How did Texas apportion the pre-2008 franchise tax to the state, and does it follow the Multistate Tax Compact's formula?

Plain-English summary

Someone wrote to the Comptroller asking a broad set of questions about how Texas apportions the franchise tax — the classic multistate questions about which formula applies, whether business and non-business income are separated, and whether consolidated reporting or alternative methods are allowed. This letter is the Comptroller's general road map.

First, the structure of the pre-2008 franchise tax: it was Texas's major business tax, imposed on corporations (a term that included LLCs, banking corporations, savings-and-loan associations, S corporations, and professional corporations, but not partnerships, proprietorships, professional associations, or trusts). The tax had two components — taxable capital (0.25% per year, based on net assets) and earned surplus (4.5%, based on federal taxable income with modifications) — and a corporation paid the greater of the two.

On apportionment itself, the key points were:

• Single gross-receipts factor. Each component is apportioned to Texas by one fraction: Texas gross receipts over total gross receipts (§ 171.106).
• No MTC/UDITPA formula. Although Texas adopted the Multistate Tax Compact in Chapter 141, § 171.112(e) says Chapter 141 does not apply to the franchise tax — so the Compact's three-factor UDITPA formula is not used, and there are no alternative apportionment elections.
• Two definitions of "gross receipts." Taxable capital uses GAAP revenue recognition; earned surplus uses federal income tax revenue recognition (§§ 171.112(a), 171.1121(a)) — so the two components' gross receipts can differ. Receipts are figured without deducting cost of goods sold, materials, labor, or other costs.
• Sourcing by category. Sections 171.103, 171.1032, 171.104, 171.105, and 171.1051 break receipts into categories (tangible personal property, services, rentals, royalties, other) and set sourcing rules; Rules 3.549 and 3.557 handle taxable capital and earned surplus.
• No business/non-business split. The statute does not classify business vs. non-business income. It does require, under § 171.1061, allocation of certain income (other than dividends and interest) to the state of commercial domicile when it lacks a unitary connection elsewhere (Rule 3.576).
• Consolidated reporting is prohibited. Each corporation reports based solely on its own financial condition (§§ 171.109(d), 171.110(h), 171.112(e), 171.1121(c)). There is no separate accounting and no special start-up or newly-expanded-business allowance.
• Administrative relief is limited. Because there are no alternative apportionment elections, the Comptroller cannot approve a method the statute does not allow, though it will review specific situations and give guidance.

Important currency note: This 2001 letter describes the franchise tax before the 2008 overhaul. The Legislature replaced the taxable-capital/earned-surplus structure with the current margin-based franchise tax effective January 1, 2008, and STAR marks this document partially superseded (on the taxation of partnerships). The current tax retains a gross-receipts apportionment concept but computes the base very differently. Use this as historical background and confirm current mechanics with the Comptroller.

What this means for you

Multistate corporations

The enduring headline is that Texas is a single-factor, gross-receipts state and has never offered the MTC/UDITPA three-factor formula or an alternative-apportionment election for this tax. If you are used to states that let you elect a formula or petition for alternative apportionment, Texas does not — you apportion by the statutory gross-receipts factor and, at most, ask the Comptroller to interpret how the rules apply to your receipts.

Groups of related companies

Do not plan around consolidated or combined franchise reporting based on this letter: it flatly prohibits consolidated reporting, requiring each corporation to stand on its own financials. (Texas later adopted combined reporting under the margin tax, which is a different regime — another reason to confirm current law.)

Accountants and tax professionals

Watch the two gross-receipts definitions (GAAP for taxable capital, federal-tax for earned surplus), the narrow § 171.1061 commercial-domicile allocation, and the "no deduction for costs" rule. All of this is pre-2008; the margin tax reworked the base, so treat the specific mechanics as historical while keeping the single-factor, no-election, no-consolidation principles in mind as Texas hallmarks.

Common questions

Q: Does Texas use the three-factor (property, payroll, sales) UDITPA formula?
A: No. For the franchise tax, apportionment is by a single gross-receipts factor (§ 171.106). Although Texas adopted the Multistate Tax Compact in Chapter 141, § 171.112(e) says that chapter does not apply to the franchise tax.

