The Supreme Court of Texas reversed the Texas Court of Appeals decision in a closely watched franchise tax case regarding apportionment of service receipts. In its March 25, 2022, decision in Sirius XM v. Hegar, the court agreed with Sirius’ method of sourcing its subscription revenue based on the locations from which it produced programming, comparing the relative costs of those activities in Texas and elsewhere.
The significance of the case lies in the huge mix of taxpayers that rely on the apportionment sourcing provisions for services, according to Danielle Ahlrich, a partner at law firm Reed Smith. “What is interesting is that in many ways most taxpayers have already been sourcing services in accordance with the way Sirius does,” she said. “It’s questionable as to why the comptroller is introducing new steps that are not in the statute.”
The case concerns the sourcing of receipts from satellite radio subscriptions for Texas franchise tax apportionment purposes. Sirius broadcasts more than 150 satellite radio channels, over 70% of which run original content that it produces. Sirius conducts the vast majority of its operations outside of Texas.
“The company’s headquarters, transmission equipment, and production studios are almost exclusively outside of Texas, and its satellites are in outer space,” Ahlrich said. “Only one channel, Willie’s Place, is produced in Texas.”
The state comptroller determined that Sirius should have sourced its subscription receipts using the location of its subscribers, since, to determine whether a service is performed in the state, the taxpayer must look to the location of its “receipt-producing, end-product act.” According to the comptroller, Sirius’ relevant act was decrypting the satellite radio signal for paying customers, which happened at the customer’s location.
The Texas Supreme Court disagreed.
“The court determined that a service is performed in Texas if the labor for the benefit of another is done in the state,” Ahlrich said. “According to the court, given the statute’s focus on the location of where the service is performed — not received — the most natural reading of ‘service performed in this state’ supports locating the performance of the service at the place where the taxpayer’s personnel or equipment is physically doing useful work for the customer.”
The state district court, which the Court of Appeals reversed, found that Sirius performed its services almost exclusively outside Texas. It apportioned to Texas only 0.47% and 0.26% of Sirus’ total receipts from the two years in question, whereas the comptroller would have apportioned 8.3% and 8.36%, respectively.
The State Supreme Court disagreed with the comptroller’s characterization of Sirius’ service as “decryption,” since “it elevates the technicalities of the transaction over the economic reality of the service performed.”
“Moreover,” the court said, “the decryption service — even if it mattered — is performed outside of Texas, at the point of transmission.”
The Texas Supreme Court concluded that the Court of Appeals decision “apportioning to Texas all of Sirius’ receipts from Texas subscribers must be reversed” and remanded the case to consider the appropriateness of Sirius’ apportionment calculation. “Remand is necessary because, now that the Texas Supreme Court has correctly characterized Sirus’ service and identified the correct sourcing test, the Court of Appeals must review the sufficiency of Sirius’ fair-value allocation evidence,” said Ahlrich.
“Whether the decision will prevent further litigation regarding the sourcing of service receipts is unclear,” she said. “Members of the comptroller’s office previously cautioned taxpayers against wishing for a taxpayer victory in Sirius XM, warning it would likely lead to battles concerning fair-value allocation. Considering that the opinion does not address the fair-value allocation step in the calculation, taxpayers may not yet be out of the apportionment woods.”
