Texas Rules that “Net Gains” Does Not Mean “Net Gains or Losses” for Franchise Tax Purposes

Texas taxpayers may have a refund claim available if they used net losses to reduce other gross receipts in the denominator of their apportionment factor.

By Jeff Glickman, SALT partner

State revenue departments adopt tax regulations to provide clarity and guidance to the existing tax statutes. However, revenue departments are prohibited from enacting regulations that are contrary to the plain meaning of the statute. This principle was addressed recently by the Texas Supreme Court (the “Court”) in a decision issued on April 15, 2016, related to the calculation of gross receipts for apportionment purposes under the Texas franchise tax. [1]

In the case, the taxpayer had engaged in several transactions involving capital or investment assets, some of which produced gains and some of which produced losses; however, the overall result of the transactions was a net loss. Texas’ statute provides that “[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.” [2] However, the Texas comptroller adopted a rule which states that “[i]f 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.” [3] Pursuant to that rule, the state assessed the taxpayer, requiring it to net that loss against other gross receipts in the denominator of the apportionment factor, thereby increasing the factor. [4]

The Court noted that a 1974 Texas case had previously addressed the issue of whether net gain should be calculated on a per-transaction basis or a cumulative basis, ruling that such calculation should be done on a cumulative basis. [5] Thus, if a taxpayer engaged in three sales of investment/capital assets and one resulted in a gain of $100, another in a loss of $125 and the third in a $50 gain, the net gain is $25, which is added to other gross receipts in the denominator of the gross receipts apportionment factor (or into the numerator and denominator if those receipts are sourced to Texas).

However, if that taxpayer’s third transaction produced no gain or loss, then the overall result of the three transactions is a net loss of $25. At issue in the current case is whether or not the taxpayer is required to reduce its other gross receipts in the denominator of the apportionment factor by the amount of that loss. The Court ruled that the statue clearly requires inclusion of “only the net gain,” and that under no reading can that include a net loss. Therefore, the Court refused to defer to the comptroller’s rule because it conflicted with the plain language of the statute.

Based on this case, taxpayers may have a Texas refund claim available if they used net losses to reduce other gross receipts in the denominator of the apportionment factor and thus reported a higher Texas apportionment percentage. Aprio’s SALT team can assist taxpayers with determining the amount of and claiming any refunds for all open tax periods. Our team is dedicated to keeping our clients advised of important issues and developments in state and local taxes in order to help them address their specific tax situations. We will continue to monitor these and other significant state tax developments, and we will include any updates in future issues of the Aprio SALT Newsletter.

Contact Jeff Glickman, partner-in-charge of Aprio’s SALT practice, at jeff.glickman@aprio.com for more information.

This article was featured in the April 2016 SALT Newsletter. To view the newsletter, click here.

[1] Hallmark Marketing Co., LLC, v. Hegar, et al., No. 14-1075 (Tex. Sup. Ct., April 15, 2016).

[2] Texas Tax Code § 171.105(b) (emphasis added).

[3] 34 Tex. Admin. Code § 3.591(e)(2).

[4] Both sides agreed that the losses were sourced outside of Texas, and so they only impacted the denominator of the apportionment factor.

[5] Calvert v. Electro-Science Inv’rs, Inc., 509 S.W.2d 700 (Tex. Civ. App. – Austin 1974, no writ).

Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or under any state or local tax law or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Please do not hesitate to contact us if you have any questions regarding the matter.

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