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January 18, 2008
FOR IMMEDIATE RELEASE
Texas Margin Tax Cost of Goods Sold Capitalization: A Review of New Texas Policy Letter Ruling 200801034L.
The Comptroller of Public Accounts of the State of Texas (the “Comptroller”) reconsidered its policy
of requiring taxpayers who elect to capitalize cost of goods sold (COGS) to assign a value of
zero to their beginning inventory for purposes of computing the COGS deduction for report year 2008.
The Comptroller’s new policy will allow said taxpayers to include their beginning inventory in the
COGS computation. The discussion below provides a review of the beginning inventory issue and an
analysis of the Comptroller’s original and current policy.
Tex. Tax Code Ann. § 171.1012(g)
Under Texas House Bill 3928 (HB 3928), taxpayers were given the option to expense or
capitalize their COGS. HB 3928 revised the language of Tex. Tax Code Ann. § 171.1012(g)
to read as follows:
A taxable entity that is allowed a subtraction by this section for a cost of goods sold and
that is subject to Section 263A, 460, or 471, Internal Revenue Code, may capitalize that cost
in the same manner and to the same extent that the taxable entity capitalized that cost on its
federal income tax return or may expense those costs, except for costs excluded under Subsection
(e), or in accordance with Subsections (c), (d), and (f). If the taxable entity elects to capitalize
costs, it must capitalize each cost allowed under this section that it capitalized on its federal
income tax return. If the taxable entity later elects to begin expensing a cost that may be
allowed under this section as a cost of goods sold, the entity may not deduct any cost in ending
inventory from a previous report. If the taxable entity elects to expense a cost of goods sold
that may be allowed under this section, a cost incurred before the first day of the period on
which the report is based may not be subtracted as a cost of goods sold. If the taxable entity
elects to expense a cost of goods sold and later elects to capitalize that cost of goods sold,
a cost expensed on a previous report may not be capitalized. [Emphasis added]
Based on the language above, it was not clear whether a taxpayer electing to capitalize COGS for the
first report under the revised franchise tax could include its beginning inventory in the COGS
deduction computation.
Comptroller’s Original Policy
The Comptroller’s original policy on this question was presented in 34 Tex. Admin. Code §
3.588(c)(2)(A) (2007) (“Rule”), which stated that:
A taxable entity that elects to capitalize costs on its first report due on or after January 1,
2008, may not include any costs incurred prior to the accounting period upon which the report
was based.
The Comptroller had concluded that, because no revenue incurred before the tax year was included
in the base, no deductions for costs incurred before the period on which the tax is based should be
allowed. Under this policy, taxpayers electing to capitalize COGS would be required to assign a
value of zero to its beginning inventory for purposes of computing the COGS deduction for the first
report year.
Comptroller’s Revised Policy
On January 11, 2008, the Comptroller issued Letter Ruling No.
200801034L stating that
the Comptroller’s position on the beginning inventory issue had changed. In the letter,
the Comptroller stated that:
Our primary concern with allowing a beginning inventory for taxpayers electing to capitalize
was a potential unequal treatment court challenge brought by taxpayers electing to expense COGS.
The letter further stated:
After researching all of the relevant court cases in Texas, however, we have decided to
allow a beginning inventory for taxpayers electing to capitalize COGS. Our rule will
be changed accordingly.
One of the court cases reviewed by the Comptroller was 3 Beall Brothers 3, Inc. v.
Rylander, 2 S.W.3d 562 (Tex. App. Austin 1999). In that case, a fiscal year taxpayer
(Bealls) that had merged out of existence argued that the additional tax was
unconstitutional because the application of the additional tax rules resulted
in unequal treatment between fiscal year and calendar year taxpayers. The
court ruled that, because Bealls had the option of filing on a fiscal year or
a calendar year, there were no grounds for an unequal treatment case, so long as
the tax is rationally related to a legitimate governmental goal and the system
operates equally within each class. Following that reasoning, taxpayers electing
to expense COGS would have difficulty prevailing in an unequal treatment challenge
because they have the option of expensing or capitalizing COGS and because the
statute treats equally all taxpayers that choose to expense.
Illustration of the Effect of the Policy Change
Facts:
| Beginning Inventory 1.1.2007 |
$3,000,000,000 |
| Purchases in 2007 |
$12,000,000,000 |
| Ending Inventory 12.31.2007 |
$4,000,000,000 |
Original Policy:
Under the Comptroller’s original policy, as presented by Rule 3.588(c)(2)(A),
the taxpayer’s COGS deduction for the first report under the revised franchise
tax would be $8,000,000,000, computed as shown below:
| Beginning Inventory 1.1.2007 |
$0 |
| Purchases in 2007 |
$12,000,000,000 |
| Goods Available for Sale in 2007 |
$12,000,000,000 |
| Less: Ending Inventory 12.31.2007 |
$4,000,000,000 |
| Cost of Goods Sold for 2007 |
$8,000,000,000 |
Revised Policy:
Under the Comptroller’s new policy, the COGS deduction for the example above
would be $11,000,000,000, computed as shown below:
| Beginning Inventory 1.1.2007 |
$3,000,000,000 |
| Purchases in 2007 |
$12,000,000,000 |
| Goods Available for Sale in 2007 |
$15,000,000,000 |
| Less: Ending Inventory 12.31.2007 |
$4,000,000,000 |
| Cost of Goods Sold for 2007 |
$11,000,000,000 |
TECHNICAL INFORMATION CONTACTS:
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