TITLE 34. PUBLIC FINANCE

PART 1. COMPTROLLER OF PUBLIC ACCOUNTS

CHAPTER 3. TAX ADMINISTRATION

SUBCHAPTER V. FRANCHISE TAX

34 TAC §3.588

The Comptroller of Public Accounts proposes amendments to §3.588, concerning margin: cost of goods sold. The comptroller is amending the section to implement House Bill 500, 83rd Legislature, 2013. The changes also add definitions and interpret ambiguous statutory language.

The comptroller amends subsection (a) to indicate that specific provisions of this section apply to reports other than those originally due on or after January 1, 2008.

The comptroller amends subsection (c) to add new paragraph (8) concerning movie theaters. New paragraph (8) implements House Bill 500, Section 10, which enacted Tax Code, §171.1012(t), effective September 1, 2013. The language in this paragraph mirrors the statutory language. Subsequent paragraphs are renumbered accordingly.

The comptroller amends renumbered paragraph (9), which implements Tax Code, §171.1012(i), concerning the ownership of goods, to add a presumption that the legal title holder is the owner of the goods and to define several additional terms that are used in the current paragraph.

Paragraph (9) is reorganized to add new subparagraph (A). Existing language for determining when a taxable entity is the owner of goods is located in new subparagraph (A). The comptroller amends the existing language to add a rebuttable presumption that the legal title holder is the owner of the goods. A taxpayer may rebut the presumption by proving an ownership right superior to the legal title holder.

The comptroller amends relettered subparagraph (B) to define the terms "labor," "material," and "project" for purposes of paragraph (9) only. The proposed amendment uses the definitions of "labor" and "material" verbatim from Property Code, §53.001 (3) and (4) (Definitions), except that the proposed amendment replaces the term "work" with the term "project." The definition of "project" tracks the language of Tax Code, §171.1012(i).

Subsection (i) states that a taxable entity "furnishing labor and materials to a project" is considered to be the owner of the labor and materials and may include the costs as allowed by §171.1012 in the computation of cost of goods sold. However, subsection (i) does not define "labor" or "materials." The lack of definitions has created uncertainty and generated numerous controversies. The courts have held that a contractor may claim labor and material costs if they are "an essential and direct" component of a project but not if they are "too far removed" from the project. Combs v. Newpark Resources, Inc., 422 S.W.3d 46, 57 (Tex. App. - Austin 2013, no pet.); Hegar v. CGG Veritas Services (U.S.), Inc., No. 03-14-00713-CV (Tex. App. - Austin 2016) (mem. op.).

The boundaries between "essential and direct" and "too far removed" are uncertain. To reduce the uncertainty, the comptroller proposes to add definitions of "labor" and "materials" based on the definitions used in Texas Property Code, Chapter 53 (Mechanic's, Contractor's, or Materialman's Lien). The Tax Code phrase "furnishing labor and materials" is similar to the Property Code phrase "furnishes labor and materials." Therefore, it is reasonable to assume that the Legislature intended similar definitions. The comptroller will consider caselaw interpreting Property Code, Chapter 53, but may adapt Property Code interpretations to conform to needs of the Tax Code.

Because the proposed amendment requires that the labor and materials be used in the "direct prosecution" of a project and the franchise tax caselaw requires that the labor and material be "direct and essential" components of a project, the proposed amendments are generally consistent with the direction given by the courts. However, outcomes could vary depending upon the facts. For example, it is conceivable that a seismic surveyor's work could be performed in the direct prosecution of a particular drilling project so that the surveyor could obtain a lien on the project. In that instance, the tax outcome would be consistent with the outcome of the CGG Veritas court decision. On the other hand, it is also conceivable that a seismic surveyor's work could be performed generically so that the surveyor could not obtain a lien on a particular project. In that instance, the tax outcome might be inconsistent with the outcome of the CGG Veritas court decision. The court decision did not discuss the ability of CGG Veritas to obtain a lien.

Finally, these definitions, which require that the labor and materials be used in the "direct prosecution" of the project, are limited to the determination of whether the taxable entity furnishing the labor and materials is considered to be an "owner" under subsection (i), and do not affect the determination of allowable costs under other subsections. For example, these definitions do not apply to direct labor costs described under subsection (d)(1).

The comptroller amends subsection (c) to add new paragraph (10) concerning pipeline entities. New paragraph (10) implements House Bill 500, Section 9, which enacted Tax Code, §171.1012(k-2) and (k-3), concerning pipeline entities. The language in paragraph (10) mirrors the statutory language. Subsequent paragraphs are renumbered accordingly.

The comptroller amends renumbered paragraph (11) concerning rentals and leases. To better distinguish this provision from subsection (d)(7) of this section, the phrase "rental or leasing companies" replaces the phrase "rentals and leases."

Additional amendments interpret ambiguous statutory language. Tax Code, §171.1012(k-1) provides that motor vehicle rental or leasing companies, heavy construction equipment rental or leasing companies, and railcar rolling stock rental or leasing companies may subtract as costs of goods sold "the costs otherwise allowed by this section in relation to tangible personal property that the entity rents or leases in the ordinary course of business of the entity."

