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September 2011 TAX POLICY NEWS
a monthly newsletter about Texas tax policy

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Special Note: The Comptroller is pleased to announce the launch of our new www.GetReadyTexas.org webpage. This new page contains information for commercial agriculture and timber producers on the new Ag/Timber Registration Number required for sales tax exemptions on eligible purchases beginning Jan. 1, 2012. It also features a link to the online application as well as other information about this new requirement.

COIN-OPERATED AMUSEMENT MACHINE TAX

Renewal Applications Due by Nov. 30

Renewal applications for a 2012 coin-operated amusement machine General Business License, Registration Certificate, Import License and Repair License are being mailed in September and are due by Nov. 30, 2011. The Coin-Operated Machines Law, in Occupations Code Section 2153.162, provides that renewal applications, inventory forms and payments that are postmarked by November 30 will be timely filed. Renewal applications mailed in December must include a $50 late fee.

In addition to the renewal fee, the law requires payment of a $60 Occupation Tax for each coin-operated amusement machine that is “exhibited or displayed on location.” An Occupation Tax Permit sticker (decal) must be affixed to each machine in use.

For information on license and registration fees and tax permits, including a fee schedule, see the Coin-Operated Machines Tax section of our website.

Coin-operated amusement machine operators who have not received renewal packets by Oct. 31 may request one by contacting our office at 1-800-252-1385.

FRANCHISE TAX

Combined Groups with Business Loss Carryforward Preserved Must Verify Certain Information

The revised franchise tax, under Tax Code Section 171.111, allows an entity to take a credit based on its business loss carryforward as of Jan. 1, 2008, but only if the entity preserved its business loss carryforward with its 2008 franchise tax report. Subsection (d) of this section does not allow the credit to be conveyed, assigned or transferred, and an entity loses the right to claim the credit if the entity changes combined groups after June 30, 2007.

To determine if an entity has changed combined groups, the Comptroller's office will send a letter on Oct. 1, 2011, to the reporting entities of all combined groups that claimed a temporary credit for business loss carryforward on a 2008, 2009 or 2010 franchise tax report. The letter requires the reporting entities to provide the name of the entity or individual that owned, directly or indirectly, more than 50 percent of all of the entities included on the combined report. The reporting entity must also include the Texas business loss carryforward as of Jan. 1, 2008, for each affiliate that filed a preservation form in 2008 or that was the basis of a temporary credit for business loss carryforward claimed on the franchise tax report.

This information must be provided by Oct. 31, 2011. Failure to provide the information will result in the loss of any temporary credit claimed on the 2008 through 2011 franchise tax reports and any temporary credit allowed for future franchise tax reports.

Additionally, for reports due on or after Jan. 1, 2012, the reporting entity of a combined group with a temporary credit for business loss carryforward preserved for itself and/or its affiliates must submit common owner information each year by the due date of the report. This information is necessary to satisfy franchise tax filing requirements, even if the combined group is not claiming the credit on the current year's report. For 2012, the common owner information must be submitted online. The 2012 Franchise Tax Report Instructions will provide additional information regarding this admission.

INSURANCE TAX

The Nonadmitted and Reinsurance Reform Act and Principal Place of Business

The Nonadmitted and Reinsurance Reform Act (NRRA) became effective on July 21, 2011. The basic tax component of this act is that only the home state of the insured can tax a multistate insurance policy; however, states may join a compact or other agreement to allocate the taxes among the states afforded coverage under such policies. The act defines “home state” as the principal place of business for an entity or the principal residence of an individual, but fails to define principal place of business. A definition of this location is crucial for the proper allocation and taxation of surplus lines and independently procured insurance and to achieve uniformity under the federal law. In general, there are two predominant, competing approaches in defining a corporation's principal place of business: the nerve center approach and the activities or place of operations approach.

The nerve center approach looks at where the executive officers hold meetings and make high-level decisions. The state from which the officers provide direction, control and coordination is deemed to be the principal place of business under this approach.

The activities or place of operations approach focuses on the location of a corporation's day-to-day business activities and operations, which is not necessarily the entities' headquarters.

