Can a manufacturer's representative that buys equipment from manufacturers and resells it to customers under its own contracts take the cost of goods sold (COGS) deduction, even though it never physically handles the product?

Plain-English summary

A manufacturer's representative that recommends and supplies heat-transfer and fluid-flow equipment asked whether it "owns" the goods it resells for purposes of the Texas franchise tax cost of goods sold (COGS) deduction — a threshold question, since only the entity that owns goods sold in the ordinary course of business can take the COGS subtraction. The company runs two relevant transaction types: (1) a single-manufacturer buy-resell deal, where it contracts to buy a product from one manufacturer and separately contracts to sell it to a customer, and (2) a multi-manufacturer deal, where it contracts with several manufacturers for individual parts that get assembled into one product it then sells as a whole.

The Comptroller ruled the company does own the goods in both scenarios, even though the manufacturer often ships the product directly to the end customer and the company itself never physically handles it. Under Texas rule, whoever holds legal title is presumed to be the owner (rebuttably), and the Comptroller found legal title flowed to the company in both transaction types because:

• The company's separate purchase and sale contracts (buying from the manufacturer, selling to the customer) show it acquired and then transferred ownership.
• Contract language explicitly shifted risk of loss to the company once the manufacturer handed the product to the common carrier — evidence of title passing to the company at that point.
• In the multi-manufacturer deals, purchase-order terms required the company to warrant clear title to its customer, which it couldn't do unless it held title itself first.

Since the company owns the goods under both transaction structures, it may deduct eligible direct acquisition/production costs as cost of goods sold. The ruling explicitly notes this conclusion is based on the specific facts and documentation presented — different contract terms could yield a different ownership conclusion.

What this means for you

Manufacturer's representatives, brokers, and drop-shippers

Never physically touching the product doesn't disqualify you from being its "owner" for COGS purposes — what matters is what your purchase and resale contracts say about title and risk of loss. If you separately contract to buy from a supplier and sell to a customer, and your contracts show title/risk passing through you (even briefly, even in a drop-ship arrangement), you may be able to claim the COGS deduction.

Businesses using commission-only or agency models

This ruling only addressed the company's buy-resell transactions — it explicitly noted a third transaction type (commission projects, where the customer orders directly from the manufacturer) was "not at issue." A pure commission/agency arrangement, where the company never takes title at all, would likely be analyzed differently and probably wouldn't support a COGS deduction for that revenue stream.

Accountants and tax professionals

The operative rule is Rule 3.588(c)(9)(A)'s rebuttable presumption that whoever holds legal title owns the goods — review the client's actual purchase/sale contract language (risk of loss, title-warranty, and title-passage clauses) rather than just the physical logistics of the transaction, since physical handling isn't determinative.

Common questions

Q: Does a company need to physically possess or warehouse goods to be their "owner" for COGS purposes?
A: No — this ruling found the company owned goods that shipped directly from the manufacturer to the end customer, based entirely on contract terms establishing legal title and risk of loss.

Q: What contract terms mattered most in this ruling?
A: Separate purchase and sale contracts (evidencing the company bought and then resold the goods), a risk-of-loss clause shifting risk to the company upon shipment, and a title-warranty clause requiring the company to warrant clear title to its customer.

Q: Does this ruling cover commission-based sales where the customer orders directly from the manufacturer?
A: No — the ruling explicitly excluded the company's commission-project transactions from its scope, since those weren't at issue in the request.

Q: Can any manufacturer's representative rely on this ruling for its own COGS deduction?
A: Not automatically — the Comptroller expressly noted its conclusion is based on the specific facts and contract documentation presented; different contract terms could yield a different ownership determination.

Citations and references

Statutes and rules:

• Tex. Tax Code § 171.1012(a)(1) (definition of "goods")
• Tex. Tax Code § 171.1012(c) (direct costs of acquiring or producing goods)
• Tex. Tax Code § 171.1012(i) (ownership determined by facts and circumstances, including benefits/burdens of ownership)
• 34 Tex. Admin. Code Rule 3.588(c)(9), (c)(9)(A) (Margin: Cost of Goods Sold — rebuttable legal-title ownership presumption)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=MAR
• Opinion: https://star.comptroller.texas.gov/view/201806034L

Original ruling text

June 29, 2018

RE: Private Letter Ruling No. 2017010150

*, Taxpayer No. *

Dear ***:

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 initial request dated Aug. 3, 2015, and your supplemental submission dated Oct. 26, 2016. Detrimental reliance relief is provided in accordance with Rule 3.10, Taxpayer Bill of Rights.

You requested guidance on whether you are the owner of goods for purposes of calculating cost of goods sold under Section 171.1012 (Determination of Cost of Goods Sold).

Facts Presented

*** (Taxpayer), located in CITY, Texas, is a manufacturer’s representative that recommends, specifies, and supplies heat-transfer and fluid- flow equipment and related systems to customers.

Taxpayer engages in three types of transactions: (1) single manufacturer buy-resell projects; (2) multiple manufacturer buy-resell projects; and (3) commission projects where the customer orders equipment direct from the manufacturer. Commission projects are not at issue in this request.