The amendments to renumbered paragraph (11) memorialize the guidance of the Third Court of Appeals in Hegar v. Sunstate Equipment Co., LLC, 2017 WL 279602 at *5 (Tex. App.-Austin Jan. 20, 2017, pet. filed) (mem. op.). The court agreed with the comptroller’s interpretation of Tax Code, §171.1012(k-1)(2), "which is that Sunstate may deduct 'all direct costs of acquiring or producing the [heavy construction equipment] ' that forms the basis of Sunstate's business, as well as additional costs 'in relation to the taxable entity's [heavy construction equipment]. ‘" The court held, "This reading of the statute is logical and consistent with the apparent purpose of subsection (k-1) to extend to renters of heavy equipment the same COGS deductions available to a company that sells identical equipment." Id.

The amendments provide that certain kinds of motor vehicle rental or leasing companies, a railcar rolling stock rental or leasing company, or a heavy construction equipment rental or leasing company may deduct costs otherwise allowed by Tax Code, §171.1012 in relation to the motor vehicles, railcar rolling stock, or heavy construction equipment that the entity rents or leases in the ordinary course of its rental or leasing business.

Tom Currah, Chief Revenue Estimator, has determined that for the first five-year period the rule will be in effect, there will be no significant revenue impact on the state or units of local government.

Mr. Currah also has determined that for each year of the first five years the rule is in effect, the public benefit anticipated as a result of enforcing the rule will be by implementing current statutory provisions and providing additional definitions to clarify existing statutory language. This rule is proposed under Tax Code, Title 2, and does not require a statement of fiscal implications for small businesses. There is no significant anticipated economic cost to individuals who are required to comply with the proposed rule.

Comments on the proposal may be submitted to Teresa G. Bostick, Director, Tax Policy Division, P.O. Box 13528, Austin, Texas 78711-3528. Comments must be received no later than 30 days from the date of publication of the proposal in the Texas Register.

This amendment is proposed under Tax Code, §111.002 (Comptroller's Rules; Compliance; Forfeiture), which provides the comptroller with the authority to prescribe, adopt, and enforce rules relating to the administration and enforcement of the provisions of Tax Code, Title 2.

This amendment implements Tax Code, §171.1012.

§3.588.Margin: Cost of Goods Sold.

(a) Effective Date. The provisions of this section apply to franchise tax reports originally due on or after January 1, 2008, except as otherwise noted.

(b) Definitions. The following words and terms, when used in this section, shall have the following meanings, unless the context clearly indicates otherwise.

(1) Arm's length--The standard of conduct under which entities that are not related parties and that have substantially equal bargaining power, each acting in its own interest, would negotiate or carry out a particular transaction.

(2) Computer program--A series of instructions that are coded for acceptance or use by a computer system and that are designed to permit the computer system to process data and provide results and information. The series of instructions may be contained in or on magnetic tapes, printed instructions, or other tangible or electronic media.

(3) Goods--Real or tangible personal property sold in the ordinary course of business of a taxable entity.

(4) Heavy construction equipment--Self-propelled, self-powered, or pull-type equipment that weighs at least 3,000 pounds and is intended to be used for construction. The term does not include a motor vehicle required to be titled and registered.

(5) Lending institution--An entity that makes loans and:

(A) is regulated by the Federal Reserve Board, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the Commodity Futures Trading Commission, the Office of Thrift Supervision, the Texas Department of Banking, the Office of Consumer Credit Commissioner, the Credit Union Department, or any comparable regulatory body;

(B) is licensed by, registered with, or otherwise regulated by the Department of Savings and Mortgage Lending;

(C) is a "broker" or "dealer" as defined by the Securities Exchange Act of 1934 at 15 U.S.C. §78c; or

(D) provides financing to unrelated parties solely for agricultural production.

(6) Principal business activity--The activity in which a taxable entity derives the largest percentage of its "total revenue".

(7) Production--Construction, manufacture, installation occurring during the manufacturing or construction process, development, mining, extraction, improvement, creation, raising, or growth.

(8) Related party--A person, corporation, or other entity, including an entity that is treated as a pass-through or disregarded entity for purposes of federal taxation, whether the person, corporation, or entity is subject to the tax under this chapter or not, in which one person, corporation, or entity, or set of related persons, corporations, or entities, directly or indirectly owns or controls a controlling interest in another entity.

(9) Service costs--Indirect costs and administrative overhead costs that can be identified specifically with a service department or function, or that directly benefit or are incurred by reason of a service department or function. For purposes of this section, a service department includes personnel (including costs of recruiting, hiring, relocating, assigning, and maintaining personnel records or employees); accounting (including accounts payable, disbursements, and payroll functions); data processing; security; legal; general financial planning and management; and other similar departments or functions.

(10) Tangible personal property--

(A) includes:

(i) personal property that can be seen, weighed, measured, felt, or touched or that is perceptible to the senses in any other manner;

(ii) films, sound recordings, videotapes, live and prerecorded television and radio programs, books, and other similar property embodying words, ideas, concepts, images, or sound, without regard to the means or methods of distribution or the medium in which the property is embodied, for which, as costs are incurred in producing the property, it is intended or is reasonably likely that any medium in which the property is embodied will be mass-distributed by the creator or any one or more third parties in a form that is not substantially altered; and

(iii) a computer program, as defined in paragraph (2) of this subsection.

(B) does not include:

(i) intangible property or

(ii) services.

(c) General rules for determining cost of goods sold.

(1) Affiliated entities. Notwithstanding any other provision of this section, a payment made by one member of an affiliated group to another member of that affiliated group not included in the combined group may be subtracted as a cost of goods sold only if it is a transaction made at arm's length.

