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November 2009 TAX POLICY NEWS
a monthly newsletter about Texas tax policy

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FRANCHISE TAX

Conversion

The Texas franchise tax was revised in 2006 (House Bill 3, 79th Legislature, Third Called Session) to include partnerships, associations and other entities not previously included in the tax base. Since then, our office has received many questions about converting from one type of entity to another.

We continue to follow the policy established under the prior Texas franchise tax which considers an entity that is legally converting into another type of entity to be a continuation of the original entity. A legal conversion from one taxable entity to another taxable entity will have no effect on the entity's franchise tax filing requirement.

For more information, see Tax Requirements for Filings with the Secretary of State in the Texas Franchise Tax section of our Web site.

FRANCHISE TAX

Compensation Deduction Limit Increased to $320,000

Beginning January 2010, and for each even-numbered year thereafter, Texas Tax Code Section 171.006(b) requires adjustments to the per-person compensation deduction limit described in Section 171.1013(c).

The adjustment is based on the percentage increase or decrease in the Consumer Price Index (CPI) during the preceding state fiscal biennium, rounded to the nearest $10,000. This adjustment raises the limit on the compensation deduction to $320,000 per person for reports originally due Jan. 1, 2010, through Dec. 31, 2011.

The statute also requires that the CPI adjustment be applied to the no tax due revenue threshold in Section 171.002(d)(2) and to the discounts from tax liability in Section 171.0021. The no tax due revenue threshold was increased to $1 million by House Bill 4765, which passed this year during the 81st Legislative Session, for reports originally due Jan. 1, 2010, through Dec. 31, 2011. As a result, CPI adjustments to the no tax due revenue threshold and discounts from tax liability are unnecessary for this period.

HOTEL TAX

Government Exemptions

Editor's note: This is the third in a series of articles on hotel occupancy tax exemptions. The first article in the May 2009 Tax Policy News defined a permanent resident and discussed the basics of the exemption; the second article in the August 2009 Tax Policy News covered the rental of a range of hotel rooms.

Texas hotel tax law exempts the United States government from state and local hotel tax, but does not provide an exemption for state or local government. Local government includes cities, counties, sheriff offices, appraisal districts and other political subdivisions of the state.

The law provides that hotel tax is not imposed on the United States, U.S. government entities or U.S. government officers or employees traveling on official business for the government entity. The exclusion covers federal credit unions and their employees and foreign diplomats who have been issued a hotel tax exemption card by the U.S. Department of State. See Tax Code Sections 156.103(a), 351.006(a) and 352.007(a) and Rule 3.161(b).

State agencies and most state employees are not exempt and must pay any hotel tax imposed. Designated state employees - mostly heads of state agencies, judicial officials at the district court level and above, members of state boards and commissions and the Texas legislature - are issued a hotel tax exemption photo identification card and are exempt from state, city and county hotel taxes.

A Texas state agency may request a refund of state and local hotel tax paid to a hotel or reimbursed to a state employee. A state agency that uses the Uniform Statewide Accounting System (USAS) will receive its state hotel tax refund automatically by way of USAS. A state agency must apply directly for a tax refund of local hotel tax with the applicable city or county. See Tax Code Sections 156.103(c), 156.154, 351.006(d) and 352.007(d) and Rule 3.163.

Contractors working for the federal government or the State of Texas are not exempt.

A completed Texas Hotel Occupancy Tax Exemption Certificate (Form 12-302 (PDF, 66KB)) must be presented to the hotel to claim an exemption. Certificates may be accepted in good faith, when presented with supporting documentation required by Rule 3.161(c).

INSURANCE TAX

CAPCO Credits

The Texas Legislature established the Texas Certified Capital Company (CAPCO) program to encourage economic development focused on small and emerging businesses located in Texas. Under this program, insurance companies may invest in companies that have met requirements to become Certified Capital Companies (CAPCOs) in Texas. The CAPCOs are similar to venture capital companies that invest money in qualified businesses. Insurance companies that make an investment in a CAPCO receive a premium tax credit equal to the amount of their investment. This credit is taken over time based on the statutory maximum allowed per year. There are various credits available to insurers that may be applied to premium taxes. The credits are applied in the following order:

(1) Examination expense credits
(2) CAPCO credits
(3) Guaranty association assessment credits.

Insurance companies were granted $200 million in available tax credits under Program One of the CAPCO program. The first year that tax credits were available for certified investors from Program One was 2008 for taxes due March 2, 2009. Program Two credits from investments of an additional $200 million begin for tax year 2012 and will affect taxes due March 1, 2013.

