How did Texas determine the legal domicile of grantor trusts holding leased aircraft or buildings, and what amount did the corporate beneficiary apportion?

Plain-English summary

Texas located a trust's legal domicile where its day-to-day operations occurred and required the corporate beneficiary to apportion the net trust amount without ignoring the trust entity.

A Delaware corporation headquartered in Connecticut financed large leased assets through seven grantor trusts. Each trust borrowed on a nonrecourse basis, acquired an aircraft or office building, collected lease payments, paid debt service, and remitted the balance to the corporate beneficiary. In the example, a trust received $1 million, paid $750,000 to its lender, and sent $250,000 to the beneficiary.

Rule 3.549(e)(47) sourced trust distributions by the trust's legal domicile. Rule 3.549(b)(6) defined that domicile as the trust's principal place of business—the location of day-to-day operations. If operations were conducted equally or fairly evenly in more than one state, the rule used commercial domicile, meaning the place from which the trust's business was directed.

The seven results were:

• Trusts 1–4, aircraft: unresolved. The Comptroller needed the time each airplane spent in Texas, other states, and other countries before locating day-to-day operations.
• Trust 5, building outside Texas: legal domicile appeared to be outside Texas.
• Trusts 6–7, buildings in Texas: legal domicile appeared to be Texas.

The beneficiary included the net amount in the numerator and denominator of its apportionment factor as applicable. Citing Hearing Decision No. 37,289 and related decisions, the Comptroller said the trusts' existence could not be ignored.

Currency note: This is a pre-2008 franchise-tax apportionment analysis. Texas replaced that regime with the margin tax effective January 1, 2008.

What this means for you

Lease-finance companies using grantor trusts

Formation law, trustee location, lessee domicile, and asset location were all facts, but the rule focused on where day-to-day trust operations occurred. Mobile aircraft required fuller location evidence.

Tax professionals

Do not collapse gross lease receipts and the beneficiary's net distribution. The question and answer here concerned net income, and the Comptroller required the net amount in the factor.

Common questions

Q: Were all four aircraft trusts legally domiciled in Texas?
A: The letter did not decide. It requested more location data.

Q: Where were the building trusts domiciled?
A: Trust 5 appeared outside Texas; Trusts 6 and 7 appeared in Texas.

Q: Could the beneficiary ignore the grantor trusts?
A: No. It included the net amount in its apportionment factor.

Citations and references

• 34 Tex. Admin. Code Sec. 3.549(e)(47)
• 34 Tex. Admin. Code Sec. 3.549(b)(6)
• Hearing Decision Nos. 37,289 through 37,295

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=FIT
• Opinion: https://star.comptroller.texas.gov/view/9910264L

Original ruling text

October 18, 1999

Dear **:

Thank you for your recent inquiry about Texas franchise tax. You have asked
for the policy concerning the apportionment of net income from grantor trusts
holding various kinds of assets.

The taxpayer is a Delaware corporation with its headquarters in Connecticut.
The taxpayer is in the business of providing lease financing for the purchase
of large assets. The taxpayer transacts its financing arrangements using
grantor trusts. The taxpayer is the beneficiary of each grantor trust. Assume
that the taxpayer has sufficient contact with Texas to make it liable for both
components of the franchise tax. The grantor trusts borrow money from
unrelated lenders. The borrowings are non-recourse to the taxpayer. The
grantor trusts use the proceeds from the non-recourse financing to purchase the
large assets. The grantor trusts lease the large assets to unrelated lessees
for use in the lessees' business. The leases are long-term and cover
approximately seventy-five percent of the assets' estimated useful life.

Twice a year, each lessee sends its semi-annual lease payment to the trustee of
the grantor trust. The trustee of the grantor trust makes a payment on the
trust's non-recourse debt. The trustee sends the balance of the lease payment
to the taxpayer. The trustee is responsible for insuring that the lessee
carries adequate insurance for the underlying leased asset. The trustee is
responsible for filing all required federal income tax forms.

Annually, each grantor trust receives payments from the respective lessee
totaling $ 1,000,000. The trustee uses these funds to make principal and
interest payments on the non-recourse debt. The trustee sends the remaining
balance to the taxpayer. The ratio of payments to the third-party lender and
the taxpayer are 75% - 25%. That is, the $1,000,000 will be paid $750,000 to
the lender and $250,000 to the taxpayer.

