After a corporate restructuring creates new subsidiaries with different federal tax filing statuses (S corp, disregarded entities, consolidated C corps), do all the resulting entities still qualify as 'affiliated entities' for Texas's intercorporate services sales tax exemption?

Plain-English summary

The Texas Comptroller ruled that after a corporate restructuring, an oil and gas limited partnership, its four newly formed subsidiaries, and several existing LLCs all still qualify as "affiliated entities" for Texas's intercorporate services sales tax exemption — even though their federal income tax filing statuses are a genuine mix of an S-corp parent, consolidated-return C-corp subsidiaries, and disregarded-entity LLCs that can't all file on the same federal return.

Texas exempts sales of taxable services between "affiliated entities" (Section 151.346), defined by reference to the federal "affiliated group" concept in IRC Section 1504 — but without that federal provision's exclusions (like the one that knocks S corporations out of a federal affiliated group). After the restructuring, the taxpayer (an S-corp-electing limited partnership) became sole shareholder of one new C-corp subsidiary, which in turn owns a second C-corp subsidiary; those two C-corps file a consolidated federal return together. The taxpayer also owns two new disregarded-entity LLCs directly, plus several pre-existing disregarded-entity LLCs unaffected by the restructuring — all of whose income/losses flow up to the taxpayer's own separate federal return. Even though federal tax rules prevent the S-corp taxpayer and its disregarded entities from joining the C-corp subsidiaries' consolidated federal return, Texas's own rule (34 Tex. Admin. Code § 3.331(c)(2)) explicitly preserves the exemption when a seller or purchaser can't file a consolidated federal return specifically because of those IRC Section 1504(b) exclusions. So every entity in the restructured group — the S-corp parent, both C-corp subsidiaries, and every disregarded-entity LLC — counts as "affiliated" for Texas sales tax purposes, and taxable services sold between any of them are exempt.

What this means for you

Companies restructuring into multiple subsidiaries with different tax elections

Mixed federal filing statuses (S corp, C corp, disregarded entity) among a corporate family don't automatically break Texas's intercorporate services exemption. The key is common ownership consistent with the federal "affiliated group" definition — the exclusions that would otherwise knock certain entity types out of a federal consolidated group don't apply for Texas sales tax purposes.

Disregarded-entity LLCs within a corporate family

An LLC that's a disregarded entity for federal tax purposes, with its income reported on its parent's return, still counts as an "affiliated entity" as long as the parent is part of an affiliated group under the federal definition — even LLCs untouched by a restructuring can be swept into this analysis.

Accountants and tax professionals

The controlling framework is Section 151.346(b) and 34 Tex. Admin. Code § 3.331(c)(2), which define "affiliated entity" using the IRC Section 1504(a)(1) "affiliated group" concept but WITHOUT applying the 1504(b) exclusions that determine which entities can actually file a federal consolidated return. STAR Accession No. 200212621L (2002) is the controlling precedent for disregarded LLCs qualifying under this exemption.

Common questions

Q: Does every entity in a corporate family need to be able to file on the same federal consolidated tax return to qualify for Texas's intercorporate services exemption?
A: No. Texas's definition of "affiliated entity" uses the federal "affiliated group" ownership concept but specifically doesn't require the exclusions that determine federal consolidated-filing eligibility (like S-corp status) to apply.

Q: Do disregarded-entity LLCs qualify for this exemption?
A: Yes, as long as their parent is part of a qualifying affiliated group and the LLC's income/losses are reported on that parent's federal return.

Q: Is tax due on services sold between affiliated entities if the service itself was already taxable before September 1987?
A: Yes — the exemption doesn't apply to services that were taxable on or before Sept. 1, 1987, a narrow historical carve-out preserved in the statute.

Q: Can another restructuring company rely on this ruling?
A: No. It's binding on the Comptroller only for the requesting taxpayer and facts presented, and cannot be relied on by any other taxpayer.

Citations and references

Statutes and rules:

• Tex. Tax Code § 151.346 (Intercorporate Services exemption)
• 34 Tex. Admin. Code § 3.331(c)(2) (Transfers of Common Interests in Tangible Personal Property; Intercorporate Services)
• 26 U.S.C. § 1504(a)(1), (b) (Internal Revenue Code — affiliated group; includible corporation exclusions)
• STAR Accession No. 200212621L (Dec. 9, 2002) (disregarded-entity LLC qualifying for the exemption)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/201801017L

Original ruling text

January 8, 2018

ADDRESS

CITY, New York 10112-0086

RE: Private Letter Ruling No. 20171019142739

**, Taxpayer No. **

Dear Mr. Bezozo:

We issue this private letter ruling in accordance with Rule 3.1, Private Letter Rulings and General Information Letters.[ENDNOTE: 1] We are responding to your request dated Oct. 13, 2017. Detrimental reliance relief is provided in accordance with Rule 3.10, Taxpayer Bill of Rights.

You requested guidance on whether entities created after a corporate restructuring are considered “affiliated entities” for purposes of the intercorporate services exemption under Section 151.346 (Intercorporate Services).

