Court Opinion

ID: 5119173
Source: CourtListenerOpinion
Date Created: 2021-10-19 09:13:43.066838+00
Date Added: 2024-06-11T08:22:11.553383
License: Public Domain

TEXAS COURT OF APPEALS, THIRD DISTRICT, AT AUSTIN

                                      NO. 03-21-00011-CV

                          CITGO Petroleum Corporation, Appellant

                                                 v.

          Glenn Hegar, Comptroller of Public Accounts of The State of Texas; and
              Ken Paxton, Attorney General of The State of Texas, Appellees

                FROM THE 201ST DISTRICT COURT OF TRAVIS COUNTY
        NO. D-1-GN-18-002457, THE HONORABLE TIM SULAK, JUDGE PRESIDING

                                          OPINION

               CITGO Petroleum Corporation (Citgo) appeals from the trial court’s judgment in

favor of Glenn Hegar, Comptroller of Public Accounts of the State of Texas, and Ken Paxton,

Attorney General of the State of Texas (collectively, “the Comptroller”) in its franchise-tax

protest suit. The issue in this appeal is whether the gross proceeds or the net proceeds from sales

of commodity futures contracts and options on commodity futures contracts should be included

in the apportionment factor denominator used to calculate Citgo’s apportioned margin for

franchise tax purposes. See Tex. Tax Code § 171.106 (how to calculate apportionment factor).

The trial court determined that only the net proceeds could be included in the calculation of

Citgo’s apportionment factor and, consequently, Citgo was not entitled to a refund of franchise

taxes paid for report years 2008 and 2009. The trial court rendered judgment that Citgo take

nothing in its franchise-tax protest suit. We will affirm.
                                         BACKGROUND

               Texas imposes a franchise tax on businesses based or operating in the state.

See id. § 171.001. In its most simplified form, franchise tax liability is calculated by multiplying

a business’s taxable margin by the applicable franchise tax rate. See id. § 171.002. Taxable

margin is determined by multiplying a business’s total margin by an apportionment factor

designed to limit the franchise tax to revenue attributable to business conducted in Texas. See id.

§ 171.101. The apportionment factor’s numerator consists of receipts from business conducted

in Texas and the denominator consists of receipts from all business anywhere, including Texas.

See id. § 171.106(a). Under this formula, franchise tax liability increases as the ratio of Texas

receipts to total receipts increases. The Texas Supreme Court has explained:

       If the numerator (Texas receipts) increases but the denominator (all receipts) stays
       the same, receipts from Texas business make up a larger share of total receipts
       and franchise-tax liability increases. If, on the other hand, the numerator decreases
       against the same denominator, receipts from Texas business make up a lesser
       share of total receipts, and franchise-tax liability decreases.

Hallmark Mktg. Co. v. Hegar, 488 S.W.3d 795, 796-97 (Tex. 2016). Similarly, if the numerator

(Texas receipts) stays the same but the denominator (all receipts) increases, receipts from Texas

business make up a lesser share of total receipts, and franchise-tax liability decreases.

               The apportionment factor denominator—the taxable entity’s gross receipts from

all business anywhere—is generally composed of the sum of the taxpayer’s receipts from:

“(1) each sale of the taxable entity’s tangible personal property; (2) each service, rental, or

royalty; and (3) other business.” Tex. Tax Code § 171.105. However, receipts that are excluded

by statute from the taxable entity’s total revenue may not be included in a taxpayer’s gross

receipts for calculation of its apportionment factor. Id. § 171.1055(a). Relevant here, Texas

                                                  2
Tax Code section 171.1011(g-2) provides that “[a] taxable entity shall exclude from its total

revenue, to the extent included under Subsection (c)(1)(A), (c)(2)(A), or (c)(3), the tax basis as

determined under the Internal Revenue Code of securities and loans sold.” Id. § 171.1011(g-2).1

Thus, because it is excluded by statute from a taxable entity’s total revenue, the tax basis of

securities sold may not be included in the taxpayer’s gross receipts for calculation of either the

numerator or the denominator of the apportionment factor. See id. §§ 171.1011(g-2), .1055(a).

