### TEXA S C OU R T OF A PPEAL S, THIR D DIST R ICT , AT AU STIN

NO. 03-04-00660- CV

Hom e Int e r ior s & G ift s, Inc ., App e lla nt

v. Ca r ole K e e to n St r ay hor n, C om pt r oll e r of P ublic Ac c ount s o f the St at e of Te xa s, and Greg A bbott, Attor ney Ge neral of the State of Texas, App ellees

F ROM THE DISTRICT CO URT OF TRAVIS COUNTY , 345TH JUDICIAL DISTRICT NO. GN303185 , HO NORAB LE DARLENE B Y RNE, JUDGE P RESIDING
O P I N I O N
I n this case, we deter

m i ne whe ther the e arne d surplus throwbac k provision of the Texas franc hise tax as applied to appellant, Home I nteriors & Gifts, I nc. (H ome Interiors),
un c on sti tut ion a lly

burd e ns int ers tat e co mme rc e . H ome I nte ri or s is se e kin g a re fu nd of fr anc his e taxes timely paid to appellee , Carole Ke eton Stray horn (the Comptroller) . Both pa rties filed motions for summary judgme nt. The district c ourt denied Home I nteriors’ motion and gra n t ed the Comptroller’s motion. On appea l, Home Interiors a rg ues that the application of the ea rned sur plus thr owba c k p ro vis ion

c a us e s th e fr anc his e ta x to ( 1) be un fa ir ly a pp or tio ne d, (2 ) d isc ri min a te a g a ins t interstate commerce , and (3) be unfairly related t o service s provided by Texas. Be cause we hold that the fr anc his e ta x as a

pp lie d to Ho me I nte ri or s la c ks int e rn a l c on sis te ncy and , c on se qu e ntl y , is2

unfairly apportioned, we r ever se the district cour t’s g rant of summar

y judgme nt in favor of

the Com ptr oll e r a nd re nd e r j ud g me nt t

hat th e ta x is un c on sti tut ion a l a s a pp lie d to Ho me I nte ri or s.
BACK GR OUND Home Inte rio rs Ho me I nte ri or s is a

Te xas c or

po ra tio n th a t e mpl oy s a

pp ro xima te ly

35 0 e mpl oy e e s in Texas. Virtually

all its operations occ ur in Texas—it has no manufac turi n g, wa re h ousing, or
a dmi nis tr a tiv e fa c ili tie s ou tsi de of thi s state
. I t is in the bu sin e ss o f p ur c ha sin g ho me de c or pr od uc ts,
acc essories, a

nd gifts and wholesa ling them to indepe ndent contra ctors, known a s “Display ers.” Additionally , Home I nteriors sells a varie ty of marke ting materia ls to the Display er s t o ai d i n the reta il sale of the pr oducts. All of Home I nteriors’ profits are g ener ated f rom the initial sale of the pr od uc ts to the Di sp lay e rs . Duri ng the pe ri od of tim e re le va nt to this a

pp e a l, H ome I nte ri or s so ld products to Display ers loca ted in all fifty

states, Washington D.C., and Puer to Rico. The Display ers g ener ate sa les by hosting promotio n al p arties where they provide samples and demonstrate various products. They also distribute cata logs a

nd rec ruit new sale smen. Essentially , the Display ers f unction as a r etail outlet for Home I n t er i o rs ’ war es. Howe ver, the Display ers a

re not employ ed by

Home Interiors. Home I nteriors doe s not compensate the Display ers and does not provide them benef its of any kind. I t does, however, pay the Dis play ers a commission on sales g ener ated by

a new ly rec ruited sales p er s on. Additionally , Home Interiors ha s no contac t wi th any of the Di sp lay e rs ’ re ta il c us tom e rs and do e s n ot i ns ta ll o r r e pa ir

pr od uc ts o uts ide of

Te xas. Be tween 1994 a

nd 1999, Home I nteriors ti mely paid i ts Texas fra nchise taxes. I t now seeks a refu n d of those taxes, contendingthat the statutory method for a

pportioning the ear

ned3

sur p lu s c o mp o n e n t o f th e f

r an c h is e tax is u n c o n s ti tuti o n a l. A f te r r e f u n d h e ar in g s w e r e held, the Comptroller issued a dec ision in J uly 2003 stating that she did not have the a uthority to rule on the constitutionalit y

of t he st atutory provisions. Consequently , Home I nteriors broug ht suit i n district court, whic h upheld the constitutionality of the e arne d surplus throwbac k provision.
Texas Franchise Tax

The fr anchise tax i s i m p osed on cor porations in Texas for the pr ivilege of doing business here
. See Te x. Tax Code Ann. § 1 71 .0 01 (a )( 1) (We st Su pp . 2 00 4- 05 ); Anderson-Clayton Br os . Fu ne ra l H

om e, I nc . v . S tra y ho rn , 149 S.W .3d 166, 169 (Tex. App.—Austin 2004, pet. filed); Rylander v. F

i s h erControls Int’l, Inc

. , 45 S.W .3d 291, 293 (Tex. App.—Austin 2001, no pet.). B e fo re Janu ar

y 1 , 1 9 9 2 , t h e f

r an c h i s e t a x w a s a s s e s s e d s o l e l y o na c o r p o r a t i o n ’ s t a xa

b l e c a p i t a l. An de rso n- Cla

y ton Br os . , 149 S.W .3d at 169. The result was that capital- intensive industries bore the brunt of the ta x . Id . I n an ef fort to broa den the fra n ch i s e tax base, the leg islature adde d an alternative assessment on a c orporati o n’s “ne t tax able e arne d surplus.” Id . Pr e se ntl y , th e ta x is
c a lc ulate d b y

a dd ingthe ta x o n ne t ta xab le c a pit a l to the dif

fe re nc e be tw e e n the ta x on n e t taxab le
ear ned surplus and the tax on n et t ax ab l e capital. See Te x. Tax Code Ann. § 1 71 .0 02 (b ) ( Wes t 20 02 ); IN OV A D iag no sti c s, In c . v . S

tra y ho rn , No. 03-04-00503- CV, 2005 Tex. App. L EXI S 4002, at *8 (Te x . App.—Austin, May 26, 2005, pet. filed). Despite this awkwar d formula, the pr actica l eff ect is to assess the g reater of a 4.5 perc ent t ax on net taxable ear ned surplus or a