For federal income tax purposes, the taxpayer accounts for the grantor trust
leases as a true leases. On its federal income tax returns, the taxpayer
reports the gross rental income and related expenses for interest,
depreciation, etc. directly on page 1 of the form 1120. Also, for federal
income tax purposes, the taxpayer is considered the owner of the underlying
assets and its tax records reflect this ownership.

For GAAP purposes, the taxpayer does not record the cost of the underlying
asset or the non-recourse debt on its general ledger. Instead, the taxpayer
reports its net, out-of-pocket investment in the underlying assets (i.e. its
equity) as lease receivables. For GAAP, the taxpayer reports the net payment
it receives ($250,000 in this example) as part interest income and part
reduction in the lease receivable.

Trust No. 1.

This trust is formed under Connecticut trust laws. The trustee is a Connecticut
Bank. The trustee's offices are in Connecticut. All of the trustee's
employees performing activities in relation to the trust work in Connecticut.
The trust owns, as its principal asset, an airplane which it leases to a major
airline. The lease is long-term and non-cancelable. The lease term covers 75%
of the airplane's estimated useful life. The lessee is responsible for
operating the airplane and for paying for all of the operating expenses. The
trustee is responsible for safe-keeping the lease agreement and related
documents at its offices in Connecticut.

The lessee is commercially domiciled in Texas. The lessee is incorporated in
Delaware. The lessee uses the airplane to fly passengers within the United
States and around the world. The lessee does not hangar the airplane at any
particular location. The taxpayer knows that the lessee flies the airplane
about 10%- 15% of the time in Texas. However, the taxpayer does not know the
number of miles that the lessee flies the airplane over all of the other
various states and countries.

Trust No. 2.

This trust is formed under Texas trust laws. The trustee is a Texas bank. The
trustee's offices are in Texas. All of the trustee's employees performing
activities in relation to the trust work in Texas. The trust owns, as its
principal asset, an airplane which it leases to a major airline. The lease is
long-term and non-cancelable. The lease term covers 75% of the airplane's
estimated useful life. The lessee is responsible for operating the airplane
and for paying for all of the operating expenses. The trustee is responsible
for safe-keeping the lease agreement and related documents at its offices in
Texas.

The lessee is commercially domiciled inside Texas. The lessee is incorporated
in Delaware. The lessee uses the airplane to fly passengers within the United
States and around the world. The lessee does not hangar the airplane at any
particular location. The taxpayer knows that the lessee flies the airplane
about 10%-15% of the time in Texas. However, the taxpayer does not know the
number of miles that the lessee flies the airplane over all of the other
various states and countries.

Trust No. 3.

This trust is formed under Connecticut trust laws. The trustee is a
Connecticut Bank. The trustee's offices are in Connecticut. All of the
trustee's employees performing activities in relation to the trust work in
Connecticut. The trust owns, as its principal asset, an airplane which it
leases to a major airline. The lease is long-term and non-cancelable. The
lease term covers 75% of the airplane's estimated useful life. The lessee is
responsible for operating the airplane and for paying for all of the operating
expenses. The trustee is responsible for safe-keeping the lease agreement and
related documents at its offices in Connecticut.

The lessee is commercially domiciled outside Texas. The lessee is incorporated
in Delaware. The lessee uses the airplane to fly passengers within the United
States and around the world. The lessee does not hangar the airplane at any
particular location. The taxpayer knows that the lessee flies the airplane
about 10%-15% of the time in Texas. However, the taxpayer does not know the
number of miles that the lessee flies the airplane over all of the other
various states and countries.

Trust No. 4.

This trust is formed under Texas trust laws. The trustee is a Texas bank. The
trustee's offices are in Texas. All of the trustee's employees performing
activities in relation to the trust work in Texas. The trust owns, as its
principal asset, an airplane which it leases to a major airline. The lease is
long-term and non-cancelable. The lease term covers 75% of the airplane's
estimated useful life. The lessee is responsible for operating the airplane
and for paying for all of the operating expenses. The trustee is responsible
for safe-keeping the lease agreement and related documents at its offices in
Texas.

The lessee is commercially domiciled outside Texas. The lessee is incorporated
in Delaware. The lessee uses the airplane to fly passengers within the United
States and around the world. The lessee does not hangar the airplane at any
particular location. The taxpayer knows that the lessee flies the airplane
about 10%-15% of the time in Texas. However, the taxpayer does not know the
number of miles that the lessee flies the airplane over all of the other
various states and countries.

Trust No. 5.

