Issue: Under Texas law, are Sirius XM’s monthly subscription fees from Texas users are receipts from a “service performed in this state”?
Holding: No. Sirius XM’s “service” is “performed in this state” if the labor for the benefit of another is done in Texas. Even though Sirius XM’s subscribers reside in Texas, the “services” performed by Sirius XM are performed outside the Texas border. Thus, the Comptroller’s assessment of state franchise tax on subscription fees paid to Sirius XM by all Texas residents was in error.
Summary of Facts: Sirius broadcasts more than 150 satellite-radio channels. The content is produced in studios mainly located outside of Texas, although Sirius ran a small radio show in Texas for a time. Content is broadcast by transmitting it to satellites from facilities in states other than Texas. The satellites are launched from outside the U.S. The satellites transmit signals back down to Earth, where they either reach radio sets or terrestrial repeaters (twenty-two of which are in Texas) that supplement the coverage. The satellites are controlled by Sirius’s facilities located outside of Texas. Once the signal reaches a customer’s radio, a circuit or “chip” decrypts the radio signal, allowing the listener to hear the programming. Customers can access Sirius’s content by paying a subscription fee.
For 2010 and 2011 tax years, Sirius filed what it believed was an appropriate franchise tax reporting for its “services performed in” Texas. However, the Texas Comptroller claimed Sirius underpaid by $878,364.39 for the 2010 tax year and $1,674,907.38 for the 2011 tax year. The Comptroller believed that the “service performed in this state” by Sirius was the service of “unscrambling” the radio signal to Texas-based consumers. The Comptroller believed that services must be apportioned to the state in which the “receipt-producing, end-product act” takes place.
Sirius argued that it performs little or no services in Texas. Sirius argued that the phrase “service performed in this state” means that the personnel or equipment performing the service must be physically located in Texas. Sirius contends that the service it performs is not the decryption of radio signals but the production and broadcasting of radio content, which happens outside Texas.
Key Points of Law:
- Texas’s franchise tax is calculated by multiplying the taxable entity’s “taxable margin” by the tax rate. Tax Code § 171.002. Determining an entity’s “taxable margin” requires three steps: (1) margin calculation, (2) apportionment, and (3) deductions. Id. § 171.101(a).
- “Margin” is generally a percentage of the taxpayer’s total revenue. § 171.101(a)(1). “Apportioning” margin to Texas is provided by section 171.106, resulting in an “apportioned margin.” The apportioned margin is calculated by multiplying the margin by a fraction, whose “numerator . . . is the taxable entity’s gross receipts from business done in this state” and whose “denominator . . . is the taxable entity’s gross receipts from its entire business.” Id. § 171.106(a). Allowable deductions are then subtracted from the apportioned margin, which yields the entity’s “taxable margin,” to which the tax rate is applied. Id. § 171.101(a)(3).
- Determining the apportioned margin requires calculating what percentage of the taxpayer entity’s gross receipts are “from business done in this state.” § 171.106(a) (emphasis added). Section 171.103 describes the required calculation, and one element for the calculation is “the taxable entity’s receipts from . . . each service performed in this state.” Id. § 171.103(a)(2) (emphasis added).
- The Texas Administrative Code rules provide that receipts from services “are apportioned to the location where the service is performed,” and if services are performed in more than one state, then the value apportioned to Texas is the “fair value of the services that are rendered in Texas.” See 34 Admin. Code § 3.591(e)(26).
- “Service,” in this context, means “performance of labor for the benefit of another.” Van Zandt v. Fort Worth Press, 359 S.W.2d 893, 895 (Tex. 1962). As for “performed in this state,” the Sirius XM Court, noted:
We see no reason to depart from these straightforward understandings of the everyday words the statute uses. A “service” is “performed in this state” if the labor for the benefit of another is done in Texas. Generally, all it takes to know where a taxable entity’s “useful labor” is “done” is to ask where the employees do their work, since businesses act only through their agents. When technology rather than personnel performs the useful act, we look to the location of that equipment, as the Comptroller and courts of appeals have done. . . . Sirius XM, slip opin. at 10
- Texas has used a single-factor test based on sales receipts. Other states consider receipts and other factors. “But Texas’s single-factor, origin-based system looks only to where the service from which the receipts are derived is performed.” Id. at 13 (emphasis added).
- “Determining the location of performance requires looking to the physical location of the taxpayer’s personnel or equipment that performs the service for which the customer pays. . . . We see no reason for the ‘receipt-producing, end-product act’ test to play any role in our decision.” at 15 (emphasis added).
- In tax cases, courts must consider (and must not disregard) the economic realities underlying the transactions in issue. “The economic reality here is that Sirius is a radio production and broadcasting company operating dozens of satellite radio channels from locations outside Texas. Characterizing the service Sirius performs as “decryption” elevates the technicalities of the transaction over the economic reality of the service performed.” at 16-17.
- when services are performed inside and outside of Texas, the taxpayer must apportion to Texas the “fair value of the services that are rendered in Texas.” Former 34 TEX. ADMIN. CODE § 3.591(e)(26).1
Insights: This Sirius XM opinion provides sound guidance on how a taxable entity–especially an out-of-state technology-focused business– must apportion gross receipts for business done in Texas. Sirius XM succeeded in the case mainly because Sirius XM—by its technology-focused business model—performed very little services in Texas. Labor and facilities were located outside the Texas border. Thus, pursuant to the Texas Tax Code and the Texas Administrative Code, Sirius XM was required to apportion to Texas the fair value of the services that are performed in Texas, but all subscriber fees paid by Texas residents were not necessarily subject to taxable apportionment because the fees were not for services performed in Texas. Sirius XM may be an outlier in the realm of technology-focused businesses doing business in Texas. Each such taxable entity must evaluate its business operations, revenue streams, labor force location, facilities locations, and services provided “in Texas” when apportioning applicable taxable margin under Chapter 171 of the Texas Tax Code.