In Hallmark Marketing,¹ the Texas Supreme Court (Court) reversed the lower courts and held that net losses from the sale of investments and capital assets are not includable in the apportionment factor denominator of the taxpayer's Texas franchise tax (i.e., Margin tax) because the applicable Texas statute² provides that only net gains from such sales can be included. In reaching its conclusion, the Court found that a conflicting administrative rule³ requiring businesses to include net gain or net loss in the apportionment factor denominator conflicted with the plain language of the Texas Tax Code and required no deference.

The Texas Comptroller of Public Accounts (Comptroller) audited the 2008 franchise tax report for Hallmark Marketing Company (Hallmark) and concluded that Hallmark miscalculated its apportionment factor by failing to include a net loss of more than $628 million from the sale of investments. Including this loss in the apportionment factor denominator would have lowered it, resulting in a higher ratio of Texas receipts to total receipts, increasing the Hallmark's Texas apportionment percentage and therefore would result in a higher tax bill.

Lack of statutory ambiguity

The trial court and the Texas Court of Appeals (Appeals Court) ruled in favor of the Comptroller, with the Appeals Court finding "net gain" in the applicable statute to be ambiguous. In its reversal, the Court noted that, even if "net gain" is ambiguous, the ambiguity is irrelevant because neither party disputed that Hallmark suffered only a net loss, and the statute requires inclusion only of the net gain "and under no reading can 'net gain' include a net loss."

The Comptroller argued that he was enforcing precedent by requiring inclusion of a net loss in the apportionment factor denominator because an appeals court ruling in Electro-Science⁴ calls for offsetting losses against gains when calculating net gain. While the Court acknowledged that losses are always taken into account when net gain is calculated, the ruling in Electro-Science does not answer the question at issue in this case — What happens when those losses overtake the gains and produce a net loss rather than a net gain? According to the Court, the ruling in Electro-Science does not speak to the statutory treatment of a net loss; rather, it clarifies how to calculate net gain.

The Court also rejected the Comptroller's argument that "net gain" can be read expansively enough to include a net loss, reasoning that a net gain cannot simultaneously be a net loss, and interpreting the statute otherwise would effectively rewrite it to "write the word 'only' out of the statute."

Ultimately, the Court found that Hallmark followed Texas' reporting requirements and the plain language of Texas law when it calculated its apportionment factor denominator by excluding net losses. To the extent the failure to include a net loss when calculating the apportionment factor denominator is a departure from one or more accounting methods, it is permitted by the Texas Tax Code.

Implications

Texas taxpayers should reconsider their apportionment positions on their Margin tax returns for open tax years and determine whether they included a net loss in the computation of the apportionment factor and therefore, might be eligible for a refund under this new ruling.

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ENDNOTES

¹ Hallmark Marketing Co., LLC v. Hegar, No. 14-1075 (Texas S.Ct. April 15, 2016).

² Texas Tax Code Section 171.105(b).

³ 34 Texas Admin. Code Section 3.591(e)(2).

⁴ Calvert v. Electro-Science Inv'rs, Inc., 509 S.W. 2d 700 (Tex. Civ. App. — Austin 1974, no writ).