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Graphic Packaging Corp. v. Hegar

Supreme Court of Texas

December 22, 2017

Graphic Packaging Corporation, Petitioner,
v.
Glenn Hegar, Comptroller of Public Accounts of the State of Texas and Ken Paxton, Attorney General of the State of Texas, Respondents

          Argued September 13, 2017

         On Petition for Review from the Court of Appeals for the Third District of Texas

          OPINION

          John P. Devine Justice.

         A taxpayer that conducts business in multiple states must apportion its business revenue among the states in which it does business. For the Texas franchise tax, section 171.106 of the Tax Code provides for such apportionment under a single-factor formula, which compares the taxpayer's gross receipts derived from its Texas business to its gross receipts everywhere. Another provision of the Tax Code, section 141.001, adopts the Multistate Tax Compact. This Compact sets out a three-factor formula for apportioning "business income" for an "income tax" and provides that a taxpayer subject to a state income tax may elect to apportion its income "in the manner provided by the laws of such state" or may elect to apportion using the Compact's three-factor formula. Tex. Tax Code § 141.001, arts. III.1, IV.9.

         At issue here is whether the franchise tax is an "income tax" to which the Compact applies, thus invoking the Compact's election and apportionment provisions. If it is an income tax, additional issues include (1) whether Tax Code section 171.106 nevertheless precludes a taxpayer from using the Compact's three-factor formula, or (2) whether Texas' membership in the Compact prevents the Texas Legislature from requiring a taxpayer to use only the single-factor formula when apportioning its tax base to Texas.

         The court of appeals did not consider the latter two issues. 471 S.W.3d 138, 147 (Tex. App.-Austin 2015). It concluded instead that the Compact's election, and therefore its three-factor apportionment formula, did not apply because the franchise tax was not an income tax within the Compact's meaning. Id. The court accordingly affirmed the trial court's summary judgment, holding that apportionment of the Texas franchise tax is exclusively the province of chapter 171. Id. We agree and affirm.

         I. Background

         Graphic Packaging Corporation sells consumer product packaging throughout the United States, including Texas. Because Graphic does business in Texas, it must pay a franchise tax. This tax applies to every for-profit entity doing business or chartered in Texas that is distinct from its owners. In re Nestle USA, Inc., 387 S.W.3d 610, 614 (Tex. 2012). And because Graphic conducts business in multiple states it must also determine the portion of its total business that is taxable in Texas. For the Texas franchise tax, Tax Code section 171.106 provides that the taxpayer apportion its tax base (labeled in the statute as the taxpayer's "margin") to Texas by multiplying its total margin by a single factor: the fraction of its total gross receipts that are derived from its Texas business. See Tex. Tax Code § 171.006(a) (providing a gross-receipts fraction for apportioning a taxpayer's margin); see also id. §§ 171.002, .103 (describing calculation of gross receipts from taxpayer's Texas business), .105 (describing calculation of gross receipts from taxpayer's total business); and see id. §§ .101, .1011-.1013 (addressing determination of taxpayer's margin).

         For tax years 2008-2009, Graphic initially used section 171.106's gross-receipts fraction to apportion its margin.[1] Graphic later amended those franchise tax reports and calculated its 2010 tax, using the apportionment formula provided in chapter 141 of the Tax Code-Texas' codification of the Multistate Tax Compact.[2] Graphic argued that the franchise tax was essentially an income tax to which chapter 141's alternative apportionment scheme could be applied at the taxpayer's election.

         The Texas Comptroller disagreed. He denied the refunds and assessed a deficiency for 2010, concluding that section 171.106's gross-receipts fraction was the exclusive method to determine the franchise tax. Graphic subsequently paid the assessed 2010 taxes under protest after unsuccessfully pursuing administrative relief.

