At root of the issue is a change by the comptroller to levying the sales taxes at the point of purchase rather than the point of sale — dramatically altering the areas in which taxes for online purchases are paid.
The U.S. Supreme Court’s ruling in South Dakota v. Wayfair opened the door for states to tax internet transactions at the place of purchase, even if the business has no physical footprint in that state. It introduced a new windfall of sales taxes for states to collect.
In 2020, Comptroller Glenn Hegar introduced an amendment to administrative Rule §3.334, moving the point of taxation from where the business operates to where the buyer lives.
The state collects sales taxes on purchases and each month remits portions of those taxes to localities who rely heavily on those remittances to shore up their budgets.
Hegar’s reasoning is that the old rule took sales tax payments out of the communities in which they’re spent and ushered them to an entirely different part of the state.
“Wherever you thought that money was going, I’ll bet you never imagined that your taxes were being shipped off to another community to fix their potholes, lower their property taxes or even provide a rebate of the local tax dollars you’ve paid back to a single business in a community far away,” Hegar said in a February 2020 note.
In short, the taxes paid by a Fairfield man purchasing a carburetor from a San Antonio company would be remitted back to San Antonio rather than the community in which it was bought.
“This loophole doesn’t represent truth in taxation. Instead, it’s the worst possible combination for taxpayers: You’re still paying the tax, but you’re getting no benefit,” Hegar added. “And your roads will still have potholes that need to be fixed.”
Six cities — Carrollton, Coppell, DeSoto, Farmers Branch, Humble, and Round Rock — sued the state to halt the rule’s implementation. The change was supposed to go into effect on October 1, 2021, but has since been delayed due to the lawsuit.
The cities invoked a “sovereign immunity” provision within Texas Local Government Code Sec. 2001.038, which reads, “The validity or applicability of a rule…may be determined [by a court] if it is alleged that the rule or its threatened application interferes with or impairs, or threatens to interfere with or impair, a legal right or privilege of the plaintiff.”
They allege that the rule would impede their “right…to receive local sales tax revenue” and that the comptroller overstepped his bounds. If the rule were implemented, the cities would not lose the ability to receive sales tax remittances. Rather, they’d lose out on some of the remittances they’re currently collecting from online sales outside their boundaries by businesses within their lines.
The localities have various Chapter 380 agreements in place with companies, some of which itemize a portion of municipal sales tax collections to the locality and the company. The foremost example in this case is Round Rock’s deal with tech manufacturer Dell, which began in 1993 and runs through 2053. Within the deal, Round Rock receives a majority of the sales tax revenues collected from Dell through the 1 percent sales tax.
Chapter 380 agreements can be quite flexible in their terms, so not every one must be structured like Round Rock’s deal with Dell.
Round Rock says the deal brings in $30 million or more every year, funding to which the locality has become accustomed. Dell benefits too, as it receives its own remittances from the collections — amounting to roughly a third of what the city brings in each year.
“This type of sweeping change should be effectuated only by state law carefully considered and passed by the Legislature, not by an abstruse agency rule,” the plaintiffs state in their filing. “Such a change will especially harm municipalities such as Round Rock by drastically reducing the amount of sales tax revenue that they receive.”
Round Rock specifically stated that it needs those remittances to pay off the debt it borrowed to build support infrastructure for Dell and other large businesses. Should the comptroller’s rule become effective, Round Rock’s Chapter 380 agreement would still be in effect through the rest of its lifetime.
The state rebuked the plaintiffs’ assertions, stating that the definition of a “place of business of the retailer” may encompass the physical location of the computer on which a purchase is made.
“It was not ‘completely unreasonable’…for the Comptroller to conclude that an automated mechanical device (a computer), that could be located anywhere and maintained by anyone, was not the equivalent of an ‘established outlet, office or location operated by the retailer,’ so as to qualify as a ‘place of business,’ under the Tax Code,” the state maintained.
Just as the Wayfair decision kickstarted the idea that a website was representative of the physical store of the seller, the comptroller’s rule aimed to reflect that. In a world where brick and mortar storefronts are no longer the only game in town, the state attests, taxation needs tweaking to compensate for the new point of contact between retailer and consumer: the internet.
After a trial back in June, Judge Karin Crump of the 250th District Court ruled this month that the comptroller “failed to substantially comply with one or more of the procedural requirements” in code necessary for rulemaking.
The state’s case is not lost, as it may refile the rule and satisfy the rulemaking issues the judge identified. But state law requires the state provide at least 30 days’ notice of an impending rule before adopting it, after which there is a 20-day waiting period before the rule becomes effective.
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Brad Johnson is a senior reporter for The Texan and an Ohio native who graduated from the University of Cincinnati in 2017. He is an avid sports fan who most enjoys watching his favorite teams continue their title drought throughout his cognizant lifetime. In his free time, you may find Brad quoting Monty Python productions and trying to calculate the airspeed velocity of an unladen swallow.