The Texas Supreme Court issued an opinion today in Hallmark Marketing Co., LLC v. Hegar. The opinion invalidated a Texas Comptroller rule regarding apportionment under the Texas franchise tax (also known as the Texas margin tax). The rule required taxpayers to reduce net gains from sales of capital assets and investments by the amount of net losses from sales of capital assets and investments when calculating the taxpayer’s gross receipts for margin tax apportionment purposes. The Texas Supreme Court found that the rule contradicted the plain language of the Texas franchise tax apportionment statute. The statute requires taxpayers to include “net gains” from such sales in their gross receipts for Texas franchise tax apportionment purposes. We discuss the opinion and its implications for the Texas franchise tax and Texas taxpayers in general below.
Court of Appeals Rules No Three-Factor Apportionment, Texas Franchise Tax Is Not an Income Tax
The Texas Third Court of Appeals issued its opinion yesterday in Graphic Packaging Corp. v. Hegar, No. 03-14-00197-CV. It ruled that taxpayers may not choose to use the Multistate Tax Compact’s three-factor apportionment method to apportion their taxable margin under the Texas franchise tax. In doing so, the Third Court of Appeals held that the Texas franchise tax is not an “income tax,” as defined by the Multistate Tax Compact. We discuss the decision and its implications for Texas taxpayers in further detail below.
Texas Legislative Recap for State and Local Taxes 2015
While the 2015 Texas Legislature gave taxpayers a significant franchise tax (margin tax) rate cut and repealed some smaller taxes (some of which had not been collected in years), it otherwise left much of the Texas tax code otherwise unchanged. In this Texas legislative recap, we’ll tell you about the changes the Texas Legislature made and provide links to the underlying bills.
The big tax cut. The franchise tax rate for most taxpayers is reduced from one percent to 0.75 percent. The franchise tax rate for retailers and wholesalers is reduced from 0.5 percent to 0.375 percent. The franchise tax rate for taxpayers using the E-Z Computation is reduced from 0.575 percent to 0.331 percent, and taxpayers with no more than $20 million in total revenue may pay using the E-Z Computation. Previously, only taxpayers with no more than $10 million in total revenue could pay using the E-Z Computation. (HB 32)
Repealed…
- $200 professional fee for attorneys, CPAs, and certain other professionals. (HB 7)
- Tax on alcoholic beverages served on trains and planes. (HB 1905)
- Controlled substances tax. (HB 1905)
- Crude petroleum production tax. (SB 757)
- Sulfur production tax. (SB 757)
- Excise tax on fireworks. (SB 761)
- Inheritance tax. (SB 752)
Supreme Court rules in state tax case
The United States Supreme Court recently decided Direct Marketing Association v. Brohl, a state tax case. In it, the Supreme Court ruled that a challenge in federal court to Colorado’s so-called “Amazon law” could go forward, contrary to Colorado’s argument that the Tax Injunction Act barred the suit. In perhaps a more interesting development for Texas tax law, Justice Anthony Kennedy filed a concurring opinion in which he urged the Supreme Court to overrule its prior decisions that bar states from requiring retailers with no physical presence in a state to collect that state’s sales tax from their customers in that state. We discuss both the Supreme Court’s decision and Justice Kennedy’s concurrence in further detail below.
Judge Finds Texas School Finance System Unconstitutional
A Travis County District Court judge ruled Thursday that Texas’s school finance system violates the Texas Constitution. The judgment and associated findings of fact and conclusions of law are available here. Review of the decision will go directly to the Texas Supreme Court. The judge wrote that his ruling would not be implemented until July 1, 2015 to give the Texas Legislature time to cure the constitutional defects in the 2015 legislative session.
The judge ruled that Texas’s school finance system is unconstitutional for several reasons. First, the judge found that the Texas school finance system effectively imposes a state property tax, in violation of the provision of the Texas Constitution that prohibits a state property tax. This is because the nature of the Texas school finance system gives local school districts no meaningful discretion over how local property taxes are raised, assessed, or spent. The judge also ruled that the amount of funding the Texas school finance system provides is not enough to provide an adequate education for all Texans and accomplish a “general diffusion of knowledge,” as the Texas Constitution requires. Further, the judge found that the Texas school finance system violates the Texas Constitution because it fails to provide equal opportunity between children who live in poor districts and children who live in rich districts.
The ruling has raised speculation about exactly what the Texas Legislature will do in the upcoming session to cure these constitutional defects (assuming the Texas Supreme Court does not overrule it). The last time the courts found that the Texas school finance system violated the Texas Constitution, the Texas Legislature enacted the revised Texas franchise tax (the Texas margin tax) as part of a stated effort to raise additional funding for Texas schools. Based on the current state of the Texas budget and the educational needs of Texas children, a similarly large tax increase or tax overhaul may be necessary to cure these constitutional impacts.
We will post additional updates on this case and any changes the Texas Legislature makes to the Texas tax laws on this blog.
Appeals Court Finds New Tax on Small Tobacco Manufacturers Unconstitutional
The Third Court of Appeals recently held in Combs v. Texas Small Tobacco Coalition that a new tax on small tobacco manufacturers violates the Equal and Uniform Taxation Clause of the Texas Constitution. In doing so, the Third Court upheld a trial court decision from late last year invalidating the tax. The opinion highlights the circumstances under which a tax violates the Equal and Uniform Taxation Clause as well as clarifying when organizations such as trade associations may sue on behalf of their members in tax cases.