In the absence of any guidance in the NRRA to determine the principal place of business, some states are looking to Hertz v. Friend, a Supreme Court case on diversity jurisdiction.

In Hertz v. Friend, the Supreme Court unanimously adopted the nerve center test so that the principal place of business refers to the center of corporate “direction, control, and coordination,” which is usually a corporation's headquarters.

One of the attempts at modernizing insurance laws and providing uniformity among states was the State Modernization and Regulatory Transparency Act (SMART Act), introduced in the House of Representatives in 2004. While the SMART Act failed to advance, Title VIII of the SMART Act was eventually incorporated into the Dodd-Frank Act as the Nonadmitted and Reinsurance Reform Act.

Although Title VIII did not contain a definition of principal place of business, Title VI of the SMART Act that relates to Commercial Property and Casualty Insurance did provide some guidance regarding principal place of business in the definition of home state for commercial policyholders: “...the term ‘Home State’ means the State where the commercial policyholder has its principal place of business (such as where the policyholder's headquarters are located, as determined by the predominant physical location in the United States of the officers and senior management of the policyholder.)”

The Comptroller's office has concluded that a definition that mirrors the finding in the Hertz v. Friend Supreme Court jurisdiction case is reasonable and will be used to determine the principal place of business for surplus lines and independently procured policies. The principal place of business is that location from which the officers provide direction, control and coordination, and where the executive officers hold meetings and make high-level decisions. This location is also generally considered the predominant physical location of the business in the United States.

SALES TAX

2011 Law Changes – No Prior Contract Exemptions Authorized

We have been asked whether the Comptroller's office will recognize any prior contract exemptions in relation to the changes to Texas tax laws resulting from house and senate bills passed during the 82nd Legislature Regular Session and the 82nd Legislature, 1st Called Session.

Rule 3.319 (Prior Contracts) provides that only when there is enabling legislation can the Comptroller recognize a prior contract exemption based on a change in the tax rate or tax base. The legislature did not provide for such enabling legislation in relation to the various changes made in the tax base, so the Comptroller has no legal authority to recognize any exemptions based on contracts that existed before the effective date of any changes in the taxability of items.

For example, Senate Bill 1, from the 1st Called Session, made changes to the types of items that qualify for the sale for resale exemption under Tax Code Section 151.006. Because there is no prior contract exemption that applies, items purchased under a contract existing before the effective date of SB 1 that qualified for a sale for resale exemption will no longer qualify when SB 1 takes effect on October 1 if the law regarding those items has changed.

SALES TAX

Bakery Items – Let Them Bake Cake!

Recent law changes allow Texans to legally sell baked goods, canned jams or jellies, and dried herbs or herb mixes they have created in their homes. (Senate Bill 81, 82nd Legislature, Regular Session amended Section 437.001 of the Texas Health and Safety Code). The amendment says "baked goods" include cookies, cakes, breads, Danishes, donuts, pastries, pies and other items baked in an oven, but exclude a potentially hazardous food item as defined by department rule.

The amendment does not:

Taxability of Bakery Items

For Texas sales and use tax purposes, bakery items are defined as baked goods typically made by bakeries, including bread, rolls, buns, biscuits, bagels, croissants, pastries, doughnuts, Danishes, cakes, tortes, pies, tarts, muffins, bars (such as lemon bars), cookies, large pretzels and tortillas. See Tax Code Section 151.314(c-3) and Comptroller Rule 3.293.

Bakery items are taxable only when sold on a plate or with other eating utensils such as forks, knives and spoons. Napkins are not considered eating utensils. A bakery item is considered to be served with eating utensils if the seller actually hands the utensils to the customer or places the utensils on a tray or plate. It does not include situations when a seller provides a central station where customers can help themselves to items such as forks, knives, spoons, straws and napkins.

The taxability of bakery items is not affected by:

  • the size or quantity of the bakery items;
  • whether they are kept refrigerated or sold heated; or
  • whether they are baked on the premises where sold or offsite.

Jams, jellies, herbs and herb mixes are exempt as food items under Comptroller Rule 3.293.

