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Litigation over the Texas franchise tax “cost of goods sold” calculation continues to wind its way thought the courts due to confusion over what exactly can be counted in the deduction. In this article, Sam Megally and William J. LeDoux of K&L Gates LLP discuss the American Multi-Cinema case, which addressed not only how cost of goods sold is determined, but also which taxpayers are entitled to use it.
By Sam Megally and William J. LeDoux
Sam Megally is a partner and William J. LeDoux is an associate at K&L Gates LLP in Dallas, Texas.
On Jan. 6, 2017, the Austin Court of Appeals issued a new opinion (the 2017 opinion) in the pending Texas franchise tax case American Multi-Cinema, Inc. v. Hegar (No. 03-14-00397-CV), replacing an April 2015 opinion (the 2015 opinion) that had relied on a different—and arguably broader—statutory provision. The American Multi-Cinema Inc. ( AMC) case began as a dispute over a movie theater company's claim that it was entitled to calculate its Texas franchise tax by subtracting as costs of goods sold (COGS) all costs associated with exhibiting films, including certain costs associated with the square footage of AMC's auditoriums. Qualification for the COGS calculation can be beneficial for some taxpayers; in AMC's case, using a different franchise tax calculation method would have resulted in a greater franchise tax liability. In the 2015 opinion, the Austin Court of Appeals construed the meaning of the term “goods” by reference to a statutory definition of tangible personal property that includes personal property “perceptible to the senses,” and concluded that AMC sold such goods and therefore qualified to use the COGS calculation. In the 2017 opinion, the court instead based its determination—again in the taxpayer's favor—on a narrower, industry-focused definition of tangible personal property that includes films, sound recordings, books, television and radio programs, and similar property. The court also expressly declined in the 2017 opinion to address the broader definition of tangible personal property on which it had relied in the 2015 opinion. As of the date of this publication, the 2017 opinion is not final and could change, including as a result of an appeal to the Texas Supreme Court.
Following the 2015 opinion, there was much discussion both among taxpayers and in the Comptroller's office about the possible fiscal implications of the court's decision. In the summer of 2015, the Comptroller's office estimated the potential impact of the 2015 opinion at up to $1.5 billion per year in lost tax revenue; in December of 2016, just before the court issued the 2017 opinion, the Attorney General's office notified the court that the 2015 opinion had led to COGS claims from taxpayers that sell “experiences,” including an aquarium and a country club. Some practitioners and taxpayers perceive the court's decision to substitute the 2017 opinion for the 2015 opinion as a response to speculation about potential economic fallout arising from refund claims and lawsuits seeking to make the COGS calculation available to taxpayers in virtually all industries. The Texas taxpayer and practitioner communities have generally been critical of courts that have based their statutory interpretations in part on fiscal concerns rather than on the language of the provisions before them. Regardless of the court's motivation for issuing the 2017 opinion, some taxpayers that have already filed refund claims or lawsuits or started calculating their franchise taxes based on the reasoning in the 2015 opinion may encounter Comptroller resistance. Because the 2017 opinion expressly declined to address the broader statutory provision supporting the 2015 opinion, additional litigation is likely to continue for companies selling products other than those encompassed in the industry-specific statutory provision.
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