Background on the Small Tobacco Tax and the Lawsuit
The Texas Legislature passed the tax on small tobacco manufacturers during the last legislative session in House Bill 3536. The bill levies a 2.75 cent tax on each cigarette produced by certain small tobacco manufacturers if the cigarettes are used, sold, or distributed in Texas. The tax applies only to tobacco manufacturers who did not enter into a 1998 lawsuit settlement with the State of Texas.
Third Court of Appeals Defers to Comptroller on Manufacturing Exemption for Oil & Gas
As we reported earlier, the Third Court of Appeals ruled in Southwest Royalties, Inc. v. Combs that oil and gas above-ground and downhole production equipment doesn’t qualify for the Texas sales tax manufacturing exemption. This case has drawn a fair amount of attention due to the large potential financial impact on the State of Texas should the taxpayers ultimately prevail — after a trial court judge initially stated after an oral hearing that he was inclined to side with the taxpayers, the Texas Comptroller announced her estimate that a taxpayer win could cost Texas as much as $4.4 billion in tax refunds and lost revenue. After another hearing, that trial court judge sided with the Texas Comptroller in his written opinion. The Third Court of Appeals affirmed that decision. This blog post discusses that Third Court of Appeals opinion and its potential implications in more detail.
Note that this opinion isn’t the end of the road for Southwest Royalties. They may still file a Petition for Review with the Texas Supreme Court, and during a presentation at the Texas Society of CPAs’ State Tax Conference, an attorney for Southwest Royalties indicated that Southwest Royalties would be filing a Petition for Review. The deadline for Southwest Royalties to file that Petition for Review is Monday, September 29, 2014, unless Southwest Royalties files a Motion for Rehearing (due August 28, 2014), in which case Southwest Royalties would have until 45 days after the Third Court of Appeals rules on that Motion for Rehearing to file a Petition for Review with the Texas Supreme Court.
Texas Supreme Court Won’t Weigh in on Prepayment Requirement for Court Access
Today, the Texas Supreme Court denied the Texas Comptroller’s Petition for Review in the Richmont Aviation case. As a result, the Third Court of Appeals’ decision in the taxpayer’s favor becomes final, but the Texas Supreme Court has taken no position on the Third Court of Appeals’ holding in Richmont Aviation, leaving some uncertainty in the law regarding the question of whether a taxpayer may file suit in Travis County District Court challenging the assessment or collection of a tax without first paying the tax or filing a bond.
The Texas Tax Code prohibits a taxpayer from challenging the assessment or collection of a tax in court without paying the tax first or filing a bond unless the taxpayer files an oath of inability to pay and a judge finds that the prepayment requirement would constitute an unreasonable restraint on that taxpayer’s access to the courts. However, in 2000 in the Bandag Licensing Corp. case, the Third Court of Appeals held that this prepayment requirement violated the Open Courts provision of the Texas Constitution and invalidated the associated statutory provision. The Third Court of Appeals wrote the oath of inability to pay provision was not a sufficient protection for taxpayers and that the prepayment requirement was an unreasonable financial barrier to access to the courts.
Nevertheless, the Texas Comptroller has maintained the position that the statutory provision remains valid despite the Bandag Licensing Corp. decision and has aggressively opposed the efforts of taxpayers to challenge assessments and collection action in court without paying the associated tax first. In recent years, the Texas Comptroller has asserted that certain language in the Texas Supreme Court’s 2012 decision in In re Nestle, a case that addressed the constitutionality of the Texas franchise tax, overruled Bandag Licensing Corp. (though the Texas Supreme Court did not mention Bandang Licensing Corp. by name and addressed the statutory provision only in passing).
In Richmont Aviation, the Third Court of Appeals reasserted its holding in Bandag Licensing Corp. and held once again that the prepayment requirement was an unreasonable financial barrier to access to the courts. It rejected the argument that the Texas Supreme Court overruled Bandag Licensing Corp. in In re Nestle.
The Texas Supreme Court’s silence leaves some doubt in its wake. It is unclear whether now, after its petition for review was denied, the Texas Comptroller will continue to refuse to follow the Third Court of Appeals’ decisions in Bandag Licensing Corp. and Richmont Aviation. Nevertheless, now that Richmont Aviation is final, taxpayers appear to have strong support for the position that they may file suits for injunction or declaratory judgment challenging the assessment or collection of tax without prepaying the tax first. A taxpayer considering such a lawsuit would be well advised to seek the assistance of a Texas tax attorney to determine which type of suit, if any, would be appropriate for their circumstances.
Court of Appeals Denies Texas Sales Tax Exemption for Oil and Gas Equipment
The Texas Third Court of Appeals just issued its opinion in Southwest Royalties, Inc. v. Combs, No. 03-12-00511-CV. The opinion affirms a district court opinion denying oil and gas operators the Texas sales tax manufacturing exemption on their purchases of certain above-ground and downhole production equipment. The opinion also provides some useful discussion of the circumstances under which the Texas Comptroller’s statutory interpretations should be accorded deference. We will soon post a longer blog entry discussing this opinion and its implications for Texas taxpayers in more detail in our Texas tax law blog.
Texas Judge Rules Auto Repair Labor Costs Includible in Cost of Goods Sold for Texas Franchise Tax Purposes
A Travis County District Court judge ruled on July 22, 2014 in Autohaus LP, LLP v. Combs that an auto dealer could include labor costs to install new and replacement auto parts in its cost of goods sold for Texas franchise tax purposes. In doing so, the judge held that the Comptroller rule defining the word “production” for cost of goods sold purposes was invalid. This case is a big win for taxpayers that, if it becomes final, could allow many taxpayers to include labor costs in cost of goods sold that the Texas Comptroller previously denied. We discuss the ruling and its potential impact in further detail below.
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