### T E X A S C O U R T O F A P P E A L S , T H I R D D I S T R I C T , A T A U S T I N

NO. 03-18-00247- CV

Rent-A -Ce nter, Inc., Appellant

v. Gle nn H egar, in his capacity as Com ptroller of P ubl ic Acc ounts of The State of Texas; and Ke n Paxt on, in his capacity as Attor ney Ge neral of Th e State of T exas, Appellees

F ROM TH E DISTRI CT COURT O F TRAVIS CO UNTY, 250 TH JUDICI AL DISTRICT NO. D-1 -GN-1 1-0 0105 9, H ONO RAB LE LO RA J. LI VINGSTO N, JUDGE P RESIDING

O P I N I O N
Appellant Rent -A-Ce nter, Inc. complains of the trial court’s judgme nt awa rding it only a portion of the fra

nchise taxes it paid under protest. Appellee s are Glenn Heg ar, in his capa city

as Comptroller of Public Acc ounts of The State of Texas, and Ken Pa x t o n , i n h i s capa city as Attorney Gene ral of The S tate of Texas (“the Comptrol l er”). The sole issue on appea l is whether Rent-A-Cente r must reduc e its cost-of- g oods-sold (“COGS”) deduction for the merc handise it sold in 2007 by depre ciation on that merc handise during the time it was rente d prior to sale, as ref lected

on Rent-A-Cente r’s fede ral tax return. See Tex. Tax. Code §§ 171.101(a) (1), .1012. Answer ing that question in the aff

irmative, we aff

irm the trial cour

t’s judgme nt.Background Summ ary Rent-A-Cente r provides furniture , elec tronics, appliance s, and computers to
consumers, either throug h immediate, outrig ht purcha se or, more commonly , throug h “re nt to own”
ag ree ments. Rent-A- Center, Inc. v. Hegar , 468 S.W .3d 220, 221 (Tex. App.—Austin 2015, no pet.). Under the “re nt to own” ag ree ments, the cu s t o m er makes wee kly , semi-monthly , or monthly
pay ments over a specifie d period of time—the aver ag e term is eig hteen months—and become s the

owner of the merc handise at the end of the term, provided the customer has not terminated or brea ched the ag ree ment. Id. at 222. The merc handise is sold in an aver ag e of approximately twenty months, the aver ag e number of renta l-purcha se agree ments afte r which an item is ultimately sold is three , and the sale price that a cus t o m er p ay s for an item decr ease s from one renta l-purcha se
ag ree ment to the next for that same item bec ause the item is then considere d used. Id. at 224.

In its 2008 fra

nchise tax repor

t, Rent-A-Cente r claimed a reta iler’s COGS deduction
t h at included $562,966,741 ref err ed to in Rent-A-Cente r’s documentation as “Rental-Purc hase Sales.” After an audit, the Comptroller deter mined that Rent-A-Cente r was not entitled to a COGS deduction at all, classify

ing Rent-A-Cente r as a service provider and not a reta il business. Rent-ACenter paid $1,070,683.67 in fra nchise taxes under protest, and then sued, asser ting that (1) it should be allowed to take a COGS deduction and (2) it was entitled to its entire asser ted COGS deduction, with no reduc tion for depre ciation of the g oods prior to sale. On the first issue, the trial court ag ree d with the C omptroller t hat R ent-A- Center was not entitled to a C OGS deduction at all. On ap p ea l of that ruling , howeve r, this Court disag ree d, deter mining that Rent-A-Cente r is entitled to a COGS deduction beca

use its business is “more like selling than leasing and that Rent-A-Cente r is, there fore ,

2primarily

eng ag ed in re tail trade.” Id. at 225. We rema nded to the t rial cour

t for conside ration of the sec ond issue—the prope r amount of Rent-A -Center ’s COGS deduction. Id.

On rema nd, Rent-A-Cente r asser ted that it was entitled to a COGS deduction
repr esenting the total c ost, when new, of all the merc handise it sold in 2007. The Comptroller, on the other hand, asser

ted that Rent-A-Cente r was require d to adjust its COGS basis to acc ount for the fac t that the merc handise at the time of final sale had been rente d or used, by subtracting an amount equal to the de prec iation Rent-A-Center had claimed on this merchandise in its federa l tax return. Following a hearing on the issue, the trial court agree d with the Comptroller and order ed that RentA-Center rec eive a ref und of $941,847.84. It is from that order that Rent-A-Cente r appe als. 1

Stand ard of Review
In construing a statute, we seek to asce rtain and eff ectuate the L eg islature’s intent in

enac ting the statute. Southwest Royalties, Inc. v. Hegar , 500 S.W .3d 400, 404 (Tex. 2016); Upjohn Co. v. Rylander , 38 S.W .3d 600, 607 (Tex. App.—Austin 2000, pet. denied)

