New Ruling Addresses COGS Deduction for Labor Costs

A Travis County District Court judge held that an auto dealer may include direct labor costs under Texas Administrative Code Rule 3.588(c)(8) in its cost of goods sold (COGS) for Texas franchise tax purposes. Consequently, this decision may enable other taxable entities to recalculate their COGS deduction and consider filing a refund claim.

Summary

On July 22, 2014, a Travis County District Court judge ruled in Autohaus LP, LLP v. Combs that the franchise tax COGS deduction applied to all labor costs associated with an auto dealer’s business of installing parts in vehicles. The issue in this case was the Texas Tax Code, which included a broad definition of costs incurred from acquiring or producing goods that the taxable entity sells, and the Comptroller’s Rule, which narrowly tailored the definition of “production” for cost of goods sold purposes. The Comptroller’s position stated that only “installation occurring during the manufacturing or construction process” qualified for the COGS deduction. However, the judge disagreed with the Comptroller’s Rule and cited the Texas Code that defines “production” to include construction, installation, manufacturing, development, mining, extraction, improvement, creation, rising or growth.

What is the impact of this decision?

This decision has significant ramifications for many taxpayers in the installation business. The judge’s inclusion of other industries means it can also impact taxpayers beyond the auto repair industry. Even if this ruling is challenged, affected taxpayers should consider filing protective refund claims for the previous four tax years.

If you have questions about this case and how it may apply to your clients or business(es), contact us.