When a Texas broker-dealer books all the revenue but affiliates perform much of the work, how are its service receipts sourced for franchise tax?

Plain-English summary

A Texas registered broker-dealer ("Company A") sat at the center of an affiliated group. Under a revenue management system, all of the group's insurance commissions, securities commissions, and investment advisory fees were recognized and received by Company A, even though affiliated operating companies ("Op Cos"), principals, non-principal employees, and independent contractors across the country performed much of the actual advisory and solicitation work. Company A paid the Op Cos a cost-plus-markup fee. The taxpayer asked whether, in sourcing its service receipts, Company A must consider the activities of those other parties and where they performed the work.

• Source to where the service is performed. Receipts from performing services are apportioned to the location where the services are performed. If services are performed both inside and outside Texas, the Texas receipts are the fair value of the services rendered in Texas (Rules 3.549(e)(38) and 3.557(e)(33)).
• Book all the revenue. Company A must include in gross receipts all revenue it receives even though another entity performed a portion of the services.
• Count the affiliates' work and its location. In determining the in-Texas versus out-of-Texas fair value, Company A must include the services performed by the Op Cos, principals, non-principal employees, and independent contractors, and where they performed them.

Currency note: This applies the pre-2008 franchise tax's service-sourcing rules, replaced by the current margin tax (House Bills 3 and 3928) effective January 1, 2008. Treat as historical.

What this means for you

Financial-services firms that centralize revenue

Pushing all revenue through one entity did not let that entity ignore where the work happened. It had to report all the revenue it received, then look through to the affiliates and contractors who did the work to figure out how much of the fair value was earned in Texas.

Accountants and tax professionals

Two moves: include 100% of the booked revenue in gross receipts, then source it by the fair value of services performed in Texas, incorporating the locations of affiliated and contracted performers. The intercompany fee arrangement does not change the look-through-to-where-performed sourcing.

Common questions

Q: If affiliates do the work but we book the revenue, do we still report it all?
A: Yes. Include all revenue you receive in gross receipts, even where another entity performed part of the services.

Q: How is the Texas portion determined?
A: By the fair value of the services rendered in Texas, taking into account the work performed by affiliates, principals, employees, and independent contractors and where they performed it.

Citations and references

Rules:

• 34 Tex. Admin. Code Sec. 3.549(e)(38) (taxable capital: service receipts sourced to where performed)
• 34 Tex. Admin. Code Sec. 3.557(e)(33) (earned surplus: service receipts sourced to where performed)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=FIT
• Opinion: https://star.comptroller.texas.gov/view/200407490L

Original ruling text

July 27, 2004

Re: Sourcing of service receipts

Dear **:

Thank you for your letter concerning the apportionment of receipts from the
performance of services for Texas franchise tax reporting purposes.

According to your letter, Company A is a registered broker-dealer and
investment advisor located in Texas. Company A is licensed to participate in
insurance activities, investment advisory activities and the purchase and/or
sale of securities. Company A does not maintain an inventory of securities for
sale. Company A is a member of an affiliated group whose parent, Company P, is
located in New York. Company P has numerous other subsidiaries (Op Cos) whose
employees’ advise clients on insurance, investments, financial planning, and
estate planning. The Op Cos are not registered broker-dealers and do not
effect securities transactions. Company A has dealings with registered
representatives located throughout the United States who are either Principals,
non-Principals employed by the Op Cos or other unrelated third parties.
Company A, as a registered broker-dealer, effects securities transactions on
business solicited and generated by these registered representatives.

Company P has instituted a revenue management system to capture and control the
flow of revenue receipts solicited and/or generated by the Op Cos. Under the
revenue management system, all revenue is recognized and received by Company A.
Company A enters into an agreement with the Op Cos whereby the Op Cos will
provide administrative and operational services supporting the marketing and
production activities of the Principals and non-Principal employees of the Op
Cos. Under the agreement, Company A pays the Op Co a fee for its services.
The fee is computed based on the Op Co’s operating costs plus a mark-up.

Although Company A has employees and expenses of its own, most of Company A’s
expenses are the service fees paid to the Op Cos and payment due and owing to
Principals, non-Principal employees of Op Cos, and independent contractors. As
a result of the solicitation, business-generation, and advisory activities
performed by the Op Cos, Principals, non-Principal employees of Op Cos and
other independent contractors located throughout the United States, Company A
recognizes as revenue the following types of receipts: insurance commissions,
securities commissions, and investment advisory fees. You ask should Company A
consider the activities of the Op Cos, Principals, non-Principal employees of
the Op Cos, and other independent contractors and the location where these
activities are performed by these parties in determining the fair value of
services rendered inside and outside the State of Texas.

Receipts from the performance of services are apportioned to the location where
the services are performed. If services are performed both inside and outside
Texas, then such receipts are Texas receipts on the basis of the fair value of
the services that are rendered in Texas. See Franchise Tax Rules Sections
3.549(e)(38) and 3.557(e)(33).

Company A should include in gross receipts all revenues received even though
another entity performed a portion of the services. In determining the fair
value of services performed inside and outside of Texas, Company A should
include those services performed by the Op Cos, Principals, non-Principal
employees of the Op Cos, and other independent contractors and where such
services were performed.

The rules mentioned, as well as other related information, are available online
at http://www.window.state.tx.us/taxinfo/franchise/index.html.

This response is based on the facts presented and current law. If there are
different or additional facts, the response may change.

If you have questions about this, please call me at 1-800-531-5441, extension
59952. You may write me at Tax Policy Division, Comptroller of Public
Accounts, P.O. Box 13528, Austin, Texas 78711-3528.

Sincerely,

Teresa Bostick
Tax Policy Division