.25 perc ent tax on net taxable capital. See I NOVA , 2005 Tex. App. L EXI S 4002, at *8. A cor poration’s ne t tax able c apital consists of its stated capital and its surplus. Fisher Controls Int’l , 4 5 S. W.3 d at 29 3. I ts ne t ta xab le e arn e d s ur plu s is c omp ri se d o f i ts r e po rt a ble ta xab leI n apportioning net taxable c apital and net taxable e arne d surplus, the g ross rec eipts of a 1 c or po ratio n fromits bu sin e ss d on e in T e xas i nc lud e the re c e ipt s f ro m a numbe r o f s pe c if

ic a lly enumer ated c ateg ories of business a ctivities and servic es per formed he re. S ee T ex . Tax Code §§ 171.103 (West 2002), .1032 (West Supp. 2004-05). 4 income (for federa l income-ta x purposes) plus c erta in other sums and less other a mounts. Id . at 294. A cor poration’s ne t tax able c apital or ne t tax able ea rn ed surplus is apportioned to the state by dividing the c orporation’s gr oss rec eipts g ener ated in Te x as by the cor poration’s total world- wide g ro ss re c e ipt s. See Te x. Ta x Cod e Ann. § 1 71 .1 06 (We st Su pp . 2 00 4- 05 ); Gene ral Dynamics Corp. 1

v . S ha rp , 919 S.W .2d 861, 863 (Tex. A pp.—Austin 1996, writ denied) . I n addition, a cor poration’s g ro ss r e c e ipt s f

ro m e a c h s a le of tan gible pe rs on a l pr op e rt y sh ipp e d f

ro m T e xas t o a

purc ha se r i n
ano the r s ta te are “ thr ow n b a c k” to T e xas and a dd e d to the g ro ss r e c e ipt s f ro m bu sin e ss d on e in Te xas. Te x. Tax Code Ann. §§ 17 1. 10 3( 1) (We st 20 02 ), .1 03 2( a )( 1) (We st Sup p. 20 04 -0 5) . G ro ss
rec eipts used to apportion net taxable c apital are only thrown bac k if the cor

poration is not subject to tax ation in the purcha ser’ s state. Id
. § 1 7 1
. 1 0 3 ( 1 ) ( taxa b le c a p it a l t h r o w b a c k p r o v is ion)
. I mportantly , g ross rec eipts used to apportion net taxable ea rned sur plus are thr own bac k if the corpor ation “is not subject to any tax on, or measure d by , net income, without re g ard to whe ther the tax i s imposed.” Id . § 171.1032(a) (1) ( ear ned surplus throwba ck provision). Th e purp os e of

the e arn e d s ur

plu s thro wb a c k p ro vis ion is t o c a ptu re and ta x inc ome g ener ated f

rom sales in other states that would otherwise g o untaxed as a re sult of Publi c L aw 86- 272. Se e id .; cf INOVA , 2005 Tex. App. L EXI S 4002, at *5 (explaining purpose of P ublic L aw 86- 272). Cong ress e nacte d Public L aw 86-272 in 1959 in response to a United States Supreme Court decision that indicate d that the fe dera l constituti on does not prohibit individual st ates fr om imposi ngWe n ote that H ome I nte ri or s’ a c tiv iti e s e xce e de d th os e pr ote c te d b y Pub lic L aw 8 6- 27 2 in 2 fo ur te e n s ta te s d

ur ing c e rt a in tim e pe ri od s re le va nt to thi s a pp e a l. Th e Com

ptr oll e r a g re e d th a t g ro ss rec eipts from sales to those states duringthe applica ble per iods were not subject to the throwbac k provision, and those re ceipts we re e x cluded f rom the appor

tionment calculation. 5 an in c ome ta x on o ut- of

-s tate c or po ratio ns , e ve n w he n th e ir on ly bu sin e ss act iv ity

in t he state is solicit ati on of purc hases. 15 U.S.C. § 381(a) (West 1997); see W isconsin Dep’t of Rev enue v . W illiam W rigley, Jr. Co. , 505 U.S. 214, 220-21 (1992) ( discussing opinion in Northw estern States Po rtlan d Ce me nt C

o. v . M inn eso ta , 358 U.S
. 4 5 0 , 4 5 2 (1 9 59)). L ess than a year afte r the Nor thw este rn Sta te

s P or tla nd

Ce me nt opinion, Publ ic L aw 86- 272 was pa ssed to cre ate minimum standards f

or business ac tivity require d within a st ate before that state m ay impose state i ncome tax on an out-of- state c orporation. See W illiam W rigley, Jr. Co. , 505 U.S. at 223. Specifica lly , the statut e pr oh ibi ts a

state fr om i mpo sin g a

ne t in c ome ta x if the fo re ig n taxpay e r’ s o nly bu sin e ss activity in the state is the solicitation of order s. See 15 U.S.C. § 381(a). A net income tax is “any tax i mposed on, or mea sured by , net income.” Id . § 383.

