs excluded under subsection (g) of this section, or in accordance with
subsections (d), (e), and (f) of this section.
(i) If the taxable entity elects to expense
those costs allowed under this section as a cost of goods sold, costs incurred
before the first day of the period on which the report is based may not be
subtracted as a cost of goods sold.
(ii) If the taxable entity later elects to
begin capitalizing those costs allowed under this section as a cost of goods
sold, costs incurred prior to the accounting period on which the report is
based may not be capitalized.
(3) Election to subtract cost of goods sold.
A taxable entity, if eligible, must make an annual election to subtract cost of
goods sold in computing margin by the due date, or at the time the report is
filed, whichever is later. The election to subtract cost of goods sold is made
by filing the franchise tax report using the cost of goods sold method. An
amended report may be filed within the time allowed by Tax Code, §
111.107 to change the method
of computing margin to the cost of goods sold deduction method or from the cost
of goods sold deduction method to the compensation deduction method, 70% of
total revenue, or, if otherwise qualified, the E-Z computation method. An
election may also be changed as part of an audit. See §
3.584 of this title (relating to
Margin: Reports and Payments).
(4)
Exclusions from total revenue. Any expense excluded from total revenue (see
§
3.587 of this title (relating to
Margin: Total Revenue)) may not be included in the determination of cost of
goods sold.
(5) Film and
broadcasting. A taxable entity whose principal business activity is film or
television production or broadcasting or the sale of broadcast rights or the
distribution of tangible personal property described by subsection
(b)(10)(A)(ii) of this section, or any combination of these activities, and who
elects to use cost of goods sold to determine margin, may include as cost of
goods sold:
(A) the costs described in this
section in relation to the property;
(B) depreciation, amortization, and other
expenses directly related to the acquisition, production, or use of the
property, including
(C) expenses
for the right to broadcast or use the property.
(6) Lending institutions. Notwithstanding any
other provision of this section, if the taxable entity is a lending institution
that offers loans to the public and elects to subtract cost of goods sold, the
entity may subtract as a cost of goods sold an amount equal to interest
expense.
(A) This paragraph does not apply to
entities primarily engaged in an activity described by category 5932 of the
1987 Standard Industrial Classification Manual published by the federal Office
of Management and Budget.
(B) For
purposes of this subsection, an entity engaged in lending to unrelated parties
solely for agricultural production offers loans to the public.
(7) Mixed transactions. If a
transaction contains elements of both a sale of tangible personal property and
a service, a taxable entity may only subtract as cost of goods sold the costs
otherwise allowed by this section in relation to the tangible personal property
sold.
(8) Movie theaters. Effective
for reports originally due on or after September 1, 2013, if a taxable entity
that is a movie theater elects to subtract cost of goods sold, the cost of
goods sold for the taxable entity shall be the costs described by this section
in relation to the acquisition, production, exhibition, or use of a film or
motion picture, including expenses for the right to use the film or motion
picture, and the costs otherwise allowed by this section in relation to
concessions sold.
(9) Owner of
goods. A taxable entity may make a subtraction under this section in relation
to the cost of goods sold only if that entity owns the goods.
(A) A taxable entity that holds the legal
title to the goods is presumed to be the owner of the goods for purposes of
this section. A taxable entity may rebut this presumption by proving an
ownership right superior to the legal title holder based on all of the facts
and circumstances, including the various benefits and burdens of ownership
vested with the taxable entity.
(B)
A taxable entity furnishing labor or materials to a project for the
construction, improvement, remodeling, repair, or industrial maintenance (as
the term "maintenance" is defined in §
3.357 of this title (relating to
Nonresidential Real Property Repair, Remodeling, and Restoration; Real Property
Maintenance)) of real property is considered to be an owner of the labor or
materials and may include the costs, as allowed by this section, in the
computation of the cost of goods sold. For purposes of determining whether a
taxable entity is considered an owner of the labor or materials under this
paragraph, and eligible to deduct costs as described in subsections (d), (e),
and (f) of this section, the following terms mean:
(i) Labor--Labor used in the direct
prosecution of the project.
(ii)
Material--All or part of:
(I) the material,
machinery, fixtures, or tools incorporated into the project, consumed in the
direct prosecution of the project, or ordered and delivered for incorporation
or consumption;
(II) rent at a
reasonable rate and actual running repairs at a reasonable cost for
construction equipment used or reasonably required and delivered for use in the
direct prosecution of the project at the site of the project; or
(III) power, water, fuel, and lubricants
consumed or ordered and delivered for consumption in the direct prosecution of
the project.
(C) Solely for the purposes of this section,
a taxable entity shall be treated as the owner of goods being manufactured or
produced by the entity under a contract with the federal government, including
any subcontracts that support a contract with the federal government,
notwithstanding that the Federal Acquisition Regulations may require that title
or risk of loss with respect to those goods be transferred to the federal
government before the manufacture or production of those goods is
complete.
