The Texas Supreme Court on April 3 ruled that American Multi-Cinema, Inc. (AMC) could not include exhibition costs in its Texas cost of goods sold (COGS) subtraction.
One qualification for a COGS subtraction is that the good is ‘sold.’ The Court viewed this qualification as requiring a ‘transfer’ of property. The Court found that no tangible personal property is transferred through AMC’s film exhibitions and, therefore, the exhibitions were not ‘goods’ under the COGS subtraction.
The appellate court’s initial decision found that film exhibition involved tangible personal property. A subsequent rehearing and the Texas Supreme Court’s decision ruled on the matter on different grounds.
The appellate court’s initial decision that film exhibition qualified as tangible personal property had the potential to impact the applicability of the COGS subtraction to traditional service providers that may engage in the transfer of goods that are perceptible to the senses. Additionally, a similar analysis could have impacted Texas sales and use tax requirements (i.e., taxability and exemptions) for service providers as both the sales tax and franchise tax have the same statutory definition of tangible personal property.
The appellate court on rehearing decided the case on the more narrowly applicable Film Prong definition of tangible personal property. However, the court expressly passed on resolving whether AMC’s film exhibition also qualifies as ‘tangible personal property,’ under the Perceptibility Prong, which left open whether the analysis in the court’s original decision could be applied to other taxpayers.
The Texas Supreme Court based its decision on a foundational issue that neither the trial nor the appellate court separately addressed. That is, whether the good at issue was ‘sold.’ The Court determined that ‘sold’ means ‘transferred’ and that ‘exhibitions’ do not constitute a transfer of tangible personal property. The Court, however, did address that those entities producing content for mass distribution in some form of medium still may qualify for the cost of goods sold deduction as long as those goods are ‘transferred’ or sold in a manner consistent with other tangible personal property rather than as a service.
The Court’s decision also may have an impact on businesses where services and tangible personal property are provided for within a single transaction. Based on the Court's ruling, the cost of goods sold deduction may include only those allowable costs associated with goods transferred or sold unless otherwise provided for by statute. Taxpayers may find the Court's reasoning instructive in determining whether a good was sold or whether a service was provided (i.e., whether tangible personal property was transferred).