Two recent Texas court opinions address apportionment under the Texas franchise tax, also known as the Texas margin tax. Apportionment is the method by which a taxpayer determines how much of its income (or, in Texas, taxable margin) is taxable to a particular state as opposed to other states.
The Texas Supreme Court decided one of these cases. That case, Lockheed Martin Corporation v. Hegar, et al., found Lockheed Martin’s receipts from the sale of fighter jets to foreign governments, with the U.S. government acting as an intermediary due to the requirements of federal law, were apportionable to the locations of the foreign buyers and not to the Texas location where Lockheed Martin delivered the jets to the federal government.
The Third Court of Appeals decided the other case. That case, Hegar, et al. v. Sirius XM Radio, Inc., determined that Sirius XM should apportion its satellite radio subscription receipts based on the locations of its subscribers and not the locations where it created the satellite radio content.
We discuss these opinions and their broader implications for Texas taxpayers in further detail below.
Lockheed Martin
Under Texas tax law, a taxpayer must apportion the receipts from sales of tangible personal property to Texas if the property is delivered or shipped to a buyer in Texas. (Note that while this case arose under the prior version of the Texas franchise tax, not the Texas margin tax, the apportionment rules remain generally the same under the Texas margin tax). The Texas Supreme Court found that the fighter jets at issue were not delivered or shipped to a buyer in Texas, even though the federal government took delivery of them in Texas, because the federal government was not the buyer of the jets.
The Comptroller argued that the transaction was the same as a standard sale-for-resale transaction — the government purchased the jets, took delivery of them in Texas, and resold them to the foreign governments. The Texas Supreme Court disagreed. It noted that the jets never entered the government’s inventory, that the government was prohibited by law from bearing profit or loss on the sales, the foreign governments specify what they want to buy and pay for the items before the federal government approaches a contractor to make them, and the jets are custom made to the foreign government’s specifications. Thus, according to the Texas Supreme Court, the federal government only acted as an intermediary due to the requirements of federal defense law, and was not itself a buyer.
While the Texas Supreme Court took great care to differentiate this transaction from standard sale-for-resale transactions, it remains to be seen whether this opinion will remain limited to this special defense law context, or if it may extend to other types of transactions involving intermediaries. Taxpayers who act as intermediaries or use intermediaries in their sales may wish to examine this opinion carefully and seek the advice of a Texas tax professional, such as a Texas tax attorney, to determine whether this opinion will affect their Texas franchise tax calculations in the future.
Sirius XM
Texas tax law provides that a taxpayer must apportion services to the location where the services are performed. Here, the parties disagreed about what service Sirius XM performed and, therefore, where Sirius XM performed the service. Sirius XM argued that the service it provided was creating satellite radio content, which it largely did at studios outside Texas. However, the Third Court of Appeals took the Texas Comptroller’s position that the service Sirius XM provided was that of unscrambling the radio signal, which occurred at the radio receiver, and that its satellite radio receipts should therefore be apportioned to the locations of its subscribers. The Third Court of Appeals stated that this is the service the subscribers purchased according to their contracts with Sirius XM, as each subscription was tied to one receiver and access to Sirius XM programming was limited to satellite-enabled radios in which the radio receiver unscrambled and decoded the Sirius XM signal.
The Third Court of Appeals distinguished this decision from its earlier decision in Westcott Communications. The Westcott case involved a company that provided training services to companies via closed circuit television. Westcott produced and transmitted the content from Texas to out-of-state customers. The Westcott court found that Westcott’s receipts from this activity should be apportioned to Texas, where it created and transmitted the content, and not to its customers locations. The Westcott court noted that Westcott was not like a cable television provider that simply provided a broadcast signal, but instead it provided training programs that it developed for its specific customers to their specifications. In distinguishing Sirius XM from Westcott, the Third Court of Appeals noted that Sirius XM did not provide customized content to its subscribers, but instead provided the ability for its subscribers to receive generalized content through their satellite radios.
In Sirius XM, the Third Court of Appeals arguably narrowed its prior Westcott holding. This has implications not just for broadcasters of various sorts, but also for other providers of remote services. Note that this decision is not yet final, as the taxpayer may file a petition for review with the Texas Supreme Court. Nevertheless, taxpayers should examine this opinion carefully and, if necessary, consult a Texas tax professional, such as a Texas tax attorney, to be certain of their Texas tax obligations.
