Texas allows cost-of-performance data for sourcing service receipts


On Nov. 10, 2022, the Texas Court of Appeals ruled that a taxpayer engaged in satellite radio production and distribution could use cost-of-performance data to source its service revenue for Texas franchise tax apportionment purposes.1 The Court of Appeals’ decision followed a remand from the Texas Supreme Court, which held earlier this year that the taxpayer’s subscription receipts should be sourced based on the location where the radio programming was produced rather than the location where the taxpayer’s subscribers received the radio signal.2






The taxpayer, Sirius XM Radio (“Sirius”), is a producer and distributor of radio programs using satellites. Sirius subscribers pay a monthly fee to access radio programming. Sirius has over 150 radio channels, the majority of which are produced by Sirius in studios located in New York City and Washington D.C., with one show broadcast from Texas for a period of time. The taxpayer’s content is transmitted to its satellites launched from Kazakhstan via uplink facilities in New Jersey, Washington, D.C., and the state of Georgia. Once the signals are sent back to earth from the satellites, they are sent either directly to the radio or to repeaters (used in densely populated areas), at least some of which are located in Texas. The satellites are controlled from facilities in Panama, Ecuador, and the state of Georgia. Once the signal reaches a customer’s radio, it is decrypted, which allows the customer to listen to the programming.


At issue in Sirius was the proper sourcing of the taxpayer’s receipts from these satellite radio subscriptions. The taxpayer initially sourced its revenue based on the locations where it produced its programming and on the relative costs of those activities in Texas and elsewhere. On audit, the Texas Comptroller of Public Accounts determined that the taxpayer should apportion its receipts based on the location of its subscribers, not based on the location where its programs are produced. The Comptroller reached this conclusion based on its position that services should be apportioned to the state in which the receipt-producing, end-product act takes place.


The taxpayer paid the assessed tax under protest and brought suit for a refund. A Texas district court held for the taxpayer, finding that Sirius performed most of its services outside Texas and ordering a refund of over $2 million for the 2010 and 2011 tax years.2 The Comptroller appealed this decision. 




Original Texas Court of Appeals’ decision 


The Texas Court of Appeals reversed the district court’s decision and agreed with the Comptroller that a service is performed in Texas if the “receipt-producing, end-product act” takes place in the state based on the language in the Texas apportionment statute.4 This statute provides in relevant part that “the gross receipts of a taxable entity from its business done in this state is the sum of the taxable entity’s receipts from . . . each service performed in this state.”5 The Comptroller argued, and the Court of Appeals agreed, that since the radios decrypted the signal at the location of the end user, the act of decrypting the radios was a service performed at the location of the end-user. Receipts, therefore, were sourced to Texas if the radio, or subscriber, was located in the state. Sirius appealed this decision to the Texas Supreme Court.




Texas Supreme Court’s decision 


In reversing the Texas Court of Appeals, the Texas Supreme Court held that the receipts should be sourced to the state where the radio programming is produced.6 The Supreme Court noted that the “receipt producing, end-product act” test as originally employed by the Comptroller in an administrative ruling served only to distinguish between the “support services” that enable a taxpayer to do business and the “receipt-producing” services for which a customer actually pays, and that it was used to determine what the service is, but not where it should be sourced. Having determined that the relevant act was the process of producing and distributing content, the court concluded that the “receipt producing, end-product act” test was not well-founded in prior case law. Rather, the court provided that a service is performed in Texas if the useful labor for the benefit of another is done in the state. When technology rather than personnel performs the useful act, taxpayers should look to the location of that equipment.7 The court agreed with Sirius that its receipt of subscription fees should be sourced to the location where Sirius produces its programming and not to the location of the subscribers’ radios. The court remanded the case to the Texas Court of Appeals to determine the fair value of Sirius’ services that are performed in the state.




Texas Court of Appeals affirms use of cost-of-performance data


On remand, the Texas Court of Appeals held that the evidence was sufficient to support the district court’s original conclusion that Sirius’ use of cost-of-performance data to source its service receipts to Texas for the 2010 and 2011 tax years was reasonable. A former regulation that applied to the tax years at issue provided that receipts from the sale of services “are apportioned to the location where the service is performed.”8 When services are performed in multiple states, the receipts from those services are apportioned as Texas receipts based on the “fair value of the services that are rendered in Texas.”9 Thus, the apportionment factor for services equals the fair value of services performed in Texas divided by the fair value of services performed everywhere. The dispute on remand to the Texas Court of Appeals concerned the methodology used by Sirius to apportion the fair value of its services performed in Texas. 