(2) Capitalization or expensing of certain costs. The election to capitalize or expense allowable costs is made by filing the franchise tax report using one method or the other. The election is for the entire period on which the report is based and may not be changed after the due date or the date the report is filed, whichever is later. A taxable entity that is allowed a subtraction by this section for a cost of goods sold and that is subject to Internal Revenue Code, §§263A, 460, or 471 (including a taxable entity subject to §471 that elects to use LIFO under §472), may elect to:

(A) Capitalize those costs in the same manner and to the same extent that the taxable entity capitalized those costs on its federal income tax return, except for those costs excluded under subsection (g) of this section, or in accordance with subsections (d), (e), and (f) of this section. A taxable entity that elects to capitalize costs on its first report due on or after January 1, 2008, may include, in beginning inventory, costs allowable for franchise tax purposes that would be in beginning inventory for federal income tax purposes.

(i) If the taxable entity elects to capitalize those costs allowed under this section as a cost of goods sold, it must capitalize each cost allowed under this section that it capitalized on its federal income tax return.

(ii) If the taxable entity later elects to begin expensing those costs allowed under this section as a cost of goods sold, the entity may not deduct any cost incurred before the first day of the period on which the report is based, including any ending inventory from a previous report.

(B) Expense those costs, except for those costs excluded under subsection (g) of this section, or in accordance with subsections (d), (e), and (f) of this section.

(i) If the taxable entity elects to expense those costs allowed under this section as a cost of goods sold, costs incurred before the first day of the period on which the report is based may not be subtracted as a cost of goods sold.

(ii) If the taxable entity later elects to begin capitalizing those costs allowed under this section as a cost of goods sold, costs incurred prior to the accounting period on which the report is based may not be capitalized.

(3) Election to subtract cost of goods sold. A taxable entity, if eligible, must make an annual election to subtract cost of goods sold in computing margin by the due date, or at the time the report is filed, whichever is later. The election to subtract cost of goods sold is made by filing the franchise tax report using the cost of goods sold method. An amended report may be filed within the time allowed by Tax Code, §111.107 to change the method of computing margin to the cost of goods sold deduction method or from the cost of goods sold deduction method to the compensation deduction method, 70% of total revenue, or, if otherwise qualified, the E-Z computation method. An election may also be changed as part of an audit. See §3.584 of this title (relating to Margin: Reports and Payments).

(4) Exclusions from total revenue. Any expense excluded from total revenue (see §3.587 of this title (relating to Margin: Total Revenue)) may not be included in the determination of cost of goods sold.

(5) Film and broadcasting. A taxable entity whose principal business activity is film or television production or broadcasting or the sale of broadcast rights or the distribution of tangible personal property described by subsection (b)(10)(A)(ii) of this section, or any combination of these activities, and who elects to use cost of goods sold to determine margin, may include as cost of goods sold:

(A) the costs described in this section in relation to the property;

(B) depreciation, amortization, and other expenses directly related to the acquisition, production, or use of the property, including

(C) expenses for the right to broadcast or use the property.

(6) Lending institutions. Notwithstanding any other provision of this section, if the taxable entity is a lending institution that offers loans to the public and elects to subtract cost of goods sold, the entity may subtract as a cost of goods sold an amount equal to interest expense.

(A) This paragraph does not apply to entities primarily engaged in an activity described by category 5932 of the 1987 Standard Industrial Classification Manual published by the federal Office of Management and Budget.

(B) For purposes of this subsection, an entity engaged in lending to unrelated parties solely for agricultural production offers loans to the public.

(7) Mixed transactions. If a transaction contains elements of both a sale of tangible personal property and a service, a taxable entity may only subtract as cost of goods sold the costs otherwise allowed by this section in relation to the tangible personal property sold.

(8) Movie theaters. Effective for reports originally due on or after September 1, 2013, if a taxable entity that is a movie theater elects to subtract cost of goods sold, the cost of goods sold for the taxable entity shall be the costs described by this section in relation to the acquisition, production, exhibition, or use of a film or motion picture, including expenses for the right to use the film or motion picture.

(9) [(8)] Owner of goods. A taxable entity may make a subtraction under this section in relation to the cost of goods sold only if that entity owns the goods.

(A) A taxable entity that holds the legal title to the goods is presumed to be the owner of the goods for purposes of this section. A taxable entity may rebut this presumption by proving an ownership right superior to the legal title holder [The determination of whether a taxable entity is an owner is] based on all of the facts and circumstances, including the various benefits and burdens of ownership vested with the taxable entity.

(B) [(A)] A taxable entity furnishing labor or materials to a project [for the construction, improvement, remodeling, repair, or industrial maintenance (as the term "maintenance" is defined in §3.357 of this title (relating to Nonresidential Real Property Repair, Remodeling, and Restoration; Real Property Maintenance)), of real property] is considered to be an owner of the labor or materials and may include the costs, as allowed by this section, in the computation of the cost of goods sold. For purposes of determining whether a taxable entity is considered an owner of the labor or materials under this paragraph, and eligible to deduct costs related to that labor and materials as described in subsections (d), (e), and (f) of this section, the following terms mean:

(i) Labor--Labor used in the direct prosecution of the project.

