Opinion ID: 4531267
Heading Depth: 2
Heading Rank: 2

Heading: Franchise Tax

Text: We have described the Texas franchise tax as a tax on the privilege of doing business in Texas. In re Nestle USA, Inc., 387 S.W.3d 610, 621–22 (Tex. 2012). For the tax years at issue, an entity was required to pay Texas franchise tax on its “earned surplus” apportioned to Texas. See Former TEX. TAX CODE §§ 171.002, 8 .106(b); 9 see also TGS-NOPEC Geophysical Co. v. Combs, 340 S.W.3d 432, 437 (Tex. 2011) (explaining that “[b]efore 2008, the franchise tax was imposed on an entity’s capital or earned surplus,” while the Tax Code “presently imposes franchise tax on an entity’s ‘taxable margin’”). That portion was determined by “multiplying the taxable earned surplus by a fraction, the numerator of which is the corporation’s gross receipts from business done in this state, as determined under [former] Section 171.1032, and the denominator of which is the corporation’s gross receipts from its entire business.” Former TEX. TAX CODE § 101.106(b). 10 In turn, former section 171.1032 described the receipts that must be added for inclusion in the numerator of the apportionment fraction. Id. § 171.1032. 11 As relevant here, 8 See Act of June 1, 1981, 67th Leg., R.S., ch. 389, § 1, 1981 Tex. Gen. Laws 1490, 1691 (as amended in 1984, 1987, 1991, 1997, 1999) (codified at TEX. TAX CODE § 171.002). Citations to former sections 171.002, 171.1032, and 171.106 of the Tax Code are to the versions in effect during the pertinent tax years. See Act of June 1, 1981, 67th Leg., R.S., ch. 389, § 1, 1981 Tex. Gen. Laws 1490, 1698 (as amended in 9 1991, 1997, 1999, 2001, 2003) (codified at TEX. TAX CODE § 171.106). 10 The current version of section 101.106 similarly instructs that apportioning “margin” to Texas is done by “multiplying the margin by a fraction, the numerator of which is the taxable entity's gross receipts from business done in this state, as determined under Section 171.103, and the denominator of which is the taxable entity's gross receipts from its entire business.” TEX. TAX CODE § 101.106. 11 See Act of Aug. 13, 1991, 72d Leg., 1st C.S., ch. 5, § 8.06, 1981 Tex. Gen. Laws 156–57 (as amended in 1993, 1997, 2001, 2003) (codified at TEX. TAX CODE § 171.1032), repealed by Act of May 15, 2006, 79th Leg., 3d C.S., ch. 1, § 5, 2006 Tex. Gen. Laws 8, 19 (recodified at TEX. TAX CODE § 171.103). 8 “gross receipts of a corporation from its business done in this state” include “each sale of tangible personal property if the property is delivered or shipped to a buyer in this state regardless of the FOB point[12] or another condition of the sale.” Id. § 171.1032(a)(1). 13
The parties’ dispute has largely focused on the identity of the relevant “buyer” for purposes of former section 171.1032. Lockheed Martin asserts that, in a cohesive FMS transaction involving the manufacture and sale of military goods to a foreign government, that foreign government is the “buyer,” and the sale therefore does not generate Texas receipts. The Comptroller responds that FMS transactions involving procurement consist of two distinct sales: the contractor’s sale of the military goods to the U.S. government, and the U.S. government’s resale of those goods to the foreign purchaser. Thus, the Comptroller contends that the U.S. government was the “buyer” and that Lockheed Martin’s sales of the aircraft to the U.S. government were completed within Texas, thereby generating Texas receipts. The parties further dispute whether former section 171.1032(a)’s applicability to sales in which “the property is delivered or shipped to a buyer in this state” denotes a “location of delivery” test or a “location of buyer” test; that is, does apportionment hinge on whether delivery occurred in Texas or whether the buyer was in Texas? 12 Under the Uniform Commercial Code, the “FOB [or ‘free on board’] point” is the designated location to which the seller bears the expense and risk of transporting the goods. See TEX. BUS. & COM. CODE § 2.319. For example, “when the term is F.O.B. the place of shipment, the seller must at that place ship the goods in the manner provided in this chapter . . . and bear the expense and risk of putting them into the possession of the carrier.” Id. § 2.319(a)(1). 