201101004H



SOAH DOCKET NO. 304-10-5539.13
CPA HEARING NO. 103,340

RE: *************
TAXPAYER NO.: ************* 
AUDIT OFFICE: ************* 
AUDIT PERIOD: January 1, 2008 THROUGH December 31, 2008

Franchise Tax/RDT

BEFORE THE COMPTROLLER
OF PUBLIC ACCOUNTS
OF THE STATE OF TEXAS

SUSAN COMBS
Texas Comptroller of Public Accounts

JAMES D. ARBOGAST
Representing Tax Division

*************
Representing Petitioner


COMPTROLLER’S DECISION

************* (Petitioner) filed its 2008 franchise tax report using a tax rate 
of 0.5 percent (one-half percent).  The Texas Comptroller of Public Accounts 
(Comptroller) reviewed the report and determined that Petitioner was not 
entitled to use the one-half percent tax rate because it is not primarily 
engaged in a retail or wholesale trade.  Petitioner’s franchise tax was 
recalculated using the 1 percent (one percent) rate, resulting in the 
assessment of a deficiency.  Petitioner insists that it is entitled to use the 
lower rate.  In his Proposal for Decision, the Administrative Law Judge (ALJ) 
recommends that the assessment of franchise tax should be affirmed, but 
recommends that the penalty assessment should be waived.

I.  PROCEDURAL HISTORY, NOTICE, AND JURISDICTION

Comptroller Staff (Staff) referred the case to the State Office of 
Administrative Hearings (SOAH) on July 30, 2010, for a written submission 
hearing.  There are no contested issues of notice or jurisdiction in this 
proceeding.  Therefore, these matters are set out in the Findings of Fact and 
Conclusions of Law without further discussion here.

Comptroller Staff was represented by Assistant General Counsel James D. 
Arbogast.  Claimant was represented by *************, of COMPANY E.  The case 
was reassigned from ALJ Alvin Stoll to ALJ Peter Brooks for docket control 
purposes.  A record closing date of October 11, 2010, was set by ALJ Brooks.

II. REASONS FOR DECISION

A.  Background and Issue Presented

Petitioner is a Texas-based corporation that markets cosmetics and skin care 
products and treatments in the United States.  The products are researched, 
developed, manufactured, and distributed by ************* (COMPANY F), which is 
based in CITY A, Spain.  In addition, COMPANY F operates specialty stores 
located throughout the world.  Petitioner is wholly owned by COMPANY F, which 
in turn is owned by 10 individual shareholders who reside in Spain.

Petitioner filed a Texas franchise tax report for 2008 with the Comptroller 
showing an apportioned taxable margin of $*************.  Petitioner applied 
the one-half percent rate reserved for retailers and wholesalers, resulting in 
a franchise tax of $*************.  The Comptroller examined the franchise tax 
report and, after determining that Petitioner did not qualify for the special 
one-half percent rate, recalculated Petitioner’s franchise tax applying the one 
percent rate.  The Comptroller found that Petitioner did not qualify as a 
retailer or wholesaler because most of its revenue is derived from the sale of 
products that it either produces or that are produced by an affiliated company. 
The Comptroller issued a Texas Notification of Exam Results dated July 21, 
2009, assessing a deficiency of $*************, plus penalty and interest.  
Petitioner timely requested a redetermination and raised the following 
contentions:

1.  Petitioner contends that it does qualify as a retailer or wholesaler 
because the restriction regarding the sale of products produced by an 
affiliated entity does not apply to COMPANY F Petitioner contends that it and 
COMPANY F are not members of the same affiliated group.

2.  Petitioner contends that it is entitled to waiver of penalty and interest 
as it relied in good faith on a literal and unambiguous interpretation of 34 
TEX. ADMIN. CODE section 3.590(b)(1).