Sirius presented expert testimony to the district court that used cost data to determine the fair value of services in Texas during the 2010 and 2011 tax years. Due to the nature of the services provided by Sirius, the expert did not include expenses for general support functions but relied on value-producing activities such as content production and transmission. The only production and broadcasting service costs associated with Texas was one radio program that transmitted from a truck stop for four hours each day and was operated by one employee. Using this method, the portion of fair value of the services Sirius performed in Texas was 0.47% and 0.26% for the 2010 and 2011 tax years, respectively. The district court determined this approach was a credible method for determining fair value and adopted these percentages. 


The Comptroller argued on remand that the evidence presented by Sirius to establish fair value was legally insufficient to support the district court’s judgment for two reasons: (i) as a matter of law, a taxpayer cannot rely on cost-of-performance data to apportion the fair value of its services; and (ii) in the alternative, Sirius failed to “meet its burden of proving the costs that represent the fair value of services performed in Texas.”


Cost-of-performance data established fair value


The Court of Appeals rejected the Comptroller’s argument that the cost-of-performance data was legally insufficient to support the district court’s finding on the fair value of the services that Sirius performed in Texas. In reaching its decision, the Court of Appeals noted that the phrase “fair value” is not defined in the Comptroller’s regulations and does not appear in any Texas Tax Code provisions describing apportionment or discussing “business done in this state” or “each service performed in this state.” Based on dictionary definitions and the plain meaning of the terms, the court concluded that “fair value,” as used in the former apportionment regulation, means the “monetary worth of the services at issue, based on an objectively reasonable assessment.”


The Comptroller did not offer an alternative interpretation of “fair value” other than the plain meaning of the term in the former regulation but argued that the term should not be interpreted to mean “cost of performance.” According to the Comptroller, “cost of performance” was a term used in the Uniform Division of Income for Tax Purposes Act when the former regulation was adopted in 2007, and the Comptroller intentionally used “fair value” to indicate something other than “cost of performance.” In rejecting this argument, the court noted that “[a]lthough the terms may have different meanings, nothing in the plain language of the Rule dictates a specific method for calculating fair value or excludes cost of performance as a reasonable means of assessing fair value for purposes of apportionment.” The court also noted that the Comptroller has indicated that cost of performance is an appropriate method for calculating fair value of services in certain circumstances.10 The court concluded that determining the relative fair value of services by using cost-of-performance data is not plainly erroneous or inconsistent with the language of the former regulation or Texas Tax Code.


District court’s judgment of fair value upheld


The Court of Appeals also rejected the Comptroller’s alternative argument that the cost-of-performance data presented by Sirius was insufficient to support the district court’s judgment. Sirius successfully argued that the Comptroller did not preserve this challenge for appeal. The court explained that to preserve a complaint that expert testimony is legally insufficient because the offered basis is unreliable, an objection must be made to the trial court. The Comptroller argued that the expert testimony presented at the trial court on cost of performance did not have probative value because the expert failed to include certain costs and should have excluded other costs. For example, the Comptroller alleged that the expert should have included the performance royalties it paid for content that it did not produce or own and the amounts spent to subsidize the installation of equipment to hear the programming in Texas. Also, the Comptroller contended that the expert should have excluded costs for research and development because they did not provide a benefit to the customer.


In rejecting the Comptroller’s argument, the court determined that the Comptroller could not raise the challenge on appeal because he failed to object to the admission of the expert testimony at trial. The Comptroller’s challenge would require an evaluation of the expert’s foundational data and underlying methodology that should have been considered by the trial court. Because the Comptroller failed to preserve this argument, the court concluded that the expert’s “testimony as to comparative cost of performance and his opinion of the fair value of Sirius XM’s services performed in Texas relative to its services performed everywhere is considered probative evidence and thus legally sufficient to support the district court’s judgment.”  






The ongoing Sirius apportionment litigation has received considerable attention in the tax community due to the importance of conclusively determining how service revenue should be sourced for purposes of the Texas franchise tax. The genesis of the dispute lies in the statutory and regulatory language requiring the sourcing of service revenue according to the location where the service has been performed, on the basis of fair value of such services. In 2020, the Texas Court of Appeals created some controversy in Sirius by allowing the Comptroller to apply a market-based sourcing methodology, in contrast to the historic perception that the use of cost-of-performance principles to source service revenue were appropriate. The Texas Supreme Court’s decision in Sirius earlier this year rejected the Comptroller’s use of market-based sourcing and applied an origin-based methodology using a cost-of-performance standard. 