(10) Pipeline
entities. Effective for reports originally due on or after January 1, 2014, and
notwithstanding paragraph (9) of this subsection and subsection (g)(3) of this
section, a pipeline entity that provides services for others related to the
product that the pipeline does not own and to which this paragraph applies may
subtract as a cost of goods sold its depreciation, operations, and maintenance
costs allowed by this section related to the services provided.
(A) For purposes of this paragraph, "pipeline
entity" means an entity:
(i) that owns or
leases and operates the pipeline by which the product is transported for others
and only to that portion of the product to which the entity does not own title;
and
(ii) that is primarily engaged
in gathering, storing, transporting, or processing crude oil, including
finished petroleum products, natural gas, condensate, and natural gas liquids,
except for a refinery installation that manufactures finished petroleum
products from crude oil.
(B) For purposes of this paragraph,
"processing" means the physical or mechanical removal, separation, or treatment
of crude oil, including finished petroleum products, natural gas, condensate,
and natural gas liquids after those materials are produced from the earth. The
term does not include the chemical or biological transformation of those
materials.
(11) Rental
or leasing companies. Notwithstanding any other provision of this section:
(A) a motor vehicle rental company that
remits a tax on gross receipts imposed under Tax Code, §
152.026, or a motor vehicle
leasing company, may subtract as costs of goods sold the costs otherwise
allowed by this section in relation to motor vehicles that the company rents or
leases in the ordinary course of its business;
(B) a heavy construction equipment rental or
leasing company may subtract as costs of goods sold the costs otherwise allowed
by this section in relation to heavy construction equipment that the company
rents or leases in the ordinary course of its business; and
(C) a railcar rolling stock rental or leasing
company may subtract as costs of goods sold the costs otherwise allowed by this
section in relation to railcar rolling stock that the company rents or leases
in the ordinary course of its business.
(12) Reporting methods. A taxable entity
shall determine its cost of goods sold, except as otherwise provided by this
section, in accordance with the methods used on the federal income tax return
on which the report under this chapter is based. This subsection does not
affect the type or category of cost of goods sold that may be subtracted under
this section.
(13) Restaurants and
bars. Entities engaged in activities described in Major Group 58 (Eating and
Drinking Places) of the Standard Industrial Classification Manual may deduct
for cost of goods sold only those expenses allowed under subsections (d), (e)
and (f) of this section, that relate to the acquisition and production of food
and beverages. Any costs related to both the production of food and beverages
and to other activities must be allocated to production on a reasonable
basis.
(d) Direct costs.
The cost of goods sold includes all direct costs of acquiring or producing the
goods. Direct costs include:
(1) Labor costs.
A taxable entity may include in its cost of goods sold calculation labor costs,
other than service costs, that are properly allocable to the acquisition or
production of goods and are of the type subject to capitalization or allocation
under Treasury Regulation Sections 1.263A-1(e) or 1.460-5 as direct labor
costs, indirect labor costs, employee benefit expenses, or pension and other
related costs, without regard to whether the taxable entity is required to or
actually capitalizes such costs for federal income tax purposes.
(A) For purposes of this section, labor costs
include 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 deductible for federal tax purposes.
(B) Labor costs under this paragraph shall
not include any type of costs includable in subsection (f) or excluded in
subsection (g) of this section. Costs for labor that do not meet the
requirements set forth in this paragraph may still be subtracted as a cost of
goods sold if the cost is allowed under another provision of this section. For
example, service costs may be included in a taxable entity's cost of goods sold
calculation to the extent provided by subsection (f) of this section.
(2) Incorporated materials. A
taxable entity may include in its cost of goods sold calculation the cost of
materials that are an integral part of specific property produced.
(3) Consumable materials. A taxable entity
may include in its cost of goods sold calculation the cost of materials that
are consumed in the ordinary course of performing production
activities.
(4) Handling costs. A
taxable entity may include in its cost of goods sold calculation handling
costs, including costs attributable to processing, assembling, repackaging, and
inbound transportation.
(5) Storage
costs. A taxable entity may include in its cost of goods sold calculation
storage costs, including the costs of carrying, storing, or warehousing
property, subject to subsection (g) of this section, concerning excluded
costs.
(6) Depreciation, depletion,
and amortization. A taxable entity may include in its cost of goods sold
calculation depreciation, depletion, and amortization reported on the federal
income tax return on which the report under this chapter is based, to the
extent associated with and necessary for the production of goods, including
recovery described by Internal Revenue Code, §197, and property described
in Internal Revenue Code, §179.
(7) Rentals and leases. A taxable entity may
include in its cost of goods sold calculation the cost of renting or leasing
equipment, facilities, or real property directly used for the production of the
goods, including pollution control equipment and intangible drilling and dry
hole costs.
