Texas: Supreme Court affirms single-factor apportionment formula for franchise tax purposes

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In a Dec. 22, 2017 opinion in Graphic Packaging Corporation v. Glenn Hegar, et al., the Texas Supreme Court affirmed the lower court’s decision in favor of the state, costing Graphic Packaging close to $1 million in taxes.

The case centered on whether the taxpayer could apportion its business revenue using the Multistate Tax Compact’s three-factor apportionment formula, or whether, instead, the company was limited to the single factor calculation set forth in Texas law. The court held that the Texas Tax Code provided the only permissible apportionment method.

We have addressed litigation concerning a state’s preclusion of a corporation’s use of the Multistate Tax Compact’s formula before, including Gillette Co. v. Franchise Tax Bd. out of California, and the Minnesota Supreme Court decision in Kimberly-Clark Corp. & Subsidiaries v. Minn. Commissioner of Rev. These disputes did not end well for the business either, and the Texas Supreme Court cited these suits, and others, to support its conclusions. On the other hand, in a different article this week, we cover the case Rent-A-Center West, Inc. v. South Carolina Dept. of Revenue, in which the taxpayer’s use of a three-factor apportionment method to apportion the only income it had in the state, from royalties, remains in place.

It should be noted that the lower court’s decision in Graphic Packaging, also in the state’s favor, was the determination that the tax at issue was a franchise tax, a tax type to which the Compact does not apply. Although the Texas Supreme Court affirmed the Appellate Court’s decision, it did so on different grounds, as described below.


As provided in the court’s opinion, Graphic Packaging sells consumer product packaging in a number of states throughout the U.S., including Texas. Texas has a franchise tax statute for all firms doing business in the state, which was imposed on Graphic Packaging, and which required the company to determine the portion of its business income that derived from Texas sales.

That statute in Sec. 171.106 of chapter 171, governing the franchise tax, requires an entity to determine the portion of its tax base, or margin attributable to sales in Texas using a specific apportionment formula: by multiplying the margin by a certain fraction; the numerator is the taxable entity's gross receipts from business done in this state, and the denominator of which is the taxable entity's gross receipts from its entire business.

For the tax years 2008-2009, Graphic Packaging used that gross receipts fraction to apportion its tax base, or margin, among the states. Later, it amended those reports, and also calculated its 2010 tax using the three-factor apportionment formula contained in the Multistate Tax Compact and codified in Texas law in chapter 141. Graphic reasoned that “the franchise tax was essentially an income tax to which chapter 141’s alternative apportionment scheme could be applied at the taxpayer’s election.”

The Texas comptroller disagreed, denied the refunds, and assessed a deficiency for 2010, which Graphic Packaging ultimately paid under protest after an unsuccessful appeal. The comptroller asserted that chapter 171 governed and provided the only apportionment option.

Thereafter, Graphic Packaging sued in district court, seeking $821,961 for the tax years 2008-2010, on the ground that it could employ chapter 141’s three-factor apportionment formula. Graphic Packaging lost, appealed, and lost again when the Texas Court of Appeals decided that chapter 141’s income-apportionment provisions do not apply to the franchise tax because it is not an income tax.

The arguments and the court’s rationale

Graphic Packaging argued that the franchise tax is an income tax, based on chapter 141’s definition: “a tax imposed on or measured by net income including any tax imposed on or measured by an amount arrived at by deducting expenses from gross income, one or more forms of which expenses are not specifically and directly related to particular transactions.” Graphic Packaging further asserted that under the definitions, the franchise tax could only be an income tax, not a gross receipts tax.

The comptroller took the position that “the franchise tax is neither an ‘income tax’ nor a ‘gross receipts tax’ but rather a hybrid of both, rendering chapter 141’s apportionment scheme inapplicable.”

The Supreme Court did not actually decide this question, pointing out that the issue was, more fundamentally, whether the “Legislature did not, or could not, make chapter 141’s single-factor apportionment formula the exclusive means for apportioning the Texas franchise tax.”

This provoked two underlying queries:

  1. Does Tax Code § 171.106 preclude a taxpayer from using the Multistate Tax Compact’s three-factor formula to apportion the franchise tax?
  2. Does Texas’ membership in the Multistate Tax Compact prevent the Legislature from requiring the taxpayer to use only the Texas formula to apportion the taxpayer’s margin for purposes of the franchise tax?

The court answered the first question in the affirmative, because any other reading to allow the compact’s alternative apportionment method would create “an irreconcilable conflict with section 171.106…When statutes irreconcilably conflict, traditional rules of statutory construction dictate that the later enacted and more specific legislation should control.” Consequently, section 171.106 prevailed.

The court, exploring the history of the amendments of section 171.106 and the franchise tax calculation, explained that “Section 171.106 continues to provide the exclusive formula for apportioning the franchise tax and, by its terms, precludes the taxpayer from using the Compact’s three-factor formula.”

As for the second query, whether the compact prevents the Legislature from requiring the taxpayer to use Texas’ statutory apportionment formula, the court agreed with the comptroller that the Multistate Tax Compact is advisory in nature, not binding. It relied in large part on the shared characteristics of binding regulatory compacts that the U.S. Supreme Court and the Ninth Circuit Court of Appeals have detailed. These shared characteristics include:

  1. The establishment of a joint regulatory body.
  2. Inclusion of state enactments that require reciprocal action for their effectiveness.
  3. Prohibitions against unilateral repeal or modification of their terms.

Among the other theories that Graphic Packaging advanced were that section 171.106 unconstitutionally violates the Contract Clause by impairing the Multistate Tax Compact’s apportionment provisions. Once again, the court disagreed with the company, on the grounds that “[e]ach state is… presumed to have reserved its sovereign tax power absent unmistakable language to the contrary…The Compact contains no unmistakable language waiving the state’s exercise of the sovereign tax power.”

Finally, to the firm’s contention that “it should be allowed to use the Compact’s formula because [p]ermitting taxpayers to use the same apportionment formula in every state . . . secures base line uniformity and compatibility,” the Court, pointing to Compact suits in other states, declared that “a uniform interpretation of the Compact…is no longer possible…[and] [n]o compelling justification exists for why this restriction should apply to Texas and not to other Compact members.”

In the end, the court resolved that the Multistate Tax Compact was never intended to be a binding reciprocal agreement; that the Texas Legislature’s enactment of section 171.106 as the exclusive method for apportioning the Texas franchise tax was within its plenary power; and that the provision “does not violate the Contract Clause or otherwise undermine the Compact’s purpose or efficacy.”

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