B.  Evidence Presented

Staff submitted the administrative record consisting of the pleadings filed 
while this case was pending before the Comptroller.  Staff attached to its 
Position Letter a copy of the certificate of stock ownership of COMPANY F  
Staff submitted as exhibits the 60-day letter, the Texas Notification of Exam 
Results, the audit report, and the audit plan.  Petitioner submitted as 
attachments to the brief filed with SOAH the Articles of Incorporation, 
Articles of Correction, and Articles of Amendment to the Articles of 
Incorporation of COMPANY G. [ENDNOTE] All these items have been admitted 
into the record.

C.  Analysis and Recommendation

Under the revised Texas Franchise Tax Act, the franchise tax is calculated by 
applying the applicable tax rate to the taxable entity’s taxable margin.  The 
standard rate applicable to all taxable entities is one percent of taxable 
margin, except for those taxable entities that are primarily engaged in retail 
or wholesale trades, which are subject to a rate of one-half percent of taxable 
margin.  TEX. TAX CODE ANN. section 171.002(a) and (b).  The issue presented in 
this case is whether Petitioner was entitled to use the one-half percent rate 
on its 2008 franchise tax report.

A taxable entity is considered to be primarily engaged in a retail or wholesale 
trade, and thus eligible for the special one-half percent rate, if it satisfies 
the following criteria set out in TEX. TAX CODE ANN. section 171.002(c):

(1)  the total revenue from its activities in retail or wholesale trade is 
greater than the total revenue from its activities in trades other than the 
retail and wholesale trades;

(2)  except as provided by Subsection (c-1), less than 50 percent of the total 
revenue from activities in retail or wholesale trade comes from the sale of 
products it produces or products produced by an entity that is part of an 
affiliated group to which the taxable entity also belongs; and

(3)  the taxable entity does not provide retail or wholesale utilities, 
including telecommunications services, electricity, or gas.

(c-1) Subsection (c)(2) does not apply to total revenue from activities in a 
retail trade described by Major Group 58 of the Standard Industrial 
Classification Manual published by the federal Office of Management and Budget.

The resolution of this case turns on whether Petitioner met the requirements of 
Subsection 171.002(c)(2), by deriving less than 50 percent of its total revenue 
from activities in retail or wholesale trade from the sale of products produced 
by an entity that is part of the same affiliated group of which Petitioner is a 
member.  Petitioner does not dispute that it derives more than 50 percent of 
its total revenue from the sale of products produced by its parent company, 
COMPANY F, which owns 100 percent of Petitioner.  COMPANY F, in turn, is owned 
by 10 individuals whose ownership interests range from 42.6 percent to 0.65 
percent.

An affiliated group is defined as a “a group of one or more entities in which a 
controlling interest is owned by a common owner or owners, either corporate or 
noncorporate, or by one or more of the member entities.”  TEX. TAX CODE ANN. 
section 171.0001(1).  A controlling interest means “for a corporation, either 
more than 50 percent, owned directly or indirectly, of the total combined 
voting power of all classes of stock of the corporation, or more than 50 
percent, owned directly or indirectly, of the beneficial ownership interest in 
the voting stock of the corporation.”  TEX. TAX CODE ANN. section 
171.0001(8)(A).  Staff asserts that, given that COMPANY F wholly owns 
Petitioner, the two are members of the same affiliated group.  Petitioner, 
however, objects on several grounds.  First, Petitioner contends that it and 
COMPANY F cannot be considered members of the same affiliated group because 
they do not share common owners, i. e., COMPANY F is owned by 10 individuals 
and Petitioner is wholly owned by COMPANY F Secondly, Petitioner contends that 
Petitioner and its parent company are not members of the same affiliated group 
because the owners of COMPANY F do not directly own Petitioner.  Petitioner 
argues that Staff is aggregating the indirect member entities, which include 
COMPANY F and the 10 individual owners, to artificially create a group for 
franchise tax purposes.  Finally, Petitioner contends that the language of 34 
TAC section 3.590(b)(1) confirms that Petitioner and its parent company are not 
part of the same affiliated group.  Unlike Section 171.0001(1), Rule 
3.590(b)(1) provides that an affiliated group consists of “Entities in which a 
controlling interest is owned by a common owner, either corporate or 
noncorporate, or by one or more of the member entities.”  According to 
Petitioner, Rule 3.590(b)(1) clearly contemplates that an affiliated group 
requires a singular common owner, which is not present in the instant case.

