Does common ownership or using independent-contractor sales reps give a Texas manufacturer nexus elsewhere, or are its shipments thrown back as Texas receipts?

Plain-English summary

A Texas manufacturer ("Taxpayer A") sold and shipped products to in-state, out-of-state, and foreign distributors. After a merger it became 100%-owned by "Taxpayer B" (a Texas corporation that is also one of A's distributors), and A switched from employees soliciting orders in other states to independent-contractor sales representatives. The taxpayer asked how this affected A's earned-surplus nexus and the throwback rule. The answers turn on two principles.

• Texas is a separate-entity state. Common ownership does not extend Taxpayer B's nexus to Taxpayer A. If A's only contact with another state is B's reselling activity there, A has no nexus in that state for purposes of the earned-surplus throwback rule. As a result, A's sales shipped from Texas into that state are subject to throwback and are Texas receipts.
• P.L. 86-272 solicitation is not nexus. Under Public Law 86-272, if a corporation's only activity in a state is soliciting orders for tangible personal property - orders sent outside the state for approval and, if approved, filled by shipment from outside the state - the corporation is not subject to that state's tax on the earned-surplus equivalent (Rule 3.554).
• Employees vs. independent contractors doesn't matter. If A's only activities in another state are protected by P.L. 86-272, A has no throwback nexus there regardless of whether the solicitation is performed by employees or independent contractors. Sales shipped from Texas into that state are again thrown back and counted as Texas receipts for earned-surplus apportionment.

How "throwback" works here: because the destination state cannot tax A (no nexus / P.L. 86-272 protection), Texas pulls those receipts back into the Texas numerator instead of letting them be "nowhere" receipts.

Currency note: This is the pre-2008 franchise tax and its earned-surplus throwback rule, replaced by the current margin tax (House Bills 3 and 3928) effective January 1, 2008, which apportions differently. Treat as historical.

What this means for you

Texas manufacturers shipping across state lines

Reorganizing under common ownership or swapping employees for independent-contractor reps did not, by itself, plant nexus in the destination states. But the flip side is that when those states can't tax you, Texas throws the sales back - so protected out-of-state selling increased your Texas receipts rather than shrinking them.

Accountants and tax professionals

Apply the separate-entity rule (ignore affiliate nexus) and test each destination state for P.L. 86-272 protection. Where the manufacturer lacks its own nexus, throwback sources the shipment to Texas. The employee/independent-contractor distinction is irrelevant to the P.L. 86-272 analysis. This throwback regime is specific to the pre-2008 tax.

Common questions

Q: Does common ownership with a distributor give my Texas company nexus in other states?
A: No. Texas is a separate-entity state, so an affiliate's nexus is not attributed to you; if your only contact is the affiliate's resales, you have no throwback nexus there and the sales are thrown back to Texas.

Q: Do independent-contractor reps change the P.L. 86-272 analysis?
A: No. If your only activity in a state is protected solicitation of orders for tangible personal property, you have no earned-surplus nexus there whether employees or independent contractors do the soliciting.

Citations and references

Statutes and rules:

• 15 U.S.C. Secs. 381-384 (Public Law 86-272)
• 34 Tex. Admin. Code Sec. 3.554 (earned surplus: nexus; P.L. 86-272; throwback)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=FIT
• Opinion: https://star.comptroller.texas.gov/view/200408781L

Original ruling text

August 31, 2004

To: **

Dear **:

Thank you for your Tax Help inquiry concerning the filing of Texas franchise
tax.

You indicate that Taxpayer "A" is a manufacturer located in Texas that sells
and ships products to distributors located both out of the state and out of the
country. In calendar year 2000 Taxpayer "A" was the survivor of a merger and
is now 100% owned by Taxpayer "B". Taxpayer "B" is a Texas Corporation with
locations in several other states besides Texas. Taxpayer "B" is also one of
the distributors of Taxpayer "A's" products. After the change in ownership,
Taxpayer "A" changed from having employee's living in and traveling to other
states for the solicitation of sales orders to using sales representatives
which are independent contractors living in other states and traveling to other
states in their territory for the solicitation of sales orders.

Based on the information provided, I presume Taxpayer "A" sells the products to
Taxpayer "B" who then resells the product to the ultimate buyer.

I have restated your questions below followed by a response.

1. Does the common ownership of Taxpayer "A" and Taxpayer "B" extend Taxpayer
   "A's" nexus to include Taxpayer "B's" nexus in other states that impose an
   income-based tax on corporations for earned surplus nexus and apportionment
   requirements?

As Texas is a separate entity state, common ownership does not extend the nexus
of Taxpayer "B" to Taxpayer "A". Additionally, if Taxpayer "A's" only contact
with another state is the activities of Taxpayer "B" who resells the products,
Taxpayer "A" does not have nexus in the other state for purposes of the
throwback rule in the apportionment of earned surplus. Sales by Taxpayer "A"
shipped from Texas into that state would be subject to throwback and would be
Texas receipts.

2. Does Taxpayer "A's" change from having employee's living in and traveling
   to other states for the solicitation of sales orders to using sales
   representatives which are independent contractors living in other states and
   traveling to other states in their territory for the solicitation of sales
   orders change their earned surplus nexus and apportionment requirements?

Pursuant to Public Law 86-272, if the only business activity within the state
is the solicitation of orders for sales of tangible personal property, which
orders are sent outside the state for approval or rejection, and, if approved,
are filled by shipment or delivery from a point outside the state, then the
corporation is not subject to the earned surplus component. See Rule 3.554.

If Taxpayer "A's" only activities in another state are protected by Public Law
86-272, Taxpayer "A" does not have nexus in the other state for purposes of the
throwback rule in the apportionment of earned surplus, regardless of whether
the solicitation is performed by employees or independent contractors. Sales
by Taxpayer "A" shipped from Texas into that state would be subject to
throwback and would be Texas receipts for earned surplus apportionment.

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

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

Our goal is to provide you with prompt, professional service. Please take a
moment to complete our on-line survey at
http://aixtcp.cpa.state.tx.us/surveys/tpsurv/.

If you have questions about this, my internet address is
, or you may call toll-free at 1-800-531-5441,
extension 59952.

Sincerely,

Teresa Bostick
Tax Policy Division