The relevant facts are based on information contained in Taxpayer’s ruling request and supplemental submission; contracts and related documentation provided by Taxpayer; and a conference call with Taxpayer on Nov. 9, 2016.

Single manufacturer buy-resell project

A single manufacturer buy-resell transaction starts when a customer places an order with Taxpayer for a customized engineered product and enters into a written contract with Taxpayer. Taxpayer subsequently enters into a contract with a manufacturer to produce the product.

Manufacturer invoices Taxpayer and Taxpayer pays manufacturer for the product. Taxpayer invoices the customer and the customer pays Taxpayer for the product.

Taxpayer provided documentation illustrating an example of this type of transaction. In the example, COMPANY A (Customer M) requested a heat exchanger from Taxpayer. Taxpayer then placed an order for the heat exchanger with COMPANY B (Manufacturer F). Manufacturer F shipped the heat exchanger by common carrier to Customer M. Taxpayer paid Manufacturer F and billed Customer M.

Multi-manufacturer project

In a multi-manufacturer transaction, a customer places an order with Taxpayer for a single item that may contain many individual parts and enters into a written contract with Taxpayer.

Taxpayer obtains proposals from multiple manufacturers to supply individual parts. One manufacturer receives all the parts from the other contracted manufacturers and assembles the parts into a single item per the contract. Each manufacturer invoices Taxpayer for the parts and assembly, as relevant, and Taxpayer pays the manufacturers. Taxpayer bills the customer and the customer pays Taxpayer for the completed product.

Taxpayer provided documentation illustrating an example of this type of transaction. In the example, COMPANY A (Customer A) contracted with Taxpayer for a thermal fluid heating system. Taxpayer contracted with multiple manufacturers for specific parts, which COMPANY C (Assembler) incorporated into the heating system. Assembler also manufactured some individual parts.

Question, Ruling and Analysis

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

Question:

For purposes of the Texas franchise tax, is Taxpayer the owner of the goods such that Taxpayer may subtract from taxable margin the cost of goods sold?

Ruling:

Yes. Taxpayer is the owner of the goods in both the single manufacturer buy-resell project and the multi-manufacturer project, as demonstrated by the two example transactions. Taxpayer may subtract eligible costs from taxable margin as costs of goods sold.

Analysis:

Section 171.1012 addresses the determination of cost of goods sold for purposes of calculating Texas franchise tax. It defines “goods” to mean “real or tangible personal property sold in the ordinary course of business of a taxable entity.” Section 171.1012(a)(1). Cost of goods sold “includes all direct costs of acquiring or producing the goods.” Section 171.1012(c).

A taxable entity may make a subtraction in relation to the cost of goods sold only if the entity owns the goods. Section 171.1012(i) and Rule 3.588(c)(9) (Margin: Cost of Goods Sold). Section 171.1012(i) states, “The determination of whether a taxable entity is an owner is based on all the facts and circumstances, including the various benefits and burdens of ownership vested with the taxable entity.”

For the purposes of calculating cost of goods sold for franchise tax, Rule 3.588(c)(9)(A) states, “A taxable entity that holds the legal title to the goods is presumed to be the owner of the goods for the purposes of this section. A taxable entity may rebut this presumption by proving an ownership right superior to the legal title holder.”

Single manufacturer buy-resell project

Taxpayer enters into a contract with the manufacturer for the purchase of the good and enters into a separate contract with its customer for the sale of the good. Because Taxpayer purchased and sold the good under the contracts, it is clear that Taxpayer obtains legal title to the good. Further, the Terms and Conditions of Sale issued by Manufacturer F to Taxpayer also provides in Paragraph VI, “Delivery and Risk of Loss and Government Licenses” that risk of loss shall shift to Buyer (Taxpayer) when Seller (Manufacturer F) provides the product to the common carrier. This is further evidence that Taxpayer obtains legal title to the goods.

Multi-manufacturer project

Taxpayer enters into contracts with multiple manufacturers, including the manufacturer that assembles the completed good, for purchase of each component part and the completed good and enters into a contract with its customer for the sale of the completed good. Because Taxpayer purchased and sold the goods under the contracts, it is clear that Taxpayer obtains legal title to the good.

The documentation further supports that Taxpayer has legal title of the good. The Standard Purchase Order Terms and Conditions issued by Customer A to Taxpayer in Section 12 “Title” state that Taxpayer warrants full and unrestricted title to Customer A, free and clear of any and all liens, restrictions, reservations, security interests, and encumbrances. It also states that if Customer A makes progress payments to Taxpayer, title to the goods shall pass to Customer A at the time that Taxpayer identifies the goods as property of Customer A by visible marking or tagging. Taxpayer could not warrant title of the goods to its customer or pass title of the goods to its customer, if it did not obtain title to the goods.

This ruling is based on the facts and documentation presented. Different facts may yield different conclusions.

The Texas Tax Code and Texas Administrative Code 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. 2017010150.

Sincerely,

Tax Policy Division – Direct Taxes

Texas Comptroller of Public Accounts

ENDNOTE:

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.