In a controversial move, the Texas Comptroller is poised to amend Rule 3.330, Data Processing Services, effectively rewriting the rules to favor the contentious stance it has adopted in recent audits and litigation. This proposed amendment, which aims to cement the aggressive stance the Comptroller has taken in audits and litigation that a marketplace provider’s commission-based earnings are taxable “data processing services,” represents a significant departure from long-standing practices and highlights a disturbing trend of what is effectively a retroactive regulatory adjustment.
A LOOK AT THE PROPOSED CHANGES
The crux of the proposed amendment is the addition of paragraph (b)(5) to Rule 3.330, which the Comptroller explains is being added “to clarify that marketplace providers provide data processing services to their customers as they enter, retrieve, search, manipulate, and store data or information in the course of their business.” New paragraph (b)(5) provides that:
Marketplace provider services may be included in taxable data processing services when they involve the computerized entry, retrieval, search, compilation, manipulation, or storage of data or information provided by the purchaser or the purchaser’s designee. For example, services to store product listings and photographs, maintain records of transactions, and to compile analytics are taxable data processing services.
This new paragraph specifically targets the commissions that marketplace providers charge for facilitating sales, taxing them separately from the underlying transactions themselves. This is not just an expansion of the tax base; it’s a redefinition of what constitutes a taxable service, applying it in ways that were never intended under previous interpretations of the law that considered such commissions nontaxable auctioneer/brokerage fees.
WHY THIS AMENDMENT IS PROBLEMATIC
The Comptroller’s approach is problematic for several reasons, including:
- Effective Retroactivity. The proposed amendment seeks to justify an aggressive (and questionable) agency position that the Comptroller has only recently begun to assert in audits and litigation after it quietly revoked a long-standing administrative ruling in 2020. The revocation of this ruling in 2020, without public notice or legislative approval, was a stark deviation from established practices. By changing the rules after the fact, the proposed amendment undermines the stability and predictability of the law.
- Double Taxation. If a marketplace facilitates a sale where a consumer pays $100 and the marketplace earns a $30 commission, the proposed amendment would not only tax the $100 transaction but also the $30 commission. This results in an effective tax on 130% of marketplace sales, with the additional 30% a double tax on the portion of the sales proceeds paid to the marketplace provider as a commission. Under this scheme, the Comptroller is demanding that marketplace providers pay tax on 130% of the sales price and charge the consumer for tax on the 100% and the seller for the 30%.
- Discriminatory Tax Under ITFA. The proposed amendment subjects commissions earned by online marketplace providers to taxation as data processing services while similar services provided offline, such as commissions earned by auctioneers of oil and gas leases, consignment stores, and real estate agents using computers, remain untaxed. This disparate treatment violates the Internet Tax Freedom Act (ITFA), which prohibits discrimination against electronic commerce by ensuring that online transactions are not taxed more heavily than their offline equivalents.
CONCLUSION
The proposed amendment rewrites the definition of data processing services subject to tax in Texas, normally something one would expect the legislature to do. The proposed amendment also purports to supersede decisions from the Supreme Court of Texas detailing how the true object test applies to sales of such services and changes the focus from the buyer’s perspective to that of the seller.
Texas should be encouraging innovation and entrepreneurship, especially in the digital commerce space, rather than retroactively penalizing it with ill-considered tax policies. The Comptroller’s move to amend Rule 3.330 in a way that supports questionable audit positions is not only unfair but also undermines the principles of equitable and predictable tax regulation.
The good news for some is that Texas is still making marketplace providers a go-forward offer they can’t refuse. If you are in this situation and need advice on navigating this new and complex Texas discussion, please reach out to the authors of this article.
Written comments on the proposed amendment must be submitted to the Comptroller by October 13, 2024.
