Another Taxpayer Win in Texas Margin Tax Case

The Third Court of Appeals’ recent opinion in Titan Transportation v. Combs is another big win for taxpayers under the revised Texas franchise tax (also known as the Texas margin tax).  In opinion, the Third Court of Appeals rejected the Texas Comptroller’s narrow, restrictive interpretation of the revenue exclusion for certain payments to those who perform work on real property in favor of the taxpayer’s more expansive view.

The opinion, the court’s second under the Texas margin tax, comes on the heels of another big taxpayer win under the Texas margin tax in Combs v. Newpark Resources, which I wrote about previously.  From these two opinions, it seems clear that the Third Court of Appeals is taking a thoughtful look at the Texas Comptroller’s interpretations of Texas franchise tax law, and will reject them if they do not comport with the Texas Tax Code.

I discuss the details of its opinion and its implications below.


To determine the amount of its taxable margin, the base on which Texas imposes the Texas margin tax, a taxpayer must first calculate its total revenue.  The taxpayer does this by adding up certain items of income from lines on its federal income tax return stated in the statute.  The Texas franchise tax statutes then allow the taxpayer to reduce its total revenue by the amount of certain “revenue exclusions” listed in the statute.  The taxpayer then generally chooses one of the available types of deductions to subtract from its total revenue, including cost of goods sold or compensation.  The taxpayer then applies the apportionment rules to this amount to determine its taxable margin.  Thus, any reduction in the taxpayer’s total revenue, such as by an increase in the amount of a revenue exclusion, ultimately reduces the amount of Texas margin tax a taxpayer owes.

One of these available revenue exclusions is commonly known as the real property revenue exclusion.  During the years at issue in the Titan Transportation case, this provision allowed taxpayers to exclude from total revenue “flow-through funds that are mandated by contract to be distributed to other entities” that are “subcontracting payments handled by the taxable entity to provide services, labor, or materials in connection with the actual or proposed design, construction, remodeling, or repair of improvements on real property or the location of the boundaries of real property.”  Note that in the past legislative session, the Texas Legislature amended this provision to change the word “contract” to “contract or subcontract,” a fact the Third Court of Appeals seemed to find relevant in its opinion.

The taxpayer, Titan Transportation, is in the business of hauling, delivering, and depositing “aggregate,” a building material that is a combination of rock or gravel and dirt, sand, or “fines,” which is dirt that comes off crushed rock (Note that The Seay Law Firm does not represent Titan Transportation and had no involvement with this case).  Titan pays subcontractors to perform these services, and its contracts with its subcontractors require it to pay the subcontractors a portion of the payment it receives for these services.  The Third Court of Appeals noted in its opinion that in the last legislative session, the Texas Legislature added a revenue exclusion to the Texas franchise tax statutes for taxpayers “primarily engaged in the business of transporting aggregates” that allows those taxpayers to exclude from total revenue subcontracting payments they make to independent contractors for delivering aggregate on their behalf.

The Opinion

The Third Court of Appeals found that Titan Transportation qualified to exclude its payments to its subcontractors from its total revenue under the real property revenue exclusion.  In doing so, it rejected all three main reasons the Texas Comptroller provided for denying the exclusion.  The Comptroller argued that Titan Transportation did not qualify for the revenue exclusion because (1) it was not a construction company; (2) it did not have a written contract with its customers that stated that a portion of the customer’s payment would go to the subcontractors; and (3) the payments its customers made were not segregated in a manner to ensure that a subcontractor would only receive the actual dollars the customer paid to it for the subcontractor’s work.  The Third Court of Appeals rejected all of these arguments because they imposed requirements in addition to those found in the Texas franchise tax statutes and altered those statutes’ plain meaning.

First, the Third Court of Appeals found that language of the Texas Tax Code and the Comptroller’s rules did not limit the application of the real property revenue exclusion to construction companies.  Instead, the court found that the revenue exclusion applies to payments for any services with a reasonable relationship to the construction activities listed in the revenue exclusion statute.  Thus, the court found that Titan Transportation qualified for the exclusion because its services were directly related to the construction of real property improvements.

Second, the Third Court of Appeals found that it is not necessary for a taxpayer to have a contract with its customer that mandated the payments to subcontractors in order for the taxpayer to exclude those payments under the real property revenue exclusion.  The court noted that the evident purpose of the revenue exclusion was to avoid double taxation of amount that don’t constitute true income to the taxpayer, and the contract with the subcontractors alone satisfied this purpose.

Finally, the Third Court of Appeals found that it is not necessary for taxpayers to segregate funds it uses to pay subcontractors in order to qualify for the real property revenue exclusion.  It found that Titan Transportation had sufficient accounting procedures to ensure that it paid its subcontractors from its gross receipts from the services they performed.  The court noted that finding otherwise would improperly ignore the economic realities of Titan Transportation’s business.


In general, this opinion, if it becomes final, is a huge asset to taxpayers subject to the Texas margin tax, as it establishes that the courts will reject the Texas Comptroller’s interpretations of the Texas franchise tax statute if they impose requirements in excess of those stated in the statute, and the courts will consider whether those requirements cause double taxation and ignore the economic realities of a taxpayer’s business.  However, it is likely that the Texas Comptroller will appeal this decision to the Texas Supreme Court, so this decision will not be final until the conclusion of that appeal.

Practically speaking, more taxpayers who use contract labor and provide services related to real property construction may be able to take the real property revenue exclusion for their payments to subcontractors.  Taxpayers who previously adopted the Texas Comptroller’s narrower positions, either on their own, as a result of a Texas franchise tax audit, or as a result of guidance from the Texas Comptroller, should consider whether they may be able to file Texas franchise tax refund claims.  Taxpayers should consult with a Texas tax professional, such as a Texas tax attorney, to determine whether they have potential Texas franchise tax refund claims as a result of this decision.



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