Edible candy decorations, candy sprinkles, toys and similar items are often used to decorate cakes. As a general rule, candy is taxable, but confections used exclusively for cooking (such as chocolate sprinkles) are not. Items such as nonpareils, candy pearls, dragees and chocolate chips are not taxable. Tax must be paid, however, when purchasing inedible items such as toys, plastic cake toppers, picks, floral decorations and candles that will be incorporated into the final product (a nontaxable baked item).

Let's take some of the above information and put it into some everyday scenarios:

Jane bakes special occasion cakes and sells them from her home. The cakes are special-ordered and decorated to the customer's specifications. Jane is not required to collect sales tax on the sale of her cakes, but she must pay tax on any inedible items, such as birthday candles, included in the final product.

A mom ordered two dozen cupcakes from Jim's cupcake business for her son's birthday party. The sale of the cupcakes is not subject to sales tax. Jim also sells individual cupcakes at farmers' markets and weekend festivals. As Jim sells each cupcake, he places the cupcake in a bag and hands it to the customer, along with a napkin. The transaction is not subject to sales tax since Jim did not serve the customer the cupcake with eating utensils.

Molly has a pie company. She sells whole pies, which are not taxable, but like Jim, sometimes Molly will visit farmers' markets and festivals to sell her pies. Molly often will sell pie by the slice. If a customer walks up and purchases a slice of pie that has been placed in a plastic or Styrofoam hinged “to go” container, the pie is not subject to tax since it was not sold with eating utensils. If, however, Molly puts that same slice of pie on a plate, or hands the customer a fork with the “to go” container, then that sale of the slice of pie is subject to sales tax.

Wrapping and Packaging

Bakers can issue a Texas Sales and Use Tax Exemption Certificate (Form 01-339/back) (PDF, 57KB) for items they will use for packaging bakery items they have produced. See Rule 3.293(h)(5). When someone is packaging bakery items they have produced (as opposed to items they have simply purchased and repackaged), items such as boxes, domes and boards are considered exempt wrapping and packaging items under Comptroller Rule 3.314.

Manufacturing Equipment

Bakers and other food processors can claim an exemption from sales tax when purchasing qualifying manufacturing equipment under Texas Tax Code Section 151.318 and Comptroller Rule 3.300.

Tax Code Section 151.318(a)(2) exempts tangible personal property used directly in or during the manufacturing of tangible personal property for sale if the use of the property is necessary or essential to the manufacturing, processing or fabrication operation and directly makes or causes a chemical or physical change to the product being manufactured, processed or fabricated for ultimate sale. Food processors are considered manufacturers and therefore may claim manufacturing exemptions from sales and use taxes on equipment that is used to cook, mix, chop, brew, proof or blend food or beverages for sale. But equipment that is used to store or maintain products, such as refrigerators and heat lamps, does not qualify for exemption.

For example, an oven is essential to baking a cake. As the oven is being used to bake the cake, the oven causes a chemical or physical change to the cake. The oven would qualify for a manufacturing exemption under Tax Code Section 151.318(a)(2). A refrigerator used to store the cake ingredients (i.e., milk, eggs and butter) or the finished cake, however, does not qualify for exemption because it does not cause a chemical or physical change to the cake.

Hand tools such as knives, peelers, spatulas, spoons and other devices that are used, managed and powered by hand, are not exempt, even if used in processing food products. See Tax Code Sec. 151.318(c)(2). Equipment that is controlled or operated by hand, but is moved or powered by electricity, gas, steam or other fuel (such as an electric mixer) is not a hand tool and may qualify for exemption.

Home bakers who claim an exemption on manufacturing equipment should be aware of the sales tax consequences associated with divergent use of such equipment. Divergent use occurs when an item purchased tax free for use in manufacturing is used for a personal or other non-exempt purpose and tax is due on such use.

For example, divergent use occurs if a home food processor issues an exemption certificate for a stove, then uses the stove to cook dinner for her family. The home food processor owes tax for the divergent use of the stove. See Tax Code Section 151.3181 and Rule 3.300(k).

Who Needs a Permit?

