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Texas Tax Talk: The Comptroller’s Full Court Press in the Texas Supreme Court

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Law360 recently published an article by Baker Botts Partners Matt Larsen and Renn Neilson, Senior Associate Ben Geslison and Associate Ali Foyt.1

A version of this piece can be read on Law360, here.

In an ambitious push to advance aggressive positions on several state-tax issues, the Texas Comptroller is the petitioner in at least four new cases in the Texas Supreme Court’s current term.  In each case, the Comptroller is seeking to overturn an appellate court decision that thwarted an attempt to impose extra-statutory requirements for tax exemptions or otherwise advance an especially assertive interpretation of the State’s tax laws.  The Texas Supreme Court has not shied away from tax cases in recent terms and has granted review already in one of these cases.  So, in at least one case, and perhaps more, the Comptroller’s zealous push this term will yield new clarification of the tax laws.  Our thoughts on each of these petitions are below.

Hegar v. Health Care Service Corp.2

The case that has advanced the furthest of the four is Hegar v. Health Care Services Corp., in which the Court heard oral argument on February 3. The Comptroller is seeking to undo a ruling by the trial court, affirmed by the Third Court of Appeals, that Blue Cross Blue Shield of Texas is entitled to a $3 million refund of insurance premium and maintenance tax on its stop-loss insurance policies, which the lower courts held were not health insurance policies subject to the tax.

Stop-loss policies are issued to self-insured employers, protecting them from potentially crippling liability by covering healthcare costs of employees once a certain threshold is exceeded.  In effect, the policy caps an employer’s financial risk arising from healthcare costs of its employees by insuring against any unusually high healthcare costs.  Blue Cross sought the refund on the basis that its stop-loss policies are not health insurance, but rather insurance against risks associated with the financial solvency of the employer’s self-funded plan.  As such, they are not taxable under the relevant statute, Texas Insurance Code § 222.002, which imposes tax on contracts or policies “covering risks on individuals or groups located in this state and arising from the business of . . . health insurance.”

The Comptroller’s contrary argument, that the statute is “expansive” and applies to any policy that covers any risk to any entity arising from the business of health insurance, met some skepticism by more than one Justice at oral argument.  Justice Lehrman, for example, observed that stop-gap insurance “certainly isn’t health insurance in the way we typically think about it,” and Justice Bland stated the issue as being whether the statute taxed only those premiums received for “directly providing health insurance.”  However it is ultimately resolved, the case shows a clear push by the Comptroller to double down on aggressive positions, even when all lower courts have rejected the position.

Hegar v. Texas Westmoreland Coal Co.3

Last November, the Comptroller petitioned the Texas Supreme Court for review of a decision by the Third Court of Appeals dealing with the scope of the manufacturing exemption in the mining context.  Affirming the trial court, the Third Court held that equipment Westmoreland used to excavate and crush lignite coal in one seamless process was used for “processing” as defined in the Tax Code and thus eligible for the manufacturing exemption in Texas Tax Code § 151.381.  Section 151.318 exempts qualifying equipment that is used for the manufacture or production of tangible personal property for sale.  The court of appeals rejected the Comptroller’s attempt to engraft an additional requirement to the statute, namely that the exemption could only apply if both the input and the output of the processing were tangible personal property.  Equipment used in excavating and processing lignite coal could not qualify, the Comptroller argues, because the input to the process was real property, not tangible personal property.  The Third Court held that both the statute’s grammar and its structure indicate that the focus is on the end product, not the inputs, so the equipment here qualifies for the exemption.

The Third Court Appeals found it significant that a few years ago, in Southwest Royalties,4 the Supreme Court mentioned, but declined to accept, the same argument the Comptroller is pressing here—that Southwest Royalties was not processing personal property because the hydrocarbons were real property while they remained underground.5 The Third Court also observed that Southwest Royalties cited with approval three earlier Comptroller decisions that allowed the exemption for equipment used to “shatter limestone formations to be processed into cement,” for explosives used to “blast rock and sandstone formations to be processed into gravel and sand,” and for dynamite used to “blast rock out of earth to be processed into gravel.”6

In its petition for review, the Comptroller contends that the court of appeals read too much into Southwest Royalties and that the Supreme Court’s refusal in that case to adopt his position that the manufacturing exemption does not apply if inputs are not personal property—as well as the Supreme Court’s favorable citation of the Comptroller decisions allowing the exemption even when the inputs were minerals in the ground—are irrelevant because they were not critical to the Southwest Royalties holding.  Westmoreland files its response to the petition this week.

