Texas Third Court of Appeals Finds that Exhibiting Movies and Other Content Produces a Good for Franchise Tax Purposes

DALLAS, May 11, 2015 /PRNewswire/ -- On April 30, 2015, in American Multi-Cinema, Inc. ("AMC") v. Glenn Hegar, the Texas Third Court of Appeals ("Appellate Court") found that 1) AMC's exhibited movies constitute tangible personal property (TPP), not intangible property; and 2) the costs of producing the exhibited movies are not isolated to the screen and speakers but include the entire production area in the auditorium.  

One of the allowed subtractions in computing franchise tax is the cost of goods sold (COGS). Tax Code section 171.1012(a)(1) defines "goods" as TPP sold in the ordinary course of business. Subsection (a)(3)(A)(i) defines TPP as "personal property that can be seen, weighed, measured, felt, or touched or that is perceptible to the senses in any other manner." The Appellate Court determined that the evidence presented to the trial court was legally sufficient to support its findings of fact and that the trial court's conclusion of law was correct in that AMC's exhibition of movies produces goods for sale in the ordinary course of business. 

The Appellate Court was not persuaded by the Texas Comptroller of Public Accounts ("Comptroller") that AMC's customers were purchasing an intangible (license) or a service, and disagreed that the Franchise Tax Code imposed a "take-home" requirement for TPP. It relied on the plain and common meaning of those words: 1) intangible - incorporeal property often evidenced by documents, such as stocks, bonds, or judgments having no intrinsic value; and 2) services - the performance of work commanded or paid for by another that does not produce a tangible commodity. The statute, to the contrary, provides that TPP includes film, sound recordings, live and prerecorded TV, and radio programs "without regard to the means or methods of distribution or the medium in which the property is embodied." Though not relied upon, the Legislature in 2013 specifically spelled out that COGS for a movie theater shall include "the acquisition, production, exhibition, or use of a film or motion picture. Because the exhibited movies are TPP, the Appellate Court ruled that AMC was entitled to include in COGS its requested movie exhibition costs. 

The franchise tax (in Tax Code section 171.1012) and sales and use tax (in Tax Code section 151.009) statutes contain the same definition of TPP: "personal property that can be seen, weighed, measured, felt, or touched or that is perceptible to the senses in any other manner." However, the Appellate Court did not hold that anything perceptible to the senses is TPP regardless of whether the purchaser takes possession or title of the item because those criteria are not part of the franchise tax. The Appellate Court found that what AMC sells is TPP because what it sells is perceptible to the senses. It only addressed the provisions that are actually in Chapter 171, related to the franchise tax. Those are, whether AMC sold TPP, which specifically excludes intangible property and services. Selling the performance of work is a service, even if you can see the person or hear the person while they are working or see the result of their work. Thus, an entity does not sell the sight, sound, or smell of a freshly cut lawn, it sells the performance of cutting the lawn. Conversely, selling the sight and sounds of a movie is TPP, not the selling of an intangible or the performance of a service. The Appellate Court properly distinguished between the two. 

Chapter 151 covering the sales and use tax applies a slightly different twist to taxing transactions. All sales of TPP are taxable, but only sales of specifically enumerated services are taxable. The mechanism for applying the tax is through Tax Code section 151.005, which defines a "sale," to include "a transfer of title or possession of tangible personal property" and "the performance of a taxable service…." Thus, for sales and use tax purposes, title or possession of the TPP is relevant. But, if the transaction is for the performance of a service, it will still be taxed, or not taxed, as a service even after the Appellate Court's ruling. This is the case even if some TPP is provided by the service provider as a part of providing the service. The essence of a mixed transaction has been the subject of many sales and use tax cases involving portable toilets, scaffolding, limousine services, pay phones, etc. The same criteria applied to those sales and use tax cases will continue to apply. 

Under the sales and use tax, the primary exemption is the manufacturing exemption relating to items used in the production of TPP for sale. The Appellate Court's franchise tax ruling still has no sales and use tax impact because the exemption is only allowed when the produced item is subject to tax as the sale of TPP. See GTE Southwest, Inc. v. Combs, 2010 Tex. App. LEXIS 4223 (Tex. App.-Austin 2010, pet. denied). The Comptroller argued and the court agreed that in the context of the sales tax statute, the phrase "tangible personal property for ultimate sale" denotes a sale that is taxed as the sale of TPP. 

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