(ii) Material--All or part of:

(I) the material, machinery, fixtures, or tools incorporated into the project, consumed in the direct prosecution of the project, or ordered and delivered for incorporation or consumption;

(II) rent at a reasonable rate and actual running repairs at a reasonable cost for construction equipment used or reasonably required and delivered for use in the direct prosecution of the project at the site of the project; or

(III) power, water, fuel, and lubricants consumed or ordered and delivered for consumption in the direct prosecution of the project.

(iii) Project--The construction, improvement, remodeling, repair, or industrial maintenance (as the term "maintenance" is defined in §3.357 of this title (relating to Nonresidential Real Property Repair, Remodeling, and Restoration; Real Property Maintenance)) of real property.

(C) [(B)] Solely for the purposes of this section, a taxable entity shall be treated as the owner of goods being manufactured or produced by the entity under a contract with the federal government, including any subcontracts that support a contract with the federal government, notwithstanding that the Federal Acquisition Regulations may require that title or risk of loss with respect to those goods be transferred to the federal government before the manufacture or production of those goods is complete.

(10) Pipeline entities. Effective for reports originally due on or after January 1, 2014, and notwithstanding paragraph (9) of this subsection and subsection (g)(3) of this section, a pipeline entity that provides services for others related to the product that the pipeline does not own and to which this paragraph applies may subtract as a cost of goods sold its depreciation, operations, and maintenance costs allowed by this section related to the services provided.

(A) For purposes of this paragraph, "pipeline entity" means an entity:

(i) that owns or leases and operates the pipeline by which the product is transported for others and only to that portion of the product to which the entity does not own title; and

(ii) that is primarily engaged in gathering, storing, transporting, or processing crude oil, including finished petroleum products, natural gas, condensate, and natural gas liquids, except for a refinery installation that manufactures finished petroleum products from crude oil.

(B) For purposes of this paragraph, "processing" means the physical or mechanical removal, separation, or treatment of crude oil, including finished petroleum products, natural gas, condensate, and natural gas liquids after those materials are produced from the earth. The term does not include the chemical or biological transformation of those materials.

(11) [(9)] Rental or leasing companies [Rentals and leases]. Notwithstanding any other provision of this section[, the following taxable entities may subtract as cost of goods sold the costs otherwise allowed by this section in relation to tangible personal property that the entity rents or leases in the ordinary course of business of the entity]:

(A) a motor vehicle rental company that remits a tax on gross receipts imposed under Tax Code, §152.026, or a motor vehicle leasing company, may subtract as costs of goods sold the costs otherwise allowed by this section in relation to motor vehicles that the company rents or leases in the ordinary course of its business;

(B) a heavy construction equipment rental or leasing company may subtract as costs of goods sold the costs otherwise allowed by this section in relation to heavy construction equipment that the company rents or leases in the ordinary course of its business; and

(C) a railcar rolling stock rental or leasing company may subtract as costs of goods sold the costs otherwise allowed by this section in relation to railcar rolling stock that the company rents or leases in the ordinary course of its business.

(12) [(10)] Reporting methods. A taxable entity shall determine its cost of goods sold, except as otherwise provided by this section, in accordance with the methods used on the federal income tax return on which the report under this chapter is based. This subsection does not affect the type or category of cost of goods sold that may be subtracted under this section.

(13) [(11)] Restaurants and bars. Entities engaged in activities described in Major Group 58 (Eating and Drinking Places) of the Standard Industrial Classification Manual may deduct for cost of goods sold only those expenses allowed under subsections (d), (e) and (f) of this section, that relate to the acquisition and production of food and beverages. Any costs related to both the production of food and beverages and to other activities must be allocated to production on a reasonable basis.

(d) Direct costs. The cost of goods sold includes all direct costs of acquiring or producing the goods. Direct costs include:

(1) Labor costs. A taxable entity may include in its cost of goods sold calculation labor costs, other than service costs, that are properly allocable to the acquisition or production of goods and are of the type subject to capitalization or allocation under Treasury Regulation Sections 1.263A-1(e) or 1.460-5 as direct labor costs, indirect labor costs, employee benefit expenses, or pension and other related costs, without regard to whether the taxable entity is required to or actually capitalizes such costs for federal income tax purposes.

(A) For purposes of this section, labor costs include W-2 wages, IRS Form 1099 payments for labor, temporary labor expenses, payroll taxes, pension contributions, and employee benefits expenses, including, but not limited to, health insurance and per diem reimbursements for travel expenses, to the extent deductible for federal tax purposes.

(B) Labor costs under this paragraph shall not include any type of costs includable in subsection (f) or excluded in subsection (g) of this section. Costs for labor that do not meet the requirements set forth in this paragraph may still be subtracted as a cost of goods sold if the cost is allowed under another provision of this section. For example, service costs may be included in a taxable entity's cost of goods sold calculation to the extent provided by subsection (f) of this section.

(2) Incorporated materials. A taxable entity may include in its cost of goods sold calculation the cost of materials that are an integral part of specific property produced.

(3) Consumable materials. A taxable entity may include in its cost of goods sold calculation the cost of materials that are consumed in the ordinary course of performing production activities.

(4) Handling costs. A taxable entity may include in its cost of goods sold calculation handling costs, including costs attributable to processing, assembling, repackaging, and inbound transportation.

(5) Storage costs. A taxable entity may include in its cost of goods sold calculation storage costs, including the costs of carrying, storing, or warehousing property, subject to subsection (g) of this section, concerning excluded costs.

