|
|
SOAH DOCKET NO. 304-22-0679.13
CPA HEARING NO. 116,701
RE: **************
TAXPAYER NO: **************
AUDIT OFFICE: **************
AUDIT PERIOD: January 1, 2014 THROUGH December 31, 2014
SOAH DOCKET NO. 304-22-0680.13
CPA HEARING NO. 116,702
RE: **************
TAXPAYER NO: **************
AUDIT OFFICE: **************
AUDIT PERIOD: January 1, 2015 THROUGH December 31, 2015
SOAH DOCKET NO. 304-22-0681.13
CPA HEARING NO. 116,703
RE: **************
TAXPAYER NO: **************
AUDIT OFFICE: **************
AUDIT PERIOD: January 1, 2016 THROUGH December 31, 2016
SOAH DOCKET NO. 304-22-0682.13
CPA HEARING NO. 116,704
RE: **************
TAXPAYER NO: **************
AUDIT OFFICE: **************
AUDIT PERIOD: January 1, 2017 THROUGH December 31, 2017
Franchise Tax/RDT
BEFORE THE COMPTROLLER
OF PUBLIC ACCOUNTS
OF THE STATE OF TEXAS
GLENN HEGAR
Texas Comptroller of Public Accounts
SARAH BERRY
Representing Respondent
**************
Representing Petitioner
COMPTROLLER’S DECISION
This decision is considered final on May 17, 2022, unless a motion for rehearing is timely filed; this date of finality is calculated based on the Administrative Procedure Act (APA).[1] The failure to timely file a motion for rehearing may result in adverse legal consequences.
Administrative Law Judge (ALJ) Matt Jones of the State Office of Administrative Hearings (SOAH) issued a Proposal for Decision (PFD) that includes Findings of Fact and Conclusions of Law. SOAH served the PFD on each party and each party was given an opportunity to file exceptions and replies with SOAH in accordance with SOAH’s rules of procedure. The ALJ recommended that the Comptroller adopt the PFD as written.
After review and consideration, IT IS ORDERED that the PFD is adopted as written.
The results from this Decision are Attachments A. The ALJ’s letter to the Comptroller is Attachment B. The PFD as written is Attachment C. Attachments A, B, and C are incorporated by reference.
Attachments A reflect a zero amount due in Hearing No. 116,701, credits owed to Petitioners in Hearing Nos. 116,702 and 116,703 and a liability in Hearing No. 116,704. [2]
The credit will be processed after the date the comptroller’s decision is final. The parties may waive the right to file a motion for rehearing to expedite the processing of the credit. A waiver of rehearing or motion for rehearing may be filed as described above. The total sum of the tax, penalty, and interest is due and payable 20 days after a comptroller’s decision becomes final.[3] If such sum is not timely paid, an additional penalty of 10 percent of the taxes due will accrue.
SIGNED on this 22nd day of April 2022
GLENN HEGAR
Comptroller of Public Accounts
By: Lisa Craven
Deputy Comptroller
Attachments A, Texas Notifications of Hearing Results
Attachment B, ALJ’s letter to the Comptroller
Attachment C, Proposal for Decision as written
ATTACHMENT C
SOAH DOCKET NO. 304-22-0679.13
TCPA DOCKET NO. 116,701
**************
Taxpayer No. **************
SOAH DOCKET NO. 304-22-0680.13
TCPA DOCKET NO. 116,702
**************
Taxpayer No. **************
SOAH DOCKET NO. 304-22-0681.13
TCPA DOCKET NO. 116,703
**************
Taxpayer No. **************
SOAH DOCKET NO. 304-22-0682.13
TCPA DOCKET NO. 116,704
**************
Taxpayer No. **************
v.
TEXAS COMPTROLLER OF PUBLIC ACCOUNTS
BEFORE THE STATE OFFICE OF ADMINISTRATIVE HEARINGS
PROPOSAL FOR DECISION
The Tax Division (Staff) of the Texas Comptroller of Public Accounts (Comptroller) audited ************** (Petitioner) for franchise tax compliance. Staff made numerous adjustments to Petitioner’s revenue, apportionment factor, and cost of goods sold (COGS) calculations for report years 2014 through 2017. Staff’s adjustments resulted in a credit for 2014 and assessments for the other years that included tax and interest. Penalties were waived for 2015 and 2016. Petitioner disagreed with the reduction in its COGS calculation and requested redetermination. Petitioner contends it should be allowed to include benefit obligations for a subsidiary’s retired employees as COGS. Staff maintains the obligations do not qualify as COGS because the subsidiary is no longer acquiring or producing goods. In this Proposal for Decision, the Administrative Law Judge (ALJ) agrees with Staff and recommends affirming the audit results.
