Texas Returns to Origin Sourcing: Refund Claims May be Due by May 15, 2022

April 12, 2022
Car Radio

On March 25, 2022, the Texas Supreme Court in Sirius XM Radio, Inc. v. Hegar reversed the lower court of appeals decision and held that the Texas franchise tax should be apportioned based on where programs are produced, not where subscribers receive the radio service. As a result, Sirius may receive a $2.5 million refund.

Why Does This Decision Matter?

This is a significant decision because the Court affirms the Texas Franchise Tax origin sourcing apportionment rules that focus on the place where the taxpayer’s personnel or equipment is doing useful work for the customer.

Prior to this decision by the Court, taxpayers were left with uncertainty on how to apply an origin sourcing statute and a conflicting market sourcing regulation. After the lower court decision, Texas, in January 2021, amended apportionment regulation 34 TAC Sec. 3.591 to state that services were performed where “receipts-producing, end-product act or acts” occurred at the location of the customer in the state. The location of other acts would not be considered, even if they are essential to the performance of the receipts-producing acts.

The amended regulation applied retroactively to January 1, 2008. Based upon this new regulation, the Comptroller overseeing franchise tax reporting and collections determined that taxpayers should be apportioning service-based income to where the benefit of the services were received (market-based sourcing). Taxpayers disagreed, contending that the amended regulation was overreaching when the statute determines Texas receipts on the basis of the fair value of the services rendered in Texas (cost of performance).

How Did the Court Reach This Decision?

Sirius broadcasts more than 150 satellite-radio channels with over 70% of the channels running exclusively original content produced by Sirius. Customers access Sirius’s content by purchasing one of Sirius’s radio sets, typically through agreements with auto makers that install Sirius-enabled radios in purchased or leased vehicles and by paying a subscription fee. When a customer pays a subscription fee, Sirius sends a signal from outside of Texas, activating the satellite radio.

The Comptroller argued Sirius’s location of the performance of services to be where the radio signal is “unscrambled,” which occurs at the location of each subscriber. Disagreeing, the Court compared this argument to calling The Wall Street-Journal Online a “paywall-removal service” rather than the creation and distribution of news and opinion content to subscribers. The Court remanded the case for further proceedings that may include reviewing the evidence concerning the fair value of the services performed by Sirius within and without the state (the parties agree that some small amount of Sirius’s services were performed in Texas).

The Sirius XM decision effectively affirms the cost of performance approach to apportionment for services for all prior years and strikes down the Comptroller’s interpretation of market-based sourcing as stated in the amended regulation. The Comptroller has yet to react to this court decision.

What Does This Decision Mean for Other Taxpayers?

As a result of this Court decision, multistate service providers performing services outside Texas for in-state customers could pursue potential refund claims. Alternatively, service providers performing services in Texas for customers outside Texas may face additional tax liabilities.

Taxpayers that are service providers conducting business in Texas can consider consulting with their tax advisor to aid in determining what implications this ruling has on current and prior year tax filings and the potential to file refund claims. The statute of limitations for the 2018 Report Year (2017 tax year) will close on May 15, 2022, for taxpayers that filed returns by the original due date. The Sirius XM decision may also have an impact on companies’ tax provisions.

Stay up to date on the latest tax considerations and issues.

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