Insurers may transfer CAPCO credits for Program One by completing Form 25-117 (PDF, 94KB), Certified Investor Annual Notification of Credit Transfer, and Form 25-118 (PDF, 56KB), Certified Investor Tax Credit Transfer Affidavit. For Program Two, Forms 25-120 (PDF, 41KB) and 25-121 (PDF, 30KB) are used. All transfers are administered on a prospective basis.

Additional information concerning the CAPCO program and credit transfers is available in Rule 3.833. The February 2009 Tax Policy News article “Certified Capital Company Tax Credits” also provides helpful information regarding this issue along with guidance to help insurers avoid penalties when making prepayments.

SALES TAX

Collocation Services

A collocation center is a type of data center where multiple customers locate network, server and storage gear and interconnect to a variety of telecommunications and network service providers. Collocation is becoming popular among companies that seek time and cost savings from using the shared data center infrastructure of a collocation center.

STAR 200908438L addresses the services provided by a collocation center. The collocation service provider generally invoices recurring charges for rack or cabinet space, Internet bandwidth and electrical power to customers locating computer hardware in its facilities. In addition to these recurring charges, the collocation service provides other collocation managed services on a stand-alone basis as requested by its customers.

Collocation Service Categories

The separately stated charges for each service fall into various categories as described below.

Real Property Rental

Below are charges which are, or may be, associated with the rental of real property.

The lease of rack space or cabinet space is the rental of real property, which is not taxable to the customer.

Electricity to power the customer's equipment is taxable to the collocation service provider rather than to its customers, since it is incidental to the rental of real property. A charge for installing power strips which remain the collocation service's property is similarly nontaxable to its customers since it is incidental to the rental of real property. See Rule 3.294(k)(1).

Migration consultation, design and move-in services sold solely in conjunction with a nontaxable item, such as a collocation lease, are not taxable. These migration services are taxable if they are part of the sales price of taxable items such as servers or additional bandwidth.

Tape storage and rotation that are part of the collocation lease are not taxable, provided that the collocation service does not perform any data processing. Tape rotation and storage are taxable when performed as part of a taxable data processing service.

Telecommunication Services

Cross-connection and bandwidth services are taxable telecommunication services. The collocation service must collect tax on the charge for these services including the cost of installation, labor and related cabling billed to its customers. The collocation service may issue a resale certificate to the telecommunications service provider in lieu of paying tax on these bandwidth and cross connection services at the time of purchase.

Repair of Tangible Personal Property

A collocation service's charge to repair a customer's computer hardware is subject to sales tax.

Nontaxable Services

Below are examples of nontaxable services that a collocation service may provide for its customers.

A charge for monitoring equipment used by the customer purchasing collocation space is not taxable. Examples include observing equipment response time or availability and analyzing problem connections. A collocation service owes tax when purchasing the hardware and software it uses to provide nontaxable monitoring services, including monitoring devices such as servers, routers and other devices attached to a network.

Installing monitoring software is not taxable to the customer, provided the collocation service is not selling the software to the customer.

Unpacking, moving and installing the customer's equipment into the collocation rack space or cabinet is not taxable, provided the collocation service did not sell the equipment to the customer.

Tracing and labeling data and power cables is not taxable when purchased by the customer in conjunction with a nontaxable collocation lease or provided as part of a nontaxable installation service.

Powering down equipment and then powering it up again is not taxable.

Installing software patches and software modifications on software the collocation service did not sell is not taxable.

Troubleshooting equipment or databases without repair or modifications being made is not taxable.

Accepting items shipped to the collocation service's location on behalf of the customer is not taxable as long as the collocation service did not sell the items to the customer.

Facilitating shipping items to the customer or for the customer, at the customer's request, is not taxable as long as the collocation service did not sell the items to the customer.

Escorting the customer or the customer's third party vendor to the customer's collocation area is not taxable.

Real Property Remodeling

Installation by a third party vendor of cabling through the ceiling, walls and floor of the collocation service's building is taxable to the collocation service as real property remodeling. If the collocation service charges and performs the cabling as part of the customer's rack space rental, the charge is not taxable to the customer.

Data Processing Services

The following services are taxable as data processing. Twenty percent of the charge for data processing is exempt. Tax is due on 80 percent of the charge.

Tape backup involves the storage and manipulation of data and is taxable as data processing.

Server imaging (delivery of images) as a part of data backup service involves the storage and manipulation of data and is taxable as data processing.

A software license purchased by the collocation service on behalf of the customer, installed on the customer's computer and used by the collocation service to facilitate data backup service is taxable to the customer as data processing, along with any charges for software installation. This is true whether the software and installation are billed as a lump sum with the data backup (data processing) or as separate line items. The collocation service owes tax on, and may not issue a resale certificate for, software used to facilitate the taxable data processing service because care, custody and control of the software are not transferred to the customer.