         After exhausting its administrative remedy, Graphic filed suit in district court, seeking $821, 961 for tax years 2008-2010 on the ground that it was entitled to apportion its margin using chapter 141's three-factor apportionment formula.[3] The parties filed cross-motions for partial summary judgment on the apportionment issue. The court granted the Comptroller's motion, denied Graphic's motion, and, after Graphic non-suited its other claims, rendered a final judgment for the Comptroller. Graphic appealed, and the court of appeals affirmed, holding that chapter 141's income-apportionment provisions do not apply to the franchise tax because it is not an "income tax." 471 S.W.3d at 147.

         II. Is the Texas franchise tax an income tax?

         Graphic argues that the franchise tax is an "income tax" because it satisfies chapter 141's definition of the term. Chapter 141 defines "income tax" as

a tax imposed on or measured by net income including any tax imposed on or measured by an amount arrived at by deducting expenses from gross income, one or more forms of which expenses are not specifically and directly related to particular transactions.

Tex. Tax Code § 141.001, art. II.4. Graphic contends that its taxable "margin" for franchise tax purposes under chapter 171 is essentially the same thing as its "net income" under chapter 141. According to Graphic, both are determined by "deducting expenses from gross income, " one or more of which "are not specifically and directly related to particular transactions." Id. And because margin and net income are synonymous, Graphic submits the court of appeals erred in denying Graphic the use of chapter 141's three-factor apportionment formula under the election provided by that chapter. Id. § 141.001, arts. III.1, IV.

         Chapter 171 specifically pertains to the franchise tax and provides several alternatives for calculating a taxpayer's margin. Tex. Tax Code §§ 171.001(a), .101. The calculation begins with "total revenue, " a figure derived by adding together select amounts reportable as gross income on a federal tax return, subtracting bad debts and other items included on the federal return, and excluding receipts associated with various transactions. Id. §§ 171.101(a), .1011. From total revenue, the taxpayer deducts the largest of: (1) 30% of total revenue, (2) $1 million, (3) the cost of goods sold, or (4) the compensation paid including benefits, subject to a cap. Id. §§ 171.101(a), .1012, .1013. The result is the taxpayer's margin. Id. § 171.101(a).

         But this calculation is not the tax base for all taxpayers. A taxpayer whose total revenue does not exceed $20 million may calculate its franchise tax using simply its total revenue. Id. § 171.1016. Although taxpayers who use total revenue as their tax base forego the alternative deductions listed above, they pay a lower rate under what the statute terms the "E-Z Computation and Rate." Id.

         For the tax years at issue, Graphic calculated its margin by subtracting the cost of goods sold from total revenue. Because those expenses included indirect costs "not specifically or directly related to a particular transaction, " Graphic concludes the franchise tax also constituted an "income tax" under chapter 141, entitling it to elect apportionment under that chapter's three-factor formula. See Tex. Tax Code § 141, arts. II.4, III.1 (providing taxpayers subject to an income tax an apportionment election); id. §§ 171.101(a), .1012 (providing a deduction for costs of goods sold among other alternatives).

         The court of appeals disagreed, concluding that the correlation between a taxpayer's margin and net income was insufficient to make the franchise tax an income tax. 471 S.W.3d at 144. In fact, the court noted the anomalous possibility that a taxpayer might have a positive margin and thus owe franchise tax even in the absence of net income. Id. at 144 & n.3. After examining the various alternatives for determining the tax base for franchise tax purposes, the court concluded that margin and net income are not the same. Id. at 144. For example, the court reasoned that a franchise tax based on "total revenue" as in the case of E-Z filers or one premised on 70% of total revenue under another alternative could not "fairly be read to mean 'net income.'" Id. The court reasoned further that subtracting a fixed amount, such as a $1 million deduction from total revenue was "not the same as 'deducting expenses from gross income.'" Id. (comparing Tex. Tax Code §171.101 and id. § 141.001, art. II.4). Similarly, the court found the cost-of-goods-sold and compensation deductions too selective and limiting to constitute the deduction of expenses from gross income. Id. And having found the existence of significant distinctions between a taxpayer's margin under chapter 171 and a taxpayer's net income under chapter 141, the court held the franchise tax was not an income tax. Id. at 147.

