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.
In 1996, the State of Texas sued the Big Four tobacco manufacturers – Phillip Morris, R.J. Reynolds, Brown & Williamson, and Lorillard – alleging that the Big Four engaged in misleading practices. The state and the Big Four settled the lawsuit. As a result of the settlement, the Big Four agreed to change their advertising practices and pay billions of dollars to the State of Texas. The settlement specified a payment plan which required the Big Four to pay over half a billion dollars each year to the State of Texas. Smaller tobacco manufacturers, who were not parties to the lawsuit, do not have to make these settlement payments. Only tobacco manufacturers who were not parties to the lawsuit and settlement are subject to the new tax.
The Texas Small Tobacco Coalition is a trade association made up of small tobacco manufacturers, distributors, and retailers, most of whom were formed after 1998. The Coalition sued on behalf of its members for declaratory and injunctive relief from the tax, arguing that it violated the Equal and Uniform Taxation Clause of the Texas Constitution as well as the Equal Protection and Due Process clauses of the United States Constitution
The Third Court of Appeals found that the small tobacco tax violated the Equal and Uniform Taxation clause of the Texas Constitution. The Third Court of Appeals wrote that while Texas law allows the State of Texas to make reasonable distinctions among taxpayers, the distinction between settling companies and non-settling companies was not reasonable and therefore unconstitutional. The Third Court stated that both the taxed and untaxed tobacco companies made identical products, and that imposing a tax on only one class of identical products violated the Equal and Uniform Taxation Clause. It found none of the policy goals, such as equalizing market share or using the tax funds for public health purposes, were reasonable, and also noted that the terms of the settlement that the big tobacco companies entered into was in many ways more favorable than the tax on the small tobacco companies.
The Third Court of Appeals also found that the Texas Small Tobacco Coalition could sue on behalf of its members, despite the Comptroller’s argument that Texas law only allowed the taxed members to sue individually. The Comptroller argued that the Texas Tax Code only allows taxpayers to challenge the assessment or collection of a tax in court after first paying the tax and the statute only allows them to do this individually. However, the Third Court of Appeals reiterated its holding from prior cases such as Bandag Licensing Corp. and Richmont Aviation that the statute that creates the prepayment requirement and prevents taxpayers from seeking a declaratory judgment against the assessment or collection of a tax violates the Texas Constitution’s open courts provision. Further, the Third Court found nothing in Texas law that prevented a trade association from seeking a declaratory judgment on behalf of its members in a tax case.
While the tax on small tobacco manufacturers at issue in this case affects only a small number of taxpayers, the case may have wider implications. Texas courts rarely find that taxes violate the Equal and Uniform Taxation clause of the Texas Constitution, but this case shows that prevailing on such a suit is still possible and sets out circumstances under which a taxpayer could prevail. Further, the case helps taxpayers generally by once again reaffirming that the prepayment requirement and prohibition on declaratory judgment actions challenging the assessment and collection of taxes is unconstitutional as far as the Third Court of Appeals is concerned, and also confirms that trade associations may sue on behalf of their members, which is helpful in spreading the burdens of litigation over more taxpayers, making it easier for taxpayers to challenge taxes that they believe affect their industries incorrectly or unfairly.
The case is not yet final, as the Comptroller may still file a Petition for Review with the Texas Supreme Court. So far, the Comptroller has not, but we will post an update on this blog if the Comptroller does. In the meantime, taxpayers should examine the opinion carefully and consider whether to consult a Texas tax professional, such as a Texas tax lawyer, to see if it may be necessary to file protective refund claims.