Hegar v. Xerox Corp.7

On December 29, 2021, the Comptroller filed another petition for review in a franchise tax case in which the Third Court of Appeals had again rejected one of his overly aggressive interpretations of a statute.  Specifically, Xerox had calculated its franchise taxes using the lower franchise tax rate applicable to wholesalers and retailers because it was “primarily engaged in selling merchandise to retailers.”8 On audit, the Comptroller disagreed with Xerox’s wholesaler designation because a large portion of Xerox’s revenue comes from equipment leases, which the Comptroller contends are not “sales” for purposes of this requirement because, although possession is transferred, title to the machines is not.

The relevant leases, which the court of appeals called “sale-type leases,” are financing leases—agreements akin to sales with installment payments (and distinct from operating leases under which equipment is used for a fixed term, then returned to the lessor).  Under these financing leases, customers are required to make all lease payments, even if the contract is terminated, bear risk of loss, and must insure the equipment.  The lease terms are generally for the entire economic life of the equipment and satisfy Financial Accounting Standards for treatment as a sale.

The Third Court of Appeals held that the ordinary meaning of the statutory term “selling” does not require transfer of title; that transfer of possession of the item is sufficient.  The court thus rejected the Comptroller’s overly narrow definition of “selling.”  The court emphasized the importance of substance over form, particularly here, where the taxpayer’s agreements are effectively sales, financed in the form of a lease over the economic life of the property transferred.

The Comptroller’s petition for review requires some logical leaps to conclude that the common meaning of “selling” does not include installment sale-type financing leases.  It is also inconsistent with the Comptroller’s explicit position in other contexts (e.g., sales tax) that such financing leases are equivalent to installment sales (and different from operating leases).9 Rather than look to the sales-tax context, the petition goes outside the tax context altogether for support, relying on a recent interpretation of the term “seller” in the products liability context (i.e., whether a distributor without title qualifies as a liable seller10).  Xerox has filed a response waiver and, as of this writing, the Supreme Court has not yet requested a response.

Hegar v. El Paso Electric Co.11

Just last week, on February 3, the Comptroller’s Office filed its most recent petition for review in Hegar v. El Paso Electric Company.  In that case, the Comptroller appeals an en banc decision by the Third Court of Appeals rejecting the Comptroller’s overly narrow application of the manufacturing sales tax exemption for telemetry units that are related to step-down transformers under Texas Tax Code § 151.318(a)(4).  Specifically, Section 151.318(a)(4) exempts, among other things, “transformers that decrease the voltage of electricity generated for ultimate sale … and telemetry units that are related to the step-down transformers.”

The taxpayer in this case, El Paso Electric, claimed the manufacturing exemption for customer meters which operate as telemetry units that are physically connected to, and have other functional connections with, step-down transformers.  Among other operations, customer meters relay information about customer consumption that is used for analysis of step-down transformer functionality.

The Comptroller argued to the Third Court that the exemption for telemetry units “related to” step-down transformers requires that the property be more than just “related to” step-down transformers.  Rather, the units must be narrowly related to step-down transformers for the transmission of a certain type of information about transformer metrics; more than just information about customer consumption that is used to analyze transformer metrics.  The en banc Third Court affirmed the panel decision rejecting the Comptroller’s position as improperly imposing extra-statutory requirements that unreasonably narrow the taxpayer’s basis for exemption.  As the Comptroller’s petition for review was just filed, El Paso Electric has yet to file a response or a response waiver.  Stay tuned.


This Supreme Court term has seen an especially active Texas Comptroller pressing particularly aggressive arguments, each of which have been rejected at all levels below.  In each of the four cases, the Comptroller has stretched the applicable statutory language or tried to add burdens on taxpayers not found in the statutory text.  Although the Comptroller is no stranger to the high court, it will be worth watching whether this term’s attempts to push the boundaries of the tax laws on several fronts continues—a trend which, if it materializes, could force Texas taxpayers to litigate positions they thought were secure.  The Comptroller’s recent losses in trial and appellate courts signal that the Texas judiciary is willing to hold the line against agency overreach, but taxpayers should monitor these developments and position themselves to be effective litigants if necessary.

1Matthew L. Larsen and Renn G. Neilson are partners, and Ben Geslison is a senior associate, at Baker Botts LLP.
Baker Botts associate Ali Foyt contributed to this article.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
2Hegar v. Health Care Service Corp., Case No. 21-0080.

4Southwest Royalties, Inc. v. Hegar, 500 S.W.3d 400 (Tex. 2016).

5See Hegar v. Tex. Westmoreland Coal Co., 636 S.W.3d 61, 66–67 (Tex. App.—Austin 2021, pet. filed).

6Id. at 67.

7Hegar v. Xerox Corp., Case No. 21-1011

8Tex. Tax Code § 171.002(c).

9See, e.g., 34 Tex. Admin. Code § 3.294(a)(1), (f)(1)(B).

10See, Inc. v. McMillan, 625 S.W.3d 101,108 (Tex. 2021).

11Hegar v. El Paso Electric Co., Case No. 21-1062.

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