(6) Depreciation, depletion, and amortization. A taxable entity may include in its cost of goods sold calculation depreciation, depletion, and amortization reported on the federal income tax return on which the report under this chapter is based, to the extent associated with and necessary for the production of goods, including recovery described by Internal Revenue Code, §197, and property described in Internal Revenue Code, §179.

(7) Rentals and leases. A taxable entity may include in its cost of goods sold calculation the cost of renting or leasing equipment, facilities, or real property directly used for the production of the goods, including pollution control equipment and intangible drilling and dry hole costs.

(8) Repair and maintenance. A taxable entity may include in its cost of goods sold calculation the cost of repairing and maintaining equipment, facilities, or real property directly used for the production of the goods, including pollution control devices.

(9) Research and development. A taxable entity may include in its cost of goods sold calculation the costs attributable to research, experimental, engineering, and design activities directly related to the production of the goods, including all research or experimental expenditures described by Internal Revenue Code, §174.

(10) Mineral production. A taxable entity may include in its cost of goods sold calculation geological and geophysical costs incurred to identify and locate property that has the potential to produce minerals.

(11) Taxes. A taxable entity may include in its cost of goods sold calculation taxes paid in relation to acquiring or producing any material, including property taxes paid on buildings and equipment, and taxes paid in relation to services that are a direct cost of production.

(12) Electricity. A taxable entity may include in its cost of goods sold calculation the cost of producing or acquiring electricity sold.

(13) A taxable entity may include in its cost of goods sold calculation a contribution to a partnership in which the taxable entity owns an interest that is used to fund activities, the costs of which would otherwise be treated as cost of goods sold of the partnership, but only to the extent that those costs are related to goods distributed to the contributing taxable entity as goods-in-kind in the ordinary course of production activities rather than being sold by the partnership.

(e) Additional costs. In addition to the amounts includable under subsection (d) of this section, the cost of goods sold includes the following costs in relation to the taxable entity's goods:

(1) deterioration of the goods;

(2) obsolescence of the goods;

(3) spoilage and abandonment, including the costs of rework, reclamation, and scrap;

(4) if the property is held for future production, preproduction direct costs allocable to the property, including storage and handling costs, as provided by subsection (d)(4) and (5) of this section;

(5) postproduction direct costs allocable to the property, including storage and handling costs, as provided by subsection (d)(4) and (5) of this section;

(6) the cost of insurance on a plant or a facility, machinery, equipment, or materials directly used in the production of the goods;

(7) the cost of insurance on the produced goods;

(8) the cost of utilities, including electricity, gas, and water, directly used in the production of the goods;

(9) the costs of quality control, including replacement of defective components pursuant to standard warranty policies, inspection directly allocable to the production of the goods, and repairs and maintenance of goods; and

(10) licensing or franchise costs, including fees incurred in securing the contractual right to use a trademark, corporate plan, manufacturing procedure, special recipe, or other similar right directly associated with the goods produced.

(f) Indirect or administrative overhead costs. A taxable entity may subtract as a cost of goods sold service costs, as defined in subsection (b)(9) of this section, that it can demonstrate are reasonably allocable to the acquisition or production of goods. The amount subtracted may not exceed 4.0% of total indirect and administrative overhead costs.

(1) Any costs already subtracted under subsections (d) or (e) of this section may not be subtracted under this subsection.

(2) Any costs excluded under subsection (g) of this section may not be subtracted under this subsection.

(g) Costs not included. The cost of goods sold does not include the following costs in relation to the taxable entity's goods:

(1) the cost of renting or leasing equipment, facilities, or real property that is not used for the production of the goods;

(2) selling costs, including employee expenses related to sales;

(3) distribution costs, including outbound transportation costs;

(4) advertising costs;

(5) idle facility expenses;

(6) rehandling costs;

(7) bidding costs, which are the costs incurred in the solicitation of contracts ultimately awarded to the taxable entity;

(8) unsuccessful bidding costs, which are the costs incurred in the solicitation of contracts not awarded to the taxable entity;

(9) interest, including interest on debt incurred or continued during the production period to finance the production of the goods;

(10) income taxes, including local, state, federal, and foreign income taxes, and franchise taxes that are assessed on the taxable entity based on income;

(11) strike expenses, including costs associated with hiring employees to replace striking personnel, but not including the wages of the replacement personnel, costs of security, and legal fees associated with settling strikes;

(12) officers' compensation;

(13) costs of operation of a facility that is:

(A) located on property owned or leased by the federal government; and

(B) managed or operated primarily to house members of the armed forces of the United States;

(14) any compensation paid to an undocumented worker used for the production of goods, provided that, as used in this paragraph only, the following terms shall have the following meanings:

(A) "undocumented worker" means a person who is not lawfully entitled to be present and employed in the United States; and

(B) "goods" includes the husbandry of animals, the growing and harvesting of crops, and the severance of timber from realty; and

(15) costs funded by a partnership contribution, to the extent that the contributing taxable entity made the cost of goods sold deduction under subsection (d)(13) of this section.

The agency certifies that legal counsel has reviewed the proposal and found it to be within the state agency's legal authority to adopt.

Filed with the Office of the Secretary of State on September 18, 2017.