The result is that only the net proceeds from the sale of loans or securities such as the commodity

futures contracts and options on commodity futures contracts at issue in this case are properly

included in the apportionment calculation.

                Citgo refines crude oil and sells gasoline, diesel, jet fuel, lubricants, petrochemicals,

and other petroleum based industrial products. Citgo owns and operates three crude oil refineries

located in Lake Charles, Louisiana; Lemont, Illinois; and Corpus Christi, Texas. Because it had

employees and a business location in Texas, Citgo reported and filed Texas franchise tax returns

with the Comptroller for franchise tax report years 2008 and 2009. For these report years,

Citgo filed combined group Texas Franchise Tax Reports for an affiliated group engaged in a

unitary business that included its wholly owned subsidiary, CITGO Trading Company, L.P.

(Citgo Trading). Citgo Trading bought and sold commodity futures contracts and options on

commodity futures contracts for the purpose of managing the risks associated with potential

fluctuation in the value of Citgo’s inventory and the crude oil that it refined to produce the

inventory ultimately sold to Citgo’s customers. The commodity futures contracts and options on

commodity futures contracts sold by Citgo Trading during the 2008 and 2009 report years met

the definition of “security” in Texas Tax Code section 171.0001(13-a). See id. § 171.0001(13-a).

       1
           The “tax basis” is typically the original purchase price of a security.
                                                   3
Because the commodity futures contracts and options on commodity futures contracts sold

during the 2008 and 2009 report years were not purchased or sold to Citgo’s customers in the

ordinary course of its business, Citgo did not hold these securities as inventory, and they will be

referred to as “the non-inventory securities.” Citgo Trading bought and sold the non-inventory

securities on the New York Mercantile Exchange and the Intercontinental Exchange.              The

purchases and sales of all the non-inventory securities took place outside Texas.

               Citgo Trading made an election under Internal Revenue Code section 475(e) and

section 475(f), which permitted it to have mark-to-market accounting rules apply to the

non-inventory securities it held as a trader.2 See 26 U.S.C. §§ 475(e) (permitting dealer in

commodities to make mark-to-market election), (f) (permitting traders in securities or

commodities to make mark-to-market election). The election ensured that the Internal Revenue

Service would account for any gains or losses resulting from the sale of the non-inventory

securities as ordinary income or loss rather than as capital gain or loss. See id. § 475(a)(2)

(method for recognizing and reporting gain or loss from non-inventory securities held by dealers

in commodities and traders in securities or commodities who have made section 475(e) or

section 475(f) election).3 The sales of Citgo Trading’s non-inventory securities were reported on

Citgo’s 2007 and 2008 consolidated federal income tax returns as non-inventory securities under

Internal Revenue Code section 475(a)(2). On its 2008 Texas franchise tax report, Citgo included

gross proceeds of approximately $10 billion from Citgo Trading’s sales of non-inventory

       2
            Mark-to-market accounting refers to accounting for the “fair value” of an asset or
liability based on the current market price at the time of the accounting.
       3
           Section 475(a)(2) also provides the method for recognizing and reporting gain or loss
from non-inventory securities held by dealers in securities. 26 U.S.C. § 475(a)(2). Accounting for
inventory securities held by dealers in securities is governed by section 475(a)(1), which provides
that they shall be included in the dealer’s inventory at fair market value. Id. § 425(a)(1).
                                                4
securities in calculating its apportionment factor for Texas franchise tax purposes. On its 2009

Texas franchise tax report, Citgo included approximately $12 billion from Citgo Trading’s sales

of non-inventory securities in calculating its apportionment factor. In both cases, the amounts

were included entirely in the apportionment factor denominator because all of the sales

generating the proceeds took place outside Texas. The apportionment factor numerator included

$0 from Citgo Trading’s sales of non-inventory securities because none of the sales generating

the proceeds took place in Texas.