(8) Repair and
maintenance. A taxable entity may include in its cost of goods sold calculation
the cost of repairing and maintaining equipment, facilities, or real property
directly used for the production of the goods, including pollution control
devices.
(9) Research and
development. A taxable entity may include in its cost of goods sold calculation
the costs attributable to research, experimental, engineering, and design
activities directly related to the production of the goods, including all
research or experimental expenditures described by Internal Revenue Code,
§174, regardless of whether the taxable entity is the producer of the good
it sells.
(10) Mineral production.
A taxable entity may include in its cost of goods sold calculation geological
and geophysical costs incurred to identify and locate property that has the
potential to produce minerals.
(11)
Taxes. A taxable entity may include in its cost of goods sold calculation taxes
paid in relation to acquiring or producing any material, including property
taxes paid on buildings and equipment, and taxes paid in relation to services
that are a direct cost of production.
(12) Electricity. A taxable entity may
include in its cost of goods sold calculation the cost of producing or
acquiring electricity sold.
(13) A
taxable entity may include in its cost of goods sold calculation a contribution
to a partnership in which the taxable entity owns an interest that is used to
fund activities, the costs of which would otherwise be treated as cost of goods
sold of the partnership, but only to the extent that those costs are related to
goods distributed to the contributing taxable entity as goods-in-kind in the
ordinary course of production activities rather than being sold by the
partnership.
(e)
Additional costs. In addition to the amounts includable under subsection (d) of
this section, the cost of goods sold includes the following costs in relation
to the taxable entity's goods:
(1)
deterioration of the goods;
(2)
obsolescence of the goods;
(3)
spoilage and abandonment, including the costs of rework, reclamation, and
scrap;
(4) if the property is held
for future production, preproduction direct costs allocable to the property,
including storage and handling costs, as provided by subsection (d)(4) and (5)
of this section;
(5) postproduction
direct costs allocable to the property, including storage and handling costs,
as provided by subsection (d)(4) and (5) of this section;
(6) the cost of insurance on a plant or a
facility, machinery, equipment, or materials directly used in the production of
the goods;
(7) the cost of
insurance on the produced goods;
(8) the cost of utilities, including
electricity, gas, and water, directly used in the production of the
goods;
(9) the costs of quality
control, including replacement of defective components pursuant to standard
warranty policies, inspection directly allocable to the production of the
goods, and repairs and maintenance of goods; and
(10) licensing or franchise costs, including
fees incurred in securing the contractual right to use a trademark, corporate
plan, manufacturing procedure, special recipe, or other similar right directly
associated with the goods produced.
(f) Indirect or administrative overhead
costs. A taxable entity may subtract as a cost of goods sold service costs, as
defined in subsection (b)(9) of this section, that it can demonstrate are
reasonably allocable to the acquisition or production of goods. The amount
subtracted may not exceed 4.0% of total indirect and administrative overhead
costs.
(1) Any costs already subtracted under
subsections (d) or (e) of this section may not be subtracted under this
subsection.
(2) Any costs excluded
under subsection (g) of this section may not be subtracted under this
subsection.
(g) Costs
not included. The cost of goods sold does not include the following costs in
relation to the taxable entity's goods:
(1)
the cost of renting or leasing equipment, facilities, or real property that is
not used for the production of the goods;
(2) selling costs, including employee
expenses related to sales;
(3)
distribution costs, including outbound transportation costs;
(4) advertising costs;
(5) idle facility expenses;
(6) rehandling costs;
(7) bidding costs, which are the costs
incurred in the solicitation of contracts ultimately awarded to the taxable
entity;
(8) unsuccessful bidding
costs, which are the costs incurred in the solicitation of contracts not
awarded to the taxable entity;
(9)
interest, including interest on debt incurred or continued during the
production period to finance the production of the goods;
(10) income taxes, including local, state,
federal, and foreign income taxes, and franchise taxes that are assessed on the
taxable entity based on income;
(11) strike expenses, including costs
associated with hiring employees to replace striking personnel, but not
including the wages of the replacement personnel, costs of security, and legal
fees associated with settling strikes;
(12) officers' compensation;
(13) costs of operation of a facility that
is:
(A) located on property owned or leased
by the federal government; and
(B)
managed or operated primarily to house members of the armed forces of the
United States;
(14) any
compensation paid to an undocumented worker used for the production of goods,
provided that, as used in this paragraph only, the following terms shall have
the following meanings:
(A) "undocumented
worker" means a person who is not lawfully entitled to be present and employed
in the United States; and
(B)
"goods" includes the husbandry of animals, the growing and harvesting of crops,
and the severance of timber from realty; and
(15) costs funded by a partnership
contribution, to the extent that the contributing taxable entity made the cost
of goods sold deduction under subsection (d)(13) of this section.
Notes
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