When a Texas company sells substantially all of its business assets, how does it apportion the gross receipts among tangible personal property, contract rights, and other intangibles for Texas franchise tax purposes?

Plain-English summary

An oilfield-services company sold substantially all of its business assets to a Delaware-incorporated buyer under an Asset Purchase Agreement. The assets included tangible personal property (some located in Texas, some already deployed outside the U.S.), plus a bundle of legal and contractual rights — joint development agreement rights, service and field-services contract rights, inspection-agreement rights, a confidentiality agreement, government authorizations, insurance rights, goodwill, and going-concern value. The company asked the Comptroller how to apportion the gross receipts from this sale across all these different asset types for Texas franchise tax purposes.

The Comptroller answered asset-by-asset:

• Tangible personal property (TPP) located/delivered in Texas at the time of sale produces Texas receipts. Per Rule 3.591(e)(29)(A), delivery is complete when possession or control transfers to the buyer — where title passes is irrelevant.
• TPP already deployed outside Texas (in a foreign jurisdiction) at the time of sale produces no Texas receipts, even though title passed under the same nationwide Agreement.
• Contract rights are intangible assets, not TPP — the Comptroller has consistently treated contract rights as intangibles (citing two prior STAR accessions) even though they aren't specifically listed among Rule 3.591(e)'s examples (stocks, bonds, patents, trademarks, goodwill, etc.). Receipts from selling intangibles are sourced under Rule 3.591(e)(21)(B) to the payor's legal domicile — for a corporation, its state of incorporation (here, Delaware) — regardless of where the seller or the underlying business activity is located.
• No capital-asset/investment treatment applied. The seller never created or purchased the intangible assets for investment purposes and never assigned them a book value before the sale, so Rule 3.591(e)(2)'s net-gain-on-investments apportionment method didn't apply to them.
• Use the same allocation as your federal return. Per Rule 3.591(d)(4), a taxable entity is deemed to have elected the same sales-price allocation methodology it used on its federal income tax return (including any IRS Form 8594 filed by the buyer, and any negotiated allocation agreed between the parties) — that same allocation governs how gross receipts are apportioned among specific assets for Texas franchise tax purposes.

The Comptroller also noted it intended to amend Rule 3.591 to clarify the definition of "investment."

What this means for you

Businesses selling substantially all their assets

Don't assume a single sourcing rule applies to the whole transaction. Break the purchase price down by asset type: TPP is sourced by where it's delivered (not where title passes), while contract rights and other intangibles are sourced to the buyer's legal domicile — which can produce a very different apportionment result than sourcing everything to where the seller (or the underlying business) is located.

Companies negotiating asset purchase agreements

The price allocation you use for federal income tax purposes (IRS Form 8594, negotiated allocation schedules) isn't just a federal filing formality — Texas requires you to use that same allocation for franchise tax apportionment. Get the allocation right at the negotiation stage; it drives both federal and Texas state tax outcomes.

Sellers hoping for capital-asset/investment treatment on intangibles

Simply calling something a "capital asset" isn't enough. The Comptroller looked for objective indicators — was the asset created or purchased for investment purposes, and did the seller ever assign it a book value as an investment — and found neither here, which is why ordinary intangible-sourcing rules applied instead of the net-gain-on-investments method.

Common questions

Q: Does the location where title to tangible personal property passes determine Texas apportionment?
A: No — per this ruling and Rule 3.591(e)(29)(A), Texas receipts turn on where the property is delivered or where possession/control transfers, not where legal title passes.

Q: How are receipts from selling a company's contract rights apportioned?
A: They're sourced as intangibles under Rule 3.591(e)(21)(B) to the buyer's legal domicile (state of incorporation for a corporate buyer) — not to where the seller or the contract's underlying activity is located.

Q: Can a seller use a different asset allocation for Texas franchise tax than it used on its federal income tax return?
A: No — per Rule 3.591(d)(4) as applied in this ruling, the same sales-price allocation used for federal income tax purposes governs the Texas apportionment as well.

