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By Jeff Thalachelloor, Analyst II, Transaction Tax | February 13, 2020

Texas Comptroller’s Proposed Changes to Local Sales Tax Rule 3.334

The Texas Comptroller is proposing amendments to Texas Administrative Code Section 3.334 in response to the U.S. Supreme Court’s decision in South Dakota v. Wayfair, Inc.. The change will require remote sellers to collect local use tax in Texas even if they do not have a physical presence in the state. The Texas Legislature passed House Bill 1525 and House Bill 2153 in 2019 in response to the Wayfair decision to recognize that the internet marketplace is increasingly substantial for Texas businesses. House Bill 1525 establishes local sales and use tax collection responsibilities on marketplace providers such as Amazon and Walmart. Additionally, House Bill 2153 determines a single local use tax rate that remote sellers may elect to use to ease the burden of applying the correct local tax rate to their sales into different jurisdictions.

The proposed amendments to the sourcing rules will also affect cities that have entered into sales tax rebate incentive agreements with businesses under Chapters 380 and 381 of the Local Government Code. These changes give taxing jurisdictions broad authority and flexibility to promote economic development. With the substantial tax implications that would occur upon execution of the proposed changes, taxpayers across Texas are seeking clarification on the impact it will have on their businesses.

How will the sourcing rule changes impact local tax collection?

Under the current rule, sales taxes on internet orders made by Texas residents can potentially be sourced to the jurisdiction in Texas where a place of business is located. Under the proposed rule, sales taxes on internet orders made by Texas residents wouldn’t automatically be sourced to the jurisdiction where the place of business is located, but instead, to the jurisdiction where the goods are shipped and received. The proposed rule will effectively redirect tax revenues from jurisdictions where businesses are located to jurisdictions where the purchasers reside, which may have a substantial impact on local governments all over Texas. The Comptroller’s rationale is that the tax revenue losses in jurisdictions with many tax collecting businesses will be offset by the gains in tax revenue that will now be sourced to the areas of purchase.

How will cities with preexisting agreements with their local businesses be affected?

For years some cities have relied on sales taxes being sourced to their city from internet orders within the state under current rules. Additionally, some cities may have entered into sales tax rebate incentive agreements with businesses under Chapter 380 of the Local Government Code with the understanding that sales taxes from internet orders would be sourced to those cities. The comptroller recognized the issue and provided a qualification- sellers who entered into a Chapter 380 economic development agreement before September 1, 2019, are exempt from the new internet order rules.

The grandfathering provision would remain active until December 31, 2022, at which point the new internet order rules would apply, assuming they are finally adopted. However, some businesses already have deals that extend much farther into the future, past 2022.  It is unclear how the Comptroller will treat agreements that extend past the end date at this time.

What are some of the concerns business owners have about the proposed changes?

As with any proposed changes to legislation regarding tax collection, businesses around Texas are wondering how their operations will be affected and what burden will be placed on them in terms of tax reporting. Orders will now have to be differentiated by the method of order placement, where internet orders are now treated differently than orders made over the phone or in person. Most point of sale systems do not differentiate between how an order is placed, and additional clarification is necessary for specific scenarios. For example, if an order is placed in person or over the phone, but the final agreement is sent via email- does that constitute an internet order? What considerations are made in the case of drop shipments by third party businesses who do not receive orders but ship items to purchasers? Issues such as these are expected to be clarified by the State before any changes go into effect. Altus Group’s transaction tax team and our clients are eagerly awaiting the results of the proposed changes in Texas and will be monitoring similar cases as other states react to the Wayfair decision.

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