              After auditing Citgo’s 2008 and 2009 franchise tax reports, the Comptroller

concluded that Citgo miscalculated its apportionment factor by including gross proceeds of

approximately $10 billion from Citgo Trading’s sales of non-inventory securities in its

apportionment factor denominator for 2008 and gross proceeds of approximately $12 billion

from Citgo Trading’s sales of non-inventory securities in its apportionment factor denominator

for 2009. The Comptroller determined that rather than including the gross proceeds from those

sales in the apportionment factor denominator, Citgo should have included only the net proceeds.

As a result, the Comptroller determined that Citgo’s apportionment factor should be greater for

each report year, which increased the amount of franchise tax owed for each report year.

              Citgo timely filed a protest letter and accompanying protest payment of

approximately $2 million and filed this tax-protest suit in Travis County District Court. See

Tex. Tax Code §§ 112.051, .151. Citgo’s suit against the Comptroller sought a refund of the

approximately $2 million in Texas franchise taxes paid under protest for report years 2008

and 2009. Citgo contended that the Comptroller overstated how much of its total revenue was

properly apportioned to Texas because the Comptroller included only the net proceeds from

Citgo Trading’s sale of non-inventory securities in Citgo’s apportionment factor denominator.

                                               5
The trial court determined that the Comptroller properly included only net, as opposed to

gross, proceeds in the apportionment calculation and rendered a take-nothing judgment in the

Comptroller’s favor. Citgo then perfected this appeal.

                                          DISCUSSION

               Although usually only the net proceeds from the sale of loans or securities such

as the non-inventory securities are properly included in the apportionment calculation, Citgo

included the gross proceeds of those sales when it calculated its apportionment factor for report

years 2008 and 2009. In doing so, Citgo relied on Texas Tax Code section 171.106(f), which

provides that “[n]otwithstanding section 171.1055, if a loan or security is treated as inventory of

the seller for federal income tax purposes, the gross proceeds of the sale of that loan or security

are considered gross receipts.” Id. § 171.106(f). Although it concedes that the non-inventory

securities do not constitute “inventory of the seller” for federal income tax purposes, it

nevertheless argues that they fall within the scope of section 171.106(f) because Citgo made an

election under Internal Revenue Code section 475(e) and section 475(f) that permits it to apply

mark-to-market accounting to the non-inventory securities. See 26 U.S.C. §§ 475(e) (permitting

dealers in commodities to elect mark-to-market accounting), (f) (permitting traders in securities

or commodities to elect mark-to-market accounting); cf. id. §§ 475(a)(1) (requiring dealer in

securities to include in inventory at its full market value any security that is inventory in hand of

that dealer), (2) (requiring dealer in securities to apply mark-to-market accounting to securities

that are not inventory in hands of that dealer). Citgo argues that because it elected to apply

mark-to-market accounting to its non-inventory securities, and because the Internal Revenue

Code provides that a dealer’s inventory securities are also subject to mark-to-market accounting,

                                                 6
its non-inventory securities are “treated as” inventory for federal income tax purposes. Citgo

points out that because it elected to have mark-to-market rules apply to its non-inventory

securities, the income and loss associated with the sale of the non-inventory securities were

reported as ordinary income, as opposed to capital gains, on Citgo’s federal income tax returns.

The mark-to-market rules also ensured that Citgo’s non-inventory securities on hand at the end

of the year would be accounted for as if sold at year end for federal income tax purposes. Citgo

refers to the foregoing as the “tax treatment” of its non-inventory securities. Next, Citgo states

that this “tax treatment” also applies to inventory securities; that is, income and loss from the

sale of inventory securities are reported as ordinary income and inventory securities on hand at

the end of the year are accounted for as if sold at year end. Finally, Citgo posits that because

both non-inventory securities and inventory securities have this same “tax treatment,” its non-

inventory securities are “treated as” inventory for federal tax purposes such that they fall within

the scope of Texas Tax Code section 171.106(f).

               The Comptroller counters that the securities at issue were not “treated as

inventory of the seller for federal income tax purposes” as required by Tax Code section 171.106(f)

but, rather, were treated as non-inventory securities which Citgo elected to, and the Internal

Revenue permitted it to, account for on a mark-to-market basis. The Comptroller asserts that

whether Citgo’s non-inventory securities are “treated as” inventory for purposes of section

171.106(f) does not turn on whether those securities may, by Citgo’s election, be accounted for

using a mark-to-market accounting practice, but rather on whether they are considered to be

inventory of the seller under the Internal Revenue Code, which Citgo concedes they are not.

