How should an internet advertising company apportion its various revenues — banner and click ads, commissions, subscriptions, hosting, and licensing — for Texas franchise tax?

Plain-English summary

This is an internal Comptroller memo (from an auditor to the Tax Policy Division) working through how an internet advertising company should apportion its many revenue streams for Texas franchise tax. The company kept offices in Texas to solicit advertising sales but performed all other advertising work in California.

The Comptroller's core move was to classify almost every revenue stream as receipts from performing a service, which — under the pre-2008 rules — were sourced to where the service is performed (and, if performed both inside and outside Texas, split by the fair market value of the work done in Texas). Applying that:

• Advertising revenue (banner, slotting, promotion, click, and barter ads): service receipts. Because all the advertising work happened in California, these were "everywhere" receipts, not Texas receipts — even though sales were solicited from Texas.
• Transaction revenue (commissions when a user clicks through and buys): treated as service receipts (commissions), sourced to where the company's server that provides the purchase link sits (citing STAR 9610799L).
• Services revenue (subscriptions, store/yellow-page listings, extra mail storage): service receipts, sourced to where the server providing the service is located.
• Business services (live/on-demand broadcasting, website development, website hosting): service receipts — broadcasting sourced to where the employees and equipment operate, website development to where the developers are, hosting to where the server sits.
• Other revenue (trademark license fees and royalties): sourced by use in Texas — to the extent a Texas company uses the license or trademark in Texas, the receipts are Texas receipts (§ 171.103(4), § 171.1032(a)(4)).

The memo also distinguished two court cases: in Gulf Publishing Co. v. Rylander, print-advertising service was performed where readers received the ads, but internet audiences are "unascertainable" (no subscription or distribution records), so that approach could not be used; and Westcott Communications, Inc. v. Strayhorn held that training programs produced in Texas and broadcast nationwide were services performed in Texas, not where received.

Important currency note — read this before relying on the sourcing conclusions. The memo's own Editor's Notes (dated April 8, 2021) state that under Rule 3.591(e)(1) (effective January 24, 2021, "clarifying long standing Comptroller policy"), gross receipts from the dissemination of advertising are sourced to the location of the advertising audience — not to where the service is performed. And under Rule 3.591(e)(13), effective January 1, 2014, receipts from internet hosting are Texas gross receipts if the customer is located in Texas. So the server-location and performance-location conclusions in this memo have been overtaken for advertising and hosting. This also predates the 2008 restructuring of the franchise tax into the current margin tax.

What this means for you

Digital and internet-based businesses

The single most important takeaway is what changed: Texas now sources advertising receipts to where the audience is and internet-hosting receipts to where the customer is. A business that once treated Texas-audience or Texas-customer revenue as out-of-state "everywhere" receipts (as the company here did) would reach a very different Texas number under current rules. Use this memo to understand the history, not to source receipts today.

Multistate service companies generally

The durable structural point survives: most of these revenues are service receipts, and Texas apportionment for services turns on a fact-specific "where is the service performed / where is the benefit" analysis. Where your servers, employees, and customers sit can each matter depending on the receipt type and the current rule.

Accountants and tax professionals

Treat every sourcing conclusion in this memo as superseded for advertising and hosting by Rule 3.591, and confirm the current treatment of each revenue stream. The license/royalty "use in Texas" concept and the service-receipt classification framework are still useful analytical anchors, but the specific outcomes are pre-2008 and pre-2021.

Common questions

Q: Did the company owe Texas franchise tax on its advertising receipts under this memo?
A: No — because it performed all advertising work in California, those receipts were "everywhere" receipts, not Texas receipts, even though it solicited sales from Texas offices.

Q: Does that still hold today?
A: No. The memo's own Editor's Note says current policy (Rule 3.591(e)(1), effective 2021) sources advertising-dissemination receipts to the location of the advertising audience, which would treat Texas-audience advertising as Texas receipts.

Q: How were commissions, subscriptions, and hosting sourced?
A: As service receipts, to where the relevant server was located. Note that since 2014, internet-hosting receipts are Texas receipts if the customer is in Texas (Rule 3.591(e)(13)).