Facts Presented

** (Taxpayer) is a Texas limited partnership involved in oil and gas exploration and production. Taxpayer plans to restructure its business operations. As part of the restructuring, Taxpayer is moving its twelve existing divisions into four newly formed subsidiaries:

COMPANY A

COMPANY B

COMPANY C

COMPANY D

Taxpayer is the sole shareholder of COMPANY A, and COMPANY A is the sole shareholder of COMPANY B. Taxpayer is the sole member of COMPANY C, COMPANY D, and four other LLCs not affected by the restructuring plan (“unaffected LLCs”).

COMPANY C only performs taxable services for Taxpayer and its subsidiaries, while COMPANY D performs taxable services for Taxpayer, its subsidiaries, and unrelated third parties. Similarly, COMPANY A and COMPANY B performs taxable services for Taxpayer, its subsidiaries, and unrelated third parties.

For federal income tax purposes, Taxpayer “checks the box,” electing treatment as an S corporation. Both COMPANY C and COMPANY D are disregarded entities for federal income tax purposes (i.e., their receipts and losses are treated as receipts and losses of Taxpayer). The unaffected LLCs are also disregarded entities for federal income tax purposes. Taxpayer will file its own federal income tax return, Form 1120-S, which will include the receipts and losses of COMPANY C, COMPANY D, and the unaffected LLCs.

COMPANY A and COMPANY B are taxed as C corporations and will file a consolidated federal income tax return together.

Question, Ruling, and Analysis

Our restatement of your question is shown below, followed by our response and analysis.

Question:

After restructuring its business operations, are Taxpayer, COMPANY A, COMPANY B, COMPANY C, COMPANY D, and the unaffected LLCs “affiliated entities” that qualify for the intercorporate services exemption in Section 151.346(a)?

Ruling:

After the restructuring, Taxpayer, Corp.1, COMPANY B, COMPANY C, COMPANY D, and the unaffected LLCs are “affiliated entities” for purposes of the intercorporate services exemption in Section 151.346(a). No tax is due on sales or purchases of taxable services between affiliated entities, unless the service was taxable on or before September 1, 1987.

Analysis:

Section 151.346 exempts from sales and use tax a sale or purchase of a taxable service between affiliated entities, at least one of which is a corporation, that report their income to the Internal Revenue Service (IRS) on a single consolidated return for the tax year in which the transaction occurs.

Section 151.346(b) defines an “affiliated entity” to include an entity that would be classified as a member of an “affiliated group” under Internal Revenue Code (IRC) Section 1504 (Definitions), but for the exclusions provided by that section.

Under IRC Section 1504(a)(1), the term “affiliated group” means one or more chains of includible corporations connected through stock ownership with a common parent corporation which is an includible corporation. Under IRC Section 1504(b), the term “includible corporation” means any corporation other than an S corporation and certain other entities.

Rule 3.331(c)(2) (Transfers of Common Interests in Tangible Personal Property; Intercorporate Services) explains tax is not due on charges for taxable services if both the seller and purchaser are entities classified as members of an affiliated group under IRC Section 1504, but either the seller or purchaser or both cannot file a consolidated federal income tax return because of the exclusions provided by IRC Section 1504(b).

Taxpayer, COMPANY A, and COMPANY B are members of an affiliated group under IRC Section 1504(a)(1). Although IRC Section 1504(b) excludes Taxpayer, an S corporation, from the affiliated group for federal income tax purposes, Section 151.346(b) and Rule 3.331(c)(2) include Taxpayer as an affiliated entity for purposes of the intercorporate services exemption from Texas sales and use tax.

COMPANY C and COMPANY D are disregarded entities for federal income tax purposes and their receipts and losses are treated as Taxpayer’s receipts and losses for federal tax purposes. In STAR Accession No. 200212621L (Dec. 9, 2002), it was determined that an LLC that elects to report as a disregarded entity for federal income tax purposes qualifies for the intercorporate services exemption if the parent company reports the disregarded entity’s income on a single consolidated federal income tax return with other affiliated entities. Because Taxpayer is a member of an affiliated group with COMPANY A and COMPANY B, COMPANY C, COMPANY D, and the unaffected LLCs are also part of that group.

COMPANY A and COMPANY B report their income on a single consolidated return for federal income tax purposes. Taxpayer reports its income (and the disregarded entities’ income) on a separate return because IRC Sections 1501 and 1504(b) prevent Taxpayer from reporting its income on the same consolidated return as COMPANY A and COMPANY B. However, Rule 3.331(c)(2) provides that the intercorporate service exemption can still apply if the seller and purchaser are affiliated entities, but at least one cannot report its income on a single consolidated return because of the exclusions under IRC Section 1504(b). See also STAR Accession No. 200212621L. Although Taxpayer reports its income (and the disregarded entities’ income) on a separate return, Rule 3.331(c)(2) allows the Section 151.346 exemption for services these entities buy from or sell to COMPANY A, COMPANY B, and each other.

STAR documents cited are available on the Comptroller’s State Tax Automated Research (STAR) system. The Texas Tax Code, Texas Administrative Code, and the STAR system are accessible at www.comptroller.texas.gov/taxes/.

If you have questions about this private letter ruling, please email us through our website at https://comptroller.texas.gov/web-forms/tax-help/ and reference Private Letter Ruling No. 20171019142739.

Sincerely,

Tax Policy Division – Indirect Taxes

Texas Comptroller of Public Accounts

ENDNOTE:

1. Unless otherwise indicated, all references to “Section” are to the Texas Tax Code, and all references to “Rule” are to Title 34 of the Texas Administrative Code.