Did a corporate partner include its share of each partnership's net profit or gross receipts in its own Texas franchise-tax receipts factor?

Plain-English summary

A corporate partner had to recognize its share of each partnership's net profit or gross receipts in its own receipts factor, even though the partnership was a separate legal entity.

The taxpayer argued that Texas partnership law gave a corporate partner no right to partnership profit until a distribution occurred and that including partnership receipts required consolidated GAAP reporting. The Comptroller disagreed.

The response separated three concepts:

• The partnership remained a separate entity. The corporate partner could not report the partnership's assets directly in the corporation's surplus. It instead reported each partnership interest as a separate asset.
• The partner still had a right to partnership profit. The Comptroller treated that right as an intangible property interest and required the corporation to recognize its share of partnership net profit or gross receipts under Rule 3.549(e)(29)'s gross-versus-net criteria.
• Reporting remained unconsolidated. Sections 171.109(d) and 171.112(d) prohibited consolidated reporting. The corporation therefore could not eliminate interpartnership transactions as a consolidated group would; it accounted for revenue attributed to each partnership interest.

The Comptroller said this result was consistent with partnership law, GAAP revenue recognition for an unconsolidated corporate investor, earlier apportionment rules, and Comptroller decisions cited in the letter.

Currency note: This is a pre-2008 taxable-capital and receipts-factor analysis. Texas replaced that regime with the margin tax effective January 1, 2008; confirm current entity and combined-reporting rules.

What this means for you

Corporations owning partnership interests

Separate-entity status did not remove partnership revenue from the corporate partner's former receipts factor. Each interest had to be considered separately under the applicable gross-versus-net rule.

Tax professionals

Do not confuse unconsolidated reporting with ignoring partnership activity. The letter prohibited consolidation while still requiring recognition of the partner's own share of partnership receipts.

Common questions

Q: Could the corporation include partnership assets directly in surplus?
A: No. It reported the partnership interest itself as an asset.

Q: Did the corporation include partnership receipts?
A: Yes, its share of net profit or gross receipts under Rule 3.549(e)(29).

Q: Could it eliminate transactions among affiliated partnerships?
A: No. Those eliminations belonged to consolidated reporting, which the former law prohibited.

Citations and references

• Texas Tax Code Secs. 171.109(d), 171.112(a), and 171.112(d)
• 34 Tex. Admin. Code Sec. 3.549(e)(29), including Sec. 3.549(e)(29)(B)
• Texas Revised Limited Partnership Act art. 6132b-4.01
• Comptroller's Decision Nos. 11,814 and 33,258

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=FIT
• Opinion: https://star.comptroller.texas.gov/view/9910273L

Original ruling text

October 29, 1999

Dear **:

As we discussed last week with Billy, I asked the franchise tax specialist to
work with Eleanor Kim to provide a response to your issues and points raised in
your September 15th letter. As we understand it, your opinion is that there is
no basis in Texas partnership law for allowing a corporate partner to include
the partnership's gross receipts in the corporation's gross receipts. As such,
you believe the Comptroller's policy of including the partnership's gross
receipts in the calculation of a corporation's gross receipts to be I
inconsistent with Texas partnership law and can only be rectified by the
application of generally accepted accounting principles (GAAP) requiring
consolidation. Our office has reviewed the legal authorities that you
submitted, and it appears that our interpretation continues to differ with
yours.

You noted that two Texas court cases and Comptroller's Decision No. 11,814
(1982) recognize a partnership to be a separate and distinct entity from its
partners. On this point, we agree. However, our positions diverge in the
understanding of the corporate partner's right to receive its share of the
partnership's net profit.