All parties in this case c oncede that Public L aw 86-272 protec ts Home Interiors fr om be ing ta xed on inc ome g e ne rate d fr om sa le s of its pr od uc ts to Di sp lay e rs loc a te d in m os t s tates. 2 Consequently , the g ross rec eipts from sales to D isplay ers in those states wer e thrown bac k to Texas and added to Home I nteriors’ r ece ipts from business done in Texas. Home Interiors c laims that the inclusion of the thrown ba ck re ceipts is signific ant bec ause, dur ing the time period at issue here,
a pp ro xima te ly

nin e ty pe rc e nt o f i ts r e ve nu e s w e re g e ne ra ted fr om s a le s o uts ide of Te xas. Acc ording ly , Home Interiors c ontends that the application of the ea rned s u r p lu s th rowba ck provision
re su lts in a

n unf a ir ly a pp or tio ne d f ra nc his e ta x ass e ssm e nt.6 STA ND AR

D O F RE VI EW We r e vie w the tr ia l c ourt ’s summa ry jud g me nt de novo
. Provident Life & Acc ident In s. Co. v . Kn ott , 128 S.W .3d 211, 215 (Tex. 2003); Texas De p’t of Ins

. v. American H ome Assurance Co. , 9 98 S.W. 2d 34 4, 34 7 ( Te x. Ap p. —Aus tin 19 99 , n o p e t. ). W he n p art ie s f ile cross-motions for summar y judgme nt, eac h party

in support of its m o t i on nece ssarily takes the position t hat there is no ge nuine issue of fa ct in the case and that it is entitled to judgme nt as a matter of law. City of Pflugerville v. Capital Metr o . Transp. Auth. , 1 2 3 S. W. 3 d 1 0 6 , 1 1 0 ( T e x. App.—Austin 2003, pet. denied). Thus, when both par ties file a motion for summary judgme nt, we deter mine all questions pr esente d and rende r such judgme nt a s the trial court should have rende red. See Comm issioners Court v. Agan , 940 S.W .2d 77, 81 (Tex. 1997). I n o rd e r t o d e te rm ine the jud g me nt t hat the tr ia l court sh ou ld h a ve re nd e re d, we mus t construe the Texas franc hise tax st atute. In construing a statute, “our objective is to deter mine and g ive ef fec t to the L eg islature’s intent.” National Liab. & Fire Ins. Co. v. Allen , 15 S.W .3d 525, 527 (T e x. 20 00 ); se e Albe rts on ’s , I nc . v . S inc lai r , 984 S. W
. 2 d 9 58, 960 (Tex. 1999). Statutory construction is a que stion of law for the court to dec ide. See Tex as Dep’ t of Tr ansp. v. Needham , 82 S.W .3d 314, 318 (Tex. 2002).
DI SCU SSIO N

Home Interiors a

rg ues that the a

pplication of the e arne d surplus throwbac k provision
cause s the fra

nchise tax to u n co n s tituti onally burden inter state commer ce be cause it results in an assessment that (1) is unfairly apportioned, ( 2) discriminates a g ainst interstate commerc e, and ( 3)7

un fa ir ly re late s to se rv ic e s pr ov ide d by Te xas. B e fo re dir e c tly c on sid e ri ng Ho me I nte ri or s’ c la im,
a br ie f r e vie w o f C omm e rc e Cla us e jur isp ru de nc e is b e ne fi c ia l.
Commerc eCla use

T h e Co mm e r c e Cl a

u s e o f th e Co n s ti tuti o ne xp r e s s ly g r an ts Co n g r e s s th e p o w e r “ [t ]o regulate Commerce with foreig n Nations, and among the sever al States, and with the I ndian Tribes.” U.S. Const., art. I , § 8, cl. 3. I n addition to this express g rant of authority , the Supreme Court ha s held that the Commerce Clause also prohibits cer tain state re g u l at i o n of interstate commerc ial activity even when Cong ress h as fa i l ed to leg islate on the subject. Oklahoma Tax Comm’n v. Jefferson Lines, Inc

. , 51 4 U. S. 17 5, 17 9- 80 (1 99 5) ; Qu ill Cor p. v . No rth Da k

ota , 504 U.S. 298, 309 (1 99 2) . T his imp lic it p ri nc ipl e is k no wn a s th e “ Do rm ant” or “ Ne g a tiv e ” Com me rc e Cla us e . Wh ile in t he or y the c on c e pt o f t

he Do rm ant C omm e rc e Cla us e is relat ivel y

sim ple to u nd e rs tand , it s
a pp lic a tio n to the pr a c tic a l r e a lit ie s o f i nte rs tate c omm e rc e ha s p ro ve d q uit e dif fi c ult
. I nitially , the Supreme Court held that interstate commerc e was wholly immune from state taxation. Jefferson Lines , 514 U.S. a t 180. Although there wer e minor deviations, the Court
ma int a ine d th is f

or ma lis tic and

me c ha nic a l a pp ro a c h to state ta xati on of int e rs tate c omm e rc e un til the late 1930s . I n 1938, the Court moved awa y from its traditional “fr ee tr ade” approa ch to the Commerce Clause . I n W

estern L ivestock v. Bureau of Reve nue , 303 U.S. 250, 252 (1938), the Court
wa s ask e d to det e rm ine wh e the r a Ne w M e xico ta x on th e pr ivi le g e of e ng a g ingin s pe c if

ie d b us ine ss activities violated t he C ommerce Clause. The tax pay er was an instate mag azine publisher and the tax i nvolved was me asure d by g ross rec eipts from the sale of adver tising i n the mag azine. W este rn Livestock, 3 03 U. S. at 25 2. Th e ma g a zine pu bli sh e r argue d that the re ve nu e g e ne rate d f ro m th e sa le8

of ad space to out-of-state adver tisers was immune fr om tax ation beca use the c ontrac ts were a for m of interstate commerc e. Id . at 25 3. Th e Court su sta ine d the ta x a nd state d, “ I t w a s n ot t

