Texas Supreme Court Invalidates Texas Comptroller’s Gross Receipts Sourcing Approach for Services

March 2022

BY

Laura HolmesManaging Director, State & Local Tax

Gene HeatlyManaging Director, State & Local Tax

Scott SmithManaging Director, Technical Practice Leader State & Local Tax

The Texas Supreme Court on March 25, 2022, delivered a unanimous opinion in Sirius XM Radio, Inc. v. Hegar, and put an end to the Comptroller of Public Account’s attempts to apply market-based sourcing for services receipts for purposes of the Texas franchise tax single gross receipts factor apportionment formula.  In doing so, the court also may have rendered invalid some of the key features of the Comptroller’s amended Texas franchise tax apportionment administrative rules issued in January 2021.
 

Background

Market-based sourcing of services and intangibles receipts has been a leading trend impacting states’ sales factors of their income apportionment formulas for at least a decade. Currently, approximately 36 of the 47 jurisdictions that impose corporate income taxes (including the District of Columbia and New York City) require sourcing of services and intangibles receipts using market-based sourcing approaches. 
 
Of the now handful of states that still apply their traditional performance-oriented sourcing methodologies for sales of services (commonly referred to as cost-of-performance sourcing), a few have imposed market-based approaches in audit examinations of some service providers. Texas was in this group until Sirius XM Radio, Inc.
 

“Receipt-Producing, End-Product Act”

Administratively, the Comptroller has been applying a “receipt-producing, end-product act” test to source gross receipts from services for purposes of the Texas gross receipts factor in audit examinations of multistate taxpayers subject to the Texas franchise tax. In January 2021, the Comptroller issued amended administrative apportionment rules that contained the receipt-producing, end-product test. 
 
Texas applies a single gross receipts factor apportionment formula. By statute, services receipts are sourced to Texas when the service is “performed in this state.” If a service is performed in Texas and one or more other states, the services receipts are sourced based on the “fair value of the services performed in Texas.” In the Comptroller’s amended apportionment rules, the location of the performance of a service is determined using the receipt-producing, end-product act test, which is a market-based analogue. 
 
Sirius XM Radio, Inc. is a well-known satellite radio broadcaster. Sirius primarily produces content from studios located in the District of Columbia and New York City. The content is broadcast by transmitting it from the studios to satellites using uplink facilities located in D.C., Georgia and New Jersey. The satellites transmit the content back to earth to Sirius XM subscribers’ radios or, in densely populated areas, Sirius terrestrial repeaters located in a number of states, including Texas. Once the radio signals are received by a subscriber’s radio, integrated circuits in the radio decrypt the signal, allowing the subscriber to listen to a Sirius XM radio broadcast. 
 
In this case, the Comptroller took the position that the “service performed in this state” of Texas by Sirius XM was the decrypting of the satellite radio signals. The Comptroller argued that Sirius XM subscribers were really paying for satellite radio decryption services and, therefore, the service was performed in Texas for Texas subscribers under the receipt-producing, end-product act test. Conversely, Sirius XM argued that the service it performed was the production and broadcasting of content, not the decryption of radio signals.
 

Texas Supreme Court’s Opinion

Sirius XM prevailed at the district (trial) court level, but a Texas Court of Appeals reversed that decision and ruled in favor of the Comptroller. The Texas Supreme Court reversed and held in favor of Sirius XM.  In doing so, the court rejected the Comptroller’s receipt-producing, end-product act test. 
 
The case presented a question of statutory interpretation. According to the court, the Comptroller’s test was inconsistent with the plain language of the Texas apportionment statute because the statute used the word “performed” and not “received.” Instead, the court held that a service is “performed in this state” if “the labor for the benefit of another is done in this state.” When a service is performed using technology rather than personnel, such as the service performed by Sirius XM, “look to the location of that equipment.” 
 
The court rejected the notion that a Sirius XM Radio subscriber was paying for satellite radio decryption services. Instead, focusing on economic reality, the court ruled that subscribers paid for the broadcasting of satellite radio content. The benefit of Sirius XM’s services was the receipt of broadcast content. The encryption-decryption of Sirius XM satellite radio broadcast signals benefited Sirius XM, not subscribers. 
 
While Sirius XM prevailed on the principal question of the statutory validity of the Comptroller’s receipt-producing, end-product test for sourcing services receipts, the parties conceded there was a small amount of services performed by Sirius XM in Texas. As noted above, when a service is performed in Texas and one or more other states, services receipts are sourced to Texas based on the fair value of those Texas services. Given the Court of Appeals’ decision upholding the Comptroller’s receipts sourcing test, that court did not address the taxpayer’s fair value allocation evidence. Thus, the Texas Supreme Court remanded the case back to the Court of Appeals to address the fair value allocation question.