Texas Sales Tax Audits: Lessons for Digital Services

Misstating the Documentation Standard: “Contemporaneous” vs. “Sufficient”

The Comptroller relied on 34 Tex. Admin. Code § 1.26(a), asserting the taxpayer must provide “contemporaneous” records to support its position.

But that standard is no longer valid. In May 2025, Tax Code § 111.0041 was amended, replacing “contemporaneous” with “sufficient.”

This matters because:

• “Contemporaneous” means the records must have existed at the time of the transaction
• “Sufficient” means taxpayers can provide any documentation—even summaries or reconstructions—that adequately proves the claim

The decision applies the wrong legal test, effectively imposing a higher evidentiary burden than the current statute requires.

Treating All Website Services as Taxable Data Processing

The decision asserts website design, development, hosting, and maintenance are taxable data processing services. That is not what Texas law says.

Under Rule 3.330(b)(12):

• Website services are taxable only when they involve data storage, data manipulation, compilation, or data entry
• Planning and blueprint-style work—including design mockups, UX/UI plans, or architectural layouts—is not taxable

By treating every web-related activity as taxable, the Comptroller collapses a critical distinction between planning/consulting work and true data processing.

For businesses that buy or sell digital services, this distinction affects whether a transaction is taxable, partially taxable, or exempt.

Incorrect Application of Multistate Benefit Rules

The decision also applies outdated multistate benefit rules when discussing allocation of use outside Texas. The ruling cites a requirement that a taxpayer must show the service was used by an “identifiable segment” of its business to qualify for multistate use relief.

That requirement no longer exists. Under the updated Rule 3.330(g) (effective April 2, 2025—but applied in audits before that date):

• A data processing service performed in Texas but used both inside and outside Texas is taxable only to the Texas portion
• A purchaser may use any reasonable, consistent method, supported by business records, to allocate multistate use
• A valid multistate use certificate shifts responsibility for reporting use tax to the purchaser

In short, the Comptroller applied an eliminated standard, creating a burden that the current rule does not impose.

Burden Placed on Taxpayer to Verify Exemption Certificates

An exemption certificate protects the seller from sales tax liability if three conditions are met:

• The seller receives the certificate in good faith from the buyer
• The certificate clearly shows a valid reason for the exemption
• The seller does not actually know the exemption claim is wrong

Here, the taxpayer provided exemption certificates after the audit began. Certificates obtained after the auditor starts work are subject to verification by the auditor, not the taxpayer. If certificates aren’t on hand during the audit, they must be provided within 60 days of written notice; after that, they’re invalid. The decision wrongly shifted the burden to the taxpayer instead of requiring auditor verification as Texas law requires.

Document Using the Current Standard (“Sufficient,” Not “Contemporaneous”)

Maintain documentation that clearly describes:

• What was delivered
• Whether the work involved data storage or manipulation
• Where the service was used (for multistate allocations)

“Sufficient” documentation gives companies flexibility—but only if they prepare it proactively.

Distinguish Taxable Data Processing from Nontaxable Planning/Consulting

On contracts and invoices, separate phases such as:

• Initial design, discovery, UX/UI planning, wireframing (nontaxable)
• SaaS or hosting fees (potentially taxable)
• Data migration, processing, or maintenance involving data storage/manipulation (taxable)

Clear descriptions reduce misclassification during audits.

Apply the Updated Multistate Use Rule

If services are used across multiple states:

• Use a reasonable allocation method supported by business records
• Provide a Multistate Benefit Exemption Certificate when applicable
• Ensure vendors understand when they can rely on the certificate

This helps avoid being taxed on 100% of the service when only a portion relates to Texas.

Collect Exemption Certificates Upfront

The case reinforces a long-standing rule: retroactive cleanup rarely satisfies the Comptroller. Obtaining certificates at the time of sale is the best protection.

Train Project Managers and Billing Teams

Teams need to understand:

• Which services are taxable and why
• What documentation matters
• How to describe services accurately in statements of work and invoices

These decisions made early in a project often determine audit outcomes years later.