he purp os e of the Commerc e C lause to re lieve those e ng ag ed in interstate c ommerce from their just share of state tax burden eve n though it incr ease s the cost of doingbusiness.” Id
. at 254. T h e C o u rt explained that the tax di d not present the r isk of double taxation:
So f ar as the value contributed to a ppellants’ New Me x ico business by circ ulation of the mag azine interstate is taxed, it cannot ag ain be taxed elsew here any more than the valu e o f ra i l ro ad property taxed locally . The tax is not one which in form or substance c an be r epea

ted by other states in suc h manner as to lay an adde d burden on the interstate distribution of the mag azine.
Id . at 260. Shortly

afte r W estern Livestock

, the C ourt further develope d this rationale by invalidating
an una pp or tio ne d g ro ss r e c e ipt s tax on th e g ro un d th a t in te rs tate c omm e rc e wo uld be su bje c te d to the risk of a

double tax burden not simil arly imposed on intrastate c ommerce :
The vice of the statute as applied to r ece ipts fr om inter state sales is that t h e tax i n c l u d e s i ni t s m e a s u r e , w i t h o u ta p p o rt i o n m e n t , r e c e i p t s d e r i v e d f r o m a c t i v i t i e s in interstate c ommerce ; and that the exaction is of such a chara cter that if lawful it may in s ub sta nc e be la id t o th e fu lle st exte nt by State s in whic h the g oo ds are so ld as we ll as those in which they

are manufa cture d.
J.D. Adam s Mfg. Co. v. Storen , 304 U.S. 307, 311 (1938).

The multipl e taxation doctrine set forth in W estern Livestock

was not fully

embra ced by the Court a

nd was temporar ily repudiated in 1946. Se e Fr e e ma n v . H e wit , 329 U.S. 249 (1946);

se e als o J. He lle rs te in & W. He lle rs te in, State Taxati on ¶ 4 .0 9 ( 3d

e d. 20 04 ) ( he re ina ft e r H e lle rs te in & H ellerstein) . I n Spector Motor Serv., Inc. v. O’ Connor , 340 U.S. 602, 607-10 (1951), the Court9

he ld t hat a state is pr e c lud e d fr om ta xing the pr ivi le g e of do ing an excl us ive ly int e rs tate bu sin e ss, even by means of a

nondiscriminatory , fairly apportioned ne t income tax. See He lle rs te in & H ellerstein, ¶

4.09. I n Nor thw este rn Sta tes Po rt lan d Ce me nt C o. v . M inn eso ta , th e Court

a tte mpt e d to
c le ar u p “ the tan gled unde rb ru shof pa st c a se s” by

ou tli nin g the a sp e c ts o f i ts C omm e rc e Cla us e jurisprudenc e that re mained in full forc e. See 358 U.S. 450, 457-58 (1959). Af t er d istinguishing Spector o nt h e gr o u n d

t h at i to n l y

i n v o l v e d a t ax o nt h e p ri v i l ege o f d o i n g b u s i n es s , al t h o u gh
measure d by

net income, the C o u rt held that there is no constituti onal bar rier to the imposition of a nondiscriminatory , fairly apportioned dire ct net income tax on a for eig n corpor ation car rying on an exclusively

interstate business within the taxing state. Id . at 45 8- 60 ; se e als o Heller stein & Heller stein, ¶ 4.10. Afte r Northw estern States many states replace d fra nchise taxes levied solely

on the privileg e of doingbusiness in the sta t e wi t h d i re ct net income taxes. See Heller stein & Heller stein, ¶ 4.10.

I n 1977, the Court overrule d Spector
. See Comple te Auto Transit , Inc. v . Brady , 430 U.S. 274, 288 (1977). The Court stated that “ the Spector ru le do e s n ot a dd re ss t he pr ob le ms w ith which the Commerc e Clause is concerne d. Acc ording ly , we now r ejec t the rule of Spector Motor S er vi ce , Inc. v . O’Connor , th a t a state ta x on th e ‘p ri vil e g e of do ingbu sin e ss’ is p e r s e unconstitutional when it is applied to interstate commer ce.” Com ple te Au to , 430 U. S
. at 2 8 8-89. I n r e a c hin g thi s c onc lus ion , th e Court no te d th a t ma

ny of its po st -W

estern Livestock opinions considere d the pra ctical e ffe ct of a state tax rather tha

n t h e for mal lang uag e of the tax s tatute. Id
. at 279. Fur

thermore , the Court articulated wh at has come to be known a s the Com ple te Au to10

doctrine. Id . Essentially , the Court decla red that a tax will survive Commerce Clause scrutiny

“ wh e n th e ta x is a

pp lie d to an acti vi ty wi th a su bs tanti a l ne xus w iththe ta xingState , is fa ir ly apportioned, doe s not discriminate aga inst interstate c ommerce , and is fair ly related to the servic es provided by

th e State.” Id . The four -prong ed Com ple te Au to test continues to g uide Commerce Clause ana ly sis today
. See, e .g., American Truck ing Ass’ns, Inc. v . Michigan Pub. Serv . Comm’n , 2005 U.S. L EXI S 4843, at *17 (J une 20, 2005).