The issue, then, is one of statutory interpretation; that is, how to interpret the phrase “treated

as inventory of the seller” in the context of calculating the apportionment factor for Texas

                                                7
franchise tax purposes. This presents a question of law, which we review de novo. See, e.g.,

State v. Shumake, 199 S.W.3d 279, 284 (Tex. 2006) (statutory construction is question of law

that is reviewed de novo).

               Because statutory construction is at the heart of the underlying dispute, we begin

our analysis by reviewing the pertinent statutory-construction principles.       Our objective in

construing a statute is to ascertain legislative intent. First Am. Title Ins. v. Combs, 258 S.W.3d

627, 635 (Tex. 2008). We discern legislative intent from the statute’s language because it is

“‘the truest manifestation’ of what lawmakers intended . . . .” Id. (quoting Alex Sheshunoff

Mgmt. Servs., L.P. v. Johnson, 209 S.W.3d 644, 651-52 (Tex. 2006)). If statutory language is

unambiguous, we will interpret and apply the statute according to its plain meaning unless a

different meaning is apparent from the context or the plain meaning leads to absurd results. In re

Ford Motor Co., 442 S.W.3d 265, 280 (Tex. 2014) (orig. proceeding). In determining a statute’s

meaning, we consider the statute as a whole rather than construing specific provisions in isolation.

Id. Undefined terms are therefore afforded their ordinary meaning unless a different or more

precise definition is apparent from the context of the statute, see Tex. Gov’t Code § 311.011(a);

TGS-NOPEC Geophysical Co. v. Combs, 340 S.W.3d 432, 439 (Tex. 2011), because we cannot

give an undefined term a meaning that is disharmonious or inconsistent with other provisions in

the statute, see Texas Dep’t of Transp. v. Needham, 82 S.W.3d 314, 318 (Tex. 2002). If an

undefined term has multiple common meanings, it is not necessarily ambiguous; rather, we will

apply the definition most consistent with the context of the statutory scheme.           Southwest

Royalties, Inc. v. Hegar, 500 S.W.3d 400, 405 (Tex. 2016).

               In ascertaining the legislature’s intent, we may also consider other matters,

including the law’s objective and the consequences of a particular construction. See Tex. Gov’t

                                                 8
Code § 311.023. Indeed, it has long been a rule of statutory construction that “a statute is to

be construed with reference to its manifest object, and if the language is susceptible of two

constructions, one of which will carry out and the other defeat such manifest object, [the statute]

should receive the former construction.” Citizens Bank of Bryan v. First State Bank, Hearne,

580 S.W.2d 344, 348 (Tex. 1979); see Nootsie, Ltd. v. Williamson Cnty. Appraisal Dist.,

925 S.W.2d 659, 662 (Tex. 1996) (“[W]e must reject interpretations of the statute that defeat the

purpose of the legislation so long as another reasonable interpretation exists.”).

               The sole basis for Citgo’s inclusion of the gross proceeds from Citgo Trading’s

sale of its non-inventory securities is its assertion that because it made an election under the

Internal Revenue Code to have mark-to-market accounting apply to its sales of non-inventory

securities, their “tax treatment” is the same as that of inventory securities, and, consequently, the

non-inventory securities are “treated as inventory” such that they fall within the scope of section

171.106(f). Citgo contends on appeal that the trial court’s order was based on an erroneous

interpretation of section 171.106(f), the relevant statutory provision. The core notion embodied

in Citgo’s argument is that if it reports proceeds from the sale of non-inventory securities in the

same manner as a taxpayer reports proceeds from the sale of inventory—i.e., as ordinary, rather

than capital, income—the non-inventory securities receive the same “tax treatment” as inventory

securities and are “treated as inventory” for federal income tax purposes. Put differently, Citgo

argues that tax treatment equivalent to that of securities that are inventory in the seller’s hands

with respect to how gain or loss from the transaction is realized (timing), the amount of the

reported gain or loss (how the gain or loss is calculated), and character of the gain or loss