TRD-201703671

Lita Gonzalez

General Counsel

Comptroller of Public Accounts

Earliest possible date of adoption: October 29, 2017

For further information, please call: (512) 475-0387


PART 11. TEXAS EMERGENCY SERVICES RETIREMENT SYSTEM

CHAPTER 302. GENERAL PROVISIONS RELATING TO THE TEXAS EMERGENCY SERVICES RETIREMENT SYSTEM

34 TAC §302.5

The State Board of Trustees (Board) of the Texas Emergency Services Retirement System (System) proposes amendments to 34 TAC §302.5, relating to the correction of errors and contributions that are past due.

The objective of the proposed amendment is to protect the System benefits earned by volunteer firefighters and ems personnel. The proposed amendment requires departments to correct errors that have affected the enrollment and qualified service of members, regardless of when the errors occurred. The proposed amendment streamlines the process of correcting errors and eliminates §302.6, a redundant rule, regarding the payment of past due contributions and any applicable interest.

Kevin Deiters, Executive Director, has determined that the public benefit in the first five years this amended rule takes effect is the consolidation of agency rules, and increased accuracy of the System's data which includes correct contributions, interest charges, qualified service credit, and membership records.

The adoption of the proposed amendments will not affect small businesses or the general public. The adoption of the proposed amendments does not have foreseeable implications to the cost or revenues of the state. Any costs that are placed upon local governments due to the proposed amendment to §302.5 are a result of past due contributions due to a correction of error that occurred during the enrollment of membership.

Comments on the amendment must be submitted in writing to Kevin Deiters, Executive Director, Texas Emergency Services Retirement System, P.O. Box 12577, Austin, TX 78711-2577, submitted electronically to outreach@tesrs.texas.gov, submitted electronically on the System's website www.tesrs.texas.gov, or faxed to (512) 936-3480 no later than October 29, 2017.

The amendment to §302.5 is proposed under the statutory authority of Title 8, Texas Government Code, Subsection H, Texas Emergency Services Retirement System, §863.005, which allows the Board to create System rules to determine the costs of contributions past due and their accrued interest charges.

No other statutes, articles, or codes are affected by this proposal.

§302.5.Correction of Errors and Contributions Past Due.

(a) The [A] local board shall [may] correct an error in enrollment in membership or computation of qualified service at a meeting of the local board. Using [by completing and submitting to the Executive Director] a form provided by the pension system, [for any error that occurred within] the correction of error shall be certified by the local board chair and provided to the Executive Director in the manner prescribed by the [five-year period prior to the date that the form is submitted to the] pension system. [The completed form must be:

[(1) signed by the chair and secretary of the local board and the administrative head of the department; and]

[(2) accompanied by any applicable past due contributions necessitated by the change, including the applicable interest charge in accordance with Rule §302.6.]

(b) The Executive Director shall review the correction of error and may require the local board to provide additional documentation with respect to the correction of error. The Executive Director [and] may reject any proposed correction if such additional documentation does not support [is not provided. The Executive Director may also permit] the proposed correction of [an] error or if such additional documentation is not provided. The [that occurred more than five years from the date that the correction form is submitted to the pension system if the] Executive Director shall notify the local board if the proposed correction of error is approved or is denied due to lack of documentation provided by the local board does not support the [determines in his or her sole and absolute discretion that such] correction of error [is equitable and justifiable under the given circumstances].

(c) The Executive Director shall determine the applicable past due contributions required by the correction of error, if any, including applicable interest charges in accordance with §863.005 of the Texas Government Code.

(d) In accordance with §865.014(a), Texas Government Code, the governing body of the political subdivision of which the participating department is a part is liable for payment of past due contributions and interest charges, if any, and such payments shall be made in accordance with instructions provided by the pension system.

The agency certifies that legal counsel has reviewed the proposal and found it to be within the state agency's legal authority to adopt.

Filed with the Office of the Secretary of State on September 12, 2017.

TRD-201703612

Kevin Deiters

Executive Director

Texas Emergency Services Retirement System

Earliest possible date of adoption: October 29, 2017

For further information, please call: (512) 936-3372


34 TAC §302.6

The State Board of Trustees (Board) of the Texas Emergency Services Retirement System (System) proposes the repeal of §302.6, regarding charges for past due contributions.

The Board proposes the repeal of §302.6 to streamline the rules regarding the correction of errors and the subsequent past due contributions, including interest charges. The repeal follows a proposed amendment to §302.5 that will incorporate the provisions of rule §302.6.

Kevin Deiters, Executive Director, has determined that every year for the first five years this repeal goes into effect the public benefit will be the repeal of a redundant rule and a clarification of the process to correct errors.

Mr. Deiters has determined that there will be no effect on small businesses or individuals. The proposed repeal does not have foreseeable implications relating to the costs or revenues of state and local governments.

Comments on the proposed repeal of the rule must be submitted in writing to Kevin Deiters, Executive Director, Texas Emergency Services Retirement System, P.O. Box 12577, Austin, TX 78711-2577, submitted electronically to outreach@tesrs.texas.gov, submitted electronically on the System's website www.tesrs.texas.gov, or faxed to (512) 936-3480 no later than October 29th, 2017.

The repeal of §302.6 is proposed under the statutory authority of Title 8, Texas Government Code, Subsection H, Texas Emergency Services Retirement System, §863.005, which allows the Board to create System rules to determine the costs of contributions past due and their accrued interest charges.

