Energy Companies and Multi-State Nexus Audits: Why Texas Leads the Charge

Energy companies operating in Texas and other states may be subject to the taxing authority of each state in which they operate. This is true whether they have a physical presence in the state or they have economic nexus with the state based on their in-state sales. For energy companies that have not complied with their state tax obligations, facing a nexus audit can pose substantial risks. Facing a multi-state nexus audit poses even greater risks still.

Texas’ Role in Multi-State Tax Enforcement

A multi-state nexus audit is a coordinated effort to assess a company’s state tax liability. Within the energy industry, Texas is leading the charge in these efforts. Texas is a member of the Multi-State Tax Commission (MTC), and the MTC has established a National Nexus Program in order to:

“[E]ncourage and facilitate compliance with nexus laws by those engaged in interstate commerce; cooperation among states regarding development and enforcement of nexus law; education of taxpayers and state staff about nexus; and fair and consistent enforcement of nexus law.”

With no state income tax, Texas has a particular interest in sales tax enforcement. With energy companies being among the state’s most important sources of revenue, the Texas Comptroller’s Office prioritizes state income tax (and related tax) enforcement within the energy industry. This includes conducting Texas sales tax audits and facilitating multi-state nexus audits targeting Texas-based companies, as well as conducting nexus audits targeting out-of-state equipment suppliers and other businesses.

Preparing for Your Company to Face State Tax-Related Scrutiny

For energy companies that operate in Texas and other states, the prospect of a multi-state nexus audit warrants careful consideration and preparation. To help minimize their risk of facing liability for back taxes, interest, and penalties, these energy companies should:

Conduct a Multi-State Nexus Assessment

Energy companies need to ensure that they have a clear and comprehensive understanding of their state tax compliance obligations. This involves conducting a multi-state nexus assessment. Companies should engage legal counsel to examine the nexus rules in each state where they conduct business (whether through physical presence or remotely), and then work with their counsel to assess whether compliance is required.

In Texas, energy companies can face state tax compliance obligations based on both physical nexus and economic nexus. Physical nexus is established by a physical presence in the state (with even minor physical connections being sufficient to establish nexus in many cases), while economic nexus is established by conducting a sufficient volume of in-state sales. Many other states have similar laws, though the specific thresholds for establishing nexus vary from state to state.

Conduct a Multi-State Tax Compliance Assessment

After identifying the states in which they have nexus, energy companies should conduct a multi-state tax compliance assessment. This assessment should also be conducted at the direction and with the oversight of legal counsel. If the assessment reveals any outstanding state tax compliance deficiencies, working with legal counsel will help ensure that these revelations are protected by the attorney-client privilege.

Develop and Implement Multi-State Compliance Policies and Procedures as Necessary

Any deficiencies uncovered during these assessments should be addressed in updates to the company’s multi-state compliance policies and procedures. If the company does not have multi-state compliance policies and procedures, these will need to be developed and implemented promptly. Not only is having comprehensive compliance documentation necessary for maintaining compliance on an ongoing basis, but in the event of a multi-state nexus audit, being able to demonstrate adherence to a comprehensive set of policies and procedures can be essential for avoiding unwarranted liability.

Maintain Thorough Documentation of Multi-State Tax Compliance

In addition to maintaining comprehensive multi-state compliance policies and procedures, energy companies should thoroughly document their compliance efforts on an ongoing basis. Depending on a company’s compliance obligations, the nature of its operations, and various other factors, this may include maintaining documentation of:

• Sales tax collected from purchasers and remitted to the appropriate state tax authorities;
• The total volume of a company’s sales to customers in a particular state;
• Sales tax paid to equipment suppliers and other vendors;
• Sales tax paid directly to state tax authorities when no tax was collected at the time of sale; and/or,
• The tax-exempt nature of a company’s products or services.

This is just a small sampling. When facing a multi-state nexus audit, having comprehensive documentation of compliance on hand can facilitate an efficient and favorable resolution. Conversely, if an energy company is not prepared to affirmatively demonstrate compliance when required, it can lead to further scrutiny and additional liability that could have been avoided.

Develop Procedures for Responding to a Multi-State Nexus Audit

In light of the high risk of facing scrutiny from the Texas Comptroller’s Office and other state tax authorities, energy companies should also develop procedures for responding to a multi-state nexus audit. Energy company executives should anticipate scrutiny and plan accordingly. Among other things, ensuring that appropriate personnel communicate with state auditors and that all requests for access or documentation are appropriately scrutinized are key to avoiding mistakes that could lead to unnecessary adverse outcomes.

Monitor for Changes in the Law and the Company’s State Tax Compliance Obligations

Finally, in addition to establishing and maintaining compliance with current state tax requirements, energy companies should monitor changes in the law. Energy companies must also monitor internal changes (e.g., increases in sales in a particular state) that may trigger additional compliance obligations. By taking this proactive approach, energy companies can both mitigate their risk of making mistakes and their risk of facing heightened scrutiny.

Learn More from the Texas State Tax Attorneys at Brown PC

If you need to know more about the risks of a multi-state nexus audit or what your company can (and should) do to mitigate its state tax-related risks, we invite you to get in touch. To request an appointment with a Texas state tax attorney at Brown PC, please call 888-870-0025 or contact us online today.