The Texas Supreme Court ruled in favor of Sirius XM Radiofinding that the service it performs for Texas subscribers occurs primarily outside the state for purposes of calculating the company's liability for the Texas Franchise Tax. The decision invalidates rule amendments adopted by the Texas Comptroller interpreting the state's apportionment statute as sourcing certain service receipts using the receipt-producing, end-product act. As a result, taxpayers that provide services to Texas customers through technology and communicationplatforms could potentially be entitled to a tax refund.

Company's Tax Apportionment Should Be Calculated Based on Where Programs Produced

In Sirius XM Radio Inc. v. Hegar, the court considered the proper source of gross receipts from satellite radio services for purposes of determining the percentage of net margin that may be subject to the Texas Franchise Tax. Specifically, the court considered how to apply the law that sources to Texas services performed in the state to the provision of satellite radio subscriptions. The court ruled that the physical presence of the taxpayer's personnel or equipment that perform the services for which the customer pays determines the location of performance as required by Texas law. Specifically, the court concluded that the taxpayer's activities, including the production of radio shows and transmission of a radio signal that occur largely outside of Texas, must be taken into consideration in determining the fair value of services performed in the state. Such focus aligned with Westcott Communications Inc. v. Strayhorn, 104 S.W.3d 141, 147 (Tex. App.—Austin 2003, pet. denied), wherein the Texas Court of Appeals similarly ruled that the location of production and broadcasts determined the source of receipts, not the location of subscribers.

Texas Comptroller's End-Product Rule Struck Down by Court

The Texas Comptroller contended that receipts should be allocated to Texas if the receipt-producing, end-product act takes place in the state. This rule applied to Sirius XM would have sourced receipts to the location of the subscriber where the radio signal was decrypted. While the court will generally uphold an agency's interpretation of a statute so long as the construction is reasonable and does not contradict the plain language of the statute, in this case the interpretation was at odds with the law. The court refused the end-product act interpretation on the basis that the legislature chose the word performed and not received. In essence, the court denied the Texas Comptroller's attempt to use market-based or customer-based sourcing.

The court explained that the Texas Comptroller's position that the service is decrypting a signal "elevates the technicalities of the transaction over the economic reality of the service performed," and said the economic reality was that Sirius was a radio production and broadcasting company. The encryption-decryption model is for Sirius's benefit, not for the customer's benefit. The court stated, "characterizing the service Sirius performs for Texans as 'decryption of radio sets in Texas' is like saying the service performed by The Wall Street Journal Online is a 'paywall-removal service,' rather than the creation and distribution of news and opinion content its subscribers want to read."

The court remanded the case to the Texas Third Court of Appeals to consider the sufficiency of evidence provided to the court to compute the fair value of the services rendered in Texas.

The Takeaway

The Texas Supreme Court's decision invalidates the Texas Comptroller's position that service receipts should be sourced based on the receipt-producing, end-product act. Instead, the decision confirms that service receipts should be sourced based upon where the service is performed. The decision impacts taxpayers that provide services to Texas customersincluding those that do so through technology and communicationplatformsand who pay Texas Franchise Tax. Taxpayers engaged in these types of activities should review the scope of service activities that ultimately reach Texas customersand the fair value of such services for purposes of apportioning the Texas Franchise Tax. Andersen can help you determine how the ruling impacts your business and analyze whether you may be entitled to a tax refund.