United States

Texas comptroller denies COGS deduction for technology service provider

TAX BLOG  | 

A recent court case emphasizes that the burden of proof is on the taxpayer when it comes to claiming deductions. On May 17, 2016, the Texas Comptroller of Public Accounts released a decision denying the costs of goods sold (COGS) deduction for costs incurred by a taxpayer in the business of information technology consulting services because the taxpayer did not demonstrate it was entitled to the deduction.

The taxpayer entered into service agreements with a company to provide contract workers for various technology services to that company’s customers. The services were charged based on approved time entries.

The taxpayer also agreed to terms allowing the customer companies to have exclusive, unlimited ownership rights to all results of any services performed by the contract workers, including any and all types of intellectual property rights, software and computer programs. Additional agreements were submitted as evidence under review, but were executed outside the periods at issue.

Significant to the decision was the fact it was not clear whether the taxpayer was selling software and that the taxpayer agreements indicated that the customers maintained exclusive ownership of the software, thus disqualifying the deduction within the meaning of Texas Administrative Code section 3.588(c)(8), which requires that an entity “own the goods” sold.

Although the Texas courts have recently been expanding the applicability of the COGS deduction, it is not surprising the comptroller took this position considering the evidence submitted.

The lesson? Always review your business activities to determine whether a COGS position can be substantiated under audit.


Mike Williams

Partner