If you are selling only exempt food items, you are not required to hold a Texas Sales and Use Tax Permit. Some suppliers of bakery supply items, however, may require purchasers to fill out a resale (PDF, 57KB) or exemption certificate for certain supplies. An exemption certificate does not require a Texas Sales and Use tax permit number to be valid, but a resale certificate does.

If you have a sales tax permit, you must file sales tax reports even if you do not have any taxable sales. You will show all of your sales as “total sales” and will have a “zero” amount for “taxable sales”. Effective for reports due on or after Oct. 1, 2011, a $50 late filing fee will be imposed on late-filed sales tax reports, even if no tax is due with the report.

To apply for a Texas Sales and Use Tax Permit, see the Texas Online Tax Registration Application section of our website.

SALES TAX

Commercial Agricultural and Timber Operations – New Registration Requirement!

Beginning Jan. 1, 2012, a purchaser claiming an exemption from Texas sales tax on the purchase of certain items used to produce agricultural or timber products for sale must provide an Agriculture and Timber Registration Number on the exemption certificate provided to suppliers. (House Bill 268, 82nd Legislature, Regular Session.)

How to Apply

To apply online, see our new www.GetReadyTexas.org webpage to register. Applicants who apply online will receive a registration number immediately.

To apply by mail, complete and print an Application for Texas Agriculture and Timber Registration Number (AP-228) and submit it to us. Applicants who submit printed applications will generally receive a registration number approximately three to four weeks after we receive the completed and signed application.

Who is Eligible for a Registration Number?

Anyone engaged in the production of agricultural or timber products for sale in the regular course of business including:

  • farmers and ranchers who raise food and agricultural products to sell to others (does not include deer or other game or exotic animal management programs);
  • persons engaged in commercial aquaculture and apiculture (i.e.,catfish farms or beekeepers);
  • custom harvesters;
  • persons engaged in agricultural aircraft operations, as defined by 14 C.F.R. Section 137.3 (crop dusting);
  • commercial nurseries engaged in fostering growth of plants for sale (i.e., growing stock from seed or cuttings, replanting seedlings in larger containers); and
  • commercial timber producers, including contract lumberjacks.

What Purchases Require the New Registration Number?

An Ag/Timber Registration Number is required when claiming a sales tax exemption on purchases made Jan. 1, 2012, and after on the following types of items:

  • fertilizers, fungicides, insecticides, herbicides, defoliants and desiccants used exclusively in the production of timber for sale, or on a commercial farm or ranch in the production of agricultural products for sale;
  • machinery and equipment, including utility and all-terrain vehicles, used exclusively on a commercial farm or ranch in the production of agricultural products for sale or building or maintaining of roads and water facilities, or in the production of timber, and the component parts of such equipment;
  • machinery and equipment used by an original producer at a location operated by the producer for packing, processing and marketing agricultural or timber products;
  • machinery and equipment exclusively used in an agricultural aircraft operation, as defined by 14 C.F.R. Section 137.3 (i.e., crop dusting);
  • tangible personal property incorporated into a structure used solely for poultry carcass disposal;
  • components of irrigation systems used in the production of agricultural and timber products for sale;
  • seedlings used in the production of timber for sale;
  • electricity used in agriculture or timber operations; and
  • services performed on tangible personal property identified in this list.

Motor Vehicle Tax

A valid Agriculture and Timber Registration Number will also be required when claiming an exemption from Texas motor vehicle tax on qualifying farm or timber vehicles, including vehicles purchased to be leased to qualifying farmers, ranchers and timber operators.

The exemption from motor vehicle tax will be claimed by entering the registration number on the Application for Texas Certificate of Title/Motor Vehicle Tax Statement (Form 130-U) when the vehicle is registered or titled with a County Tax Assessor-Collector. Retailers and County Tax Assessor-Collectors will be able to verify registration numbers through an online system.

New Ag and Timber Exemption Certificates

Also beginning Jan. 1, 2012, purchasers claiming an exemption on qualifying items used in the production of food or other agricultural products are required to issue the new Texas Agricultural Sales and Use Tax Exemption Certification (Form 01-924) (PDF, 297KB) .

