A Travis County District Court judge ruled on July 22, 2014 in Autohaus LP, LLP v. Combs that an auto dealer could include labor costs to install new and replacement auto parts in its cost of goods sold for Texas franchise tax purposes. In doing so, the judge held that the Comptroller rule defining the word “production” for cost of goods sold purposes was invalid. This case is a big win for taxpayers that, if it becomes final, could allow many taxpayers to include labor costs in cost of goods sold that the Texas Comptroller previously denied. We discuss the ruling and its potential impact in further detail below.
One of the categories of deductions that taxpayers may elect to take under the Texas franchise tax is cost of goods sold. The Texas franchise tax cost of goods sold deduction generally includes the costs of acquiring or producing the goods the taxpayer sells. The Texas Tax Code defines “production” to include “construction, installation, manufacture, development, mining, extraction, improvement, creation, raising, or growth” (emphasis added). However, the Texas Comptroller’s rule defining production for cost of goods sold purposes states that the only “installation” that constitutes production is “installation occurring during the manufacturing or construction process.”
In this case, the taxpayer, Autohaus, is an auto dealer. As part of its business, it sold new and replacement auto parts to its customers and installed them in vehicles. The Texas Comptroller allowed Autohaus to deduct the cost of the parts themselves but not the installation labor, arguing that the labor costs didn’t qualify for inclusion in the cost of goods sold deduction under the Texas Comptroller’s rule defining production as the installation didn’t occur during a manufacturing or construction process. Autohaus argued that it should be allowed to deduct the installation labor costs because the installation was part of the production of the goods according to the statute, which by its language included “installation” generally in production. Autohaus also argued that the Texas Comptroller’s rule defining production was invalid because it improperly defined the word more narrowly than the statute did.
The Judge’s Ruling and Its Impact
The Travis County District Court Judge held that Autohaus was entitled to include all of its labor costs associated with installing the parts it sold in its cost of goods sold deduction. The judge also held that the Comptroller rule defining “production” for cost of goods sold purposes was invalid.
If the ruling stands, it will allow for the deduction of a much broader scope of installation labor costs than the Texas Comptroller has previously allowed. Therefore, taxpayers who install goods may wish to review their records to determine whether it may be necessary for them to file protective refund claims in light of this decision. A Texas tax professional, such as a Texas tax lawyer, may be able to help taxpayers make this determination and assist them in filing any necessary refund claims.
The Texas Comptroller has not stated whether this decision will be appealed. We will post an update on this blog if the Texas Comptroller appeals this decision or it becomes final.