Not Much Deference to the Comptroller From the Courts These Days

Over the last few weeks, Texas courts haven’t been giving much deference to the Texas Comptroller—at least, not to her administrative rules. Two courts have determined that certain Comptroller rules are unnecessary at best, and invalid at worse. One of those courts was the Texas Supreme Court.

The Roark Case and the Texas Sales Tax Sale-For-Resale Exemption: Courts Need No Help Determining What “Integral” Means

Image for Roark Texas Sales Tax CaseIn Combs v. Roark Amusement & Vending, L.P., the Texas Supreme Court determined that “the Comptroller cannot through rulemaking impose taxes that are not due under the Tax Code.” The Roark case is near and dear to my heart, and I’ll write more about it later. The case involves crane machines—those machines you often see in arcades and grocery stores. A person inserts coins into the machine for the pleasure of controlling the crane’s arm for a brief period of time. The goal is to use the crane to retrieve a toy from inside the machine. In Roark, the taxpayer is the company that owns those machines. Roark paid sales tax when it purchased all the prizes. It now requests a refund. Roark argues that the toys are exempt from sales tax because Roark transferred the toys as an integral part of its taxable amusement service. (A major question here is whether the amusement service that Roark provides is actually a “taxable service;” that’s a matter to be addressed in a later post.) Without toys in the machine, there would be no reason to operate the crane. There would be no amusement. Therefore, the Court determines, the toys are integral to the amusement service.

For many years, the Comptroller has had a rule on the books pertaining to the sale-for-resale exemption and carnival-style games. This Rule (3.301(b)) announces a fairly bright-line test. If every person playing a game receives a prize, the game owner may purchase prizes tax free for resale. But if a prize does not transfer every time a customer plays a game, the Comptroller considers the game owner to be the consumer of the item. The resale exemption does not apply, and the owner must pay tax on the prizes.

However, in Roark, the Texas Supreme Court has determined that taxpayers do not have to follow the Comptroller’s instructions in this rule: “The question of statutory construction presented in this case ultimately is one left to the courts.” The Court likely ruled this way because it determined that the sections of the Tax Code that provide the sale-for-resale exemption are unambiguous.  “When a statute’s words are unambiguous and yield but one interpretation, ‘the judge’s inquiry is at an end.’” The Court didn’t expressly invalidate the Comptroller’s Rule, but the Court believed that the rule either conflicted with the statute or was wholly unnecessary.

The Winstead case and the Texas Franchise Tax Compensation Deduction: the Court Needs No Help Determining What a “Benefit” is

image for Winstead texas franchise tax caseSlightly over a month before the Texas Supreme Court issued its Roark Decision, a Travis County District Court Judge filed a letter announcing a strikingly similar decision for a completely different area of Texas tax law. The case is Winstead, PC v. Combs, and the tax is the Texas franchise tax, also known as the Texas margin tax.

Like many large law and accounting firms in Texas, Winstead, P.C. used the “compensation deduction” to compute its franchise tax. Winstead paid various expenses for its employees: parking expenses, attorney occupation taxes, and continuing education expenses. The Tax Code (section 171.1013) states that the compensation deduction may include “the cost of all benefits, to the extent deductible for federal income tax purposes” that a taxpayer provides to its eligible employees. The statute provides no definition for “benefits.” Winstead included the parking expenses, taxes, and education expenses in its compensation deduction because the costs were deductible for federal tax purposes.

The Comptroller disagreed with Winstead. The Comptroller has published a rule (Rule 3.589(e)(2)) that states that the term “benefits” does not include “working condition amounts provided so employees can perform their jobs.”  The Comptroller’s position is that Winstead paid the  parking expenses, attorney occupation taxes, and continuing education expenses  so its employees could do their jobs.  Therefore the costs are not “benefits” and should not be in the compensation deduction.

On February 7, Judge Naranjo issued a letter stating that the relevant portion of section 171.1013 of the Tax Code is unambiguous. A “benefit-related cost” is deductible if it is deductible for federal tax purposes. The Comptroller’s Rule “improperly narrows the application of the statute and violates the plain language of the applicable section.” The Judge hasn’t issued a final judgment yet, and expressly stated that the statements quoted above should not be considered conclusions of law, but the judge appears ready to declare the rule invalid.

Since February 7, the Comptroller has argued that although the court does not have jurisdiction to declare the rule invalid—instead, it should just order the Comptroller to return the taxes that Winstead paid in protest. The Comptroller is understandably concerned about the judge’s potential ruling, because if the rule falls, many service companies around the state will be filing refund claims. Winstead argues that it’s now a bit late for the state to be making arguments about the court’s jurisdiction, and in any event, the court has jurisdiction to declare the rule invalid. The court will likely decide in the next few weeks.


Both cases illustrate a point easy for practitioners to overlook. While the Comptroller’s Rules are supposed to make our lives easier by interpreting the statute and removing ambiguities, the Rules are not always correct. When a statute is unambiguous, It is the statute—not the rules—that control. Therefore the Tax Code is always the best place to start when analyzing a Texas tax problem. The Tax Code is available on the Texas Legislature’s website.

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