Citations and references

Statutes and rules:

• Tex. Tax Code § 171.103(a)(1) (Apportionment — Texas receipts from TPP sales delivered/shipped to a Texas buyer)
• 34 Tex. Admin. Code Rule 3.591(e)(29)(A) (TPP sourced to delivery/possession-transfer location; title passage irrelevant)
• 34 Tex. Admin. Code Rule 3.591(e)(21)(B) (Intangibles sourced to payor's legal domicile)
• 34 Tex. Admin. Code Rule 3.591(b)(7) (Corporate legal domicile = state of formation)
• 34 Tex. Admin. Code Rule 3.591(b)(8) (Location of payor defined)
• 34 Tex. Admin. Code Rule 3.591(e)(2) (Net gain apportionment for capital assets/investments — held inapplicable here)
• 34 Tex. Admin. Code Rule 3.591(d)(4) (Sales-price allocation must match the taxpayer's federal income tax return)

Cited prior guidance:

• STAR Accession Nos. 9205L1173C11 and 9404L1356C11 — cited for the principle that contract rights are treated as intangible assets

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=MAR
• Opinion: https://star.comptroller.texas.gov/view/201607948L

Original ruling text

July 22, 2016

Re: Private Letter Ruling Request #152320291

Dear **:

We issue this private letter ruling in response to your August 15, 2015 and
September 3, 2015 requests. You are seeking guidance on the proper
apportionment of gross receipts from the sale of substantially all of an
entity’s assets.

We issue this ruling in accordance with Rule 3.1, Private Letter Rulings and
General Information Letters. [ENDNOTE 1] Detrimental reliance relief is
provided in accordance with Rule 3.10, the Taxpayer Bill of Rights.

Relevant Facts

COMPANY A, located in CITY, Texas, provided services for the oil and gas
industry. In 2014, COMPANY A sold substantially all of its assets to COMPANY B,
an entity incorporated under the laws of Delaware. The terms of the sale are
memorialized in the Asset Purchase Agreement (Agreement).

The business assets COMPANY A sold to COMPANY B included tangible personal
property located in Texas at the time of the sale, tangible personal property
deployed outside of the United States at the time of the sale, and tangible
personal property with an unlabeled location.

COMPANY A transferred title to all of the tangible personal property to COMPANY
B at the time of the sale; however, some of tangible personal property was in
the physical possession of one of COMPANY A’s customers, a large oil company,
as part of COMPANY A’s provision of services to that customer. Under the
Agreement, COMPANY A assigned all of its rights and obligations under its
service contract with the large oil company to COMPANY B.

Under the Agreement, COMPANY A also transferred the following legal and
contractual rights to COMPANY B:

1. Rights under a joint development agreement for advanced oil production
   technology with a large oil company;

2. Rights under a field services contract with a large oil company;

3. Rights under a master agreement for provision of services with large oil company;

4. Rights under an agreement with large oil company to provide inspections services;

5. Rights under confidentiality agreement with the manufacturer of COMPANY A's
   proprietary technology;

6. Rights arising from all government authorizations and pending applications
   for government authorizations, including rights arising from consent, license,
   franchise, permit, exemption, clearance, or registration granted;

7. Rights and interests arising from insurance on COMPANY A or its assets in
   the event of causality or liability;

8. All goodwill associated with COMPANY A or the assets purchased from COMPANY A; and

9. Residual value created by COMPANY A as a going concern.

COMPANY A did not create or purchase these assets for investment purposes;
instead, the assets arose out of business operations. Further, COMPANY A did
not assign these legal or contractual rights a book value at any time before
COMPANY A and COMPANY B executed the Agreement.

Requested Rulings and Responses [ENDNOTE 2]

Requested Rulings 1 & 2:

1. COMPANY A completed delivery of tangible personal property deployed to
   foreign jurisdictions by entering into the Agreement and transferring title to
   the property under Rule 3.591(e)(29).

2. The delivery of tangible personal property resulted in no Texas receipts,
   but resulted in receipts everywhere, when title to the tangible personal
   property deployed to foreign jurisdictions passed to COMPANY B, even if
   physical possession and control isn't established until the assets are brought
   to Texas at a later time, under Rule 3.591(e)(29).

Responses:

Per Section 171.103(a)(1) and Rule 3.591(e)(29), transactions that involve the
sale of tangible personal property result in Texas receipts when the tangible
personal property is delivered or shipped to a buyer in Texas. Delivery is
complete upon transfer of possession or control of the property to the
purchaser. Rule 3.591(e)(29)(A). Location of title passage is not relevant to
the determination of Texas gross receipts. Id.

COMPANY A’s sale of the tangible personal property located in Texas, including
all tangible personal property identified on Schedule 2.1(d)—“Laptops and
Phones” and “CITY, TX Asset List,” results in Texas receipts.

