There’s no way the Texas Revised Franchise Tax could be an income tax because, well, the Legislature says so, state officials recently argued in a brief filed with the Texas Supreme Court, as reported by Bloomberg BNA’s Paul Stinson (subscription required). The case is Graphic Packaging Corp. v. Hegar, Tex., No. 15-0669, and the Texas Supreme Court requested merit briefing to determine whether it will review the case.
“The State has never wavered from its position: the Texas Franchise Tax is not an income tax,” Chris Bryan, spokesperson for the Texas Comptroller of Public Accounts, told Bloomberg BNA. On the other side of the debate, taxpayers and the Financial Accounting Standards Board (FASB) agree that the Texas Franchise Tax is more like an income tax than not. The Texas Franchise Tax is also referred to as the Texas ‘Margin’ Tax.
What’s at stake? Millions of dollars in tax payments. Taxpayer Graphic Packaging Corp. will have its 2008, 2009, and 2010 tax burdens eased if the Texas Supreme Court reverses the appellate court’s decision by holding that the Texas Franchise Tax is an income tax. This will likely please the other businesses that have contributed to the $4 to $6 billion the tax brings in annually.
Franchise Taxes Aren’t Just for Franchises
At first blush, one might think that the Texas Franchise Tax is a franchise tax because that’s what the legislature named it. But what’s in a name? Not much. California, D.C., Idaho, Minnesota, New Jersey and New York have income taxes based on net income but call them franchise taxes. And some states have both an income tax and a separate franchise tax imposed on all corporations.
Traditionally, a franchise tax is imposed on a business for the privilege of doing business in that state, regardless of its income. Instead of starting with net income like an income tax, they are usually based on factors like capital stock, net worth or a simple flat fee. For example, neighboring New Mexico has a traditional franchise tax: it charges all corporations doing business a $50 annual fee to do business in the state regardless of income.
The Experts Weigh In
“The MTC Compact definition of income tax as adopted by the Texas Tax Code includes ‘any tax imposed on or measured by an amount arrived at by deducting expenses from gross income, one or more of which expenses are not specifically and directly related to particular transactions.’ explained Steve Moore, partner at Jackson Walker LLP’s Austin, Texas, office and coauthor of the Bloomberg BNA Texas Corporate Income Tax Navigator (subscription required).
Moore continued, “The Texas Franchise Tax base is ‘total revenue,’ less the greatest of four alternative deductions based on compensation, cost of goods sold, 30 percent of gross revenue, or $1 million.” While Graphic Packaging Corp. and others argue that the Texas Franchise Tax is encompassed by the MTC definition of an income tax, the MTC wants to give states the deference to make decisions about apportionment.
Some member states allow taxpayers to apply Articles III.1 and IV of the Compact to calculate state income tax liability, and Graphic Packaging Corp. wants to apply the Compact’s provisions to its Franchise Tax liability. Texas has never permitted the application of Articles III.1 and IV to the Franchise Tax, but requires taxpayers to follow a single-factor apportionment system based on a taxpayer’s gross receipts instead.
“The Third Court of Appeals ruled for the State in Graphic Packaging. In that case, the Multistate Tax Commission filed an amicus brief that agrees with the Texas Comptroller that Compact Article IV (division of income) and the related election in Article III.1 (apportionment provisions) do not apply to the Texas Franchise Tax,” said Bryan.
The FASB guides accountants in how to calculate taxes. It has issued accounting standards for what constitutes an income tax and, in 2006, decided that the then-recently-passed Texas Franchise Tax was decidedly an income tax.
“After FASB staff recommended that the Texas Franchise Tax be treated as an income tax, the FASB Board concurred, reasoning there would not be diversity in conclusions reached by preparers, auditors, and regulators on whether the Texas Franchise Tax was an income tax,” Moore told Bloomberg BNA.
‘One of the Worst Business Taxes in the Country'
Either way, the Tax Foundation describes the Texas Franchise Tax as a “complicated hybrid of a gross receipts tax and a tax on business profits” and “one of the worst business taxes in the country” in its 2015 report, ”The Texas Margin Tax: A Failed Experiment."The Tax Foundation claims that gross receipts-style taxes like the Texas Franchise Tax are going out of fashion: four states repealed similar taxes in recent years, leaving only Texas, Delaware, Washington, and Ohio with taxes based on gross receipts.
“We remain confident in our legal position and look forward to receiving a favorable decision from the Supreme Court of Texas upholding the Court of Appeals decision in this case,” said Bryan. The Texas Legislature has had its say; now we’ll see what the Supreme Court decides to call the tax.
Do you think the Texas Franchise Tax is an income tax? Continue the discussion on Bloomberg BNA’s State Tax Group on LinkedIn.
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