Home Interiors now a

vers that, as applied to it, the application of the ear ned surplus throwbac k provision cause s the fra nchise tax to fail the Com ple te Au to te st.
Subs tan tia l N

e xus T h e first prongof the Com ple te Au to t es tas k s wh et h er Ho m e Int er i o rs ’ a ctivities have
a substantial ne x us with the state justify ing the application of the fra nchise tax. Both par

ties ag ree that H ome I nte ri or s’ a c tiv iti e s w ith in t he state are su ff

ic ie nt t o c on sti tut e a

su bs tanti a l ne xus.
Fai r Ap po rtionmen t The more difficult question is wh et h er the application of the e arne d surplus thr owba c k p ro vis ion

to H ome I nte ri or s r e su lts in a n unf a ir a pp or tio nme nt o f f

ra nc his e -t a x lia

bil ity under the second pr ong of the Com ple te Au to te st. Th e fa ir

a pp or tio nme nt r e qu ir e me nt atte mpt s to
ensure that no State taxes more than its fair share of an int erstate transac tion. Jefferson Lines , 514 U. S. at 184 ; Goldberg v. Swee t , 488 U.S. 252, 260-61 (1989). “ This principle of f air shar e is the lineal desc endant of W

es te rn Li v e Stock ’s p ro hibition of mul tiple tax ation, which is threatened wh e ne ve r on e State ’s a c t of ov e rr e a c hin g c omb ine s wi th the po ssi bil ity that ano the r State wi ll c la im11

its fair share of the value taxed.” Jefferson Lines , 514 U.S. at 184. I n order to determine w hether
a ta x is f a ir ly a pp or tio ne d, we fi rs t a sk wh e the r it is “ int e rn a lly c on sis te nt, ” and if so , w he the r i t is also “e x terna lly

consistent.” Id . at 18 5; Go ldb e rg , 488 U.S. at 261. The interna l consistency

test require s us to imagine a hy pothetical sce nario a ssuming that ever y state imposes a tax identical to the one at issue. Jefferson Lines , 5 14 U. S. a t 18 5. I n th is hy pothetical, if interstate commer ce be ars a burden that is not also borne by i n t ra s t at e commer ce, then the tax is not internally consistent. Id . “ Th e te st a sk s no th in g abou t th e de g re e of e c on omi c
rea lity ref lected by the tax.” Id . The test is me rely a tool use d to de termine whether , as a matter of law, a State is attempting to tax more than its fair shar e of inter state transa ctions. Id
.

Although the Supreme Court a n d various state c ourts have a pplied the interna l consistency

test on a number of

occa sions, th e t wo m o s t signific ant and a nalog ous examples are Ar mc o, In c . v . H

ar de sty , 467 U.S. 638 (1984), and Tyler Pipe Industries, Inc . v. W ashington Dep’t of Reve nue , 483 U.S. 232 (1987). In Armco , the Court de termined that West Virg inia’s business and occupation tax (B &O tax) was int erna lly inconsistent. Armco , 467 U.S. at 642-46. The B &O tax had two compone nts, a tax on wholesaling a nd a tax on manufac turing
. Id . at 6 40 -4 1. I n g e ne ra l,
a ta xpay e r e ng a g e d in

bo th who le sa li ng and manu fa c tur ingwo uld be lia ble fo r t a xes o n b oth activities. Id . H ow e ve r, the re wa s a “ mul tip le a c tiv iti e s” e xemp tion that re lie ve d in state
ma nu f a c tu r e r s w h o a ls o w h o le s a le d th e ir p r o d u c ts in th e s tate f

r o m l ia b il it y f o r th e w h o le s a le tax. Id .; see Heller stein & H ellerstein, ¶ 4.15. The res u l t was that an instate manufa cture r/wholesale r
on ly pa id t he manu fa c tur ingta x, bu t an o ut- of -s tate manu fa c tur e r who ma de wh ole sa le sa le s in Wes t Virg inia paid the wholesa le tax, even if it paid a manuf actur ing tax in another state
.12 An Oh io c or po ratio n c ha lle ng e d We st V ir g in a ’s B & O t a x sch e me , c la imi ngthat it
was fac ially discriminatory and that it unconstitutionally discriminated ag ainst interstate c ommerce . Armco , 467 U.S. at 6 39-40. The Court a g ree d, concludingthat the multiple activities ex emption
cause d the B& O tax to be internally inconsistent. Id
. at 642-46. The Court expl ained that, if e very state adopte d an identica l B& O tax scheme, cor porations t hat manufa cture d products in one state and made whole sale sale s i n another state would be subjec t to manufac turing taxes in t he state of production and w holesale ta x es in the st at e o f sale. Id . H ow e ve r, a c or po ratio n th a t bo th
manu fa c tur e d a

nd ma de wh ole sa le sa le s in the same state wo uld ne ve r b e su

bje c t to the wh ole sa le tax. Id
. Significa

ntly , in r esponse to the argument that an instate manufa cture r/wholesale r paid more taxes than an out-of-state manufa cture r as a result of the hig her ta x rate on manufa cturing , the Court held that a showingof ac tual discriminatory impact was unne cessa

ry . Id . at 644-45. I n Tyler Pipe , the C ourt addre ssed W ashing ton state’s B& O tax scheme, which w as
near ly identical to the one struc k down in Armco
. Tyler Pipe , 483 U.S. at 234. T he only differ ence was that the Washington tax ex empted instate manuf actur er/whole salers f

rom the manufa cturing tax as opposed to the whole sale tax. Id . at 23 6-37. As a res ult , Wa sh ing ton ’s ta x wa s n ot f a c ia lly discriminatory

beca use both instate manufa cture r/wholesale rs, who benef itted from the e x emption, and out-of- state manufa cture rs, who made wholesale sales in Washington, we re liable for the wholesale tax. Id
. at 239. Neve rtheless, the Court conclude d that the re asons for inva lidating the West Virginia ta x equally applied to the Washing ton tax
. Id
. a t 2 34. L ike A r mco , if e ve ry state hy pothetically

imposed Washington’s B &O tax s cheme , then cor porations that manufa cture d in one state and sold wholesa le in another would ultimately

