Corporate Close-Up: Texas Appeals Court Rules That Foreign Military Sales Are Properly Sourced to Texas


In Lockheed Martin Corp. v. Hegar, the Texas Third District Court of Appeals recently affirmed the Travis County District Court’s ruling that the proper sourcing of receipts from sales of military aircraft through the foreign military sales (FMS) program for Texas franchise tax apportionment purposes is to Texas, rather than the respective foreign nations that are the ultimate purchasers and users of the aircraft.

The FMS program allows for approved foreign nations to purchase specific military goods and services from the U.S. government (USG). Under the FMS program, the USG conducts defense procurement on behalf of the foreign government in a similar manner as to how it procures goods or services for itself. The USG contracts with a U.S. contractor for the goods or services that will be resold to the foreign government. Under the FMS program, there are is a contractual relationship between the USG and foreign government, and between the USG and the U.S. contractor, but no contractual relationship between the foreign government and the U.S. contractor.

Lockheed Martin produced aircraft in Texas that it then sold to foreign countries through the FMS program, and Lockheed Martin conducted business in Texas that subjected it to the Texas franchise tax. When calculating and paying its Texas franchise tax for tax years 2005, 2006, and 2007, Lockheed Martin treated the FMS receipts in question as Texas receipts. However, in 2011, Lockheed Martin filed amended reports, sourcing the FMS receipts in question to the foreign countries that were the ultimate purchasers of the aircraft, which reduced its franchise tax liability by approximately $2.5 million. The Texas Comptroller claimed that the relevant buyer was the USG, so the sales should have been sourced to Texas, and denied relief to Lockheed Martin. After exhausting its administrative remedies, Lockheed Martin brought suit in district court, which ruled for the Comptroller, and Lockheed Martin appealed.

The main issue on appeal was whether the relevant buyer of the aircraft was the USG or the foreign countries that were the end users. Under former Tex. Tax Code § 171.1032 (2007), sales of tangible personal property were sourced to Texas if the property was delivered or shipped to a buyer in Texas, regardless of the FOB point or other condition on the sale. The Court of Appeals found that, under the terms of the contract, the sales were made by Lockheed Martin to the USG in exchange for payment from the USG, and the aircraft were transferred to the USG in Texas. Lockheed Martin claimed that the substance of the transactions was such that the sales were made to the foreign countries, and that the USG was only an intermediary, so the sales should have been sourced to the foreign countries. Although the Court of Appeals acknowledged that the substance of the transactions could not be disregarded, it found that the FMS program sales were made to the USG, because the purpose of the FMS program is to advance the USG’s national security and foreign policy interest, and because the USG had ultimate power of control over the sales over any objection from the foreign end users. Thus, the receipts from the FMS program sales were properly sourced to Texas, and subject to Texas franchise tax.

Continue the discussion on Bloomberg BNA’s State Tax Group on LinkedIn: Were the receipts from the foreign military sales properly sourced to Texas?

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