You state that Texas partnership law does not grant a corporate partner the
right to receive a partnership's net profits until a distribution is made,
whereas our office has recognized such a right. The Comptroller's position is
evident even in Comptroller's Decision No. 11,814 that you submitted. The
decision stated that each partner's interest in a partnership is a right to
receive his share of the net profits and that this interest is an intangible
property right. Accepting that a corporate partner had receipts from the
partnership, the decision addressed the disputed issue whether those receipts
were Texas receipts or non-Texas receipts based on the location or domicile of
the payor. Based on the facts, the administrative law judge concluded the
receipts not to be Texas receipts, but they were nevertheless included in gross
receipts from everywhere.

Comptroller's Decision No. 11,814 was consistent with Franchise Tax Rule
3.403(b)(19), effective August 15, 1980, and earlier rules addressing
partnership receipts. Subsequent apportionment rules have continued to require
a corporation to include its share of a partnership's net profit or gross
receipts in the corporation's receipts factor. None of the authorities that you
submitted persuade this office that we should abandon our long-standing
approach.

When Section 171.112(a) was added to the Tax Code in 1987, we were required to
look to GAAP in determining gross receipts for taxable capital, including
receipts from partnerships. GAAP also supports our office's practice of
including a corporate partner's share of a partnership's receipts.

For example, in accordance with the GAAP requirement, we have looked to
Accounting Interpretation #2 of Accounting Principles Board Opinion No. 18
(AIN-APB 18, #2, Investments in Partnerships and Ventures) in handling certain
partnership/joint venture gross receipt issues. This interpretation states, "if
it is the established industry practice (such as in some oil and gas venture
accounting), the investor-venturer may account in its financial statements for
its pro-rata share of the assets, liabilities, revenues, and expenses of the
venture." Such practice would result in a corporation recognizing its share of
the gross receipts of a partnership or joint venture. Please see Rule
3.549(e)(29)(B) and Comptroller's Decision No. 33,258.

Although GAAP is the foundation of taxable capital, the franchise tax statute
expressly identifies specific exceptions to GAAP. Consolidated reporting
required by GAAP is prohibited by the Tax Code. See Sections 171.109(d) and
171.112(d).

First, a corporation must report its surplus based solely on its own financial
condition. Because a partnership is considered a separate legal entity, a
corporate partner cannot report the partnership's assets in its surplus. The
corporate partner, however, would have to report its partnership investment as
an asset in computing its surplus. Each partnership interest is considered a
separate asset.

Second, a corporate partner reporting its gross receipts based solely on its
own financial condition cannot consolidate the partnership's gross receipts
with its gross receipts. However, in reporting its own financial condition, the
corporation would recognize its share of the partnership's net profit or gross
receipts. Rule 3.549(e)(29) addresses the gross vs. net criteria. This
treatment is consistent with the GAAP revenue recognition requirements for a
corporate partner reporting partnership income on an unconsolidated basis.

The above treatment would apply to each partnership in which the corporate
partner has an interest. While a consolidated reporting method would require
the elimination of transactions between affiliated entities, the corporate
partner reporting its own financial condition must account for the revenue
attributed to each of its partnerships. Therefore, the elimination of
interpartnership transactions required under consolidated reporting would not
apply when the corporate partner reports its financial condition on an
unconsolidated basis.

We feel that our application of the franchise tax law to partnership receipts
is consistent with Texas partnership law. Under partnership law, a partner is
credited with profit or loss according to the partner's interest. See Art.
6132b-4.01, Texas Revised Limited Partnership Act. Applying this provision
along with the GAAP revenue recognition requirement (for taxable capital
purposes) and the unconsolidated reporting requirement to partnership receipts
results in the corporate partner recognizing its share of the receipts from
each partnership interest.

I hope this information provides a better explanation of our position. If you
have questions, Jerry Bobbitt will be happy to work with you to address them.
You may contact Jerry at 1-800-531-5441, extension 3-4496.

Sincerely,

Karey Barton
Director, Tax Policy

cc: Billy Hamilton, Deputy Comptroller
Bryant Lomax, Manager, Tax Policy
Teresa Comer, Tax Policy
Jerry Bobbit, Tax Policy
Eleanor Kim, Deputy General Counsel for Legal Services