(ordinary gain or loss as opposed to capital gain or loss) is sufficient to bring the non-inventory

                                                 9
securities within the scope of section 171.106(f) despite the fact that the non-inventory securities

do not otherwise share the characteristics of “inventory.”4

               During the report years, Citgo Trading bought and sold commodity futures

contracts and options on commodity futures contracts to manage the risks associated with

potential fluctuation in the value of Citgo’s inventory and the crude oil that it refined to produce

the inventory of gasoline, diesel fuel, jet fuel, lubricants, petrochemicals, and other petroleum

based industrial products it sold to its customers. Citgo Trading elected to use the “mark-to-

market” accounting method for its non-inventory securities pursuant to Internal Revenue Code

sections 475(e) as dealer in commodities and 475(f) as a trader in securities or commodities.

Because of that election, the non-inventory securities were reported on Citgo’s federal income

tax returns under Internal Revenue Code section 475(a)(2). Consistent with section 475(a)(2),

Citgo Trading reported the proceeds from the sales of its non-inventory securities on Form 4797

and Form 1120, line 9 as ordinary income. A separate section of the Internal Revenue Code,

section 475(a)(1), requires that inventory securities held by dealers in securities be accounted for

using the mark-to-market method and that dealers in securities report proceeds from the sale of

their inventory securities as ordinary income. Dealers in securities, who are sellers of inventory

securities, report proceeds generated by the sale of those securities on Form 1120, line 1. Despite

the fact that Citgo reported its securities as non-inventory securities under section 475(a)(2) as

       4
          Securities held by one who is regularly engaged in the purchase of securities and their
resale to customers are considered “inventory” of the seller and the seller is considered to be a
“dealer in securities.” A dealer in securities is “one who as a merchant buys securities and sells
them to customers with a view to the gains and profits that can be derived therefrom.” 26 CFR
§ 1.471-5(c) (Inventories by dealers in securities). “Taxpayers who buy and sell or hold securities
for investment or speculation, irrespective of whether such buying or selling constitutes the
carrying on of a trade or business . . . are not dealers in securities” within the meaning of section
1.471-5, and the securities they trade are not considered to be the taxpayer’s “inventory.” Id.
                                                 10
opposed to reporting them as inventory securities under section 475(a)(1), and despite the fact

that Citgo reported the income from the sale of non-inventory securities on Form 1120, line 9,

rather than on Form 1120, line 1 where income from the sale of inventory securities is reported,

Citgo maintains that its non-inventory securities were “treated as” inventory securities for federal

income tax purposes. Citgo maintains that the section 475(e) and (f) election and resulting

mark-to-market accounting “tax treatment” of Citgo Trading’s transactions equates to those

transactions being “treated as inventory of the seller for federal income tax purposes” for

purposes of Texas Tax Code section 171.106(f). We disagree.

               Citgo’s argument ignores that, under section 475(a), the proceeds from sales of

both inventory and non-inventory securities are accounted for as ordinary gains and losses.

Thus, taxing the proceeds of the sale of securities as ordinary income does not definitively

constitute “treatment as” inventory securities.      It could equally be said that it constitutes

“treatment as” non-inventory securities.      Citgo’s argument erases the distinction between

inventory and non-inventory securities, both of which can receive similar tax treatment although

through application of different subsections of Internal Revenue Code section 475. Although

non-inventory securities held by a trader who makes the election under section 475(e) and 475(f)

have the same “tax treatment” as a dealer’s inventory securities for federal income tax purposes

under 475(a)(1), they also have the same “tax treatment” as a dealer’s non-inventory securities

under 475(a)(2).