Q: How were trademark license fees and royalties treated?
A: Sourced by use in Texas — to the extent a Texas company used the license or trademark in Texas, the receipts were Texas gross receipts (§ 171.103(4), § 171.1032(a)(4)).

Q: Can I rely on this memo?
A: No. STAR documents bind the Comptroller only as to the taxpayer they were issued to, and this one is expressly overtaken on advertising and hosting sourcing and predates the current margin tax.

Citations and references

Statutes and rules:

• Tex. Tax Code § 171.103(2); § 171.1032(a)(2) (service receipts sourcing)
• Tex. Tax Code § 171.103(4); § 171.1032(a)(4) (license/trademark receipts sourced by Texas use)
• Franchise Tax Rules 3.549(e)(38), 3.557(e)(33) (services performed inside and outside Texas)
• Franchise Tax Rules 3.549(e)(30)(A)(iii), 3.557(e)(25)(A)(iii) (licenses/royalties)
• Franchise Tax Rule 3.591(e)(1), (e)(13) (current sourcing of advertising and internet-hosting receipts — per the memo's Editor's Notes)

Case law and prior guidance:

• Gulf Publishing Co. v. Rylander (print-advertising service performed where readers receive ads)
• Westcott Communications, Inc. v. Strayhorn (services performed in Texas, not where received)
• STAR Accession No. 9610799L (commissions as service receipts)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=FIT
• Opinion: https://star.comptroller.texas.gov/view/200305904L

Original ruling text

STAR Superseded Information

Supersede type: partial

Document superseded on: see Editor's Note below

Issue(s) that caused the document to be superseded: see Editor's Note below

Reason(s): see Editor's Note below

Date: May 16, 2003

To: Karen Tram, **** Audit

From: Lowell Olsen Dunn, Tax Policy

Subject: Gross Receipts Apportionment for Internet Advertising

In your December 6, 2002 memo you requested a determination on how the gross

receipts from various activities should be apportioned for COMPANY, an internet

advertising company. I have taken the list of types of revenues the taxpayer

provided and responded to how each type should be apportioned for franchise tax

purposes. You also indicated the taxpayer maintains offices in Texas to

solicit advertising sales, but COMPANY performs all other work related to

advertising in California.

Advertising Revenue

Banner advertising includes posting a banner for a customer with revenue based

upon a cost per impression with a minimum number of impressions guaranteed.

Slotting revenue is more comprehensive than banner advertising because it

involves a longer term contract and more integration with other COMPANY

services, including fixed placement of advertisements, integration of content,

and exclusivity.

COMPANY generates promotion revenue by an advertisement pointing to a COMPANY

page that has a sweepstakes or other offer.

Click advertising revenue comes from internet users clicking a certain

advertisement on COMPANY. The customer would pay for advertising based upon the

number of clicks per month.

COMPANY earns barter advertising revenue by exchanging something in kind, such

as advertising, sponsorship, goods, or services with another entity. The

amount of revenue depends upon the type of in kind exchange.

Gross receipts from all of these types of internet advertising are receipts

from the performance of a service. Gross receipts from the performance of a

service should be apportioned to the location where the service is performed.

If services are performed both inside and outside Texas, then such receipts are

Texas receipts on the basis of the fair market value of the services that are

rendered in Texas. See Texas Tax Code Section 171.103(2); Section

171.1032(a)(2); Comptroller's Rule Section 3.549(e)(38); and Rule Section

3.557(e)(33). Editor's Note @ 4/8/2021: Gross receipts from the dissemination of advertising are

sourced to the location of the advertising audience, which is considered to be where the service is

performed. See Rule 3.591(e)(1), effective Jan. 24, 2021 clarifying long standing Comptroller policy.

You have indicated that all activities relating to advertising are performed in

California. For Texas franchise tax purposes, these gross receipts would be

considered everywhere gross receipts because the services are performed outside

of Texas.