. “We start with the text beca use it is the best indication of the L eg islature’s intent.” Ojo v. Farmers Grp., Inc. , 356 S.W .3d 421, 435 (Tex. 2011). We examine the languag e used in the statute, in the context of the entire act, and we rea d ever

y word, phrase , and expression presuming that the L eg islature chose eac h word for

a p urpose and purposef

ully omitted words not chosen. City of Dallas v. TCI W

. End, Inc. , 463 S.W .3d 53, 55 (Tex. 2015); Upjohn Co. , 38 S.W .3d at 607. When a statute is unambiguous, we

This appea l was transfe rre d by a docket equalization order to the El Paso Court of Appea ls 1 in Aug ust 2016, then transfe rre d back to this Court in April 2018. See Misc. Docke t No. 18-9054 (Tex. Apr. 12, 2018). 3do not turn to extrinsi c aids or canons of construction to const ru e i t

—we simply follow the unambig uous languag e. City of Richardson v. Oncor Elec. Deliv er y Co
. , 5 3 9 S.W .3d 252, 261 (Tex. 2018); Combs v. Roark Amuseme nt & Vending, L.P. , 422 S.W .3d 632, 635 (Tex. 2013); Ojo , 356 S.W .3d at 435-36.

I f a statute is ambiguous, we will g ener ally defe r to the ag ency ’s interpre tation as long

as that interpre tation is consistent with the statutory languag e and not plainly err oneous. Texas Dep’ t of Ins. v. American Nat’l Ins. Co. , 410 S.W .3d 843, 853 (Tex. 2012); TGS-NOPEC Geophy sical Co.

v. Co mb s , 340 S.W .3d 432, 438 (Tex. 2011). Our defe renc e, howeve r, is “temper ed by sever al considerations,” and we look to whether “(1) the ag ency ’s interpre tation has been formally adopted; (2) the statutory languag e at issue is ambiguous; and (3) the age ncy ’s construction is rea sonable.”
American Nat’l Ins. Co. , 410 S.W .3d at 853-54 (quoting Railroad Comm’n of Tex. v. Texas Citi zens for a Safe Future & Clean W ater , 336 S.W .3d 619, 625 (Tex. 2011) ); see Texas Utils. Elec

. Co. v

. Sharp , 962 S.W .2d 723, 726 (Tex. App.—Austin 1998, pet. denied).

The leg islature enac ted Texas’s fra nchise tax statutes “pure ly for reve nue purposes,” and we are to liber ally construe the rele vant statutes so as to e ffe ctuate that purpose. Isbell v. Gulf
Union Oil Co. , 209 S.W .2d 762, 764 (Tex. 1948) (quoting Fede ral Crude Oil Co. v. Y ount-Lee Oil Co. , 52 S.W .2d 56, 61 (Tex. 1932)); Upjohn Co. , 38 S.W .3d at 606. A statute that imposes a tax is “strictly construed ag ainst the taxi ng authority and liberally construed in favor of the taxpay er.” Up j o h n Co
. , 38 S.W .3d at 606; see Calvert v. Texas Pipe Line Co. , 517 S.W .2d 777, 7 8 1 (Tex. 1974). An exemption or deduction fr o m t ax, howeve r, is disfavore d by the law and thus is construed strictly ag ainst the taxpay er. North Alamo W ater Supply Corp. v. W

illacy Cty. Appraisal

4Dist. , 804 S.W .2d 894, 899 (Tex. 1991) (tax exemptions undermine equality and un iformity by

placing g reater burden on some taxpay ers rat her than on all taxpay ers) ; Texas Utils. Elec. , 962 S.W .2d at 726 (“[T]o promote uniformity and eq u ali ty in taxation, we construe tax exemptions —and provisions tantamount to tax exemptions —strict ly ag ainst the taxpay er and in favor of the taxing a

uthority .”).

Discussion This case prese nts a limit ed question: whether Rent-A-Cente r is entitled to deduct the full cost of merc handise when new as its asser ted COGS, totaling $1,055,657,987, or whether it must reduc e that deduction by an amount repr esenting the depre ciation du ri n g the time Rent-A-Cente r
rente d out these assets, see Rent-A- Center , 468 S.W .3d at 224, here repr esente d by the depre ciation it repor ted on its fede ral income tax return. To rea ch our decision, we look to the Texas Tax Code’s provisions related to f

ranc hise taxes. Wit h a fe w e xc e p ti o n s not applicable here , a fra nchise tax is imposed on ever y taxable entity that does business in or is char tere d or org anized in Texas. Tex. Tax Code § 171.001(a)

