Do a software developer's Texas sales, installation, and license fees create franchise-tax nexus, and do a franchisor's initial fee and royalties?

Plain-English summary

An out-of-state company asked whether various Texas activities of two New Jersey corporations created (pre-2008) Texas franchise-tax nexus. The Comptroller first noted that a foreign corporation is not subject to the earned-surplus component if its Texas activities are protected by Public Law 86-272 (which shields mere solicitation of sales of tangible personal property). It then answered:

Corporation #1 — a software developer selling to governments:

• Soliciting sales through salespeople in Texas creates nexus for both the taxable-capital and earned-surplus components (Rules 3.546 and 3.554).
• Charging the customer to send an employee to install the software creates nexus, because the corporation is performing services in Texas.
• Charging an annual license fee for using the software was said to create nexus (Question 3) — but that specific holding was later withdrawn (see currency note).
• Providing only telephone support, with no other Texas contact, does not create nexus.

Corporation #2 — a franchisor of retail party-goods stores:

• The initial franchise fee creates nexus, because the franchisor is providing services in Texas; it could be subject even if no employees came into Texas (Rule 3.546(c)(8)).
• Monthly royalties are treated the same way.

Important currency note: STAR marks this document partially superseded on January 27, 2010. The holding that a software licensing fee alone qualifies as Texas franchise-tax nexus (Question 3) was withdrawn as an error / inaccurate statement of policy. In addition, this letter applies the pre-2008 franchise tax; the 2007 legislation (House Bills 3 and 3928) replaced it with the current margin tax, which has its own nexus and apportionment rules. Treat every conclusion here as historical and confirm current law.

What this means for you

Out-of-state software and franchise businesses selling into Texas

Before 2008, sending salespeople, performing installation, or franchising into Texas pulled a corporation into the franchise tax, while pure solicitation of tangible-goods sales could still be shielded from the earned-surplus component by PL 86-272. Note that the old idea that a software license fee by itself creates nexus was later disavowed — do not rely on it.

Accountants and tax professionals

Watch the two-component structure (taxable capital vs. earned surplus) and the PL 86-272 shield, but re-verify every nexus conclusion under the margin tax's economic-nexus framework — and disregard the superseded Question 3 licensing-fee holding.

Common questions

Q: Did soliciting software sales in Texas create franchise-tax nexus?
A: Yes — salespeople soliciting sales in Texas gave the corporation nexus for both the taxable-capital and earned-surplus components.

Q: Is the annual software license fee still treated as creating nexus?
A: No. That specific holding (Question 3) was superseded on January 27, 2010 as an inaccurate statement of policy.

Q: Did the franchisor have nexus even without sending employees to Texas?
A: Yes — its initial franchise fee and monthly royalties made it subject, and Rule 3.546(c)(8) meant it could be subject even without employees in Texas.

Citations and references

Statutes and rules:

• Public Law 86-272 (shields a foreign corporation from the earned-surplus component when its Texas activity is limited to solicitation)
• Franchise Tax Rule 3.546 (Taxable Capital: Nexus)
• Franchise Tax Rule 3.554 (Earned Surplus: Nexus)
• Franchise Tax Rule 3.546(c)(8) (activities constituting doing business in Texas)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=FIT
• Opinion: https://star.comptroller.texas.gov/view/9305L1261E01

Original ruling text

STAR SUPERSEDED INFORMATION

Accession No.(s):
Superseded Type: Partial
Document superseded on: January 27, 2010
Issue(s) that caused the document to be superseded: Software licensing fee
qualifying as Texas nexus for Franchise Tax (Question 3).
Reason(s): Error - inaccurate statement of policy.

May 26, 1993

Dear ***:

In your letter of April 27, you requested a determination regarding the
application of income or similar taxes in Texas.

Texas imposes a franchise tax on certain entities including Texas domestic
corporations and foreign (non-Texas) corporations that are authorized to do
business in Texas or are actually doing business in Texas. In general, the
franchise tax is based on the greater of the tax on net taxable capital or the
tax on net taxable earned surplus. However, a foreign corporation is not
subject to the tax on net taxable earned surplus if the corporation's
activities in Texas are protected under the provisions of Public Law 86-272. I
have enclosed a publication which provides general information regarding the
calculation of these components.

I have restated the activities and questions for each corporation with my
responses:

Corporation #1

Corporation #1, a developer of computer software, is located in New Jersey. The
company sells only to municipal, county, and state governments. Although the
corporation's employees may come into Texas to solicit business, the employees
have no authority to accept orders, handle customer complaints, or collect
delinquent accounts. The software is shipped into Texas by common carrier.

Question #1

Does the corporation have nexus for the sale of the software only?

Response

Yes. Because the corporation has salesman in Texas soliciting sales of
software, the corporation has nexus for the taxable capital and earned surplus
components of the franchise tax. I have enclosed Rule 3.546 and Rule 3.554
which address the nexus standards for the taxable capital and earned surplus
components respectively. You should note that Rule 3.554 is currently being
revised as indicated in the enclosed excerpt from the Tax Policy News
(September, 1992).

Question #2

If the corporation charges the customer to send an employee into Texas to
install the software, does this constitute nexus?

Response

Yes. In this case, the corporation is subject to the taxable capital and earned
surplus components because the corporation is performing services in Texas.

Question #3

If the corporation charges an annual fee to the customer for using the
software, does this constitute nexus?

Response

Yes. Corporation #1 would be subject to the taxable capital and earned surplus
components of the tax because the corporation 9 licensing of the software in
Texas constitutes nexus.

Question #4

Does providing telephone support which is charged to customers in Texas create
nexus if no employees are located in Texas?

Response

If the company has no contact with Texas (including those activities listed in
Questions #1 through #3), the company is not subject to franchise tax.

Corporation #2

Corporation #2, a New Jersey corporation, is a franchiser of retail party good
stores. The franchisee is charged an original franchise fee plus royalties of
3% of sales on a monthly basis. Prior to the opening of a franchisee's store,
Corporation #2 (the franchiser) sends its personnel into the store to supervise
the set-up of merchandise. Otherwise, Corporation #2 sends no employees into
Texas.

Question #1

Does the charge for the initial franchise fee create nexus?

Response

Yes. In this situation, the corporation is providing services in Texas.
Therefore, the corporation is subject to the taxable capital and earned surplus
components of the franchise tax. You should note that the corporation could be
subject to franchise tax even if no employees came into Texas as indicated in
Rule 3.546(c)(8).

Question #2

Does the charging of monthly royalties create nexus in Texas?

Response

See response to Question #1.

This opinion is based on the facts presented. If there are additional or
different facts, the opinion may change.

If you have any questions, contact Tax Administration Division. You may call
toll free 1-800-531-5441, or our regular number is 512/463-4600. My extension
is 3-4662. You may write me at Tax Administration Division, Comptroller of
Public Accounts.

Sincerely,

Bob Jeffcoat
Tax Administration Division

NOTE: Previous Accession Number 9305094L