b e l i ab l e for

both the manufa cturingand the13

wholesale tax, whil e the instate ma nufac turer

/w h o le s a le r w o u ld n e v e r b e li a b le for the ma

nufac turing tax. Again, the Court he ld that the Washington tax scheme wa s not internally consistent. Id . at 248. T h e r e ar e a

nu mb e r o f l e s s o n s w e c a

nl e ar nf ro m Armco and Tyler Pipe reg arding int e rn a l c on sis te nc y . F ir st, a ta x may be int e rn a lly inc on sis te nt e ve n if a c or po ra tio n d oin g int

ra state business pay s more than a corpor ation doing inter state business. Se e id . at 24 0- 41 ; see also Armc o , 467 U.S. at 642-46. This was the c ase in Armco wher e the intra state cor poration ac tually

paid more ta x, bu t the B&O t ax sch e me wa s st ill he ld t o b e int e rn a lly inc on sis te nt b e c a

us e the int e rs tate
c or po ratio n w a s su

bje c t to a se pa rate ta x un de r the sc he me that th e int ra state c or

po ratio n w a s n ot. Second, the inter

nal consistency

test does not require a showing o f eit her a ctual discrimination or actua l multi ple taxation; t he test is purely hy pothetical. See Tyler Pipe , 4 8 3 U
. S
. a t 2 4 2
- 4 7
. F i n a l l y,
a ta x tha t is int e rn a lly

inc on sis te nt, and

the re fo re un fa ir ly app or tio ne d, dis c ri min a te s a g a ins t interstate c ommerce . Id . at 247.

Home Interiors a

rg ues that the interplay betwee n Public L aw 86- 272 and the Te x as
ear ned surplus throwbac k provision c auses the f ranc hise tax t o be interna lly inconsistent as applied to i t. T o d e te rm ine if

Ho me I nte ri or s’ argume nt i s v a lid, ou r fi rs t st e p is to i ma g ine a sit uatio n in which eve ry

state imposes an integ rate d fra nchise tax, i d en t i ca l to the Texas tax , in which a corpor ation’s liability is the g reater of a 4.5 perc ent tax on net tax able e arne d surplus or a .25 pe rce nt tax on net taxable capital. Our sec ond step is to imagine two c orporations li ke Home I nteriors. The first corpor ation (intrastate corpor ation) re sides in Texas and sells its products completely instate. Th e se c on d c or

po ratio n ( int e rs tate c or

po ratio n) a lso re sid e s in Te xas bu t se lls its pr od uc ts t o in state
and ou t- of -s tate buy e rs and

is pr ote c te d by Pub lic L aw 8 6- 27 2 f ro m be ingta xed

on its ne t in c ome14

from out-of- state sales. Our fina l step is to determine whe ther the inter state cor poration bea

rs a tax burden that is not also borne by the intrastate c orporation. Un de r t his hy po the tic a l ta x s c he me , the int ra state c or

po ra tio n w ill on ly

pa y fr anc his e tax t o Texas. I ts fra

nchise tax liability will be the g reater of a 4.5 per cent tax on net taxable ear ned surplus or a .25 pe rce nt tax on net taxable capital. I t will never pay a tax on both it s tax able c apital and its net taxable ear

ned surplus. See Te x. Tax Code An n. § 1 71 .0 02 (b ). Es se nti a lly , th e int ra state corpor at i o n ’s fra

nchise tax liabili ty

will be assessed on 100 pe rce nt of either its taxable ca pital or its ne t taxab le e arn e d s ur

plu s. The interstate cor

poration i s potentially

liable for f

ranc hise tax i n eac h state in which it has a substantial nexus, basic ally eac h state in which it sold its products. As discussed ea rlier, the Te xas f ra nc his e ta x is a

pp or tio ne d b a se d o n th e g ro ss r e c e ipts fro m sa le s and oth e r s pe c if

ic a lly
e nume rate d b us ine ss a c tiv iti e s attr ibuta ble to a n in div idu a l st a te . How e ve r, be c a us e the int e rs tate corpor ation is protected f rom beingtaxed on its net i n co m e g ener ated f rom out-of-state sales by Public L aw 86-272, the ea rned sur plus throwback pr ovision mandates that the g ross rec eipts from the se sa le s b e thr ow n b a c k to Te xas f or us e in a pp or tio nin g Te xas’ share of the i nte rs tate corpor ation’s cumulative fra nchise tax burde n. Thus, the interstate corpor ation’s fra nchi s e tax liability to T exas w ill be the g reater of a 4.5 perc ent tax on net tax able e arne d surplus or a .25 pe rce nt tax on net tax able c apital. B oth parties ag ree that in Texas the gr eate r of the two f ranc hise tax components will be the tax on net tax able e arne d surplus beca use of the hig her ta x rate and the inclusi o n o f t h e gross rec eipts resulting from the a pplication of the e arne d surplus throwbac k provision.15 Even thoug h Public L aw 86- 272 protec ts the interstate c orporation from a tax based
on ne t inc ome in state s oth e r tha n Te xas, the int e rs tate c or po ra tio n w ou ld s til l be lia

ble fo r f ra nc his e ta xes o n it s n e t taxab le c a

pit a l in tho se state s th a t hy

po the tic a lly

a pp ly the int e g rate d Te xas f ra nc his e tax. See I nova , 2005 Tex. App. L EXI S 4002, at *20-21 (whe re Public L aw 86- 272 prohibits tax ation of ea rned sur plus, comptroller may impose tax based on capital). Unde r this hy pothetical sce nario, the interstate corpor ation would be subject to a fra nchise tax based on its net taxable ear ned surplus in T e xas a

nd fr anc his e ta xes ba se d o n it s n e t taxab le c a pit a l in a ll o the r s tate s. Th e re fo re , b e c a us e an int e r s tate c o r

p o r a ti o nc o u ld

b e s u b je c t t o a ta x th a t a nin tr a s tate c o r

p o r a ti o nw o u ld

n e v e r b ear , the Texas fra

nchise tax as applied to Home Interiors is not internally consistent. See Tyle r Pipe , 483 U. S. at 24 8; Armco , 467 U.S. at 644.