13 The current version of the Tax Code similarly takes into account, in apportioning an entity’s taxable margin based on gross receipts from business done in this state, the entity’s receipts from “each sale of tangible personal property if the property is delivered or shipped to a buyer in this state regardless of the FOB point or another condition of the sale.” TEX. TAX CODE § 171.103(a)(1). 9 The court of appeals agreed with the Comptroller that the U.S. government is the relevant buyer, that Lockheed Martin’s sales to the U.S. government were completed within Texas, and that the receipts from those sales were thus properly sourced to Texas. 550 S.W.3d at 868–71. Noting the absence of privity of contract between Lockheed Martin and the foreign countries, the court concluded that Lockheed Martin “inescapably ‘sold’ or made ‘sales’ of the aircraft in question to the U.S. government” and that “any subsequent or related transactions between the U.S. government and the foreign governments” do not alter the fact that those sales “begin and end in Texas.” Id. at 868–69 (internal quotations omitted). Both the court of appeals and the parties rely to some extent on the Third Court of Appeals’ decision in Bullock v. Enserch Exploration, Inc., 614 S.W.2d 215 (Tex. App.—Austin 1981, writ ref’d n.r.e.). In that case, taxable entities sold natural gas to interstate transmission companies in Texas and delivered the gas to those companies in Texas. Id. at 216. The transmission companies transported the gas out of state and resold it to out-of-state purchasers. Id. at 216–17. The court held that the taxable entities were “not sellers of natural gas to out-of-state buyers” and that the entities’ transactions with the transmission companies began and ended in Texas. Id. The court of appeals in this case held that under Enserch, the U.S. government’s resales of the F-16s at issue to foreign governments did not “convert the identity of Lockheed Martin’s ‘buyer’” to those foreign governments. 550 S.W.3d at 869. The court further cited the federal case law discussed above regarding the absence of contractual privity between Lockheed Martin and the foreign governments, concluding that while the U.S. government “to some extent does act ‘on behalf of’ a foreign government or akin to a hired purchaser when conducting FMS procurements,” the governing framework for those procurements serves the U.S. government’s 10 national-security and policy interests and gives the government “ultimate power and control over the transactions relative to the foreign nations’ respective interests.” Id. at 869–70. The Comptroller defends the court of appeals’ analysis as properly reflecting the structure of the FMS program, which purposefully interposes the U.S. government between contractors and foreign customers in a “mandatory sale-for-resale transaction.” Lockheed Martin disputes the characterization of an FMS procurement as a typical “sale for resale” akin to the transaction at issue in Enserch. Lockheed Martin notes that (1) the defense articles being purchased never enter the U.S. government’s inventory, (2) FMS buyers specify up front what they wish to buy and remit payment or assurance of payment before the Defense Department approaches a contractor to manufacture the items, and (3) the U.S. government is statutorily forbidden from bearing any profit or loss from an FMS procurement sale. Lockheed Martin further emphasizes the fact that the foreign buyer supplies design specifications and directives to procure components from certain vendors, sometimes even requiring incorporation of buyer-supplied equipment. Noting that “[w]ithout a foreign buyer, there is no Foreign Military Sale,” Lockheed Martin characterizes an FMS procurement sale as a single transaction, “initiated by a foreign-government buyer and effectuated by two interrelated, interdependent contracts, with the United States overseeing the transaction, not as mere reseller, but as sovereign.” For the reasons discussed below, we agree with Lockheed Martin’s characterization of the transaction. As an initial matter, we take no issue with Enserch’s general holding that a sale of goods to a Texas purchaser is not transformed into a sale to an out-of-state buyer merely because the Texas purchaser resells the goods to that out-of-state buyer. See 614 S.W.2d at 217. However, in the unique circumstances presented by the FMS transactions at issue, Lockheed Martin is correct 11 that the pertinent “buyers” for Texas franchise-tax purposes are the foreign governments for