This response represents a variation from apportionment of advertising receipts

in Gulf Publishing Co. v. Rylander. Gulf Publishing argued and prevailed with

the argument that the service is performed when readers receive the

advertisements in newspapers or magazines. However, with internet advertising,

the audience and readers are unascertainable because there are no subscription

or distribution records to rely upon. Therefore, it would be impossible to

apportion the gross receipts along those guidelines.

Transaction Revenue

A customer browses the internet and clicks on an advertisement link for a

product listed on COMPANY. If the customer purchases the product, the seller

then pays a certain amount to COMPANY based on the sale. Gross receipts

received from these transaction agreements are essentially commissions.

The commissions COMPANY earns from the sales would be considered revenue from

the performance of a service. See STAR Accession No. 9610799L. The gross

receipts from the performance of a service are apportioned to the location

where the service is performed. Consequently, these gross receipts will be

apportioned to the location where COMPANY maintains the server that provides the

link to the customer to purchase the item from the seller.

Editor's Note @ 4/8/2021: Gross receipts from the dissemination of advertising are

sourced to the location of the advertising audience, which is considered to be where the service is

performed. See Rule 3.591(e)(1), effective Jan. 24, 2021 clarifying long standing Comptroller policy.

Services Revenue

Subscription revenue includes store listings, yellow page listings, and extra

mail storage space for customers that pay a fixed fee. The gross receipts

COMPANY earns from these subscriptions are also receipts from the performance of

a service, apportioned to the location where the service is performed. Where

COMPANY maintains the server that provides the extra storage space for a

customer would be where the service is performed.

Editor's Note @ 4/8/2021: RE: Store listings, yellow page listings, and gross receipts from the dissemination

of advertising are sourced to the locations of the advertising audience, whcih is considered to be where the

service is performed. See Rule 3.591(e)(1), effective Jan. 24, 2021 clarifying long standing Comptroller policy.

RE: mail storage, effective Jan. 1, 2014, receipts from internet hosting are Texas gross receipts if the customer

is located in Texas. See Rule 3.591(e)(13), effective Jan. 24, 2021.

Business services revenue consists of fees for broadcasting live and on-demand

events, website development, and website hosting. Gross receipts from

broadcasting live and on-demand events, website development, and website

hosting activities would be considered gross receipts from the performance of a

service and should be apportioned to the location where the service is

performed. For broadcasting live and on-demand events, the location where the

service is performed is where COMPANY's employees and equipment actually conduct

the broadcasting. Website development is performed where the employees are

creating websites. Website hosting would be apportioned to where the server is located that is actually storing the

website information. Effective Jan. 1, 2014, receipts from internet hosting are Texas gross receipts if the

customer is located in Texas. See Rule 3.591(e)(13), effective Jan. 24, 2021.

At issue in Westcott Communications, Inc. v. Strayhorn was whether educational

training programs produced in Texas and broadcast nationwide via satellite and

videotape should be considered services performed within the state. The Third

Court of Appeals (Austin, Texas) ruled that the services were performed in

Texas and not at the location where the customer received the satellite

broadcasts as the taxpayer argued.

Finally, gross receipts from revenue including, but not limited to, market

research, targeting, and advanced reporting are revenues from the performance

of a service. These gross receipts should be apportioned to where the service

is performed. If these services are performed in more than one location,

please refer to Rules Section 3.549(e)(38) and Section 3.557(e)(33).

Other Revenue

COMPANY receives license revenue in the form of a fixed or variable fee for the

right to use COMPANY's trademark. COMPANY also receives royalty revenue in the

form of a variable fee for the resale of COMPANY services. Revenue and

royalties from specific licenses and trademarks should be apportioned based

upon the use in Texas. See Tax Code Section 171.103(4); Section

171.1032(a)(4); and Rules Section 3.549(e)(30)(A)(iii) and Section

3.557(e)(25)(A)(iii). To the extent a Texas company uses a COMPANY license or

trademark in Texas, the gross receipts COMPANY receives are Texas gross

receipts.

If you need any additional information, please feel free to call me at

1-800-531-5441, extension 34629.