I. PROCEDURAL HISTORY, NOTICE, AND JURISDICTION
Staff referred the contested cases to the State Office of Administrative Hearings (SOAH) and, on November 16, 2021, issued Notices of Hearing to Petitioner. On November 22, 2021, ALJ Matt Jones issued Order No. 1, which joined the cases and set out pre-hearing requirements. On January 25, 2022, the ALJ convened a videoconference hearing on the merits. The record closed February 4, 2022. INDIVIDUAL A of COMPANY A. represented Petitioner, and Sarah Berry represented Staff.
There are no issues of notice or jurisdiction; therefore, those matters are set out in the Findings of Fact and Conclusions of Law without further discussion.
II. REASONS FOR DECISION
A. Evidence
Staff called auditor Paul Natalino to testify and submitted the following exhibits for each hearing:
1. Sixty-Day Notification Letter;
2. Texas Notification of Audit Results;
3. Audit Report;
4. Audit Plan; and
5. Tax Policy Response.
For the 2015, 2016, and 2017 report year hearings, Staff also submitted the Penalty and Interest Waiver Worksheet. Staff’s exhibits were admitted without objection.
INDIVIDUAL B, a consultant for Petitioner, testified on its behalf. Petitioner also submitted the following exhibits for each case:
1. Texas Tax Code Chapter 171;
2. 34 Tex. Admin. Code§ 3.588(d);
3. Treasury Regulation § 1.263A‐1 Uniform Capitalization of Costs;
4. Comptroller Decision No. 110,597 (2014);
5. Reply to Position Letter; and
6. Combs v. Newpark Resources, Inc. 422 S.W.3d 46 (Tex. App.—Austin 2013, no pet.)
Staff objected to Petitioner’s exhibits as not being evidentiary. The ALJ overruled the objection and admitted the exhibits.
B. Agreed Adjustments
Staff did not agree to adjust the audits.
C. Issues and Facts Established by the Evidence
Petitioner was the reporting entity for its combined group for franchise tax purposes during the 2014 through 2017 report years at issue. The combined group consisted of commonly controlled affiliates primarily engaged in worldwide manufacturing.
One of the controlled affiliates was COMPANY B. COMPANY B was a manufacturer until 2006, when it sold its operating assets. However, COMPANY B continued to maintain benefit obligations for retired employees. The benefits accrued during years COMPANY B manufactured goods, but the costs were not paid until later, including the report years at issue. For federal tax purposes, Petitioner reported these costs when paid as a current expense on Line 23 of Form 1120 (pension, profit-sharing, etc., plans). For Texas franchise tax purposes, Petitioner included COMPANY B’s benefit obligation costs in its COGS calculation.
In November 2017, Staff initiated franchise tax compliance audits of Petitioner’s combined group. Staff adjusted Petitioner’s revenue, apportionment factor, and COGS. The adjustments included denying a COGS deduction for COMPANY B’s benefit obligation expenses.
On September 19, 2018, Staff issued Texas Notifications of Audit Results to Petitioner. The audit resulted in a credit for 2014; tax and interest due for 2015 and 2016; and tax, penalties, and interest due for 2017. Petitioner timely requested redetermination contending the auditor erred by denying the COGS deduction for COMPANY B’s benefit obligations.
D. ALJ’s Analysis and Recommendations
Because Petitioner contends Staff’s reduction of its COGS deductions is in error, Petitioner’s burden of proof is preponderance of the evidence. See Sunstate Equipment Company, L.L.C. v. Hegar, 601 SW 3d 685 (Tex. 2020).
Taxable entities that are part of an affiliated group engaged in a unitary business shall file a combined group report in lieu of individual reports based on the combined group’s business. Tex. Tax Code § 171.1014(a). For franchise tax purposes, the combined group is a single taxable entity. Id. § 171.1014(b).
Franchise tax is imposed on each taxable entity that does business in this state or that is chartered or organized in this state. Id. § 171.001. Taxable margin is determined by calculating 70% of total revenue from the entity’s total business, or by subtracting, at the election of the taxpayer, either COGS or compensation. Id. §§ 171.101(a)(1), .1011-.1013. A taxable entity that elects to subtract COGS for the purpose of computing its taxable margin is entitled to include all direct costs of acquiring or producing goods. Id. § 171.1012. COGS is determined in accordance with the methods used on the federal income tax return on which the report is based, but this does not affect the type or category of COGS that may be subtracted. See 34 Tex. Admin. Code § 3.588(c)(12).
COGS includes 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 §§ 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. 34 Tex. Admin. Code § 3.588(d)(1).
Pension and employee benefit expenses are indirect costs that must be capitalized to the extent they are properly allocable to property produced. 26 C.F.R § 1.263A-1(e)(3). Contributions to employee plans representing past services must be capitalized in the same manner (and in the same proportion to property currently being acquired or produced) as amounts contributed for current service. Id. § 1.263A-1(e)(3)(ii)(C).
