March 29, 2006
FOR IMMEDIATE RELEASE

Texas Tax Reform Commission Releases Tax Plan. In a press conference held today, Governor Rick Perry and Chairman John Sharp presented the Texas Tax Reform Commission’s draft legislation reforming the cap on property tax rates as well as overhauling the Texas franchise tax with a net margin tax. A copy of the proposed legislation may be found at http://www.governor.state.tx.us/priorities/tax_reform/TTRC_report/files/
tax_reform_bill.pdf.

School District Property Tax Relief. The draft legislation requires school districts to reduce their property tax rates for maintenance and operations (“M&O”) from $1.50 to $1 per $100 of valuation by the 2007 tax year, through rollback tax rate calculations. The Education Code is also amended to reduce the limitation on the Tier 2 enrichment tax rate to 44 cents effective September 1, 2007.

Franchise Tax. The draft legislation will substantially overhaul the Texas franchise tax by extending the application of the tax to all business entities that have some liability protection under state law, broadening the base, and lowering the tax rate and manner of reporting.

Taxable Entities. The franchise tax would apply to:

• a partnership,
• a corporation,
• a banking corporation,
• a savings and loan association,
• a limited liability company,
• a business trust,
• a professional association,
• a business association,
• a joint venture,
• a joint stock company,
• a holding company, or
• any other legal entity.

The franchise tax would not apply to:

• a sole proprietorship,
• a general partnership directly owned by natural persons,
• a passive entity,
• an entity that is already exempt from franchise tax under prior law,
• a grantor trust,
• an estate of a natural person,
• an escrow,
• a family limited partnership, subject to certain conditions,
• a passive investment partnership,
• a trust that is a passive entity,
• a real estate investment trust (“REIT”), and
• a real estate mortgage investment conduit (“REMIC”).

Tax Base. The franchise tax changes from a separate report filing state to a combined report filing state based on unitary business. Taxable capital and earned surplus are replaced with a margin tax, which is based on the lesser of 70% of the taxable entity’s total revenue or the taxable entity’s total revenue reduced by either a cost of goods sold adjustment or a compensation adjustment. This margin is apportioned according to traditional apportionment provisions, less any allowable deductions, to derive the taxable margin.

When determining a taxable entity’s cost of goods sold deduction, the draft legislation follows federal guidelines with the exceptions set out in the draft legislation. Generally, cost of goods sold applies to real and tangible personal property sold in the ordinary course of business and does not include services sold. It incorporates all direct costs of acquiring and producing goods, including the cost of labor and materials. Indirect costs are also included but cannot exceed 4% of the taxable entity’s total indirect overhead costs. The statute excludes certain costs, such as selling, distribution, outbound transportation, and advertising costs. If a taxable entity is a lending institution, the cost of goods sold includes interest expense.

When determining a taxable entity’s compensation deduction, a taxable entity may deduct wages, salaries, stock options, and net distributive income from entities treated as partnerships for federal income tax purposes if received by a natural person. Notwithstanding any adjustment, there is a $300,000 cap on any individual employee’s compensation, indexed to inflation every two years. The compensation deduction also includes the actual cost of health, retirement, and workers’ compensation benefits, which is not capped.

Tax Rates and Manner of Reporting. Taxable entities that are part of an affiliated group of businesses with 80% common ownership and engaged in a unitary business must file a water’s edge combined group report. The combined group is treated as a single taxable entity and must elect the same deduction from total revenue (cost of goods sold or compensation).

Each taxable entity computes its total revenue as if it were a stand-alone entity. All the revenue is combined, from which inter-entity revenue is eliminated. The deduction for cost of goods sold and compensation is similarly computed, combined, and reduced for inter-entity deductions.

The Texas apportionment factor is computed based on the Texas gross receipts for taxable entities with nexus in Texas over the combined gross receipts, using the rules under current Texas law. This Texas factor is applied to the margin to derive the taxable margin.

The margin tax rate is 1%, except for business' predominately engaged in retail or wholesale trade, which pays at the lower rate of .5%. While the draft legislation repeals all existing franchise tax credits, it does permit a taxable entity to continue to carryforward these credits for a certain period of time depending on the type of credit, as if the former law was in effect. Existing contracts for franchise tax credits would also be honored and the taxpayer may claim the credit in the same manner and for the same term as provided in the agreement.

The reformed franchise tax would take effect on January 1, 2008.

Motor Vehicle Sales and Use Tax. The draft legislation will reduce sales tax fraud on the transfer of used motor vehicles. The total consideration for a used motor vehicle is deemed to be its “standard presumptive value” as determined by the Texas Department of Transportation, if certain conditions exist. The legislation also requires a motor vehicle dealer to provide a certified appraisal of the motor vehicle. These provisions take effect on October 1, 2006.

Tax on Tobacco Products and Alcohol. This draft legislation raises the cigarette tax and tax rate on tobacco products other than cigars. A mixed-beverage tax permittee may separately state the tax on each invoice, billing, sales slip, and ticket for the purchase of an item so that the consumer knows that the tax is already included in the invoice, billing, sales slip, and ticket and so that the permittee may deduct the tax from the gross receipts subject to tax.

If you have any questions regarding the above information, please contact Mr. Eric Stein, Principal of the Ryan & Company Austin office, at 512.476.0022. Mr. Stein can also be reached via e-mail.

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