Petitioner’s literal interpretation of both Subsection 171.0001(1) and Rule 
3.590(b)(1) would have some clearly unintended consequences.  For example, 
under Petitioner’s interpretation an affiliated group would never consist of a 
chain of vertically owned subsidiary companies with Company A owing 100 percent 
of Company B that owns 100 percent of Company C that in turn owns 100 percent 
of Company D.  An affiliated group would only consist of a company that 
directly held a controlling interest in other companies.  Additionally, under 
Petitioner’s interpretation, the parent company would never be part of the 
affiliated group, even though it held a controlling interest in the other 
companies, because it would not share a common owner or owners with its 
subsidiary companies.

Petitioner’s interpretation is not supported by the language of Subsection 
171.0001(1).  The statute clearly contemplates the ownership structure in the 
instant case, with COMPANY F holding a controlling interest in Petitioner.  
Subsection 171.0001(1) explicitly provides that the affiliated group may 
consist of entities in which a member entity holds the controlling interest.  
Consequently, COMPANY F, as Petitioner’s parent, is a member of the same 
affiliated group as Petitioner, thus disqualifying Petitioner under Subsection 
171.002(c)(2).

Petitioner asserts that it is entitled to penalty waiver because it acted in 
good faith in relying on the literal language of the applicable statute and 
rule.  Late penalties are automatically imposed on delinquent taxes.  TEX. TAX 
CODE section 111.061(a) and 151.703.  The Comptroller has the discretionary 
authority to waive penalties if a taxpayer has exercised reasonable diligence 
to comply with tax laws.  TEX. TAX CODE section 111.103.  The taxpayer has the 
burden to establish its reasonable diligence by a preponderance of the 
evidence.  34 TEX. ADMIN. CODE section 1.40(2)(B).  In making the reasonable 
diligence determination the Comptroller reviews the factors set forth in 34 
TEX. ADMIN. CODE section 3.5(c):

(1) the taxpayer’s audit history;
(2) the tax issues involved;
(3) a change in Comptroller policy during the audit period;
(4) size and sophistication of the taxpayer;
(5) whether tax was collected and not remitted;
(6) whether returns were timely filed;
(7) completeness of records;
(8) delinquencies in other taxes; and
(9) reliance on advice provided by the Comptroller’s office which caused 
imposition of penalty.

Staff dismisses Petitioner’s request for penalty waiver on the grounds that the 
Tax Code is clear in disqualifying Petitioner as a retailer or wholesaler.  
Staff, however, does not take into account the sweeping changes inherent in the 
revised franchise tax act that was adopted effective January 1, 2008.  The new 
franchise tax act introduced such novel concepts as combined and affiliated 
groups and different tax rates for taxpayers engaged in different lines of 
business, wholesale, and retail trades.  The tax issues involved in this case 
are complex and constitute a significant change in the underlying tax 
principles, which are among the enumerated factors in 34 TEX. ADMIN. CODE 
section 3.5(c) that argue in favor of penalty waiver.  Not only did Petitioner 
have to determine whether its revenue was derived from retail or wholesale 
activities, it also had to determine whether it and its parent company were 
members of the same affiliated group.  In addition, the 2008 franchise tax 
report was the first franchise tax report prepared and submitted by Petitioner 
after the newly- revised franchise tax act became effective.  The ALJ 
recommends that penalty should be waived based on the particular facts and 
circumstances of this case.

