Texas Comptroller of Public Accounts STAR System
Date: October 9, 2007
To: All Audit Staff
From: David Rock, Audit HQ
Subject: Earned Surplus Throwback
Audit procedures relating to earned surplus throwback have changed, effective
immediately and retroactive for report periods within statute of limitations,
due to the Texas Supreme Court case Home Interiors & Gifts, Inc. vs. Strayhorn,
SUMMARY OF NEW AUDIT PROCEDURE
As a result of this court case a number of refunds are expected. Refunds
granted on this issue will be limited to taxpayers with earned surplus
throwback where the taxpayer can prove they had solicitation in the other state
and throwback receipts were reported to Texas for earned surplus franchise tax
for report periods in statute. For those states in which the taxpayer had
people soliciting sales of tangible personal property but were protected by
Public Law 86-272, taxpayers will have to recalculate their franchise tax
liability without throwing sales back for the earned surplus component. Sales
in states in which a taxpayer had no nexus will continue to be thrown back to
Texas for earned surplus apportionment purposes. In other words, we will now,
in effect, apply the same standard for earned surplus throwback that we have
been applying for taxable capital throwback.
Sales are thrown back if the corporation is not subject to tax in the
purchaser's state. For taxable capital, subject to taxation means
constitutional nexus. Constitutional nexus means the seller does not need to
pay tax to the other state; the seller only has to have enough contact with the
other state so that the other state could tax the seller. If the seller is
doing business or is incorporated in the other state, the seller is subject to
taxation in that state, and therefore, sales of tangible personal property
shipped from Texas to a purchaser in a state in which the seller is subject to
taxation will not be thrown back to Texas. See Rule 3.564, Taxable Capital:
Earned Surplus (old policy)
For earned surplus purposes, sales were thrown back to Texas if the corporation
was not subject to any tax on, or measured by, net income, without regard to
whether the tax was imposed; see TX Tax Code Ann [section] 171.1032(a)(1).
Prior audit procedure dictated if these activities were protected by Public Law
86-272, then the receipts MUST be thrown back to Texas, even if the seller had
constitutional nexus to be subject to a state tax in general. See Rule 3.554,
Earned Surplus: Nexus.
TAXPAYERS QUALIFYING FOR REFUND
* Taxpayer sold tangible personal property that was shipped from Texas to
purchasers in one or more other states, and
* Taxpayer was protected by PL 86-272 (from a tax on net income in those
* Taxpayer reported sales to those states as throwback sales to Texas, for
apportioning earned surplus.
Excerpt from Rule 3.357(e)(37)(I), "the corporation or limited liability
company has the burden of proving that it is subject to taxation in the other
state." Therefore, the burden of proof is on the taxpayer to produce evidence
to the contrary.
* Home Interiors refunds are applicable to the Earned Surplus component only.
* Merely holding a certificate of authority in another state is not sufficient
evidence of nexus in another state.
* Proof of payment of taxes to another state is not sufficient evidence of
nexus in another state (tax may be voluntarily paid without having nexus
* If solicitation (PL 86-272 guidelines) occurred in other states, supporting
documentation must exist and be presented to substantiate solicitation in the
other state (actual documentation for expenses and receipts are required, not
just the reimbursement of said expenses).
* The supporting documentation of the selling corporation or limited liability
company must have occurred during the accounting period upon which the report
year tax is based.
* If no nexus exists in other states, sales will continue to be reported as
Texas receipts (thrown back to Texas) using the same criteria as used for
If you have any questions, contact the Area Manager of Technical Support, the
Franchise Tax subject matter expert in Audit Headquarters, or the Audit
Headquarters Franchise Tax trainer.
As STAR is the Comptroller's research system for Texas tax policy issues,
only tax-specific audit policy memos (AP Memo) are included here. AP memos
not on STAR can be found on Window on State Government on the
Audit Memos web page.
ACCESSION NUMBER: 200710433L
DOCUMENT TYPE: L
TAX TYPE: FRANCHISE