Finance Leases Qualify for Lower Franchise Tax Rate
Texas Franchise Tax Update
By Jimmy Martens and John Grubb
Martens Todd & Leonard - Austin, TX.
Businesses that finance sales using leases should consider filing Texas franchise tax refund claims based upon a recent Texas court case.
A Texas appellate court recently held that Xerox Corporation (“Xerox”) was entitled to compute its franchise tax based upon the lower Texas franchise tax rate, which resulted in a refund of half of the Texas franchise tax Xerox had paid during the relevant periods.
Xerox leases printers long-term to businesses under financing lease agreements.
Xerox’s finance lessees:
- Receive possession, but not title, to the equipment;
- Were responsible for insuring the equipment against loss;
- Were required to make all payments under the lease, even if the contract was terminated; and
- Could purchase the equipment at the end of the lease but typically did not because the lease was designed to last for the useful life of the equipment.
Wholesale sales qualify for lower Texas franchise tax rate, but rentals do not.
Generally, taxpayers pay Texas franchise tax at the rate of 0.75%. Tex. Tax Code § 171.002(a). Retailers and wholesalers (collectively hereinafter “Retailers) pay Texas franchise tax at half that rate, or 0.375%. Tex. Tax Code § 171.002(b).
Retailers may qualify for the reduced Texas franchise tax rate when they derive more than half of their revenues from sales at retail or wholesale.
Products sold under installment contracts qualify as retail sales, just like cash sales.
Products leased or rented, however, generally are not treated as retail sales.
Despite being called “leases,” finance leases are really sales.
Certain businesses, like Xerox, offer deferred payment plans that function like installment contracts, but are labeled as “finance” leases.
In the Xerox case, the appellate court found that Xerox’s finance leases were more like sales than traditional leases because:
- The lease term was at least 75% of the useful life of the equipment;
- The present value of the lease payments was at least 90% of the fair value of the equipment; and
- The customer was required to make the lease payments, even if the contract was cancelled.
In other words, the leases were structured such that Xerox’s customers had to pay for the equipment throughout its entire useful life (which would be the same as if Xerox had sold the equipment to the customer on a payment plan). As a result, Xerox was entitled to the lower Texas franchise tax rate and a refund of half of the franchise tax it had paid during the affected report years.
While the Xerox decision reflects current law, the Comptroller has signaled he plans to ask the Texas Supreme Court to review the case.
Xerox creates potential for refund of half of Texas franchise tax paid in open periods and has other implications.
In order to preserve rights to refunds based on the Xerox case, taxpayers that have:
- Sold products under a financing lease; and
- Paid Texas franchise tax at the regular rate should consult with their tax advisors about filing refund claims seeking recovery of half of the Texas franchise taxes paid for open periods.
Since the Xerox case treats certain financing leases as sales, taxpayers may also consider deducting their Cost of Goods Sold from revenue related to goods or equipment leased in a similar manner when deriving taxable margin for Texas franchise tax purposes.
CPAs and other tax professionals unclear about whether a client may qualify for the reduced Texas franchise tax rate are welcome to call our firm for a courtesy consultation to get our thoughts. Such consultation does not, and is not intended to, constitute legal advice.
About Jimmy Martens
Jimmy Martens, Attorney and CPA, is a partner with Martens, Todd & Leonard, a Texas tax litigation law firm located in downtown Austin, Texas. Mr. Martens has tried tax cases through both the Texas Supreme Court and the U.S. Supreme Court. He limits his practice to challenging Texas franchise and sales tax assessments during audits, in administrative hearings, and in the state courts of Texas. He is board certified by the Texas Board of Legal Specialization in Tax Law.
About John Grubb
John Grubb represents clients in a wide variety of state tax controversy matters. Mr. Grubb assists taxpayers with challenges to state and local sales tax and franchise tax assessments before administrative agencies and district courts.
About Martens, Todd & Leonard
Martens, Todd & Leonard is a trial and appellate law firm headquartered in Austin, Texas. It handles only Texas tax cases, specifically those involving the Texas sales tax and Texas franchise tax. The firm’s attorneys have handled cases all the way through the Texas Supreme Court and U.S. Supreme Court. They speak and write frequently on a variety of Texas sales tax and franchise tax topics and have published articles in publications such as the Journal of State Taxation, the Texas Bar Journal, the Texas Lawyer, and the Texas Tech Administrative Law Journal. For more information, please visit texastaxlaw.com.