Transaction facilitation services not sourced to the state
On April 12, 2016, Texas Comptroller of Public Accounts issued a private letter ruling, advising a transportation management company that the commissions it earns from matching shipping customers and transportation carriers through its proprietary online software would not be sourced to Texas for the purposes of computing its franchise tax apportionment factor because the income producing activity is the provision of matching services, which occur outside of Texas.
The company addressed in this letter ruling earns commission revenue by matching shipping customers and transportation carriers through its proprietary online software, which is housed on a server located in Arizona and allows a shipping customer to post a request for shipping, view bids on their request, and select a shipping provider. The company does not own transportation equipment, transport or take possession of its customers’ goods, control any of the shippers, or in any way act as a freight-forwarder. The company’s only connection to Texas is that it employs a small number of individuals who solicit sales within the state and perform customer service activities, such as training and addressing complaints, for Texas customers. Essentially, the company is a cloud-based transaction facilitator that performs some activities within the state that are ancillary to its revenue-generating services.
The company requested a private letter ruling from the Texas Comptroller of Public Accounts to determine how it should source its sales of cloud-based transaction facilitation services for franchise tax purposes. The Comptroller advised the company that this issue is controlled by Texas Administrative Code Sec. 3.591(e)(26), which provides that receipts from a service are apportioned to the location where the service is performed, and Comptroller’s Decision No. 104,224, under which the Comptroller advised a different company that its receipts generated by Texas customers would be sourced based on the “specific, end-product acts for which the customer contracts” take place and not the location at which “non-receipt producing, albeit essential, support activities” are performed. Based on this guidance, the Comptroller advised the company that its cloud-based transaction facilitation services would not be sourced to Texas because the activities directly related to the creation, maintenance and housing of the software solution occurred outside the state. In reaching this decision, the Comptroller determined that the ancillary activities undertaken on the company’s behalf within the state were irreverent.
Businesses engaged in cloud-based transaction facilitation services for Texas customers should review this ruling, and determine whether refunds or additional tax could be due. Further, from a broader perspective, this ruling represents a break away from a recent trend in other states, such as Florida and Indiana, where, under similar sourcing rules, services like this were sourced to the location of the customer based on the reasoning that the event that triggers the right to revenue is delivery and that any acts leading up to delivery are ancillary to the delivery itself. For more information on this sourcing approach, please read our article, Indiana: Where market-based sourcing and income-producing activity collide.