In this case, COMPANY B was obligated to make the payments at issue on behalf of production employees under a collective bargaining agreement. The costs were accrued during years in which COMPANY B was producing goods. However, the costs were not deductible, for federal tax purposes, until the costs were actually paid. See I.R.C. § 404(a)(1)(A). Finally, there is no dispute benefit obligation costs fall within COGS for Texas franchise tax purposes.
COMPANY B’s retirement benefit costs are generally the type subject to capitalization or allocation under Treasury Regulation §§ 1.263A-1(e) or 1.460-5. See 34 Tex. Admin. Code § 3.588(d)(1). However, capitalization of contributions to employee plans representing past services must be capitalized in the same manner (and in the same proportion to property currently being acquired or produced) as amounts contributed for current service. See 26 C.F.R § 1.263A-1(e)(3)(ii)(C). This provision limits the retirement benefit costs that may be capitalized. In this case, because COMPANY B is not acquiring or producing goods, the retirement costs eligible for capitalization are zero. Therefore, these expenses are not the type subject to capitalization or allocation under Treasury Regulation §§ 1.263A-1(e) or 1.460-5.
Petitioner argues the expenses remain eligible COGS deductions. According to Petitioner, because it and other members of the combined group continue to produce goods, it is entitled to a COGS subtraction for Texas franchise tax purposes. Petitioner argues it may include the costs of its subsidiaries, including COMPANY B, in its COGS subtraction.
Petitioner is correct that a combined group will be treated as a single taxable entity. See Combs v. Newpark Res., Inc., 422 S.W.3d 46, 47 (Tex. App.—Austin 2013, no pet.). However, the combined group is limited to eligible COGS deductions. Sunstate Equip. Co., LLC v. Hegar, 601 S.W.3d 685, 693 (Tex. 2020) (“we next turn to the question of which, if any, costs Sunstate is entitled to subtract in determining its taxable margin.”). As explained above, the costs are not the type eligible for capitalization or allocation under Treasury Regulation §§ 1.263A-1(e) or 1.460‑5. Therefore, they are not eligible for the COGS deduction and Petitioner’s contention should be denied.
III. FINDINGS OF FACT
1. ************** (Petitioner) was the reporting entity for its combined group for franchise tax purposes during the 2014 through 2017 report years at issue.
2. Petitioner’s combined group consisted of commonly controlled affiliates primarily engaged in worldwide manufacturing.
3. One of the affiliates was COMPANY B.
4. COMPANY B was a manufacturer until 2006, when it sold its operating assets.
5. COMPANY B continued existing after 2006 to maintain benefit obligations for retired employees. The benefits accrued during years COMPANY B manufactured goods, but the costs were not paid until later, including the report years at issue.
6. For federal tax purposes, Petitioner reported COMPANY B’s retirement benefit costs when paid as a current expense on Line 23 of Form 1120 (pension, profit-sharing, etc., plans).
7. For Texas franchise tax purposes, Petitioner included COMPANY B’s benefit obligation costs in its cost of goods sold (COGS) calculation.
8. In November 2017, the Tax Division (Staff) of the Texas Comptroller of Public Accounts (Comptroller) initiated franchise tax compliance audits of Petitioner’s combined group.
9. Staff adjusted Petitioner’s revenue, apportionment factor, and COGS. The adjustments included denying a COGS deduction for COMPANY B’s benefit obligation expenses.
10. On September 19, 2018, Staff issued Texas Notifications of Audit Results to Petitioner.
11. The audits resulted in a credit for 2014; tax and interest due for 2015 and 2016; and tax, penalties, and interest due for 2017.
12. Petitioner timely requested redetermination.
13. On November 4, 2021, Staff referred the contested cases to the State Office of Administrative Hearings (SOAH), and hearings were set.
14. Staff issued Notices of Hearing to Petitioner. The notices contained the date, time, and location of the hearings; a statement of the nature of the hearings; a statement of the legal authority and jurisdiction under which the hearings were to be held; a reference to the particular sections of the statutes and rules involved; and a short, plain statement of the factual matters asserted or an attachment that incorporated by reference the factual matters asserted in the complaints or petitions filed with the state agency.
15. On November 22, 2021, the Administrative Law Judge issued Order No. 1, which joined the cases and set pre-hearing requirements.
16. On January 25, 2022, a hearing on the merits convened via Zoom.
17. The record closed on February 4, 2022.
IV. CONCLUSIONS OF LAW
1. The Comptroller has jurisdiction over this matter. See Tex. Tax Code ch. 111.
2. SOAH has jurisdiction over matters related to these hearings, including the authority to issue a proposal for decision with findings of fact and conclusions of law. See Tex. Gov’t Code ch. 2003.