On remand, the Texas Court of Appeals clarified the determination of fair value for purposes of sourcing service receipts under the former apportionment regulation by allowing the use of cost-of-performance data. However, the court did not closely examine the items that were included or excluded from the cost-of-performance calculation because the Comptroller did not properly preserve this argument for appeal. Therefore, this decision does not provide complete clarity regarding the substantive cost-of-performance calculation to be made. Given that the Court of Appeals did not explain exactly which costs should or should not be considered, and in light of this case’s history, it would not be surprising if the Comptroller again appeals this case to the Texas Supreme Court. At the very least, taxpayers should expect that the Comptroller will place higher emphasis on the costs included in the calculation of cost of performance prospectively.


Despite the extensive Sirius litigation, there is still uncertainty regarding the sourcing of service revenue in Texas, in part based on the Comptroller’s response to the Texas courts’ varying decisions. Following the Texas Court of Appeals’ original decision in 2020, the Comptroller issued updated regulations regarding the sourcing of service receipts effective Jan. 24, 2021, stating that “a service is performed at the location of the receipts-producing, end-product act or acts.”11 That regulation adds that “[if] there is a receipts-producing, end-product act, the location of other acts will not be considered even if they are essential to the performance of the receipts-producing acts.”12 In addition, the regulation addresses “fair value” by concluding that the “cost of performing a service does not necessarily represent its value,” and that if costs are considered, only direct (and not overhead) costs should be considered.


The more recent decisions by the Texas Supreme Court and the Texas Court of Appeals restoring the cost-of-performance test, clarifying the definition of “fair value,” and rejecting the receipt-producing, end-product act test will require the Comptroller to revisit the regulation again. At the same time, the Sirius controversy highlights the distinctive nature of Texas’ cost-of-performance approach, leaving open the possibility that the Texas legislature could address this issue during its next legislative session, either by codifying the Sirius interpretation of the current statute, or by potentially changing the sourcing rule to a market-based approach that a majority of states now use to apportion service revenues. 


As continuing uncertainty exists with respect to this issue, taxpayers will need to closely watch what happens next — from the standpoint of the Comptroller’s future regulations, the Comptroller’s treatment of older rulings that applied different sourcing tests prior to the Sirius litigation, whether the Comptroller appeals the latest Sirius ruling, and the potential for legislative action next year when the Texas legislature meets. Taxpayers that have significant service revenue streams and are currently being audited by the Comptroller should be prepared to robustly defend how their service revenue is being sourced, while accounting for the new Sirius standards that the Comptroller may attempt to apply retroactively. In some cases, taxpayers alternatively could consider refund claims for open tax years to the extent a post-Sirius cost-of-performance / “fair value” methodology is preferable to a market-based sourcing or other historic standard that may have been applied on an original return based on the Comptroller’s regulations.



Hegar v. Sirius XM Radio, Inc., Texas Court of Appeals, Third District, Austin, No. 03-18-00573-CV, Nov. 10, 2022.
Sirius XM Radio, Inc. v. Hegar, 643 S.W.3d 402 (Tex. 2022).
3 The Comptroller also was required to pay the taxpayer’s costs.
4 604 S.W.3d 125 (Tex. App. 2020). For a detailed discussion of the Court of Appeals’ decision, see GT SALT Alert: Texas OKs in-state radio subscription sourcing.
5 Tex. Tax Code Ann. § 171.103(a).
Sirius XM Radio, Inc. v. Hegar, 643 S.W.3d 402 (Tex. 2022). For further discussion of the Supreme Court’s opinion, see GT SALT Alert: Texas court interprets service sourcing rules and Saylor Sims, Debasish Chakrabarti, Robert Gershon & Richard Jackson, Texas Supreme Court Addresses Sourcing of Electronically Delivered Services, Tax Notes State, July 4, 2022.
Id. at 407-08.
8 Former 34 Tex. Admin. Code § 3.591(e)(26).
10 Letter No. 200807139L, Texas Comptroller of Public Accounts, July 24, 2008.
11 34 Tex. Admin. Code § 3.591(e)(26).
12 Id.




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