No other statutes, articles, or codes are affected by this proposal.

§302.6.Charge for Certain Contributions Past Due.

The agency certifies that legal counsel has reviewed the proposal and found it to be within the state agency's legal authority to adopt.

Filed with the Office of the Secretary of State on September 12, 2017.

TRD-201703613

Kevin Deiters

Executive Director

Texas Emergency Services Retirement System

Earliest possible date of adoption: October 29, 2017

For further information, please call: (512) 936-3372


34 TAC §302.8

The State Board of Trustees (Board) of the Texas Emergency Services Retirement System (System) proposes an amendment to §302.8 concerning Qualified Service.

The amendment to §302.8 will correct an error in the reference to statute. The references in the current rule to §864.001(10)(B)(i) and §864.001(10)(B)(ii) are incorrect, as these sections do not exist in the Texas Government Code. The amendment corrects these errors by referencing §861.001(10)(B)(i) and §861.001(10)(B)(ii) of the Texas Government Code which define Qualified Service.

Kevin Deiters, Executive Director, has determined that for each year of the first five-year period that the amended rule is in effect the public benefit will be that the System corrects an error in its rules.

Mr. Deiters has determined that there will be no effect on small businesses or individuals. Administration of the amended §302.8 does not have foreseeable implications relating to the costs or revenues of state and local governments.

Comments on the amendment must be submitted in writing to Kevin Deiters, Executive Director, Texas Emergency Services Retirement System, P.O. Box 12577, Austin, TX 78711-2577, submitted electronically to outreach@tesrs.texas.gov, submitted electronically on the System's website www.tesrs.texas.gov, or faxed to (512) 936-3480 no later than October 29, 2017.

The amendment is proposed under the statutory authority of Title 8, Subsection H, Texas Emergency Services Retirement System, §864.001, which requires the Board to create rules regarding qualified service.

No other statutes, articles, or codes are affected by this proposal.

§302.8.Qualified Service.

The local board shall be responsible for the policy for its participating department relating to the requirements for percentage of attendance of emergencies defined under §861.001(10)(B)(i) [§864.001(10)(B)(i)], Texas Government Code, or the percentage of providing support services for emergencies defined under §861.001(10)(B)(ii) [§864.001(10)(B)(ii) ], Texas Government Code, in connection with the determination of whether a person is performing or has performed qualified service for purposes of the pension system.

The agency certifies that legal counsel has reviewed the proposal and found it to be within the state agency's legal authority to adopt.

Filed with the Office of the Secretary of State on September 12, 2017.

TRD-201703614

Kevin Deiters

Executive Director

Texas Emergency Services Retirement System

Earliest possible date of adoption: October 29, 2017

For further information, please call: (512) 936-3372


CHAPTER 308. BENEFITS FROM THE TEXAS EMERGENCY SERVICES RETIREMENT SYSTEM

34 TAC §308.2

The State Board of Trustees (Board) of the Texas Emergency Services Retirement System (System) proposes amendments to 34 TAC §308.2 to conform with Title 8, Texas Government Code, Subsection H, Texas Emergency Services Retirement System, §864.016(a) regarding Claim and Appeal Procedures.

The objective of the proposed amendments is to reduce delay in the payment of retirement checks to retired firefighters and first responders that occur when local boards fail to meet and decide a retirement claim pursuant to the statutory requirement of 16 days. The proposed amendments conform the rule with statute outlined in Title 8, Texas Government Code, Subsection H, Texas Emergency Services Retirement System, §864.016(a). The language in the current rule does not follow the process provided by the statute which allows the Executive Director to determine the merits of a service retirement claim after the 16th day after a local board receives the claim and fails to hold a hearing to decide the claim. Under the current rule, the determination of a claim remains with a local board after the 16-day period. The proposed amendments to §308.2 will correct this error and conform to the process provided by the statute.

Kevin Deiters, Executive Director, has determined that the public benefit in the first five years this amended rule takes effect is a reduction in the delay of initiating payments to eligible members of the System and that the amended rule conforms to statute.

The adoption of the rule will not affect small businesses or the general public.

The adoption of the proposed amendments does not have foreseeable implications to the cost or revenues of the state.

Comments on the amended rule must be submitted in writing to Kevin Deiters, Executive Director, Texas Emergency Services Retirement System, P.O. Box 12577, Austin, TX 78711-2577, submitted electronically to outreach@tesrs.texas.gov, submitted electronically on the System's website www.tesrs.texas.gov, or faxed to (512) 936-3480 no later than October 29, 2017.

The proposed amendment to §308.2 is proposed under the statutory authority of Title 8, Texas Government Code, Subsection H, Texas Emergency Services Retirement System, §864.016(a), which outlines the Claim and Appeal Procedure.

No other statutes, articles, or codes are affected by this proposal. The proposed amendment has been reviewed by legal counsel and is within the System's authority to adopt.

§308.2.Service Retirement Annuity.

(a) In this section, normal retirement age is the later of the month a member completes 15 years of credited qualified service or attains the age of 55.

(b) A member who has terminated service with all participating departments may apply for a service retirement annuity by filing an application for retirement with the Executive Director. The application may not be filed more than one calendar month before the date the member wishes to retire and must designate a desired retirement date, which may not precede the date of filing or the date of first eligibility to retire. The effective date of a member's retirement is the first day of the calendar month after the later of the following:

(1) the date on which a member turns 55 years of age;

(2) the date of termination of service with the department; or

(3) the date on which the pension system receives an application that meets the requirements of this subsection from a member.