. The
tax code sets out the fra nchise tax rate , which is a perc entag e of t h e t ax ab le entity ’s “taxable
marg in. ” Id

. § 171.002. An entity ’s taxable marg in, as rele vant here , is calc ulated by deducting from its total reve nue its cost of g oods sold. Id

. § 171.101(a) (1)( B)

. An entity ’s COGS de duction is deter mined under section 171.1012, which provides that the “cost of g oods sold includes all direc t
costs of acquir ing or producing the g oods,” including, inter alia : labor costs; costs of materia ls; costs of materia ls consumed in production; handling and storag e costs; depre ciation, depletion, and amortization repor

ted on the entity ’s fede ra l i n come taxes and associate d with the production of

5g oods; costs for renta l and repa ir of equipment or fac iliti es used for the production of the g oods; and

eng ineer ing a

nd desig n costs. Id. § 171.1012(c) . Section 171.1012 further provides: (g ) A taxable entity

that is allowed a subtra ction by this section for a cost of goods sold and that is subject t o Section 263A, 460, or 471, Interna l Rev en u e Code, may capitalize that cost in the same manner and to the same extent that the taxable entity capitalized that cost on its fe d era l income tax return or may expense those costs, except for costs excluded under Subsection (e) , or in acc ordanc e with Subsections (c) , (d), and (f)

. I f the taxable entity elec ts to capitalize costs, it must capitalize eac h cost allowed under this section that it capitalized on its fede ral income tax return. I f the taxable entity later elec ts to beg in expensing a cost that may be allowed under this section as a cost of g oods sold, the entity may not deduct any cost in ending inventory from a previous repor

t. I f the taxable entity ele cts to expense a cost of g oods sold that may be allowed under this section, a cost incurre d befor e the first day o f t h e p eriod on which the repor t is based may not be subtracte d as a cost of go o d s s o l d

. I f the taxable entity elec ts to ex p en s e a cost of g oods sold and later elec ts to capitalize t hat co s t o f g oods sold, a cost expensed on a previous repor t may not be capitalized. Id . § 171.1012(g ). Our a naly sis turns on subsection (g ). The Comptroll er asser

ts that beca

use Rent-A-Cente r’s proper ty was subject to section 263A of the Interna l Revenue Code, which require s costs of non-inventory proper ty to be capitalized, Rent-A-Cente r must there fore reduc e its COGS deduction by the amount of depre ciation it capitalized on its fede ral taxes. Rent-A-Cente r, on the other hand, insists that subsection (g ) means that it “must use the same allocation formula and methods it used to allocate direc t and indirect costs

on its fede ral tax return” and that subsection (g) “addr esses only how a taxpay er d et er m i n es what
costs must be capitalized and added to the cost of g oods it sells. I t d o es n o t s ay any thing about deducting amounts from that capitalized total and does not include the word ‘depr eciation.’” RentA-Center asser

ts that the fac t that it depre ciated its capitalized merc handise is irrelev an t to the fra nchise tax calculation.

6Secti o n 263A—titled, “Capitalization and inclusion in inventory costs of cer tain expenses”—provi d e s th a

t n o n - in v e nto ry proper

ty “shall be capitalized.” 26 U.S.C. § 263A(a )(1) (B );

see also 26 C.F.R. § 1.263A-1(c ) (“Under section 263A, taxpay ers must capitalize their direc t costs and a pr operly

allocable share of their indire ct costs to proper ty produce d or prope rty

acquir ed for

resa le.”)

. The applicable feder al rules explain, “Costs that are capitalized under section 263A are

rec overe d throug h depre ciation, amortization, cost of g oods sold, or by an adjustment to basis at the time the proper

ty is used, sold, place d i n s ervice, or otherwise disposed of by the taxpay er.” 26 C.F.R. § 1.263A-1(c )(4)

.

The parties acknow ledg e both that Rent-A-Cente r may take a COGS deduction and that it is subject to Section 263A. See Tex. Tax Code § 171.1012(g ). They further ag ree that Rent- 2
A-Center asser

ted $562,966,741 in depre ciation for the rele vant merc handise on its fede ral income
tax return. Thus, under subsection (g ), Rent-A-Cente r could either capitalize its merc handise costs

3

The Interna l Revenue Service explains that “[y ]ou cannot depre ciate inventory beca use it 2 is not held for use i n y our busi ness.” I RS Publication 946, “ How to Deprec iate Property ,” Ch. 1, pg . 5, https://www.irs.g ov/pub/irs-pdf/p946.pdf (last visited Apr. 3, 2019). But “[i] f y ou are a rent-to- own deale r, y o u m ay be able to treat cer tain proper

ty held in y our business as depre ciable p ro p er t y rathe r than as inventory .” Id