whom the aircraft were manufactured and to whom they were ultimately delivered. Again, in apportioning business done in Texas, a corporation’s Texas receipts include “each sale of tangible personal property if the property is delivered or shipped to a buyer in this state regardless of the FOB point or another condition of the sale.” Former TEX. TAX CODE § 171.1032(a)(1). Lockheed Martin argues that, for defense articles governed by FMS procurement obligations, the requirement that the U.S. take intermediate title to the goods is a “condition of the sale” to the foreign government that is disregarded for franchise-tax purposes. We agree. A “condition” is “something that exists as an occasion of something else: a circumstance that is essential to the appearance or occurrence of something else.” Condition, WEBSTER’S THIRD NEW INTERNATIONAL DICTIONARY (2002). When a foreign government wishes to purchase certain particularly sensitive military goods manufactured by U.S. contractors, federal law mandates that the sales be effected by two contracts, as the trial court found happened in this case. In this way, the U.S. government essentially acts as a required intermediary, allowing it to retain maximum oversight over the transaction in service of national-security interests. See Trimble Navigation, 484 F.3d at 707; see also 550 S.W.3d at 869–70 (recognizing that, at least to some extent, the U.S. government acts on behalf of a foreign purchaser when conducting an FMS procurement but retains ultimate control over the transaction). Thus, the U.S. government’s involvement is “essential” to the sale of goods that may be purchased only through the FMS program, including the F-16s at issue. Because the sale of the F-16s could not occur without that involvement, the federal mandate is a statutory “condition of the sale” that we disregard for franchise-tax purposes. 12 Moreover, an FMS procurement transaction does not fit the “sale for resale” paradigm on which the court of appeals relied in Enserch. The Comptroller does not dispute that the F-16s at issue were “custom built” and “uniquely designed” to the foreign buyers’ specifications. Lockheed Martin was paid “out of funds the foreign buyer ha[d] on deposit with the [U.S. government] as part of the FMS program or based upon a ‘dependable undertaking’ by that foreign government based on which the [U.S. government] ha[d] extended to it credit for the funds.” The price of the items tracked the cost to the U.S. government, which neither profits from nor takes a loss on an FMS procurement transaction. 14 See 22 U.S.C. § 2762. For franchise-tax purposes, the U.S. government’s role was as a statutorily mandated intermediary, albeit an intermediary with ultimate authority over the transaction. Our holding is also consistent with Texas’s use of a single-factor franchise-tax apportionment method premised on sales. Gen. Dynamics Corp. v. Sharp, 919 S.W.2d 861, 864 (Tex. App.—Austin 1996, writ denied) (citing TEX. TAX CODE § 171.106). Generally, a salesfactor apportionment formula is intended “to reflect the contribution of the market state to the taxpayer’s income.” JEROME R. HELLERSTEIN ET AL., STATE TAXATION ¶ 9.18[3][a] (3d ed. 2019). Unlike a typical sale-for-resale middleman that serves as an intermediate market for goods, the U.S. government was never the “market” for the F-16s at issue. Rather, the “market” all along was the purchasing foreign governments. 15 The Comptroller points out that the U.S. government benefits from FMS transactions in ways other than 14 monetary profit, such as facilitating U.S. military objectives and global relationships and achieving cost-reducing economies of scale in securing defense equipment for U.S. allies. While that may be true, it does not make the U.S. government the market for the defense articles it procures at the behest of those allies. 15 The dissent summarily discounts the distinctions between the FMS transactions at issue and typical salefor-resale transactions as irrelevant to whether the U.S. government was “a buyer” under the Tax Code. Post at ___. To the contrary, the fact that the U.S. government incurs no profit or loss on the transaction and pays only from funds 13 The court of appeals cited several cases for the proposition that “federal courts have rejected, in a variety of contexts, similar invitations to disregard or ‘pierce’ the two-contract structure of FMS transactions.” 