Petitioner also requested interest waiver on the same grounds.  Interest is 
automatically imposed on delinquent tax.  TEX. TAX CODE ANN. section 111.060.  
However, the Comptroller has discretionary authority to waive interest 
assessments, but exercises that discretion only in a few limited circumstances. 
TEX. TAX CODE ANN. section 111.103 and 34 TEX. ADMIN. CODE section 3.5.  The 
Comptroller limits interest waiver to the following three grounds:  (1) undue 
delay caused by Comptroller personnel, (2) reliance on advice provided by the 
Comptroller’s office, and (3) natural disasters.  34 TEX. ADMIN. CODE section 
3.5(d).  None of these three circumstances apply to the instant case.  The ALJ 
does not recommend waiver of the interest.

III. FINDINGS OF FACT

1.  ************* (Petitioner) filed a Texas Franchise Tax Report for 2008 with 
the Texas Comptroller of Public Accounts (Comptroller) showing an apportioned 
taxable margin of $*************.  Petitioner applied the one-half percent tax 
rate reserved for retailers and wholesalers, resulting in a franchise tax of 
$*************.

2.  The Comptroller examined the franchise tax report and, after determining 
that Petitioner did not qualify for the special one-half percent rate, 
recalculated Petitioner’s franchise tax applying the one percent rate.  The 
Comptroller found that Petitioner did not qualify as a retailer or wholesaler 
because most of its revenue is derived from the sale of products that it either 
produces or that are produced by an affiliated company.

3.  On July 21, 2009, the Comptroller issued a Texas Notification of Exam 
Results to Petitioner assessing a deficiency consisting of tax, penalty, and 
interest for the report year 2008.

4.  Petitioner timely filed a request for redetermination.

5.  On July 30, 2010, Comptroller Staff (Staff) referred the case to the State 
Office of Administrative Hearings for written submission hearing.

6.  Staff provided a notice of written submission to Petitioner.  The notice 
contained a statement of the nature of the hearing; a statement of the legal 
authority and jurisdiction under which the hearing was to be held; a reference 
to the particular sections of the statutes and rules involved; and a short, 
plain statement of the matters asserted.

7.  Petitioner is a Texas-based corporation that markets cosmetics and skin 
care products and treatments in the United States.  Petitioner is wholly owned 
by ************* (COMPANY F), which in turn is owned by 10 individual 
shareholders who reside in Spain.

8.  Petitioner derives more than 50 percent of its total revenue from the sale 
of products produced by its parent company, COMPANY F

9.  The new franchise tax act introduced new tax concepts such as combined and 
affiliated groups and different tax rates for taxpayers engaged in different 
lines of business.  These changes were effective January 1, 2008.

10.  The tax issues involved in this case are complex and constitute a 
significant change in the underlying tax principles.

11.  The 2008 franchise tax report was the first franchise tax report prepared 
and submitted by Petitioner after the newly-revised franchise tax act became 
effective.

12.  Petitioner did not show that there was (1) undue delay caused by 
Comptroller personnel, (2) reliance on advice provided by the Comptroller’s 
office, or (3) natural disasters.  None of these three circumstances apply to 
the instant case.

IV. CONCLUSIONS OF LAW

1.  The Comptroller has jurisdiction over this matter pursuant to TEX. TAX CODE 
ANN ch. 111.

2.  The State Office of Administrative Hearings has jurisdiction over matters 
related to the hearing in this matter, including the authority to issue a 
proposal for decision with findings of fact and conclusions of law pursuant to 
TEX. GOV’T CODE ANN. ch. 2003.

3.  The Comptroller provided proper and timely notice of the hearing pursuant 
to TEX. GOV’T CODE ch. 2001 and TEX. TAX CODE ANN section 111.009.

4.  Under the revised Texas Franchise Tax Act, the franchise tax is calculated 
based on a taxable entity’s taxable margin.  Taxable margin is computed by 
applying the applicable tax rate to the taxable entity’s taxable margin.  The 
standard rate applicable to all taxable entities is one percent of taxable 
margin, except for those taxable entities that are primarily engaged in retail 
or wholesale trades, which are subject to a rate of one-half percent of taxable 
margin.  TEX. TAX CODE ANN. section 171.002(a) and (b).

