Texas Comptroller Limits Telecommunications Company’s COGS Deduction

The Texas Comptroller of Public Accounts recently upheld a decision by the Administrative Law Judge (ALJ) to limit a telecommunications company's cost of goods sold (COGS) deduction for purposes of the Revised Texas Franchise Tax (RTFT) to those costs incurred in purchasing certain telephone equipment that was sold to its customers in the regular course of business.1 On the report filed, the taxpayer had sought to include in its COGS deduction, a deduction for costs associated with the telecommunications products provided to its customers. The ALJ determined that the telecommunications products sold by the taxpayer were services and therefore, inclusion of costs related to those services was improper.

Background

The taxpayer, a telecommunications company that received substantially all of its revenue from the sale of certain "telecommunications products" such as local and long distance telephone, Internet access and video telecommunications products, also derived a minimal amount of revenue from the sale of "telephone equipment," such as multi-line telephones and headsets. On its 2008 report, the taxpayer claimed a COGS deduction for costs associated with both the sale of its telephone equipment and its telecommunications products. A desk audit was performed, whereby the Comptroller disallowed the entire COGS deduction based on the overall determination that the taxpayer sold services and not tangible personal property. Therefore, the Comptroller determined that the taxpayer was required to compute its taxable margin based on 70 percent of its total revenues.

The taxpayer requested a redetermination, and the matter was assigned to the State Office of Administrative Hearings. At the hearing, the Comptroller conceded that those costs associated with the purchase of telephone equipment were deductible, but those costs associated with the sale of the taxpayer's telecommunications products were not. Since the total COGS deduction after the change would still have been less than 30 percent of the taxpayer's revenues, the Comptroller determined that the use of the 70 percent methodology was proper and therefore, denied the taxpayer's refund claim. The ALJ recommended that the audit assessment be affirmed, and the Comptroller subsequently adopted the ALJ's recommendation.

Computation of Revised Texas Franchise Tax

The RTFT, for reports due on or after January 1, 2008, is imposed on a combined unitary basis.2 The tax base is generally total revenues...