550 S.W.3d at 869. For example, in Trimble Navigation, the Fourth Circuit held that a foreign government in an FMS transaction cannot sue the U.S. contractor directly as a third-party beneficiary of the procurement contract. 484 F.3d at 707. And in United States ex rel. Campbell v. Lockheed Martin Corp., the district court rejected Lockheed Martin’s argument that the False Claims Act did not apply to its alleged fraudulent claims for payment from the U.S. government in an FMS transaction, holding that the fact that the claims were paid out of funds deposited by the foreign government was irrelevant because the United States had a contractual obligation to pay and used funds in the U.S. Treasury to do so. 282 F. Supp. 2d 1324, 1338, 1340–41 (M.D. Fla. 2003). Lockheed Martin argues that “whether a relationship exists between parties sufficient to assign contractual or tort duties and liabilities is irrelevant to identifying a buyer for Texas franchise-tax purposes.” Again, we agree. Our holding is premised on a state statute governing payment of state taxes. Recognizing the foreign government as the pertinent “buyer” for purposes of sourcing receipts from FMS transactions for state franchise-tax purposes comports with the plain language of the Tax Code and, importantly, does not affect the FMS program or the important national-security purposes it serves. Cf. Trimble, 484 F.3d at 702 (noting that affording an FMS purchaser third-party beneficiary status “is contrary to the structure and intent of the Foreign Military Sales program”). deposited by the foreign buyer (or based on a dependable undertaking by that buyer) only serves to highlight that the U.S. government’s role is a “condition of the sale” of defense articles to a foreign government. 14 In sum, we hold that Lockheed Martin’s “sale” of each F-16 at issue was to the respective foreign-government “buyer” for whom the aircraft was manufactured and to whom it was ultimately delivered. The U.S. government’s involvement in each transaction was a “condition of the sale” that has no bearing on whether to apportion the receipts from that sale to Texas. 16
The Comptroller argues that even if the foreign governments are the relevant buyers of the F-16s at issue, the aircraft were “delivered” in Texas and thus the receipts from the sales of those aircraft are properly sourced to Texas. See Former TEX. TAX CODE § 171.1032(a)(1) (Texas receipts include “each sale of tangible personal property if the property is delivered or shipped to a buyer in this state regardless of the FOB point or another condition of the sale”). The Comptroller argues that “in this state” modifies “delivered or shipped” such that the place of delivery controls for apportionment purposes even if the buyer is located out of state. Here, the Comptroller contends, the place of delivery was Lockheed Martin’s Fort Worth manufacturing facility, where title to the F-16s was transferred to the U.S. government. Lockheed Martin takes the position that “in this state” modifies “buyer,” meaning that the product’s ultimate destination—the buyer’s location—determines sourcing. We need not resolve this dispute. Because the foreign governments are the buyers for franchise-tax purposes, even under the Comptroller’s interpretation the sales are properly sourced to Texas only if the aircraft were delivered to the foreign governments in Texas. The record belies that conclusion. As the parties stipulated, after title and possession shifted to the U.S. government 16 The Comptroller notes that Lockheed Martin does not argue that its receipts are taxable to the foreign government and that concerns of double taxation are not raised here. We agree, but we fail to see how that point is relevant to the analysis. 15 in Fort Worth, 17 a U.S. government pilot took responsibility for “ferrying the aircraft to the purchasing foreign government.” Upon the aircraft’s arrival in the foreign country, the “receiving” foreign government countersigned the AFTO 290 form to document “receipt, delivery, and transfer of possession of the aircraft from the [U.S. government] to the foreign government.” Those stipulations confirm that the F-16s at issue were delivered to the “buyers” outside of Texas. Accordingly, the receipts from the sales of those aircraft are not properly sourced to Texas under either party’s interpretation of the apportionment statute.