United States

Texas: State Supreme Court Holds Taxpayer’s Net Loss Was Excluded from the Apportionment Formula

Apr 25, 2016
From KPMG TaxWatch

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The Texas Supreme Court recently reversed the Texas Court of Appeals and held that a taxpayer is not required to include a net loss resulting from the sale of an investment in computing its apportionment factor. Under Texas law, a multistate taxpayer apportions its taxable margin to Texas using a single-sales factor apportionment formula. The apportionment factor numerator equals the taxpayer’s Texas gross receipts, while the denominator is the taxpayer’s total gross receipts. However, for sales of capital assets or investments, per Texas statute, “only the net gain” from the sale is included in the apportionment factor. A Comptroller regulation provides that if the combination of net gains and losses from the sale of investments or assets results in an aggregate net loss, a taxpayer must net the loss against other receipts in the apportionment formula (but not below zero). The taxpayer at issue had a $628 million loss from the sale of investments. On its return, the taxpayer did not include the net loss in its denominator. If the taxpayer had done so, its denominator would have been reduced, which would have increased the taxpayer’s overall Texas apportionment. On audit, the Texas Comptroller determined that the taxpayer should have included the loss in its denominator and issued an assessment accordingly. The taxpayer paid the additional tax and sued for a refund. After both the trial court and court of appeals ruled in favor of the Comptroller, the Taxpayer appealed to the Texas Supreme Court.

The state’s high court, disagreeing with the court of appeals, first determined that even if there was ambiguity in the term “net gain,” the ambiguity was irrelevant to the case at hand because the taxpayer only suffered a “net loss” from the sale of investments. In the court’s view, a net gain cannot also be a net loss. An earlier Texas case dictated that when there are a series of transactions net gains and net losses must offset each other. However, that case did not address what should happen when the losses are greater than the gains and produce an overall net loss. Because the taxpayer at issue did not have a net gain, any ambiguity around the term “net gain,” the court determined, was the “red herring” in getting the case resolved. In the court’s view, whichever way net gain was calculated, a statutory net gain cannot simultaneously be a net loss. And by the plain language of the statute, only net gains were included. Thus, the Comptroller’s rule to the contrary was not entitled to deference and net loss from the sale of the taxpayer’s investments was not included in the apportionment factor denominator.  For more information on Hallmark Marketing Co. v. Heger, please contact Doug Maziur at 713-319-3866.

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The following information is not intended to be "written advice concerning one or more federal tax matters" subject to the requirements of section 10.37(a)(2) of Treasury Department Circular 230.

The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.