Storage area network (SAN) fiber channel storage is data storage and backup, and is taxable as data processing.

SALES TAX

'Tis the Season - Holiday Goods and Services

Decorations

Holiday Trees, Greenery and Flowers

In general, sales tax is due on sales of Christmas trees, mistletoe, holly, poinsettias and other greenery. Tax is not due, however, on trees, greenery and flowers sold during a tax-free sale by an organization that is exempt from sales tax on the Comptroller's records .

For more information on sales by exempt organizations, see Exempt Organizations: Sales and Purchases (Pub. 96-122 (PDF, 405KB) ) and Rule 3.322.

Renting Decorations

If a decorator uses his or her own decorations, the rental charge and installation are taxable as the rental of tangible personal property.

Tree Decorating

When the customer provides the decorations, the charge to decorate a tree is not taxable.

When a decorator both sells or rents the decorations to the customer and decorates the tree, the total charge is taxable.

Home Decorating

Charges to decorate a residence are not taxable when the customer provides the materials.

If a decorator sells or rents the materials to the customer and provides the decorating service, the total charge for the materials and labor is taxable.

Decorating an Office or Other Nonresidential Structure

The labor charge to remodel nonresidential real property is taxable. Remodeling includes such activities as painting, running electric or other cables and installing permanent fixtures in real property. So when a decorator installs permanent hangers or other fixtures as part of the decorating service, the charge is taxable. When a decorator sells or rents the decorations to the customer and installs the decorations, the total charge is taxable.

If a decorator uses decorations provided by the customer and merely installs the decorations in the building without remodeling it, the charge is not taxable.

Window Painting

Charges to paint holiday pictures and messages on nonresidential windows are taxable as the taxable remodeling of a nonresidential structure. The paint used to perform the service can be purchased tax free by issuing a properly completed resale certificate (PDF, 76KB) since the paint is transferred to the care, custody and control of the purchaser in the course of performing the taxable service.

Holiday Foods

Bakery Products

Bread, rolls, cakes, cookies and other bakery products are not taxable unless they are sold with plates or eating utensils.

Prepared Meat

Prepared meat, such as turkey and ham, kept hot and ready to eat is taxable whether sold whole or cut into pieces.

A smoked turkey or ham that is not kept hot is taxable only if sold with eating utensils.

A charge to a customer to smoke a turkey or ham owned by the customer is not subject to tax.

Prepared Holiday Meals

A complete holiday meal (such as turkey with all the trimmings) that is sold hot and ready to eat is taxable. If the meal needs further preparation or heating, it is not taxable.

Other Holiday Items and Services

Firewood

The sale of firewood is taxable as the sale of tangible personal property.

Chopping down a tree or cutting up a fallen tree (other than in a disaster area) is a taxable real property service.

Charges for stacking wood after a tree has been cut and charges to remove a tree or debris are also taxable.

Gift Wrapping

When the store that sold a taxable item also wraps the item for the customer, the gift wrapping charge is taxable as the sale of a service in conjunction with the sale of a taxable item. Gift wrapping is not a taxable service when an item is purchased at one store and the customer takes it to another store to be wrapped.

Layaways

A handling fee charged by a retailer to put an item on layaway is not subject to sales tax. Similarly, a cancellation fee charged by a retailer on a canceled layaway purchase is not taxable. A restocking fee is not taxable.

RECENTLY PROPOSED RULES

The Comptroller's office filed the following rule with the Texas Secretary of State for publication in the Nov. 20, 2009, issue of the Texas Register. The comment period is 30 days after publication.

Prepaid Higher Education Tuition Program

Section 7.81 - Refunds

ABOUT THE NEWSLETTER

The Comptroller's office publishes this newsletter to keep you informed about state taxes. Tax questions can be complicated, so please use these summaries as guidelines only.

For a Copy of a Proposed Rule

For a copy of a proposed rule or information about a proposed rule, write to Bryant Lomax, Tax Policy Division, 1700 North Congress Avenue, Austin, Texas, 78701-1436, or submit a request via Texas Tax Help.

For Publications, Rules or Other Tax Information

For a wealth of tax information sorted by tax type or by subject matter, please visit the Texas Taxes section of our Web site.

Contributors to This Month's Issue

Teresa Bostick, Robin Corrigan, Don Dillard, Gary Johnson, Carol McAnnally, Jerry Oxford, Viki Smith, Karen Snyder and Jennifer Specchio

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