Earlier today, the Texas Third Court of Appeals at Austin issued its highly anticipated decision in Graphic Packaging Corporation v. Hegar, et al., No. 03-13-00400-CV (Tex. App.―Austin, July 28, 2015). The decision affirms the trial court’s ruling that the election under the Multistate Tax Compact to use a three-factor apportionment formula (the “Compact Election”) is not available to taxpayers for Texas franchise tax purposes. Instead, taxpayers must apportion their taxable margin using the statutory single-factor apportionment formula based on receipts.
Because the trial court did not divulge the basis for its decision, this opinion marks the Texas courts’ first effort to weigh in on the Compact Election litigation that has swept the nation over the last several years. Courts in other states have wrestled with the difficult question of whether the Multistate Tax Compact contractually binds states to provide the Compact Election. The Third Court of Appeals, however, did not reach this question; instead it resolved the case by conducting a statutory construction of the Compact Election’s terms.
By its own terms, the Compact Election is available only for “income taxes.” The Multistate Tax Compact defines an “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.
The Texas Court of Appeals analyzed the Multistate Tax Compact’s definition of an “income tax” and concluded that the limited types of deductions available from total revenue under the Texas franchise tax do not produce net income. Accordingly, the Court held that “the franchise tax is not ‘a tax imposed or measured by net income’ and, therefore, ...it does not fall within [the Multistate Tax Compact’s] definition of an ‘income tax.’”
The taxpayer in Graphic Packaging will probably file a motion for rehearing or a motion for rehearing en banc. If it does not find relief through a rehearing, it may petition the Texas Supreme Court to review the Court of Appeals’ decision. If it does, the Texas Supreme Court may take the case, given the national importance of the Compact Election litigation and the number of pending cases in the state. That said, the Texas Supreme Court would be more likely to take the case if the decision had turned on interstate compact law rather than a statutory construction of the Compact Election’s terms.
It remains to be seen how the Texas Court of Appeals’ decision will affect related questions regarding the Texas franchise tax’s status as an income tax, including for purposes of:
- Accounting for income taxes under ASC 740
- Availability of P.L. 86-272 protection
- Add-back of net income taxes by other states