5.  A taxable entity is considered to be primarily engaged in a retail or 
wholesale trade, and thus eligible for the special one-half percent rate, if it 
satisfies the criteria set out in TEX. TAX CODE ANN. section 171.002(c).

6.  Under TEX. TAX CODE ANN. section 171.002(c)(2), less than 50 percent of the 
taxable entity’s total revenue from activities in retail or wholesale trade 
must come from the sale of products it produces or products produced by an 
entity that is part of an affiliated group to which the taxable entity also 
belongs.

7.  Based on Findings of Fact Nos. 7 and 8 and Conclusions of Law Nos. 4, 5, 
and 6, Petitioner does not qualify for the one-half percent tax rate reserved 
for retailers and wholesalers.

8.  The Comptroller has the discretionary authority to waive penalties if a 
taxpayer has exercised reasonable diligence to comply with tax laws.  TEX. TAX 
CODE section 111.103.

9.  The taxpayer has the burden to establish its reasonable diligence by a 
preponderance of the evidence.  34 TEX. ADMIN. CODE section 1.40(2)(B).

10.  Based on Findings of Fact Nos. 9 - 11 and Conclusions of Law Nos. 8 and 9, 
Petitioner has established that it is entitled to penalty waiver.

11.  The Comptroller has discretionary authority to waive interest assessments, 
but only exercises that discretion in a few limited circumstances.  TEX. TAX 
CODE ANN. section 111.103 and 34 TEX. ADMIN. CODE section 3.5.

12.  The Comptroller limits interest waiver to the following three grounds: (1) 
undue delay caused by Comptroller personnel, (2) reliance on advice provided by 
the Comptroller’s office, and (3) natural disasters.  34 TEX. ADMIN. CODE 
section 3.5(d).

13. Based on Finding of Fact No. 12 and Conclusions of Law Nos. 11 and 12, 
Petitioner did not establish that it was entitled to interest waiver.

14.  Based on the foregoing Findings of Fact and Conclusions of Law, the 
assessment should be affirmed, except that waiver of penalty is recommended.

Hearing No. 103,340

ORDER OF THE COMPTROLLER

On October 22, 2010, the State Office of Administrative Hearings’ 
Administrative Law Judge (ALJ), Peter Brooks, issued a Proposal for Decision in 
the above-referenced matter to which Petitioner filed Exceptions on November 8, 
2010.  Staff filed a Response on November 10, 2010.  The Comptroller has 
considered the Exceptions, Response, and the ALJ’s recommendation letter and 
determined that the ALJ’s Proposal for Decision, except for minor changes to 
correct typographical or clerical errors, should be adopted without change and 
this Decision represents the ruling thereon.

The above Decision resulting in Taxpayer's liability as set out in “Attachment 
A,” which is incorporated by reference, is approved and adopted in all 
respects.  The Decision becomes final twenty days after the date Petitioner 
receives notice of this decision, and the total sum of the tax, penalty, and 
interest amounts is due and payable within twenty days thereafter.  If such sum 
is not paid within such time, an additional penalty of ten percent of the taxes 
due will accrue, and interest will continue to accrue.  If either party desires 
a rehearing, that party must file a motion for rehearing, which must state the 
grounds for rehearing, no later than twenty days after the date Petitioner 
receives notice of this Decision.  Notice of this Decision is presumed to occur 
on the third day after the date of this Decision.

Signed on this 31st day of January 2011.


SUSAN COMBS
Texas Comptroller of Public Accounts

by: Martin A. Hubert
Deputy Comptroller

ENDNOTE
Petitioner was formerly known as COMPANY F.




ACCESSION NUMBER: 201101004H
SUPERSEDED: N
DOCUMENT TYPE: H 
DATE: 01/31/2011
TAX TYPE: FRANCHISE