Purchasers of qualifying items used in the production of timber products must issue the new Texas Timber Operations Sales and Use Tax Exemption Certification (Form 01-925) (PDF, 270KB) .

The generic exemption certificate (Form 01-339) (PDF, 57KB) should not be used to claim either the agricultural or timber exemptions on purchases made on or after Jan. 1, 2012. Blanket exemption certificates issued to suppliers on the old form must be replaced with new certificates for purchases made on or after Jan. 1, 2012.

SALES TAX

Sales by Federal Agencies and Instrumentalities – The “Buck” Does Not Stop Here

Federal agencies and instrumentalities of the United States government sell a variety of taxable items, such as maps, flags, clothing, books, emergency preparedness kits and collectable items. Under the provision of the Buck Act [4 U.S.C. Section 107(a)], however, states cannot require the federal government or its agencies and instrumentalities to collect or remit sales and use tax. See STAR document 8208L0482B11.

This exemption does not extend to concessionaires and other independent contractors operating on federal enclaves. They are required to hold a Texas Sales and Use Tax Permit and collect and remit the appropriate amount of Texas state and local sales tax.

The federal government and its agencies and instrumentalities may voluntarily collect and remit Texas sales tax on its sales of taxable items, and if so, must obtain a Texas Sales and Use Tax permit and collect and remit the tax like any other seller engaged in business in Texas.

If a federal agency or instrumentality does not collect the Texas tax citing federal law, the responsibility of reporting and remitting the tax shifts from the federal agency or instrumentality to the purchaser. The tax remains the obligation of the purchaser of the taxable items even when the federal agency or instrumentality does not collect the tax. See Subsection (h)(3) of Tax Rule 3.322 related to exempt organizations.

A purchaser who is permitted for sales tax in Texas should report the tax due as a “taxable purchase” on their sales and use tax return. A non-permitted purchaser should report the tax using the Texas Occasional Use Tax Return (Form 01-156) (PDF, 51KB) .

Some federal agencies and instrumentalities are easily identifiable, while others are not. For example, the American National Red Cross (corporation) is a federally chartered instrumentality of the United States. See 36 USCS Section 300101. Federal law states that the chapters of the American National Red Cross are the local units of the corporation. For purposes of Texas sales and use tax collection and reporting, the American National Red Cross, its chapters and local units are not required to collect state and local sales tax on sales of taxable items.

SALES TAX
Texas Wildfires – Sales Tax Relief for Texas Wildfire Victims

On Sept. 1, 2011, in response to the extreme drought and potential for wildfires throughout Texas, Governor Perry reissued an emergency proclamation declaring a disaster in all 254 counties in Texas.

Due to this disaster declaration, taxpayers who have property damaged by a wildfire that occurred within Texas at any time since May 13, 2011, or within one of the counties included in the disaster proclamations issued between Dec. 21, 2010, and May 13, 2011, may claim an exemption from sales tax on labor charges to repair the damage. The materials and equipment used in the performance of the repairs continue to be taxable.

The exemption allowed under Tax Code Section 151.350 applies only to charges for labor to repair or restore damage resulting from the condition that caused the area to be declared a disaster area. Therefore, the exemption authorized by this disaster proclamation is limited to damage caused by a wildfire and does not extend to repairs to personal property, or to a building or other improvement to realty damaged by other sources.

To receive an exemption from tax on the charges for the labor, the purchaser must give the seller a Texas Sales and Use Tax Exemption Certificate (Form 01-339/back) (PDF, 57KB) showing both the seller's and the purchaser's names and addresses and the item(s) being repaired. The certificate must also give the reason for claiming the exemption. For example, “Repair to _________ (property type or damaged tree) due to ‘natural disaster’ in ________ County, Texas.”

See the Comptroller's Disaster Relief section of our website for more information.

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 website.

Contributors to This Month's Issue

Melissa Brogan, Robin Corrigan, Lisa Davis, Don Dillard, John Huffman, Carol McAnnally, Stefanie Medack, Karen Ortosky, Lindey Osborne, Jerry Oxford, Jo Samuel, Viki Smith, Karen Snyder, Jennifer Specchio and Steve White

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