Per COMPANY A’s submissions, the tangible personal property identified on
Schedule 2.1(d)—“Deployed Asset List,” is not located in Texas and at the time
of the sale was deployed for use in a foreign jurisdiction. COMPANY A’s sale of
the tangible personal property deployed to a foreign jurisdiction at the time
of the sale does not result in Texas receipts.

Requested Rulings 3 & 4:

3. The assets described as “Assets Composed of Legal and Contractual Rights”
   are intangibles, and gross receipts from the sale of those assets are
   apportioned under Rule 3.591(e)(21)(B) to location of payor.

4. A corporation that is incorporated under the laws of the state of Delaware
   is legally domiciled in Delaware for purposes of Rule 3.591(b)(7).

Responses:

COMPANY A sold its rights under existing contracts to COMPANY B per the
Agreement. Per Rule 3.591(e), examples of intangibles include but are not
limited to, stocks, bonds, commodities, futures contracts, patents, copyrights,
licenses, trademarks, franchises, goodwill, and general receivable rights.
While contract rights are not specifically listed, the Comptroller has consistently
held that contract rights are intangibles. See STAR ACCESSION NOS. 9205L1173C11
and 9404L1356C11. The assets described as “Assets Composed of Legal and
Contractual Rights” in the Agreement and identified on Schedule 2.1(c) “Included
Contracts” and on Schedule 3.23 “Insurance” are intangible assets.

Per Rule 3.591(e)(21)(B), the gross receipts from the sale of intangibles are
apportioned based on the location of payor. The location of payor is the legal
domicile of the payor. Rule 3.591(b)(8). The legal domicile of a corporation
is its state of formation. Rule 3.591(b)(7). COMPANY B, the payor/purchaser, is
incorporated under the laws of Delaware.

COMPANY A’s sale of the contract rights is the sale of an intangible asset. The
gross receipts from the sale of the contact rights should be apportioned to Delaware.

Requested Rulings 5 & 6:

5. Intangible assets are always held as a capital assets or investments at the
   time of the sale and will be apportioned under Rule 3.591(e)(2).

6. The method for determining the seller’s basis in certain assets for purposes
   of the net gain calculation of Rule 3.591(e)(2) is the same as the method used
   to determine basis for those certain assets for purposes of filing federal
   income tax returns.

Responses:

None of the intangible assets COMPANY A sold to COMPANY B were created or
purchased for investment purposes. COMPANY A had not assigned a book value to
these assets at any time before the Agreement was executed. There is no
evidence that the assets addressed in this ruling are capital assets or
investments. Therefore, the net gain calculation in Rule 3.591(e)(2) is not
applicable. We will be amending Rule 3.591 to clarify the definition of “investment.”

Requested Ruling 7:

7. Under Rule 3.591(d)(4), the correct allocation of the sales price to
   specific assets sold in the Agreement is consistent with the method used by
   COMPANY B's appraisal of the assets, the allocation to be filed by COMPANY B in
   IRS Form 8594, the negotiated statement signed by both parties regarding the
   allocation of the sales price, and COMPANY A’s federal income tax return to be
   filed for the period the sale occurred, and these are the values that should be
   applied for apportioning the gross receipts for Texas franchise tax.

Response:

Rule 3.591(d)(4) states that when a taxable entity computes gross receipts for
apportionment, the taxable entity is deemed to have elected to use the same
methods that the taxable entity used in filing its federal income tax return.
The same allocation of the sales price to specific assets that COMPANY A used
for federal tax purposes should be used for apportioning the gross receipts for
franchise tax.

If you have questions about this private letter ruling, please email us through
our website at https://www.comptroller.texas.gov/taxhelp/ and reference Private
Letter Ruling No. 152320291.

Sincerely,

Tax Policy Division

ENDNOTES

1. Unless otherwise indicated, all references herein to “Section” are to the
   Texas Tax Code, and all references to “Rule” are to Title 34 of the Texas
   Administrative Code. Comptroller’s Decisions and STAR Documents cited can be
   found on the Comptroller’s State Tax Automated Research (STAR) system. The
   Texas Tax Code, Texas Administrative Code, and the are all
   accessible from the Comptroller’s website at http://www.comptroller.texas.gov/taxes/.

2. The ruling requests have been renumbered from COMPANY A’s original submissions.