The Comptroller conte nds that the Texas fra nchise tax is int er n al ly

consistent be c a us e , ev en if eve ry

state imp os e d a

n id e nti c a l tax, no mor e tha n 1 00 pe rc e nt o f a

n in te rs tate corpor ation’s taxable capital ba se or net taxable ear ned surplus base would be subjec t to tax . The Comptroller’s theory

is predicated on the notion that the internal c onsistency test should be applied t o o n e t a x b a s e a ta t i m e , n e t t a x a b l e c a p i t a l o r n e tt a x a b l e e ar n e d s u r p l u s . In s u

p p o rto f t h i s t h e o r y, the Comptroller cites to Con tai ne r Cor p. v . F ra nc his e Tax

Bo ar d , 4 63 U. S. 1 59 , 1 63 (1 98 3) ; Armco , 46 7 U.S. a t 64 0; Tyler Pipe , 48 3 U. S. a t 25 3; American Truck ing Ass’ns, Inc. v . Scheine r , 4 83 U. S. 26 6 ( 19 87 ); Go ldb e rg , 488 U.S. at 256; and Jefferson Lines , 514 U.S . at 177, to establish that the Supreme Court has invar iably ap p l i ed t h e test t o one taxable base . The Comptroller’s r eadingof Con tai ne r Co rp ., American Truck ing , Go ldb e rg , and Jefferson Lines is correct beca us e in t ho se ins tanc e s th e Court

wa s a pplyingthe int e rn a l c on sis te nc y te st t o a sin g ula r t a x. Ho we ve r, in b oth16

Armco and Tyler Pipe , the Court applied the test to tax schemes that consi s t ed o f t wo di stinct tax bases. See Tyle r Pipe , 4 83 U. S. at 23 4- 36 ; Armco , 4 6 7 U. S
. at 6 40-42. I n both case s, the Court conclude d that the tax scheme wa s not fairly apportioned be cause , applying the internal c onsistency te st, an i n t e r s t a t e c o r

p o r a t i o nw a s s u

b j e c tt o a t a x th a tw o u l d

n e v e r b e a s s e s s e d

o nani n t r a s ta te corpor ation. See Tyler Pipe , 4 83 U. S. at 24 8; see also Armc o , 467 U.S. at 644-46. Simil arly , if the hy po the tic a l in te rn a l c on sis te nc y te st i s a pp lie d to the int e g rate d Te xas fr anc his e ta x, an in te rs tate corpor ation, that both resides in Texas and is protec ted by Public L aw 86- 272 from the imposition of a tax b a s e d

o nn e t i n c o me in

o th e r s tate s , w o u ld

b e s u b je c t t o b o th

a tax o nc a p it a l i nth e o ther state and on ear

ned surplus in Texas, while a similarly situated intrastate c orporation would only be subject to the g reater of the two taxes. Thus, we find no diffe renc e betwe en the a pplication of the internal consistency test in this case and the Supreme Court’s application of the test in Armco and Tyler Pipe
. The Comptroller insists that the Te x as fr anchise tax i s not facia lly discriminatory

and would pass the interna l consistency test in the absence of Public L aw 86-272. I n her r eply brief, the Comptroller expl ains, “The risk of t axing m ulti-state corpor ations on 100% of e arne d surplus and 100% of c apital does not arise from ‘impermissible discrimination a g ainst interstate c ommerce ,’ but from the relationship betwe en Public L aw 86- 272 and the f ranc hise tax.” She also states, “Without Public L aw 86- 272, Texas f ranc hise taxpay ers would all be taxed on the g reater of e arne d surplus
or c a pit a l.” She the n c ite s Shell Oil Co. v. Iowa Department of Re venue , 488 U.S. 19, 30 (1988), for the proposition that “[a] federa l law ena cted unde r the Commerc e Clause d o es not invalidate a neutra l state statute u n der the neg ative Commerce Clause.” She c ontends that while in operation17

there may be a r isk of discrimination ag ainst an interstate company , it is onl y Public L aw 86- 272,
n o t t he Te x as fr anchise tax, t hat produc es this possibil ity . There fore , in light of Sh e ll O il , the C o mp tr o l l e r

i n s i s t s t h a tth e n e u t r a l T e x a s f r an c h i s e t a x s ur

v i v e s C o m m e r c e C l a

u s e s c r u t i n y. Whil e we ag ree that the Tex as franchise tax is fac ially neutra l, we disag ree with the Comptroller’s rea ding of Sh e ll O il . Now h er e i n t h e o pinion do we find support for the g ener al proposition proffe red by

the Comptroller. I n fac t, the Court’s Commerce Clause ana ly sis appear s to dictate a c ase- by -ca se ana ly sis when deter mining whe ther a

fede ral lawpree mpts a state law, e ven when the state law is fac ially neutra l. Se e Sh e ll O il , 488 U.S. 24-28. More importantly , Public L aw 86 -2 72 pr ov ok e d th e e arn e d s ur plu s th ro wb a c k p ro vis ion ; th e thr owba c k p ro vis ion wa s d e sig ne d to take a dvantag e of the eff

ect of Public L aw 86-272—leaving a si g nificant portion of net income from interstate c ommerce untax ed b y any state—by

having those rec eipts thrown bac k to Texas for inclusion in our franc hise tax computations when the business has a sig nificant ne x us with this s tate. See I nova , 2005 Tex. App. L EXI S 4002, at *10 n.3 (re cog nizi ng that Public L aw 86- 272 has bee n incorpora ted into Compt roller’ s rules). In the abse nce of Public L aw 86- 272, other states w ould be allowed to impose net income taxes on corporations that merely solicit sales in the ir state. Without Public L aw 86-272 there would be no ear ned surplus throwbac k provision in Tex as bec ause the re would be nothing to throw bac k. T h u s , we co n clude that it would be improper to analy ze the fra nchise tax without considering the ramifications of Public L aw 86- 272.