Q: Can a corporation elect a different apportionment method or ask for relief?
A: No alternative apportionment elections are available. The Comptroller cannot approve a method the statute does not allow, though it will review specific situations and provide guidance.

Q: Can related companies file a consolidated franchise report?
A: Not under this letter — consolidated reporting was prohibited, and each corporation reported on its own financial condition (§§ 171.109(d), 171.110(h), 171.112(e), 171.1121(c)).

Q: Are business and non-business income separated?
A: The statute did not classify business vs. non-business income. It required only a narrow allocation of certain income to the state of commercial domicile under § 171.1061.

Q: Is this still current?
A: No. It describes the pre-2008 franchise tax, which was replaced by the margin tax effective January 1, 2008. Confirm current apportionment mechanics with the Comptroller.

Citations and references

Statutes and rules:

• Tex. Tax Code Ch. 141 (Multistate Tax Compact); § 171.112(e) (Ch. 141 does not apply to the franchise tax)
• Tex. Tax Code § 171.106 (general apportionment — single gross-receipts factor)
• Tex. Tax Code §§ 171.103, 171.1032, 171.104, 171.105, 171.1051 (sourcing of receipts by category)
• Tex. Tax Code §§ 171.112(a), 171.1121(a) (gross-receipts definitions — GAAP vs. federal income tax)
• Tex. Tax Code § 171.1061 (allocation of certain income to commercial domicile)
• Tex. Tax Code §§ 171.109(d), 171.110(h), 171.1121(c) (consolidated reporting prohibited)
• Franchise Tax Rules 3.549, 3.557 (apportionment of taxable capital and earned surplus); Rule 3.576 (earned surplus allocation)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=FIT
• Opinion: https://star.comptroller.texas.gov/view/200102029L

Original ruling text

STAR SUPERSED INFORMATION
Accession No. —
Supersede type - Partial
Document superseded on - 12/15/14
Issue(s) that caused the document to be superseded — Taxation of partnerships
Reason(s): The Franchise Tax Code was amended by House Bill 3 and House Bill 3928,
Acts 2007, 80th Legislative Session, effective January 1, 2008 and affected Franchise
reports due on or after January 1, 2008. One of the many changes to this Tax Code
subjected partnerships (previously not required to file) to the franchise tax reporting
requirement.

February 5, 2001

Dear **:

Comptroller Rylander forwarded your letter requesting information about
apportionment issues for state taxation purposes. This response represents the
Texas franchise tax implications of the matters that you have addressed.

First, a few comments about the Texas franchise tax. It is the state's major
business tax and is imposed on each corporation that is chartered in Texas.
Out-of-state corporations doing business in the state are also liable for the
tax.

The term "corporation" includes a limited liability company, a banking
corporation, a savings and loan association, an S corporation, and a
professional corporation. Partnerships, proprietorships, professional
associations and trusts are not liable for the franchise tax.

There are two components of the franchise tax: taxable capital and earned
surplus. Each component is apportioned to Texas based on a single gross
receipts factor (to determine the percentage of business done in the state).

Taxable capital is based on a corporation's net assets. The tax rate on
taxable capital is .25 percent per year of the privilege period. The earned
surplus component is based on a corporation's federal taxable income with
certain modifications. The tax rate on earned surplus is 4.5 percent. A
separate calculation is made for each component. Corporations pay the greater
of the tax due on net taxable capital or net taxable earned surplus.

Now, I will address each of your questions. The responses below are listed by
category as set out in your letter.

Multistate Tax Commission's Apportionment Recommendations

Chapter 141 of the Texas Tax Code covers the Multistate Tax Compact (MTC).
Sec. 141.001 provides for Texas' adoption of the MTC. However, Sec. 171.112(e)
of the Tax Code states that Chapter 141 does not apply to the franchise tax
statute.

Therefore, for franchise tax apportionment purposes, the MTC's recommended
apportionment formula as set out in the Uniform Division of Income for Tax
Purposes Act has not been adopted. As noted above, the general apportionment
formula is based on a single gross receipts factor. The statute does not
provide for alternative apportionment elections.