. The I RS also explains that the “re cover y period” —“th e number of y ea rs o v er which y ou rec over [t he proper ty ’s] cost”—for “[q] ualified rent-to- own proper ty ” such as t he merchandise sold by Rent-A-Cente r is three or four y ear s, depending on the depre ciation sy stem used. See id. Ch. 4, pgs. 28, 29, 31. In its response to the Comptroller’s motion for summary judgme nt, Rent-A-Cente r actua lly 3 stated that it had “deduc ted depre ciation

. . . equal to $234,991,362” on its fede ral income tax return, explaining that it “re duced its orig inal cost of $797,958,103 by $234,991,362 and only included the differ ence of $562,966,741 as the cost of that merc handise,” citing to deposition testimony by Hug h Tollack, Rent-A -Center ’s Direc tor of Tax Audits, Resear ch and Planning, and to Rent-A-Center ’s brea kdown of its asser

ted COGS deduction as set out i n i t s “S chedule A.” Tollack testified that Rent-A-Cente r paid approximately $798 milli on for merc handise for which “the sale was completed in y ear 2007.” Asked why Schedule A l i s t ed “Rental-Purc hase Sales” t otaling $562,966,741, not $797,958,103, Tollack said, “The differ ence is that the schedule that we wer e just talking about with 7“in the same manner and to the same extent that [R ent-A- Center] capitalized that cost on its fede ral

income tax return,” or it could expense those costs, provided the costs wer e not excluded elsewhe re in section 171.1012. Id

. Rent-A-Cente r chose to capitalize those costs an d t h u s wa s re quired to “ca pitaliz e eac h cost allowed under this section that it capitalized on its fede ral income tax return.” 4
Id. Rent-A-Cente r argues t h at s ubsection (g ) only require d it to allocate its direc t and indirect cos t s as i t did on its fede ral tax return. Howeve r, under the unambiguous languag e of subsection (g ), Rent-A-Cente r was require d to capitalize its merc handise costs “in the same manner and to the same extent” that it capitalized those costs on its fede ral income tax return. See id. This 5
dictates that Rent-A-Cente r’s COGS deduction be reduc ed by the amount of depre ciation it claimed on its feder al taxes. W e ther efor e over rule Rent-A -Center ’s issue on appe al.

the 798 milli on, roug hly , part of that cost was alre ady deducte d in the fede ral L ine 9, so we deducte d that 200—well, approximately $235 milli on from the $798 milli on to arr ive at the figure there that shows about $563 milli on.” Another trial court ex hibit shows a table provided by Rent-A-Cente r that sets out acc umulated depre ciation over a number of y ear s, totaling $562,966,741. Although the rec ord appea

rs to ref lect some confusion about how much depre ciation was claimed, Rent-A-Cente r has stated in its appellate filings that the a pproxi mately

$563 milli on was it s depre ciation, and we will acce pt and re ly

on that repr esentation of fac t. A commentator discussing the fra nchise tax noted that if a taxable entity elec ts to capitalize 4 its expenditures, it must capitalize for CO GS p u rp o s es the same way it capitalized on its fede ral income tax return. Ira A . L ipstet, Franchise Tax Re formed: The New Margin Tax Including 2007 Legislati ve Change

s &Final Comptrol ler Rules , Tex. J . Bus. L ., Spring 2007, at 1, 28. Even if the languag e of subsection (g ) was ambiguous, under the canons of construction, 5 we would construe its provisions of h o w to calc ulate a COGS deduction strictly ag ainst Rent-ACenter. See Upjohn Co. v. Rylander , 38 S.W .3d 600, 606 (Tex. App.—Austin 2000, pe t. de nied). 8Conclusion Under the unambiguous langu age of section 171.1012(g ), Rent-A-Cente r was require d to reduc e its COGS deduction by the amount of depre ciation it claimed on its fede ral taxes, an amount the pa

rties agree was $562,966,741. We theref ore a ffirm the tria l court’s judg ment. 6

__________________________________________ J eff Rose, Chief J ustice
Be fore Chief J ustice Rose, Jus tices Goodwin a nd Kelly Affir med Filed: Apr il 30, 2019

Re nt- A

- Ce n

te r a ctually ref

ers in its briefing to $562, 766 ,741, asser ting that the Comptroller 6 argue s that its COGS deduction “must be reduc ed by $562,766,741, repr esenting the amount o f depre ciation on those g oods that Rent-A-Cente r claimed as a deduction on its prior fede ral income tax returns.” Howeve r, the Comptroller argues that Rent-A-Cente r c laim e d $ 5 6 2 , 9 6 6 , 7 4 1 , a sum that is borne out by

the evidenc e and f

ilings bef ore the trial court. 9