Texas Supreme Court: Margin Tax Apportionment Rule Invalid

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.

 

Background

Under the Texas franchise tax, apportionment is the method by which a taxpayer determines how much of its taxable margin is taxable to Texas, as opposed to other states.  The Texas franchise tax statutes provide that a taxpayer calculates how much of its taxable margin is apportioned to Texas by multiplying its taxable margin by a fraction called the apportionment factor.  The numerator of the fraction is the taxpayer’s gross receipts from business done in Texas, while the denominator of the fraction is the taxpayer’s gross receipts from business done everywhere.

The Texas Tax Code provides a special rule for determining the amount of receipts from the sale of capital assets and investments that a taxpayer should include in its gross receipts from Texas franchise tax apportionment purposes.  Texas Tax Code section 171.105 states, “[i]f a taxable entity sells an investment or capital asset, the taxable entity’s gross receipts from its entire business for taxable margin includes only the net gain from the sale.”  On the same topic, Texas Comptroller Rule 3.591(e)(2) states that generally:

net gains and losses from sales of investments and capital assets must be added to determine the total gross receipts from such transactions. If both Texas and out-of-state sales have occurred, then a separate calculation of net gains and losses on Texas sales must be made. If the combination of net gains and losses results in a net loss, the taxable entity should net the loss against other receipts, but not below zero.

In this case, the taxpayer, Hallmark Marketing Co., LLC, had a net loss from its sales of investments and capital assets.  When calculating its gross receipts for Texas franchise tax apportionment purposes, it treated the amount of gross receipts from sales of investments and capital assets as zero, and did not subtract the net loss from its other gross receipts.  The Texas Comptroller took the position, based on its rule, that the taxpayer should have subtracted the net loss from its gross receipts.  This would have resulted in a larger Texas franchise tax liability for the taxpayer.  The trial court and the Third Court of Appeals agreed with the Texas Comptroller.  The Third Court of Appeals reasoned that the Texas Comptroller’s rule controlled the outcome because the term “net gain” in the underlying statute was ambiguous.

The Texas Supreme Court’s Opinion and Its Implications

The Texas Supreme Court held that the Texas Comptroller’s rule was invalid because it contradicted the plain, unambiguous language of the underlying statute.  The Court found that the tern “net gains” was unambiguous.  The Court wrote, “… the answer is obvious and easy: No.  However net gain is calculated, a statutory net gain cannot simultaneously be a net loss . . .  Accountants might dispute how to properly offset losses against gains and whether the correct calculation should result in a positive or negative figure, but none can dispute that if the end result is a positive number, it’s a net gain, and if it’s a negative number, it’s a net loss.”

For taxpayers with net losses from the sale of investments and capital assets, the opinion has obvious implications of reversing the Texas Comptroller’s long-time interpretation of the law.  If they have not already done so, these taxpayers may wish to seek the advice of a Texas tax professional, such as a Texas tax attorney, to determine whether they should file Texas franchise tax refund claims.

While the Texas Supreme Court’s opinion may not have immediate implications for other taxpayers, it demonstrates the Court’s continuing focus on giving control to the plain language of tax statutes, regardless of the Texas Comptroller’s policy positions.  With other high-profile Texas franchise tax and Texas sales tax cases pending before the Texas Supreme Court, it remains to see whether the Texas Supreme Court’s taxpayer-friendly focus on plain statutory language will continue.

 

 


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