Effective June 5, 2013, the Texas Comptroller of Public Accounts adopted an amendment to Margin Tax Rule §3.588 concerning Cost of Goods Sold (COGS). The major change deals with adding a definition of “Service costs,” which means 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. The definition of “Labor costs” is amended to memorialize the comptroller’s revised policy, which is based in part on federal income tax requirements regarding the labor expenses that may be included in a taxpayer’s COGS calculation.
Service costs means 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.
Subsection (d)(1) of Texas Rule §3.588 is amended to capture certain costs that may be included in a taxpayer COGS calculation under Texas Tax Code, Section 171.1012(c)(1), which is based in part on federal income tax requirements. Internal Revenue Code (IRC) Section 263A identifies costs that would otherwise be deductible as ordinary and necessary business expenses for federal income tax purposes but must instead be capitalized into inventory. Under IRC Section 263A, taxpayers must capitalize both direct labor and material costs and indirect costs that directly benefit, or are incurred by reason of, the performance of production activities. Many of the indirect costs that are required to be capitalized for federal purposes are specifically referenced in Texas Tax Code, Section 171.1012(c) as part of “all direct costs of acquiring or producing goods.”
Based upon this, the comptroller has concluded that Texas Tax Code, Section 171.1012(c)(1) allows taxable entities to include in their cost of goods sold calculation both direct labor costs and those indirect labor costs, other than service costs, that are subject to capitalization under the Treasury Regulations interpreting IRC, Section 263A. The proposed amendments reflect this policy determination. The comptroller is aware that many taxpayers fall under the regulations related to IRC, Section 460, rather than IRC, Section 263A. The amendments in this subsection include a reference to the federal regulations interpreting IRC Section 460, which apply the rules set forth in the relevant portions of the Section 263A Internal Revenue regulations. In addition, the amendments make clear that the expenses described in subsection (d)(1) Margin Tax Rule §3.588 are expenses of the type that are subject to capitalization under IRC Section 263A, without regard to whether a taxable entity actually capitalized those expenses on its federal return.
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