I n conclusion, we hold that the interplay betwee n Public L aw 86-272 and the e arne d
surp lus thr owba c k p ro vis ion c a us e s th e fr anc his e ta x, a s a pp lie d to H ome I nte ri or s, to b e int e rn a lly inc on sis te nt. Th e re fo re , it fa ils Com ple te Au to ’s fa ir

a pp or tio nme nt r e qu ir e me nt. B e c a us e we ho ld18

t h at t h e t ax i s u n fa i rl y

ap p o rt i o n edas t o Ho m e Int er i o rs , we n ee d n o tad dre s s t h e f

i n al t wo p ro n gs of the Com

ple te Au to te st. Although w e hold that the fr anchise tax as applied to Home I nteriors lac ks internal
c o n s is te n c y , w e a c kn o w le d g e th a t th e Su p r e me Co u rt h a s e n v is io n e d a r e me dy . T h e Court has
rec og nized that a cre dit sy stem can be used to cure fair a pportionment problems. I n Go l dberg v. Sweet , th e Sup re me Court he ld that t h e I l l i nois Tax Act did not pos e a r isk of multipl e taxation beca use of a cre dit provision. See 48 8 U.S. 25 2, 26 3- 64 (1 98 9) ; see also Tyler Pipe , 483 U.S. at 245
n. 13 (n oti ng , “ [m]any

State s pro vi de tax c re dit s th a t a lle viate or e lim inate the po te nti a l mu lti ple tax ation th a t r e su lts wh e n tw o o r m or e so ve re ig ns have jur isd ic tio n to ta x part s o f t he same c ha in of c omm e rc ia l e ve nts .” ). Simi larl y , th e Te xas l e g isl atur e mig ht e xplor e g ra nti ngan in te rs tate
c o mp an y a

f r an c h i s e t a x c r e d i tt o o f

f s e t an y t a x e s a s s e s s e d o n t h e i n t e r s t a t e c o mp an y’ s c a p i t a l b y a state that th re w b a c k r e c e ipt s to Te xas.

We ag ree with Walter Hellerste in that “[t] h e C ourt has embr ace d a doctr ine of ‘interna l c onsistency ’ that may introduce confusion and uncer tainty in a n are a of the law that has had more than its fa ir share of bot h.” Walter Heller stein, Is Internal Consistency Foolish?: Re flections

on an Emerging Commerc e C lause Restraint on State Taxation , 87 Mich. L . Rev. 138, 188 (1988). An un fa ir ly a pp or tio ne d s tate ta x disc ri min a te s a g a ins t in te rs tate c omm e r c e , b ut i s a hy po the tic a l te st that ignor es the practica l interplay of st ates’ actual tax ation scheme s on interstate c ommerce a prope r way to measure internal co n s i s t en cy ? We join J ustice Scalia in e x pressingour distrust of hy po the tic a l a ssumpt ion s to me a sure the pr op e r r e a c h of the Do rm ant Com me rc e Cla us e : “ I t se e ms to me that we should adhere to our l ong tradition of judg ing state taxes on their own terms, and that there is even less justification for striking t hem down on the basis of assumptions as to what other19

State s might

do tha n th e re is f

or str iki ngthe m do wn

on the ba si s of wha t ot he r S tate s in f ac t do.” Tyler Pipe , 48 3 U. S. a t 25 9 (S c a lia , J., c on c ur ri ng ) (e mph a sis in o ri g ina l) . H ome I nte ri or s’ int e rs tate
c omm e rc e is n ot a c tua lly burd e ne d by the e arn e d sur plu s thr owba c k pro vis ion ; the ri sk of mul tip le ta xa ti o n is o n ly h y

p o th e ti c a l. N e v e rth e le s s , th e Su p r e me Co u rt h a s h e ld th a t th e me re r isk of multipl e taxation is sufficient to invalidate a state tax as unduly burdensome on inter state commer ce. See J efferson Lines , 5 14 U. S. at 18 5; Tyler Pipe , 483 U.S. at 247. We cannot ig nore that the Texas
e arn e d s ur

plu s th ro wb a c k p ro vis ion c re a te s su c h a hy

po the tic a l r isk

a s a pp lie d to Ho me I nte ri or s.
CO NC LU SION We h old t h a t t h e i nt e r p l a y b e t w e e n t h e e arn e d s ur

plu s thro wb a c k p ro vis ion

and Pub lic L aw 8 6- 27 2 c a

us e s th e Te xas f

ra nc his e ta x to fa il the int e rn a l c on sis te nc y te st a s a pp lie d to Ho me I n te r io r s . A c c o r d in g ly , H o me I n te r io r s ’ f r an c h is e tax a s s e s s me n t i s unfairly a p p o rti o n e d
. We
reve rse the district c ourt’s g rant of summar y judgme nt in favor of t h e Comptroller and re nder judgme nt that the Texas f ra n ch i se tax, as applied to Home Interiors, unc onstitut ionally burdens interstate c ommerce .

__________________________________________ Be a Ann Smith, J ustice Be fore Chief J ustice L aw, Justi ces B . A. Smith and Pemberton: Opinion by J ustice B . A. Smith; ConcurringOpinion by J ustice Pemberton Reverse d and Rende red Filed: Jul y

28, 2005