How were dividends and interest, including income from federal obligations, treated under the former Texas franchise-tax components?

Plain-English summary

Dividends and interest entered taxable capital broadly, while earned surplus followed federal income subject to specific reductions.

For taxable capital, the corporation included dividends and interest—including interest exempt from federal income tax—in surplus and everywhere receipts. Dividends entered surplus when declared. The income was a Texas receipt if the payor's legal domicile was Texas.

For earned surplus, dividends and interest were included only to the extent they entered reportable federal taxable income. Section 171.110 then required the stated subtractions, and Rule 3.555(k) allowed a reduction for dividends and interest from qualifying federal obligations. Any amount remaining in earned surplus entered everywhere receipts and was sourced to Texas by the payor's location.

What this means for you

Corporations holding investments

Federal tax-exempt status did not automatically remove interest from the former taxable-capital calculation.

Tax professionals

Analyze taxable capital, federal-income inclusion, Texas modifications, federal-obligation qualification, and receipt sourcing as separate steps.

Common questions

Q: Was federally exempt interest included in taxable capital?
A: Yes.

Q: When were dividends included in surplus?
A: When declared.

Q: Did earned surplus include every dividend and interest item?
A: No; it followed reportable federal taxable income and the cited reductions.

Citations and references

• Texas Tax Code Secs. 171.001, 171.109(f), and 171.110(a), (d)
• 34 Tex. Admin. Code Secs. 3.555(k), 3.549, and 3.557
• I.R.C. Sec. 78 and Secs. 951-964

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=FIT
• Opinion: https://star.comptroller.texas.gov/view/9710256L

Original ruling text

October 6, 1997

To: **

Dear **:

Thank you for your e-mail in which you requested franchise tax information
regarding the dividends and interest received by a Delaware Corporation doing
business in Texas.

Because the Delaware corporation is doing business in Texas, it is subject to
the franchise tax. See Section 171.001 of the Texas Tax Code (TTC).

For the taxable capital component of the franchise tax, the dividends and
interest (including interest exempt from federal income tax) earned by the
corporation will be included in the calculation of surplus and in gross
receipts everywhere. The dividends will be included in surplus on the date
that the dividends were declared. See Sec. 171.109(f). The dividends and
interest will be included in Texas gross receipts if the legal domicile (state
of incorporation) of the payor is in Texas.

For the earned surplus component, the dividends and interest will be included
in the calculation of net taxable earned surplus to the extent that they are
included in the calculation of reportable federal taxable income. A
corporation's reportable federal taxable income is defined in Sec. 171.110(d)
as "the corporation's federal taxable income after Schedule C special
deductions and before net operating loss deductions as computed under the
Internal Revenue Code..."Sec. 171.110(a) states that "any amount included in
reportable federal taxable income under Section 78 or Sections 951-964,
Internal Revenue Code, and dividends received from a subsidiary, associate, or
affiliated corporation that does not transact a substantial portion of its
business or regularly maintain a substantial portion of its assets in the
United States" should be subtracted from reportable federal taxable income when
calculating earned surplus.

Rule 3.555(k) allows for a reduction of earned surplus for dividends and
interest received from federal obligations. This section of the rule provides
a definition of a federal obligation.

To the extent that the dividends and interest are included in the calculation
of earned surplus they will be included in gross receipts everywhere and in
Texas gross receipts based on the location of the payor.

For additional information on the apportionment of gross receipts, see Rule
3.549, Taxable Capital: Apportionment and Rule 3.557, Earned Surplus:
Apportionment. These rules and Rule 3.555 mentioned above can be viewed at
.
The statutory cites mentioned above are in Chapter 171 of the TTC which can be
viewed on the world wide web at
.

If you have questions about this, you may call me at 1-800-531-5441, extension
3-4612, or e-mail me at the address below.

Sincerely,

Janet Spies
Tax Policy Division
[email protected]