               For federal income tax purposes, securities that dealers in securities buy from and

sell to their customers as part of their regular business are considered inventory of the seller and

                                                11
are treated as inventory of the taxpayer under the Internal Revenue Code.5 This tax treatment is

automatic, is not optional, and is not triggered by any election by the taxpayer. Those securities

are accounted for based on fair market value pursuant to section 475(a)(1), the proceeds from

their sale are considered to be ordinary income, and that income is reported on Form 1120,

line 1. Conversely, securities held by dealers in securities for other reasons, i.e., not for sale to

customers in the ordinary course of business, are not considered inventory for federal income

tax purposes. Those securities are subject to mark-to-market accounting pursuant to section

475(a)(2).   Thus, the Internal Revenue Code distinguishes a securities dealer’s inventory

securities from its non-inventory securities based on whether or not those securities are sold to

customers in the ordinary course of business.

               In drafting Texas Tax Code section 171.106(f), the legislature created an

exception to the general rule that proceeds from the sale of securities could not be included in the

apportionment calculation on a gross basis. It conditioned the inclusion of gross proceeds from

sales of securities on the requirement that the securities whose sale generated the proceeds be

treated as “inventory of the seller,” that is, that they have some characteristic unique to a seller’s

inventory securities as opposed to its non-inventory securities. That characteristic cannot be the

one put forward by Citgo—that the proceeds are treated as ordinary income by virtue of the

mark-to-market election—because there are also other non-inventory securities that share that

characteristic in the absence of a section 475(e) or section 475(f) election. Specifically, section

475(a)(2) requires that a dealer’s non-inventory securities be accounted for in the same manner

as its inventory securities; a dealer must mark both its inventory and non-inventory securities to

       5
         A dealer in securities may also hold securities for other purposes, such as for trading or
hedging, and those securities are not considered to be its inventory.
                                                 12
market annually, recognizing both gains and losses as ordinary. Thus, there is no difference

between the “tax treatment” of a dealer’s inventory securities and of its non-inventory securities

under section 475 of the Internal Revenue Code. Consequently, the “tax treatment” Citgo equates

to being “treated as inventory” is not a characteristic unique to an inventory security such that

that characteristic determines whether a security falls within the scope of Texas Tax Code

section 171.106(f).

               The legislature plainly intended section 171.106(f) to permit the gross receipts

from the sale of only certain types of securities to be included in the apportionment calculation.

It identified those types of securities as those that are “treated as inventory of the seller for

federal income tax purpose,” as opposed to the seller’s non-inventory securities. The distinction

turns not on whether the net gains or losses attributable to the securities are ultimately

recognized as ordinary income, the “tax treatment” Citgo relies on, which is not a characteristic

unique to inventory securities, but on how the securities were handled as part of the seller’s

business. That is, whether the securities were sold to customers in the ordinary course of

the seller’s business (inventory securities) or whether they were held for other purposes

(non-inventory securities). The former would be treated as inventory of the seller for federal

income tax purposes and the latter would not. The fact that inventory securities are sold to

customers in the ordinary course of a taxpayer’s business is a characteristic unique to inventory

securities and sets them apart from the seller’s non-inventory securities, unlike their “tax

treatment,” which does not.

               The plain language of the statute evidences the legislature’s intent for Texas Tax

Code section 171.106(f) to permit the inclusion of gross proceeds from only those securities that

the Internal Revenue Code classifies as inventory of the seller. We further conclude that “treated

                                               13
as inventory of the seller for federal income tax purposes” in section 171.106(f) refers only to

securities that have the unique characteristics of inventory securities; i.e., those that are bought

from and sold to customers in the ordinary course of the taxpayer’s business—not any security

that happens to have the “tax treatment” identified by Citgo, either automatically or by election.

Because it is undisputed that the non-inventory securities at issue in this case were not Citgo

Trading’s inventory as defined by the Internal Revenue Code for federal income tax purposes,

they do not fall within the scope of section 171.106(f), and the trial court properly concluded that

the gross proceeds of the sale of those securities could not be considered gross receipts for

purposes of Citgo’s apportionment calculation.

                                         CONCLUSION

               For the reasons stated in this opinion, we affirm the trial court’s judgment

                                              __________________________________________
                                              Chari L. Kelly, Justice

Before Chief Justice Byrne, Justice Triana and Kelly

Affirmed

Filed: October 14, 2021

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