3. Staff provided proper and timely notice of the hearings. See Tex. Gov’t Code ch. 2001; Tex. Tax Code §§ 111.009, .105.
4. Because Petitioner contends Staff’s reduction of its COGS deductions is in error, Petitioner’s burden of proof is preponderance of the evidence. See Sunstate Equipment Company, L.L.C. v. Hegar, 601 SW 3d 685 (Tex. 2020).
5. Taxable entities that are part of an affiliated group engaged in a unitary business shall file a combined group report in lieu of individual reports based on the combined group’s business. Tex. Tax Code § 171.1014(a).
6. For franchise tax purposes, the combined group is a single taxable entity. Tex. Tax Code § 171.1014(b).
7. Franchise tax is imposed on each taxable entity that does business in this state or that is chartered or organized in this state. Tex. Tax Code § 171.001.
8. Taxable margin is determined by calculating 70% of total revenue from the entity’s total business, or by subtracting, at the election of the taxpayer, either COGS or compensation. Tex. Tax Code §§ 171.101(a)(1), .1011-.1013.
9. A taxable entity that elects to subtract COGS for the purpose of computing its taxable margin is entitled to include all direct costs of acquiring or producing goods. Tex. Tax Code § 171.1012.
10. COGS is determined in accordance with the methods used on the federal income tax return on which the report is based, but this does not affect the type or category of COGS that may be subtracted. See 34 Tex. Admin. Code § 3.588(c)(12).
11. COGS includes 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 §§ 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. 34 Tex. Admin. Code § 3.588(d)(1).
12. Pension and employee benefit expenses are indirect costs that must be capitalized to the extent they are properly allocable to property produced. 26 C.F.R. § 1.263A-1(e)(3).
13. Contributions to employee plans representing past services must be capitalized in the same manner (and in the same proportion to property currently being acquired or produced) as amounts contributed for current service. 26 C.F.R. § 1.263A-1(e)(3)(ii)(C).
14. COMPANY B’s costs were not deductible, for federal tax purposes, until the costs were actually paid. See I.R.C. § 404(a)(1)(A).
15. COMPANY B’s retirement benefit costs are generally the type subject to capitalization or allocation under Treasury Regulation §§ 1.263A-1(e) or 1.460-5. See 34 Tex. Admin. Code § 3.588(d)(1).
16. Because COMPANY B is not acquiring or producing goods, the retirement costs eligible for capitalization are zero. See 26 C.F.R § 1.263A-1(e)(3)(ii)(C).
17. COMPANY B’s retirement expenses are not the type subject to capitalization or allocation under Treasury Regulation §§ 1.263A-1(e) or 1.460-5.
18. A combined group will be treated as a single taxable entity. See Combs v. Newpark Res., Inc., 422 S.W.3d 46, 47 (Tex. App.—Austin 2013, no pet.).
19. The combined group is limited to eligible COGS deductions. Sunstate Equip. Co., LLC v. Hegar, 601 S.W.3d 685, 693 (Tex. 2020) (“we next turn to the question of which, if any, costs Sunstate is entitled to subtract in determining its taxable margin.”).
29. COMPANY B’s retirement costs are not the type eligible for capitalization or allocation under Treasury Regulation §§ 1.263A-1(e) or 1.460‑5.
21. Petitioner’s contention should be denied.
22. The audits should be affirmed.
SIGNED February 18, 2022.
MATT JONES
ADMINISTRATIVE LAW JUDGE
STATE OFFICE OF ADMINISTRATIVE HEARINGS
ENDNOTES:
[1] The date calculated is 25 days after this decision is signed. See APA, Tex. Gov’t Code § 2001.146(a); S.B. 1095, Acts 2017, 85th Leg. For additional guidance, refer to the Frequently Asked Questions Related to Motions for Rehearing, found here: http://comptroller.texas.gov/taxes/publications/96-1789.pdf
[2] At present, insufficient information is available to determine which items and amounts are disputed or undisputed for purposes of Tex. Tax Code, Ch. 112. In the absence of this information, the Comptroller will assume the entire amount of the assessment, as it appears in Comptroller’s Decision Attachment A, the Notification of Hearing Results, remains in dispute. If Petitioner intends to sue the comptroller to dispute an amount of tax, penalty, or interest assessed in a deficiency redetermination or jeopardy determination under Tex. Tax Code, Ch. 111, Petitioner is required to file a motion for rehearing that “states the specific grounds of error and the disputed amounts associated with the grounds of error.” Tex. Tax Code § 112.201(a)(3). Petitioner should refer to Tex. Tax Code, Ch. 112, for further guidance regarding a suit after redetermination.