This trust is formed under Texas trust laws. The trustee is a Texas bank. The
trustee's offices are in Texas. All of the trustee's employees performing
activities in relation to the trust work in Texas. The trust owns, as its
principal asset, an office building which is physically located outside Texas.
The lease is long-term and non-cancelable. The lease term covers 75% of the
building's estimated useful life. The lessee is responsible for maintaining
the office building and for paying for all of the operating expenses. The
trustee is responsible for safe-keeping the lease agreement and related
documents at its offices in Texas.

The lessee is commercially domiciled inside Texas. The lessee is incorporated
in Delaware.

Trust No. 6.

This trust is formed under Connecticut trust laws. The trustee is a
Connecticut Bank. The trustee's offices are in Connecticut. All of the
trustee's employees performing activities in relation to the trust work in
Connecticut. The trust owns, as its principal asset, a large office building
which is located in Texas. The lease is long-term and non-cancelable. The
lease term covers 75% of the building's estimated useful life. The lessee is
responsible for maintaining the building and for paying for all of the
associated operating expenses. The trustee is responsible for safe-keeping the
lease agreement and related documents at its offices in Connecticut.

The lessee is commercially domiciled inside Texas. The lessee is incorporated
in Delaware.

Trust No. 7.

This trust is formed under Connecticut trust laws. The trustee is a
Connecticut Bank. The trustee's offices are in Connecticut. All of the
trustee's employees performing activities in relation to the trust work in
Connecticut. The trust owns, as its principal asset, a large office building
which is located in Texas. The lease is long-term and non-cancelable. The lease
term covers 75% of the building's estimated useful life. The lessee is
responsible for maintaining the building and for paying for all of the
associated operating expenses. The trustee is responsible for safe-keeping the
lease agreement and related documents at its offices in Connecticut.

The lessee is commercially domiciled outside Texas. The lessee is incorporated
in Delaware.

I have restated each of your questions, followed by my response.

1. For each of the seven (7) grantor trusts, would you please state whether
   the Comptroller's policy is to treat them as legally domiciled in Texas? Would
   you please provide the reasons for your conclusion for each of the six trusts?

Comptroller Rule 3.549(e)(47) states that distributions to beneficiaries of a
trust are apportioned based on the legal domicile of the trust. The rule
directs the reader to subsection (b)(6) for the definition of legal domicile.

Subsection 3.549(b)(6) states that the legal domicile of a trust is its
principal place of business. A trust's principal place of business is defined,
by this rule, as the location of its day-to-day operations. The rule further
provides that where a trust's operations are conducted equally or fairly evenly
in more than one state, the trust's principal place of business is its
commercial domicile. A trust's commercial domicile is the place from which the
trade or business of the trust is directed. As you know, the determination of
a trust's principal place of operations is fact-sensitive and all of the facts
must be considered in making a determination.

In connection with Trusts 1 through 4, additional information is needed in
order to determine the location of day-to-day operations, and thus, the legal
domicile. For each airplane owned by Trusts 1 through 4, please advise how
much time the airplane spends in Texas, as well as the amount of time the
airplane spends in other states and countries.

For Trust 5, the principal trust asset is an office building located outside
Texas. Based on the information provided, it appears that the location of
day-to-day operations, and thus, the legal domicile, for Trust 5 is outside
Texas.

For Trust 6 and Trust 7, the principal asset of each trust is an office
building located in Texas. Based on the information provided, it appears that
the location of day-to-day operations, and thus, the legal domicile, for Trust
6 and Trust 7 is Texas.

2. For each of the seven (7) grantor trusts, would you please state the
   Comptroller's policy regarding the amount to be reported in the numerator and
   denominator for the apportionment formula?

In keeping with HD 37,289 et. al., the existence of the trusts cannot be
ignored. Thus, the Taxpayer beneficiary would include the net amount in the
numerator and denominator of its apportionment factor. In addition, the facts
set out in your letter state that your question concerns the apportionment of
net income.

3. Does the statement in Hearing Decision Nos. 37,289, 37,290, 37,291, 37,292,
   37,293, 37,294, and 37,295 that the grantor trusts are legally domiciled in
   Texas represent the Comptroller's present policy in regard to determining
   whether or not distributions from grantor trusts should be apportioned to
   Texas?

HD 37,289 et. al., provides that the revenues at issue are apportioned to
Texas, i.e., the existence of the trusts cannot be ignored.

This response is based on the facts presented in your letter. If the facts
change or if there are additional relevant facts, the response may change.

If you have additional questions about this or any other franchise tax matter,
please write me or call me toll free at 1-800-531-5441, extension 3-4662.

Sincerely,

Jerry Oxford
Tax Policy Division