(c) The local board of trustees shall hold a hearing on an application for service retirement within 15 days of the date of notice by the Executive Director of the filing of the application. If the local board of trustees does not hold a hearing on or before the 16th day after the date the local board receives the claim, the executive director may determine the merits of the claim. [If the local board of trustees does not hold a hearing on or before 32 days following the date that the Executive Director provides notice, the application will be deemed approved by the local board and benefit payments may commence.]

(d) A monthly service retirement annuity is payable for the period beginning on the effective date of retirement through the month in which the retiree dies but is not payable for any month for which the retiree was eligible to retire but did not. Amounts payable for periods following the effective date of retirement but prior to the commencement of benefit payments will be paid in a lump sum with the first benefit payment.

(e) A service retirement annuity is payable in equal monthly installments.

(f) Except as otherwise provided by this section, the full service retirement monthly annuity is equal to six times the governing body's average monthly Part One contribution as described in Rule §310.6 during the retiring member's term of qualified service.

(g) For credited qualified service in excess of 15 years, a retiring member is entitled to receive an additional 6.2 percent of the annuity compounded annually and adjusted for months of credited qualified service that constitute less than a year.

(h) Notwithstanding subsection (g) of this section, a person who had more than 15 years of qualified service as of December 31, 2006, is entitled to a service retirement annuity computed as the greater of the amount that existed on that date or the amount computed under the formula in effect on the date the person terminates service with all participating departments.

The agency certifies that legal counsel has reviewed the proposal and found it to be within the state agency's legal authority to adopt.

Filed with the Office of the Secretary of State on September 12, 2017.

TRD-201703615

Kevin Deiters

Executive Director

Texas Emergency Services Retirement System

Earliest possible date of adoption: October 29, 2017

For further information, please call: (512) 936-3372


CHAPTER 310. ADMINISTRATION OF THE TEXAS EMERGENCY SERVICES RETIREMENT SYSTEM

34 TAC §310.12

The State Board of Trustees (Board) of the Texas Emergency Services Retirement System (System) proposes new §310.12 concerning Access to Information about Members, Annuitants, and Beneficiaries.

The Board is proposing a new rule that establishes specific requirements that the System and local pension boards must meet before individuals are provided access to confidential information. The rule will require the System to develop a security policy (Policy) that outlines appropriate security management practices and controls, including the assurance that appropriate steps are taken by the System and local pension boards to protect confidential information from unauthorized access.

The new rule will require each local pension board to review the Policy each year and to implement processes to protect confidential information. The new rule also establishes a process for local pension boards to follow when designating authorized users and requires each authorized user to submit a confidentiality agreement with the System before the Executive Director may authorize access to confidential information.

Kevin Deiters, Executive Director, has determined that for each year of the first five-year period that the rule is in effect the public benefit is enhanced security of confidential information.

The adopted rule will not affect small businesses or individuals. Administration of new §310.12 does not have foreseeable implications related to the cost or revenues of state or local governments.

Comments on the new rule must be submitted in writing to Kevin Deiters, Executive Director, Texas Emergency Services Retirement System, P.O. Box 12577, Austin, Texas 78711-2577, submitted electronically to outreach@tesrs.texas.gov, submitted electronically on the System's website www.tesrs.texas.gov, or faxed to (512) 936-3480 no later than October 30th, 2017.

The new §310.12 is proposed under the statutory authority of Title 8, Texas Government Code, Subsection H, Texas Emergency Services Retirement System, §865.019, regarding Confidentiality of Information about Members, Annuitants, and Beneficiaries.

No other statutes, articles, or codes are affected by this proposal.

§310.12.Access to Information about Members, Annuitants, and Beneficiaries.

(a) The Executive Director shall develop a pension system security policy to protect member information, including electronic data.

(b) The local board annually shall review the pension system security policy and implement processes which protect member information, including electronic data.

(c) At a meeting of the local board, the local board shall designate primary and secondary users who are approved by the local board to have access to the participating department's information in the pension system's online database. Using forms provided by the pension system and certified by signature of the local board chair, the local board shall report to the Executive Director the required information for each of the local board's approved users. At a meeting of the local board no later than January 31st of each calendar year, the local board shall designate and approve the primary and secondary users and report user information to the Executive Director in the manner prescribed by the Executive Director.

(d) The Executive Director shall authorize access to the pension system's online database only to users who complete a confidentiality agreement.

(e) Authorized users' confidentiality agreements under this section remain in effect until January 31st of each calendar year or until the local board chair provides the Executive Director a written revocation of an authorized user's local board approval to maintain member records through access to the pension system's online database.

(f) If an authorized user's local board approval is revoked, the local board shall fill the vacancy for the remainder of the calendar year by the procedure in which the user was originally approved.

(g) All user access to the pension system's online database is subject to the Executive Director's approval and may be terminated at any time.

The agency certifies that legal counsel has reviewed the proposal and found it to be within the state agency's legal authority to adopt.

Filed with the Office of the Secretary of State on September 12, 2017.

TRD-201703616

Kevin Deiters

Executive Director

Texas Emergency Services Retirement System

Earliest possible date of adoption: October 29, 2017

For further information, please call: (512) 936-3372