How did Texas treat a Nevada loan-participation subsidiary, its Texas nexus, and dividends paid to a Texas bank?

Plain-English summary

Texas found loan-servicing nexus on the original facts and treated the subsidiary dividends differently under the two former franchise-tax components.

A Texas banking corporation proposed contributing loan-participation interests to a Nevada subsidiary. The subsidiary would use the Texas bank as master servicer, coordinate Texas and non-Texas servicers, lend collections back to the bank, and declare annual dividends.

The May response said the Nevada subsidiary had Texas nexus because the bank and other Texas servicers performed services on its behalf. It also said:

• A payment formally declared by the subsidiary's board from earnings, rather than capital, would be respected as a dividend.
• Because the bank was commercially domiciled in Texas, dividends were included in both numerator and denominator of its taxable-capital apportionment factor.
• To the extent dividends entered earned surplus, they likewise entered both earned-surplus apportionment numerator and denominator.
• To the extent Rule 3.555(e) excluded the dividends from federal taxable income through Schedule C deductions, they were excluded from taxable earned surplus and earned-surplus receipts.
• The dividends entered taxable capital and taxable-capital gross receipts when declared.

The June follow-up said the Comptroller needed the participation agreement and more information about whether the Texas bank had to pay the subsidiary even when borrowers did not pay. That request for facts limits how broadly the original nexus answer should be read.

What this means for you

Banks and finance companies reviewing historical structures

Using a separately incorporated out-of-state subsidiary did not prevent Texas nexus when Texas entities serviced the subsidiary's loans.

Tax professionals

Separate nexus, dividend characterization, taxable-capital sourcing, and the Schedule C earned-surplus exclusion. Also obtain the operative servicing agreement before applying the nexus analysis.

Common questions

Q: Did Texas find the Nevada subsidiary had nexus?
A: Yes, on the original facts, because services were performed for it in Texas.

Q: When would a payment be respected as a dividend?
A: When formally declared by the board from earnings rather than as a return of capital.

Q: How did a Schedule C deduction affect earned surplus?
A: The excluded dividend was removed from taxable earned surplus and earned-surplus receipts to that extent.

Q: Did the follow-up finally resolve the collection arrangement?
A: No. It requested the participation agreement and additional facts.

Citations and references

• Texas Tax Code Secs. 171.001(b), 171.1031(a), and 171.109(f)
• 34 Tex. Admin. Code Sec. 3.555(e)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=FIT
• Opinion: https://star.comptroller.texas.gov/view/9706435L

Original ruling text

June 20, 1997

Dear Mr. **:

Thank you for your follow-up letter concerning the nexus of your client. In my
response to your April 7 inquiry, I determined that your client was subject to
the franchise tax.

In your June 4, 1997 letter, you stated that "A still has the obligation...to
collect loan payments made by the borrowers,..." You also stated that "Nevco
has engaged A...to gather together and pay to Nevco amounts due it under the
participation agreement." I do not see a distinction between these statements
and the statement in your original letter that Nevco has appointed "A" as the
master servicer of the loans in question.

I believe that the only way for us to clearly understand the facts and
circumstances is for us to review the participation agreement. I would also
like to know what happens if "A" does not actually collect from the borrowers.
Is "A" still obligated to pay Nevco the proceeds on the loans whether or not
the loan proceeds are collected?

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

If you have any questions about this or any other franchise tax matter, please
call me at
1-800-531-5441, extension 34612. My direct number is (512) 463-4612. You may
write me at Tax Policy Division, Comptroller of Public Accounts, Austin, Texas
78774.

Sincerely,

Janet Spies
Tax Policy Division

May 21, 1997

Dear Mr. **:

Thank you for your letter concerning the franchise tax consequences resulting
from a corporate restructuring of a financial institution. I apologize for the
delay in responding to your inquiry.

You stated in your letter that your client, Corporation A ("A"), is a Texas
financial institution which is a banking corporation as defined under Texas Tax
Code (TTC) Section 171.001(b). It is commercially domiciled in Texas. In
addition to "A's" operation as a financial institution, it has a substantial
quantity of investments in difficult to service commercial loans. "A"
currently arranges with a number of different companies (located both within
and without Texas) to service the loans.

"A" and its principals have proposed that a wholly owned subsidiary (Nevco) of
"A" be formed in Nevada. Nevco will conduct no business activity in, nor have
any nexus with the State of Texas. "A" would capitalize Nevco with a capital
contribution in the form of a 100% participation in certain loans from the
portfolio currently held by "A." As the grantee of a 100% participation in the
loan proceeds, Nevco would have the legal right to all such proceeds, but would
not own the loans itself. Subsequent to the contribution of participation
interests, Nevco will appoint "A" as the master servicer of the loans.

Nevco will have money collected on its behalf by various loan servicers who
will be coordinated by "A." Some of the servicers are located in Texas and
others are not. Nevco will receive its loan payments on a monthly basis from
the loan servicers. Subsequent to receiving the loan proceeds, Nevco will lend
funds to "A" each month. On an annual basis, Nevco will declare a dividend to
"A" approximately equal to the loan amount due from "A." "A" will then repay
the loan amounts due on the same annual basis.

I have restated and responded to your specific ruling requests below.

1)Nevco will not be subject to Texas franchise tax as a result of its loan
participation arrangement with "A" for any reason.

Response: Nevco will have nexus in Texas because it will have services
performed on its behalf by Corp. A and other servicers in Texas.

2)Nevco will not be treated as doing business in Texas as a result of any
activities performed by servicers in connection with its loan participation
arrangement.

Response: See response to number 1 above.

3)Dividend payments declared and made by Nevco to "A" will be respected as
dividends.

Response: As long as the dividends are formally declared by Nevco's board of
directors, out of earnings (not return of capital), the dividends will be
considered dividends for the calculation of Texas franchise tax.

4)Dividend payments received by "A" are included in gross receipts of both the
numerator and denominator of the apportionment factor of "A" because "A" is a
banking corporation domiciled in Texas.

Response: Section 171.1031(a) of the Texas Tax Code (TTC) states that
"interest and dividends received by a banking corporation or a savings and loan
association are gross receipts of the banking corporation or savings and loan
association from its business done in this state if the banking corporation or
savings and loan association has its commercial domicile in this state."
Because "A's" commercial domicile is in Texas, the dividends it receives from
Nevco will be included in both the numerator and denominator of the
apportionment factor for the taxable capital component of the franchise tax.
To the extent that the dividends are included in earned surplus, they will be
included in both the numerator and denominator of the apportionment factor for
the earned surplus component of the tax.

5) Dividend payments received by "A" from Nevco are excluded from "A's" earned
surplus tax base. Conversely, such dividend payments are included in "A's"
taxable capital base.

Response: To the extent that the dividends received from Nevco are excluded
from "A's" federal taxable income under Rule 3.555(e) (Schedule C deductions),
the dividends will be excluded from "A's" taxable earned surplus and from gross
receipts for earned surplus apportionment.

The dividends will be included in "A's" taxable capital base and gross receipts
as of the date of declaration. See TTC Section 171.109(f).

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

If you have any questions about this or any other franchise tax matter, please
call me at
1-800-531-5441, extension 34612. My direct number is (512) 463-4612. You may
write me at Tax Policy Division, Comptroller of Public Accounts, Austin, Texas
78774.

Sincerely,

Janet Spies
Tax Policy Division