Sec. 171.106 of the Tax Code provides the general apportionment guidelines.
Under this provision, the taxable capital and earned surplus components are
apportioned to Texas by an apportionment factor that is a fraction, the
numerator of which is the corporation's gross receipts from business done in
Texas and the denominator of which is the corporation's gross receipts from its
entire business. Sec. 171.106 does provide some specific exceptions to the
general apportionment formula (e.g., receipts from certain types of
administrative services performed for regulated investment companies and
employee retirement plans).

The statutory definitions of gross receipts for taxable capital and earned
surplus refer to the Generally Accepted Accounting Principles (GAAP) and
federal income tax (FIT) reporting concepts of recognizing revenue,
respectively. The statute further specifies that gross receipts are computed
without deduction for cost of property sold, materials used, labor performed,
or other costs incurred, unless otherwise specifically provided for in the
franchise tax law. Thus, in order for a gross receipt to be recognized, the
respective revenue recognition test must be established. Please see Sections
171.112(a) and 171.1121(a), Texas Tax Code.

Because of the different standards used to define gross receipts (i.e., GAAP
revenue for taxable capital and FIT revenue for earned surplus), the gross
receipts for the tax base components may be different. Other Tax Code
provisions and rule requirements may result in additional differences in the
computation of gross receipts for taxable capital and earned surplus.

Some of the other statutory provisions directed at franchise tax apportionment
include Sections 171.103, 171.1032, 171.104, 171.105, and 171.1051. These
provisions essentially break out gross receipts by category (i.e., receipts
from sales of tangible personal property, services, rentals, royalties, and
other business) and specify sourcing criteria by type of receipt. Franchise
Tax Rules 3.549 and 3.557 address the apportionment of taxable capital and
earned surplus, respectively.

Classification of Business Income and Non-business Income

The franchise tax statute does not provide a classification of business income
and non-business income. Sec. 171.1061 of the Tax Code, however, does require
the allocation of certain items of income in the computation of the earned
surplus tax base.

This provision is directed at income (other than dividends and interest) that
can only be allocated to the state of commercial domicile because the income
has insufficient unitary connection with any other state or country. The
allocated income is net of related expenses and is not otherwise subject to the
statutory apportionment requirements. Please see Franchise Tax Rule 3.576 for
more information about earned surplus allocation.

Commercial Domicile

A corporation's commercial domicile is a factor in the allocation of earned
surplus under Sec. 171.1061. However, it generally does not come into play in
our apportionment formula.

Consolidated Reporting

A corporation must report both taxable capital and earned surplus based solely
on its own financial condition. Consolidated reporting is prohibited.
Sections 171.109(d), 171.110(h), 171.112(e), and 171.1121(c).

Separate Accounting

The franchise tax statute does not provide for separate accounting.

Special Apportionment Allowances and Departures for Start-up and Newly Expanded
Businesses

The franchise tax law does not contain any provisions that address these areas.

Administrative Relief

This group of questions asked what avenues of administrative relief are
available if a corporation feels the apportionment formula results in more
income being apportioned to Texas than the corporation deems reasonable.
Because the statute does not provide for alternative apportionment elections,
this office cannot approve an apportionment method that is not otherwise
allowed by law. We are glad to review any specific situation and provide
guidance to individual taxpayers who request interpretations of the statutory
apportionment provisions.

You may access the franchise tax statutes, rules, publications, reports forms
and instructions, along with certain other information, through our Web site at
. At that site, click on "Texas Taxes." On the
ensuing screen, select "Franchise Tax."

Please note that Chapter 171 of the Tax Code contains the franchise tax
statutes. Title 34, Part 1, Chapter 3, Subchapter V of the Texas
Administrative Code (TAC) contains the franchise tax rules. As cited in this
response, the first number, 3, represents the chapter number with the last
three digits being the rule number.

Should you have any questions about this subject, please contact Jerry Bobbitt
of my Tax Policy Division, by e-mail at or by
phone at 1-800-531-5441, extension 3-4496.

Thanks again for writing. Please let me know if I can be of further
assistance.

Sincerely,

Jesse Ancira, Jr.
Director, Tax Administration

cc: Jerry Bobbitt