Income/Franchise:
Texas Letter Ruling Concludes Certain Subcontractor Payments are Excludable from Franchise Tax Base

Letter No. 202407025L, Tex. Comptroller of Public Accounts (7/24/24). The Tax Policy Division of the Texas Comptroller of Public Accounts issued a letter ruling holding that a taxpayer may exclude from its Texas franchise tax base subcontracting payments related to consulting and supervision services for completions and workovers of oil and gas drilling and workover rigs as the services were made in connection with the construction, remodeling, remediation, or repair of improvements on real property. However, the ruling explains that any subcontractor activities related to production are not considered to “improve real property,” and must be included in total revenue. The ruling cites Texas caselaw involving the exclusion of certain subcontractor payments under Texas Tax Code § 171.1011(g)(3) – explaining that a payment to a third-party generally qualifies for an exclusion from revenue where:

• The payment is a subcontracting payment, meaning the payments the taxpayer makes to another entity to do work or provide materials that the taxpayer is obligated to provide to its customer and for which that customer compensates the taxpayer;
• The payment is a flow-through fund, meaning the taxpayer’s customer compensates the taxpayer for the subcontractor’s work;
• The payment is mandated by contract or subcontract, meaning the taxpayer has a contractual obligation to pay its subcontractor; and
• The payment is in connection with the actual or proposed design, construction, remodeling, remediation, or repair of improvements to real property, which requires more than a tangential or incidental relationship between the subcontracting activities and the services, labor, or materials for which the subcontractors receive payment.

Consistent with prior guidance, the ruling also acknowledges that drilling an oil or gas well is considered an improvement to real property. Please contact us with any questions.