Texas Supreme Court clarifies proper method of sourcing franchise tax receipts from services

A recent decision by the Texas Supreme Court around the often-contentious question of how to properly source receipts from services offers a commonsense approach that will hopefully assist taxpayers in apportioning their own income and determining tax liabilities. Read on for a summary of the Sirius XM case, the Court’s decision, and what it means for businesses with customers in Texas.

Sirius XM produces and broadcasts satellite radio channels from facilities primarily located in New York and Washington, D.C., to customers located all across the globe, including within Texas. In computing its Texas Franchise Tax liability, Sirius XM took the position that their service performed was the creation and broadcast of radio content, which occurred outside of Texas. Under the facts of the case, Sirius XM employed only de minimis personnel and equipment located within Texas.

The Texas Comptroller, however, took a different view. Attempting to employ a “receipt-producing, end-product act” test, the Comptroller argued that the service provided by Sirius XM to its customers in Texas was, in fact, a decryption service, whereby Sirius XM unlocked its broadcast signal, enabling Texas customers to access the radio channel content. The Comptroller argued that this activity took place within Texas and therefore the Texas apportionment should have been significantly greater.

Upon review, the Texas Supreme Court agreed with Sirius XM, rejected the Comptroller’s arguments, overturned the Court of Appeals, and remanded the case for further consideration. In reaching its decision, the Texas Supreme Court reasoned that a service is performed within Texas “if the labor for the benefit of another is done in Texas.” The Court further stated that “the most natural reading of ‘service performed in this state’ supports locating the performance of the service at the place where the taxpayer’s personnel or equipment is physically doing useful work for the customer.” Under the facts, Sirius XM’s personnel and equipment were located outside of Texas, and therefore the service provided by Sirius XM took place outside of Texas.

Texas Regulation 34 TAC Section 3.591(e)(26) had originally provided that “gross receipts from a service are sourced to the location where the service is performed”; however, the Comptroller modified this regulation in inserting the “receipt-producing, end-product act” standard to where if there is a “receipts-producing, end-product act,” “the location of other acts will not be considered even if they are essential to the performance of the receipts-producing acts.” In essence, this modified version of the regulation had attempted to disregard all other acts that were performed in sourcing the service revenues to the extent that any such end-product act could be identified at the customer location resulting in a market sourcing of such revenues.

The Texas Supreme Court characterized the Comptroller’s reliance on the “receipts-producing, end-product act” test as “atextual and unhelpful.” Sirius XM is a radio production and broadcasting company operating from outside of Texas, the Court wrote, and to treat its services as merely a decryption service “elevates the technicalities of the transaction over the economic reality of the service performed.” In fact, the Court analogized that treating Sirius XM’s service for its Texas customers as little more than a decryption service “is like saying the service performed by The Wall Street Journal Online is a ‘paywall-removal service,’ rather than the creation and distribution of news and opinion content its subscribers want to read.”

Further, the Court concluded that even if Sirius XM provided a decryption service, even that activity was not performed inside of Texas.

Businesses operating in a multistate environment must contend with multiple state rules seeking to divvy up their income: Does the business have nexus with a state? If so, does it have a filing obligation? If so, how should it apportion its income and source its revenue? The issue of how to properly source receipts from services can, as demonstrated here, raise significant questions and lead to protracted disputes. In the Sirius XM decision, the Texas Supreme Court has taken a commonsense approach in looking to where the true labor of performance occurring in all locations takes place in terms of properly sourcing gross receipts from provided services. This decision will hopefully assist taxpayers with Texas customers in better understanding the appropriate methodology to be used to compute their Texas tax obligations. Business taxpayers should undertake an evaluation of their operations and the tax treatment of their revenue streams to evaluate their best practices.


John Iannotti, Partner, State & Local Tax


Subject matter expertise

  • Contact John John+Iannotti John.Iannotti@cohnreznick.com
    John Iannotti

    CPA, Partner

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