         The Comptroller, of course, agrees that the franchise tax is not an income tax but adds that the most direct resolution of the issue lies in an uncodified provision included in the 2006 act that restructured the franchise tax. There, the Legislature stated: "The franchise tax imposed by Chapter 171, Tax Code, as amended by this Act, is not an income tax and Pub. L. No. 86-272 does not apply to the tax." Act of May 2, 2006, 79th Leg., 3d C.S., ch.1, § 21, 2006 Tex. Gen. Laws 1, 38 (emphasis added). The Comptroller submits that in providing by law that the franchise tax "is not an income tax, " the Legislature could not have meant for the tax to meet a definition of "income tax" in the very code it was amending. See, e.g., In re Bridgestone Americas Tire Operations, LLC, 459 S.W.3d 565, 572 (Tex. 2015) (quoting Acker v. Tex. Water Comm'n, 790 S.W.2d 299, 301 (Tex. 1990) ("We presume the Legislature enacted the statute 'with complete knowledge of the existing law and with reference to it.'")).

         But of course the Legislature's stated intent not to create an income tax cannot alter the facts. If the franchise tax is indeed a tax on net income as chapter 141 defines income tax, the Legislature's disclaimer is for naught. But some ambiguity exists here. While deductions for the cost of goods or wages are perhaps sufficiently close to chapter 141's income tax definition, other deductions that permit a fixed amount or percentage to be subtracted from total revenue are, as the court of appeals observed, "not the same as 'deducting expenses from gross income.'" 147 S.W.3d at 144. And certainly chapter 141's income tax definition says nothing about a franchise tax based solely on a taxpayer's total revenue. Tex. Tax Code § 141.001, art. II.4.

         In the court of appeals, Graphic argued that the choice was a binary one, contending "that 'a tax on business activity' must be either an 'income tax' or a 'gross receipts tax' as those terms are defined in chapter 141." 471 S.W.3d at 146. Graphic urged that the franchise tax was clearly not a gross receipts tax, as defined, and therefore must be an income tax. See Tex. Tax Code § 141.001, art. II.6 (defining a gross receipts tax). The court of appeals disagreed with Graphic's premise that the franchise tax had to be either a "gross receipts tax" or an "income tax, " concluding that the tax did not fall within the chapter's definition of either term. 471 S.W.3d at 146. Instead, the court noted that the chapter "expressly recognizes and defines other types of taxes, including defining 'tax' to include 'any other tax which has a multistate impact.'" Id. (citing Tex. Tax Code § 141.001, art. II.4-.9). The Comptroller similarly submits that the franchise tax is neither an "income tax" nor a "gross receipts tax" but rather a hybrid of both, rendering chapter 141's apportionment scheme inapplicable. See Tex. Tax Code § 141.001, art. III.3 ("Nothing in this article relates to the reporting or payment of any tax other than an income tax."); see also Cynthia M. Ohlenforst, The New Texas Margin Tax: More Than a Marginal Change to Texas Taxation, 60 Tax Law. 959, 959 (2007) (describing the franchise tax as "an entirely new tax that combines elements of a gross receipts tax with elements of a net income tax"); John A. Biek, Alternativ e Formulary Apportionment Under the Multistate Tax Compact, 16 J. Passthrough Entities 41, 46 (2013) (observing that the margin tax might not be determined to be an income tax because it "is computed on a modified revenue tax base").

         Even were we to agree with Graphic that its franchise tax for the years in question amounted to the same thing as chapter 141's income tax (an issue we do not decide), Graphic must still establish that the Legislature did not, or could not, make chapter 171's single-factor apportionment formula the exclusive means for apportioning the Texas franchise tax. We turn then to the issues the court of appeals did not consider: (1) whether Tax Code section 171.106 precludes a taxpayer from using the Compact's three-factor formula, and (2) whether Texas' membership in the Compact prevents the Legislature from requiring the taxpayer to use only the single-factor formula to apportion the franchise tax.

         III. Does Tax Code ยง 171.106 preclude a taxpayer from using the Compact's three-factor ...


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